Examination of Witnesses (Questions 500-516)
DR DIETER
HELM
16 NOVEMBER 2005
Q500 Chairman: Who makes the decision?
Are industry and the Government getting involved, because the
whole benefit of your approach is that it keeps the Government
out of these sorts of decisions. Who does take the decision?
Dr Helm: Lots of these particular
forms of costs are costs that will be reflected by properly pricing
the different bits; for example, the cost of intermittency is
priced through the market, the cost of the transmission systems
required to back up the wind should be passed through to wind.
They are not at the moment, but they should. In some senses that
is both good regulation and properly designed markets. Residual
risks in areas like water companies, electricity distribution
companies, have ring-fencing, special administrative provisions
etc. It could be a regulatory issue, it could be for regulatory
bodies, it could be for the energy agency to do so but, remember,
I have got capacity auctions going on here, so the contract form
that people bid for would specify that these things have to be
covered. I do not think it is rocket science. I think in contracting
terms normally these sorts of things go on. My guess is it would
probably be either the organiser of the capacity auction or the
energy agency, or both.
Q501 Emily Thornberry: I am concerned
about your reliance on this idea of auctioning long-term carbon
contracts, because, for the same sorts of reasons, we have just
had, have we not, the fiasco of the new generation of mobile phone
technology and people bidding too high, and then those who bid
too high going bankrupt. The same could happen here, could it
not? You could have people bidding for long-term carbon contracts
and then simply going bankrupt. Your system is so dependent on
these things—
Dr Helm: It is clearly my fault
for not explaining the concept correctly. What you bid for in
a long-term carbon contract is you bid for a price to be paid
for the tonnes of carbon actually saved. If we had a contract
for 2015 to 2030, wind might put in £4 per tonne, nuclear
might put in £5 or £2, somebody else might put £10
in per tonne. This is an obligation for HMT to pay whatever the
lowest bid is for carbon. In my proposal, of course, this is not
a public expenditure constraint because the Government then sells
the contract in to the Emissions Trading Scheme when and as the
Emissions Trading Scheme after 2012 is further developed. Somebody
has got to pay for the carbon emission reduction. If you have
a nuclear obligation, a renewables obligation for wind, the customer
is underwriting the cost for those carbon reductiona. In my world,
I am using emissions trading in the long run to be a mechanism
by which carbon is financed. The problem is, we do not have an
emissions trading regime beyond 2012 yet, nor are we likely to
have the binding targets required to get there.
Q502 Emily Thornberry: But I do not follow,
you see, why if someone bids for this contract, let us say nuclear
bids for those contracts, and they simply bid for too low a price—
Dr Helm: There are two possibilities.
It is very important to understand what I am saving the Government
underwriting if there was to be a nuclear programme. In the renewables
obligation and in a nuclear obligation, you basically underwrite
all the costs of a project. They are passed through to the customers.
In my world, I did not want the Treasury, or anybody else, any
customer, to underwrite the construction costs or how long it
takes for the plant to produce the output or its performance.
That is what we underpinned in the event of Dungeness B when it
took 22 years to produce a spark. All I want to underwrite is
the carbon cost. If the station does not come on on time, it does
not get paid until it comes on and if it never comes on, it never
gets paid. In other words, this is only a payment for actual carbon
saved when it occurs. When that occurs, given the way carbon objectives
are going and the constraints—remember, this is not the
entire carbon reduction requirement being auctioned, it is only
a part—there will be lots of companies desperate to buy
permits to pollute as they did under the emissions trading, so
these are the natural counterparts to those contracts. Wind would
have a problem too if wind bids for these contracts and it wins
the contract and it does not work, or it is intermittent and its
forecast is 30% and it turns out to be 15%, it is going to be
a shortfall. Of course, what does that do to the project developer?
They might go bust.
Q503 Emily Thornberry: What does it do
to the country if it goes bust? You are talking about the importance
of securing our supply and yet you are setting this up.
