Examination of Witnesses (Questions 300-319)
DR ANTHONY
WHITE MBE
2 NOVEMBER 2005
Q300 Mr Hurd: Therefore, if that is right,
have some of the witnesses we have listened to been over complacent
in saying that as all this generation capacity comes off stream,
in terms of coal and nuclear, it will be replaced by gas.
Dr White: It might be replaced
by gas, but not after the price has gone up an awful long way.
That is my worry. The reason this is happening is that the contracts
by which people buy power from power stations are short-term by
nature. They are no more longer-term contracts. It was the previous
regulator's view that long-term contracts would develop. I had
furious arguments with him on this because he said that Ofgem's
view was that the market in long-term contracts would develop
and we had not seen one yet because it was an immature market.
You do not really get very long-term contracts in oil either and
that is not an immature market. The reason is that if you believe
you have competition at the customer end, no-one in their right
mind would sign a long-term contract at prices well above marginal
cost because they would know they could end up on the wrong side
of it. However, if your contract prices are high, and the market
price low, so you have to buy expensively and sell cheaply and
that does not let you go for very long and that is what happened
to TXU Europe. I do not think we are going to get a market in
long-term contracts developing at prices which would remunerate
capital, which is what you need. You might get them down at marginal
costs though, but that is not much use to anybody. That means
it is difficult to build a new station in this market and be comfortable
you are going to make a return.
Q301 Mark Pritchard: You mentioned that
finance is perhaps the most critical issue and I accept that,
but within the context of a policy framework. Do you think the
risks are increased by a devolved energy policy to, for example,
the Welsh Assembly? From memory, Andrew Davies, the Minister for
Economic Development in the Assembly, was reported by the BBC
as saying that they are not that excited about a new generation
of nuclear plants and want to move perhaps more to clean coal
technology. Do you think, if the Government were to devolve energy
policy to the Welsh Assembly, that would help or hinder the type
of secure market you are speaking about?
Dr White: To be honest, I had
not really thought about that. I would have thought that was yet
another level of Government and let us face it, electrons do not
stop at the border between England and Wales. I just think it
would complicate matters and investors would regard it quite warily.
Q302 Mr Pritchard: So the view of industry,
the sector you are representing within the industry, is that having
a single UK energy policy would help the market as compared to
devolving energy policy to devolved assemblies?
Dr White: Yes.
Q303 Dr Turner: It is quite clear from
your answers so far that you have given some fairly cogent reasons
why we are facing a potential generation gap in this country and
a lack of investor confidence to plug that gap. What measures
do you think the Government should be taking to restore some long-term
confidence in the future? Do you have any suggestions?
Dr White: Yes; I certainly do.
I have thought long and hard about this issue. One is that you
allow some kind of cosy oligopoly to exist. Okay; I used to work
for the CEGB and there is no way that I should like to get back
to the CEGB. However, you have to recognise that there are four
risks in generation: the risks are whether you can build to time
and to cost; whether the fuel you have is going to become expensive
or cheap in the future, the fuel price risk; whether you have
built too many or too few power stations; whether you can operate
this power station properly. Under the system of the CEGB, customers
bore all of those risks. If the CEGB did it badly, the customers
paid a lot of money: if they did it well they did not have to
pay so much. When you go to a liberalised market, what we have,
you end up with customers no longer taking the operational risk,
no longer taking the construction risk, taking bits of the fuel
price risk and bits of the demand risk and that is inevitable,
which is showing prices going up or down and investors would take
that as well. What we need to do is give investors a bit more
confidence that those risks, particularly for electricity as you
cannot store it in those peaks, could be quite severe. We need
to ameliorate them a bit. One way is to allow a cosy oligopoly
to exist and then the oligopolists, if they are sensible—big
question -will price below the new entrant level. As long as you
maintain open access to the networks, if they try doing what National
Power and PowerGen did by pricing very, very highly, they would
soon lose their market share and take the risk of a price collapse.
If they are sensible, they price at the new entrant level so customers
have a bit of protection, but not as much as a fully over-supplied
competitive market. The next step is to have a form of capacity
payment and, I cannot believe I am saying this, but that is where
I have got to. You need a capacity payment which incentivises
people to have capacity and either you could have it plant specific,
that is different types, or certain payments for nuclear and certain
payments for coal or what have you, or you make it just generic
capacity, which works as well and there is a different shifting
of who takes the risks there. What you must also do is make sure
that the person who builds a power station is not then subject
to losing his shirt if too many people build power stations later.