Dr Helm: No, you cannot have investment
in base-load capacity of the electricity system without risk.
Any form of investment might not work. If you thought that recklessly
international companies were bidding to do things where they were
clearly going to go bust in the process of doing it, this would
be something that would give you immense concern. The corollary
of that is, never ever take the risk of investing in a long term,
large scale base-load power station system, because it might not
work. That is true, but we are not given the luxury of being able
to say that we have dead cert technologies which are definitely
going to produce in 2016 or 2018. It is a risk that has to be
taken, that it might not work and that is why in general one prefers,
for example, technology which is second generation rather than
first; for example you would, if you were doing nuclear power,
want to choose well known PWRs rather than the latest cutting
edge innovation. That was the mistake that was made in the 1970s
picking the AGRs. In wind turbines, you clearly do not want the
latest design that someone says might work in 15 years' time;
you want something that is predictable, because you want that
security. You cannot avoid risk. You cannot have investment in
the power stations by the private sector of any form without there
being risk involved. The question is, is the risk priced properly?
You may take the view that the risk of a particular technology
is so great that you want to rule it out. Where I come from, I
could see risks with all these technologies and I would not want
to be faced with the huge mountain of climate change to address
to rule out any technologies purely on that kind of risk but it
does have a price.
Chairman: I am conscious of the need
to move on.
Q504 Mark Pritchard: Do you think that
the climate change debate would be better served by knowing more
about energy efficiency, both on the transmission of energy, the
supply side, but also on the demand side, from the consumers and
indeed, a big customer, such as the Government, which is perhaps
the worst offender, of whatever political complexion? Just look
at the energy efficiency of the Palace of Westminster across the
road. Do you think we need to hear more from Government and, indeed,
the industry on efficiency?
Dr Helm: Clearly at this point
we need to consider and hear a lot about lots of the possible
options. On energy efficiency I have a particular, very strong
view. We need to have a debate which is not based on the premise
that energy efficiency is free and the net present value of a
very large amount of energy reduction could be done at zero cost.
The debate that is being led by the energy efficiency lobby, to
convince people that the costs of these types of energy demand
reduction are just trivial in total burden, has misled us quite
considerably. Indeed, I would say that is why we are in the mess
we are in on the Climate Change Review, because it has suddenly
been realised that the objective of energy efficiency would require
quite substantial public expenditure and, of course, the Energy
White Paper leads us to believe that there is not any public expenditure
of substance that is required. So I think that a grown up debate,
in which people are told, this is not a free lunch, it is expensive,
may be the best possible way forward. I do not rule that out at
all, but I think people have been systematically led to believe
that it is all much more rosy than it actually is.
Q505 Mark Pritchard: My supplementary
is, the Energy Minister last week in the House suggested that
the lights would not go out in Britain this winter unless we had
a 1:50 winter. Is that your view?
Dr Helm: My view is that that
is not even the most important question.
Q506 Mark Pritchard: Sorry, that is the
question that I asked.
Dr Helm: I am going to answer
it. Supply will always equal demand in electricity; there is a
physical requirement that the system must balance. The question
is, at what price? That is what I mean by the question. If you
say, is there a security of supply problem this winter? Yes. Is
there a security of supply problem even if the lights do not go
out? Yes. It is in the price. That is our security of supply crisis.
That is what happens when supply and demand come close together.
If we lose the power for a couple of days, that would be very
serious but we are already having the impact of that security
of supply problem right now, and that is the price that everyone
is paying.
Q507 Mr Hurd: May I bring you back to
climate change piece and two specific questions about your idea
of auctioning long-term carbon contracts. Just to be clear, are
you suggesting that this is something that a British Government
would be struggling to meet, that its climate change targets should
consider on a unilateral basis, or does this idea only fly on
the precondition that there is a new international, multilateral
agreement on carbon reductions post-2012?
Dr Helm: The answer to that is
it would always be better to do it internationally, because global
warming is an international problem not a domestic one, but note
that I want the contracts to be a lot less than the amount of
reductions we will have to make in almost any scenario. We do
not have the luxury of saying, "Let's forget about what base-load
we invest in. Let's build some coal plants and gas plants because
we will think about how to solve this problem when we get there."
We will have to reduce emissions anyway and some chunk of that
will relate to the replacement of the base-load of the electricity
system, which is the decision to make now. Therefore I think the
UK should pursue a long-term carbon contract cautious policy in
any event, to get the incentives right now, because this is the
historical moment when our base-load energy electricity production
is turned over. If you do not do it now, what you are going to
have is a lot of gas stations which are going to last for the
next 20 or 30 years and you have missed the opportunity, because
the cost of closing stations that are in mid-life is enormously
greater than using that unique opportunity, decade opportunities,
when the capital stock rotates.
Q508 Mr Hurd: May I ask you to expand
on what value you see the carbon contract idea adding to the concept
of emissions trading which has started and which it is argued
is not going far enough because of the absence of a framework
of long-term carbon contracts? Should not Government be focused
on making the emissions trading work? What value does carbon contracts
add to emissions trading?
Dr Helm: The problem with emissions
trading is the emissions trading regime is very short-term. It
has virtually no effect on investment as it currently is and it
has no effect on R&D, because the time horizon that we know
for the emissions permits goes to 2008. It is completely irrelevant
to the investment cycle and to R&D. What you want to do is
give long-term signals to this market. In 2012 there are no internationally
yet known targets at all, and without targets you cannot have
emissions trading, full stop.
Q509 Mr Hurd: My point is that if you
could get those targets, would not emissions trading get you where
you want to get to? In that context, do not these contracts just
complicate the picture?
Dr Helm: If you had long-term
emissions targets, you would have long-term carbon contracts,
QED. It just happens. I have devised this as a second best. I
do not think governments are going to agree quick enough what
the target is going to be and we need to get our own investment
and know what those are going to be. Note one other characteristic
of my carbon contract world: it gives the Treasury a fantastic
incentive to promote the continuation of emissions trading afterwards,
because that is the way it unbundles these contracts into the
market and gets out of any liability it has.
Q510 Mr Hurd: What sorts of signal would
the UK be sending if we basically said we do not believe in the
pace at which emissions trading is working; we want to replace
it with our own system of carbon contracts?
Dr Helm: It is not replacing—it
is perfectly consistent with emissions trading; and that is the
distinction. Remember, what is your alternative? You can have
a renewables obligation or are you going to have a nuclear obligation
if it is nuclear power you want to do? These are all long-term
carbon contracts. They are just in the renewables obligation and
a nuclear obligation, a very expensive way of doing it, because
you are underwriting not only the long-term carbon, but the construction
costs and the performance costs as well. The world in which there
are not any targets going forward and no long-term carbon contracts,
the world to compare that with is a world where there is neither
that, nor a renewables obligation, nor a nuclear obligation, and
all the wind collapses as well. It is not a luxury choice we have.
We are in an investment phase, it is a risky phase, we have got
to get the incentive structure right and get on with it. The contracts
are just a much more economically efficient way than the renewables
obligation or a nuclear obligation of achieving that. They do
not pick winners either, which the renewables obligation most
certainly does, and so would a nuclear obligation.
Q511 Dr Turner: Would your carbon contracts
deal with emerging technologies? It seems to me that they are
a great disincentive, that they simply do not recognise the possibility
of bringing forward new technologies, particularly marine technologies,
which have great potential but at the moment obviously cannot
compete at a commercial rate. Is not your carbon contract idea
far too rigid to deal with those?
Dr Helm: No. The problem of emerging
technology is further out. First of all, I do not imagine this
is a one off game of contracts. There will be repeated contracts
going out into the future. It tells people there is going to be
a carbon price. It gives them more certainty about a carbon price
in the long run which should encourage R&D, but it is not
enough, because the other problem that emerging technologies have
is the classic R&D problem: no market will—
Q512 Dr Turner: Your paper does not seem
to take account of that.