There are ways of doing that and it is something I have written
to Government about on how we could set up such a thing. The other
way of doing it is that the suppliers—and let us face it
there are only really six around this in this country—decide
between themselves to offer long-term contracts of equal types
to new generation coming on so that none of them is more exposed
or less exposed than the other. None of them is particularly palatable,
but I do believe those are solutions.
Q304 Dr Turner: If Government do not
take some long-term intervention of any of these types, and they
are all fairly radical interventions given the trend towards total
liberalisation, what do you think the consequences are likely
to be?
Dr White: I do not think the lights
will necessarily go out. What you will see is extremely high prices.
Q305 Dr Turner: In the long term you
think it would be better to take some pain now to avoid much greater
pain later.
Dr White: Yes. If you could provide
some less commodity-like exposure to investors, the kind of cost
of capital you could apply to the market would be low and customers
would benefit in the longer term.
Q306 Dr Turner: Ofgem is really very
much a key player here.
Dr White: Absolutely; yes. Whether
you believe long-term contracts will come or not, I do not think
they will, in this kind of a market.
Q307 Mr Chaytor: I am confused. A few
moments ago you were arguing the virtues of the market and saying
we really did have a free market. Just now you were saying that
the only way to make sure of a market is to rig it. Either your
advocacy of more oligopolies, or your advocacy of the suppliers
operating a cartel is essentially rigging the market, is it not?
This is the root cause of the problem that there is an endemic
weakness in our system that the market can only survive if it
is rigged. That is what you are saying.
Dr White: Yes, I think I would
agree with you. The actual market we have created, which is this
very, very competitive one, is unpalatable. In the free market
you expect to see extremely large price excursions. Put it another
way. If I were a generator trying to decide whether to build a
power station now because I thought we might have a shortage coming
up in 2008-09 and other people did it at the same time, I would
not make a return on my investment. How do I go to my board? A
lot of people have said to me that real men like to build power
stations, that is what you do and it is true. There is nothing
chief executives like more than building a power station; that
is very, very strong. Look at the refining industry around the
world. At the moment it is incredibly profitable, but it has been
awful over the previous 20 years and a power company is a refinery
acting in reverse. It takes coal, oil and gas, nuclear, hydro,
puts in some capital and generates power which is sold at one
price. A refinery takes crude oil, puts in some capital and makes
different products, sold at different prices. They are exactly
the same.
Q308 Mrs Villiers: This is probably going
to sound like a very stupid question. You are talking about the
uncertainty caused in a new power station build because one does
not know the long-term price of fuel. With ever-decreasing stocks
of fossil fuels has the long-term trend not got to be up? Is it
not a pretty safe bet that in the longer term the price of energy
is surely not going to come down? Is that not some comfort to
people who want to build a power station?
Dr White: Possibly; possibly it
will not go down, but I can see situations where we could have
a price collapse in gas. Let us face it: those of us who were
around in the mid 1990s, we had BG beautifully pricing up at oil
index prices, because that was what it always used to do; then
we had the Government introducing competition, stopping the designation
contracts, stopping the flaring in the North Sea, all the gas
was coming in and we had new entrants in gas supply. Then suddenly
a dollop of gas arrived in the UK because Medway and Keadby were
slow in commissioning their power stations. So a dollop of gas
arrived and prices collapsed down to the marginal cost level.
They stayed there until we built the interconnector. Then the
prices went up and followed the European prices. Interestingly
as well, when the interconnector was out for maintenance, prices
fell again and they went back up when it came in. Yes, you might
be right that we are always going up, but if I were a banker looking
at this curve of what has happened to prices and someone said
they wanted to build a nuclear power station, how much money would
I lend them, I would ask what the lowest price they ever had was:
£15, £17 a megawatt hour? I would say I did not care
as the price was £30 now and that was all I would give them.
That is the essence of the problem.
Q309 Mr Chaytor: Do you not think then,
when we say the market is unpalatable, what we are saying is that
the market is unpalatable in terms of electricity generation?