Dr Helm: No, it is complementary
to this. Nothing in my paper says we should not have a very coherent
R&D policy as well, but if you want to encourage people to
go and invest in R&D for non-carbon technologies, it is a
good way to do it, to tell them that we are devising a system
that is giving a long-term price signal to carbon. Put it the
other way round: supposing we do not, we do not have any signal
for carbon prices. What we are saying is politically the framework
going forward is one which may not reward carbon properly.
Q513 Dr Turner: I agree with you; we
need a carbon price signal, but this is not the only possible
carbon price signal that we could use. You have not answered my
point, because let us say R&D is financed separately, but
the actual cost reductions that you get only come with commercial
use on a reasonably large scale and your carbon contracts just
do not allow for that.
Dr Helm: When it becomes commercial,
that is fine.
Q514 Dr Turner: It cannot become commercial
until it has been there.
Dr Helm: I am thoroughly with
you on that. That has always been a problem with developing any
new technologies in the energy sector and that is why people have
demonstration plants, they have support for that, that is why
the discussion of the hydrogen plant in Scotland is on the basis
of what kind of support framework would go out with it. The core
of this is you still need a price of carbon and what my system
does is to give you a price of carbon going forward and that is
incredibly important to investors in R&D as in other technologies.
It is not sufficient, I am with you, on that entirely.
Q515 Emily Thornberry: Why is the Government
well placed to make a decision on additional costs of that nature,
but is not well placed to make a decision on what technologies
we should use?
Dr Helm: Because, in the case
of R&D, the market failures are so great that it is unavoidable
that you have to have some technology basis of your R&D policy.
You just cannot avoid it. It is a bit of an institutional way
of doing it, but once you have got up and running, proven technologies
that work, it really is a question of cutting through all the
lobbying, cutting through all the ways in which particular technological
interests promote themselves and turning to the market and saying,
"What is the price you wish to pursue?" What I find
with the idea of using markets in carbon is, those technologies
that think that they might not win an auction are against it,
and those that think that they might win it, are in favour of
it. I do not know the answer; all I know is that Government's
estimates of the price of different technologies—and reflected
in the White Paper really deeply in the estimates of the costs
of renewables of various forms and of nuclear power—in the
past historically turned out to be wrong, in some cases, staggeringly
wrong. I turn to my political scientist colleagues to explain
to me why people get attracted by thinking that nuclear power
is too cheap to meter or they think that wind should be paid transmission
costs, or whatever. I want the market to sort that out; I want
investors to take over this, not taxpayers. In the case of having
obligations for specific technologies, the very interesting thing
is, the end result would be that customers will be told they will
underwrite it, and that is just as much a cost as would be a subsidy
of tax.
Chairman: I am afraid we are going to
have to end the session. There are a number of other issues that
we would like to raise with you, but I am afraid that we may have
to do them in writing.
Q516 David Howarth: What is the reaction
of the various promoters of different types of technology to your
project? From what you just said, I think that might be rather
an interesting thing to know.
Dr Helm: At the moment the main
scepticism comes from those who are interested in things like
wind and in particular the types of renewable technology. I would
say the nuclear industry is probably fairly sceptical too, but
if the nuclear industry believes that their power plants are economic
at current oil prices—and I am addressing the carbon question
there—what I am really saying to the nuclear industry and
the wind industry, "Well, I do not know what the costs are.
You come forward with your projects. You bid. You put the price
on the table." The market will not necessarily get it right,
but my argument is, the Government will almost certainly get it
more wrong than the market will, and history, I think, is on my
side.
Chairman: On that note we will say thank
you very much indeed; it has been a very stimulating and interesting
session and I am sorry we have run out of time.
Dr Helm: There is a separate paper
on the detail of carbon contracts that I can provide to the Committee.
Chairman: That will be very helpful,
too, thank you. Many thanks.
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