The source of the problem is that when the electricity industry
was privatised 20 years ago all the focus was on supply and not
on demand. Had we set up a market in energy services companies
rather than a market in generators and suppliers, we might have
been living in a completely different world now.
Dr White: I could not agree with
you more. Our problem is that we have no demand response. We have
missed a massive trick in this country and I think Keith was alluding
to it. We just have the wrong kind of meters. If we had meters
which gave proper signals, people, ESCos, would start giving more
intelligent tariffs and you could have various appliances which
would turn off if prices were higher and not others. Where we
went wrong was back in 1996, when we were talking about splitting
distribution from supply. What we did not understand was that
in a competitive market what you require from the network is totally
different from a vertically integrated monopoly. In a vertically
integrated monopoly you are providing transport; you are taking
power from here and moving it to there. In a competitive market,
what you want the network operator to do is to provide facilities
for people to buy and sell energy services. That is what it is
about. What you want to reward our network operators on now is
not how much wire they have in the sky, which is what our regulation
does—it is the rate-of-return-on-assets type basis—you
want to reward them on how well they run their network. If you
reward people on how many outages they get, how many times the
lights turn off, how quickly they connect people, the quality
of electricity you receive, how many beautiful overhead lines
they have buried, how quickly they connect new people, if you
rewarded them that way then the network operators would ask themselves
whether they need to build that line over there and if they had
a bit of load management there they could pay that person to load
manage. To do that properly, you need proper meters. What we did
when we split distribution from supply was to put metering into
the supply part. We did not only do that, which is the wrong way,
but we also made competition in meter operating and all these
other things. The idea that drove us was that the more competition
you can have at any possible level the better. We ignored the
fact that if you introduce competition at these various places,
you introduce a whole administrative process as well, which stops
any competition. If you had left distribution with meters and
said to the distribution operators that they should provide services
which allowed people to do intelligent metering and send signals,
and do it at the lowest possible cost, that would have been the
way forward, but we missed it. If we could go back, then we would
get more to your area. Frankly, Italy is going this way, but we
are a long way from it.
Q310 Mr Chaytor: This was obviously a
political failure and remains a failure at the political level.
What is the role of the regulator here? Do you think the regulator
should have had a responsibility for advising on this at any point
in the last few years?
Dr White: That is a good one.
I just regard it as the two working together. The DTI at the time
did not want to give a monopolistic service which did not have
to be monopolistic to the network operator. Ofgem was of a similar
view; OFFER at the time. I think it was a failure of both. What
is worse is that at that time the national grid was finally floated
and part of it was a £50 rebate to customers. If we had used
those £50s to put in meters, customers would be getting lower
prices.
Q311 Joan Walley: But we are where we
are.
Dr White: Yes.
Q312 Joan Walley: Having had the energy
review, we have the current review which is taking place. Following
what you said to Mr Chaytor, is there any recommendation you would
like to be taken into account in terms of changing the way the
big tanker is being steered from what we inherited, which has
got us here, to where we need to be going down a different direction?
Dr White: The first thing is that
I should like to change the regulation of the networks to be a
more performance based form of regulation.
Q313 Joan Walley: How would you do that?
Dr White: I have written papers
on it and I am quite happy to send them in.
Q314 Joan Walley: In simple terms.
Dr White: You do not make their
revenues related to the size of the asset base times a return
plus their costs. You say you will give them so much money for
this service and so much money for that service and so much money
for the other services. Part of the problem we have is that the
DNOs, the network operators, do not look at their business in
that way; they look at their business as providing a network rather
than the provision of facilities to allow people to offer energy
services to buy and sell. That is one. The other one I would say
is look very carefully at the incentive mechanisms for capacity
in this market. Yes, if we had very violent prices people would
load manage, but if they cannot see the signals they will not
load manage. Load management does mean or can mean people turning
off factories for a time. Let us have a capacity mechanism which
could help smooth those prices.
Q315 Joan Walley: May I turn very briefly
to the ETS and the issue of the price of carbon, which I understand
is now significantly higher than was originally forecast. You
said earlier on, if you were a banker, but given the company you
work for, does that have any impact on investment?
Dr White: Yes, it does. The European
emissions trading scheme. When I last came to see you, I was saying
that I thought governments were likely to be lily-livered and
not set tough abatement targets. I got that right. What I got
wrong was the fact that the oil price went through the roof which
threw the gas prices up and the price of an allowance is effectively
linked to the cost of abatement, which is what you would expect.
So what is the cost of reducing carbon dioxide? The easiest way
of doing that is turning down your coal station just a little
bit and increasing another gas station somewhere else just a little
bit. If you plot what the emissions trading price has been since
February this year against what I would calculate it to be, they
are entirely correlated with a 95% confidence level; this goes
together. What is not right though is that the price of the allowance
is only about a half of what it should be, which I do not understand.
Normally someone from the City says that it is sentiment. That
means they do not know. Why is the price lower? It could be due
to a number of reasons like not actually needing to buy any allowances
before March 2008 because you can use your 2006 allowances to
meet your 2005 obligations, et cetera. The point I should like
to make is that the price of an allowance is driven by the gas
price and the coal price. Coal prices are "reasonably-ish"
stable, even though they have gone up quite a lot recently. Gas
prices can go all over the shop.
Q316 Joan Walley: What effect is that
having on investment?
Dr White: It stops you investing.
What you do is you do whatever you do at lowest short-run cost,
which is turning down your coal stations and turning up your gas
stations. What it means is that I have no visibility of prices
after 2008 and none at all after 2012. I shall just do the things.
The issue we have as policy is this: supposing you are an oil
company, the price of oil is $60 a barrel, you are not investing
in any new oil fields which need $60 a barrel to make them economic;
you might do it at $25 a barrel, possibly $30. What we have in
the EUETS is a price and allowance of about
20 to
30 a tonne, but any investment is being done on the
basis of a cost of maybe
5. Do you see what I mean? It is not an efficient
signaller of the need for investment. What it says to us is: how
are we going to make this scheme work? That is the crucial thing:
we do want it to work. So the more we can give signals about the
longer term, what levels of abatement is this country and all
the European 25 going to want? Are we going to turn our backs
on buying Russian hot air for low costs? If we could make those
kinds of statement, it would make the City a lot, lot happier.
There is much more visibility of price.
Q317 Joan Walley: You are talking there
about the long term. I should like very briefly to turn to the
strategic generating options that there are. We have heard quite
a bit in the first evidence session about nuclear. I am just interested
in your view as to whether or not nuclear does require greater
Government financial support than other competing technologies
such as clean coal?
Dr White: If I just go to the
table which came out of the Royal Academy of Engineering—I
am not going to say whether I agree with it or not—
Q318 Joan Walley: It would be useful
if you did say whether or not you did. From the evidence paper
you have given us, you seem to be suggesting that it is based
on assumptions which are no longer relevant.
Dr White: The irrelevance of them
is that first of all the fuel prices are different now and also
that the cost of capital which they have used is very, very low.
They are using about seven%. If you are building a merchant station,
that is you just build the station and you take your chance on
what the price is going to be later, you would be way higher than
that; something like 12 to 15%. If, on the other hand, someone
is willing to give you a long-term contract at a fixed price,
then these are the kinds of rates of return, the 7%, 8%, which
you might well accept. That is why is comes back to this market
structure issue. The prices are stable and not going to have these
commodity type fluctuations. You can get away with lower costs
of capital. In answer to your question about whether I think the
nuclear industry needs support, if it could get Keith and all
of his friends to sign long-term contracts, as they did in Finland,
and maybe even take a share in a power station, I do not think
any support would be necessary, apart from underwriting the back-end
fuel costs and the decommissioning, maybe underwriting the first
projects or the expenditure of £100 million or £200
million to get the first one through. Apart from that I do not
think so. Why do we not give another £100 million to get
some of the early wave or offshore wind technology going at the
same time?
Q319 Dr Turner: Instead of?
Dr White: No, I think you need
both frankly; we do need to push those. One area where I did not
agree with Keith's evidence is on the ROCs and how to get offshore
to work. The trouble with the Renewables Obligation is that it
does not really work for new technologies where the cost of the
third or fourth or fifth is going to be lower than the first one.
Why build the first one, if you know the third, fourth or fifth
is going to be lower priced? What you need to do is to give some
support to the first one and the ROC mechanism, rather than direct
support from the Treasury, is the right way to do it.
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