Memorandum submitted by ScottishPower
1. INTRODUCTION
Background on ScottishPower
ScottishPower welcomes the opportunity to contribute
to the Environmental Audit Committee's inquiry. As one of the
UK's largest energy companies, we are pleased to offer our views
on the issues identified by the Committee.
These views are based on our practical commercial
experience across the energy supply chain, including generation,
transmission and distribution, and supply. In the UK, ScottishPower:
— operates some 6,200 MW of generating
capacity, from a diverse portfolio of thermal electric, hydroelectric,
renewables and CHP sources;
— is the 3rd-largest distribution company,
operating and maintaining large power transmission and distribution
networks;
— supplies energy and energy services
to more than five million domestic customers; and
— is one of the leading developers
of windpower, with 300 MW of onshore wind currently operational
or under construction. Upon completion of our windfarm at Black
Law later this year, it will become the largest in the UK. We
are also in the final stages of seeking consent for our Whitelee
windfarm, which will be the largest in Western Europe.
Meeting the Government's 2010 and 2015 renewables
generation targets of 10% and 15% respectively will require significant
investment in plant and infrastructure. In meeting this challenge
ScottishPower plans to invest £1 billion over the next five
years in delivering a further 1,000 MW of renewable energy. In
addition as part of the RETS programme of network reinforcement
in Scotland, we plan to invest £190 million in the first
phase of upgrading and reshaping Scotland's high voltage transmission
lines.
In partnership with AMEC and Ocean Power Delivery,
we are also pioneering the development of marine energy in the
UK. Current feasibility studies of the Pelamis wave energy technology
could, with appropriate financial support, lead to the development
of a revolutionary 22.5 MW wave farm.
With substantial coal- and gas-fired generation
assets, we believe there may be opportunities to develop and apply
carbon capture and storage technologies in the UK, and we support
the aims of the Government's carbon abatement strategy, announced
in June 2005.
Our industry and commercial experience gives
us a valuable perspective on the impact of Government policy on
the energy sector, and we hope this perspective and our projections
for the future development of the energy market are of interest
to the Committee.
Policy Context
In the 2003 Energy White Paper, the Government
set out four key objectives for future UK energy policy: moving
to a low carbon economy; maintaining the reliability of energy
supplies; promoting competitive markets in the UK and beyond;
and ensuring that every home is adequately and affordably heated.
ScottishPower has supported these policy goals
and in particular believes that the Government's ambition to reduce
carbon dioxide emissions by 60% by 2050 is achievable, but only
if the correct market framework is implemented. Achieving a low
carbon economy requires Government, regulators and business to
work hand in hand to design the correct regulatory framework and
market mechanisms for delivery. The existing mechanisms of the
Renewable Obligation Certificate scheme, the Energy Efficiency
Commitment and the EU Emissions Trading Scheme have already started
to deliver the low carbon economy. However we encourage Government
to continue to develop mechanisms with transparent and long-term
outlooks, which serve to remove regulatory uncertainty. We believe
that such mechanisms will stimulate investor confidence and that
market based, tradable mechanisms, which are not technology specific,
will be more effective at securing buy-in from companies and delivering
security of supply.
ScottishPower would support a move to bring
industry and Government together to determine future mechanisms
and would seek to be fully engaged in any such initiative.
In its 2nd Annual Report on the Energy White
Paper[363],
the Government committed itself to:
"giving the market as much advance notice
and clarity as possible on the way new measures—particularly
environmental regulation—will be implemented to inform decision-making
and maximise the scope for efficient market response. There could
be implications for security of electricity supply arising from
the impending introduction of a series of European initiatives
and Directives aimed at reducing pollution."
We acknowledge the importance of environmental
legislation in driving energy policy. This includes climate policies,
such as the EU Emissions Trading Scheme, the Large Combustion
Plant Directive and the Renewable Obligation, as well as measures
to tackle pollution and environmental impact. In the UK the combined
effect of environmental policy drivers has already had a profound
effect on the generation mix in recent years, accelerating the
growth of gas, hastening the retirement of coal plant, and delivering
support for renewables. Whilst ScottishPower supports the environmental
objectives that are driving this change in the generation mix,
we believe that it is essential that advanced notice of environmental
legislation is needed to ensure early market signals to aid investment
decisions. Equally timely decisions around the future legislative
environment are required to give investor confidence and secure
adequate rates or return.
In practical generation terms, the effect of
the EU ETS and LCPD will be to increase commercial pressure on
fossil fuel-based generation. Despite this pressure, in addition
there has been a prolonged lack of clarity in respect of the LCPD
methodology and confirmation of running hours. Equally for the
second phase of the EU ETS, discussion is taking place as to the
appropriate allocation mechanism. It is clear that such discussion
and the subsequent decisions taken will benefit certain technologies
at the expense of others. This presents a massive risk for investors
and heightens the likelihood of incorrect investment decisions.
Such an environment does not promote an optimal outcome and has
the potential to affect security of supply and investor confidence.
Therefore without early clarity on these issues there are clear
implications for generators and the investment decisions that
they need to make, at a time when significant changes in generation
patterns are already taking place. For example moves from baseload
operation to more flexible operating regimes are already under
way.
For policy-makers, the key challenge continues
to be balancing the environmental policy priorities, and the mechanisms
designed to achieve them against the commercial operation of the
electricity market and the expectations of industry and investors.
Again, we believe that an open debate between Government and industry
is required, during which priorities and mechanisms to achieve
them can be discussed. In any event such mechanisms should be
long term and stable.
In the longer term, there will need to be significant
changes to the make up of generation in the UK in order to achieve
Government targets on renewable generation and climate change.
Given current environmental and economic pressures, it is difficult
to see a long-term future for existing coal-fired generation,
although clean coal technology and carbon sequestration may encourage
new investment in coal. The other key determinant on the future
of generation will be Government policy on nuclear new build or
clean coal development.
In determining the UK's future generation mix
there are many options open. As the experiences of other countries
suggests, there is no single technological route to follow. Under
different scenarios, a variety of generation mixes can deliver
a low carbon economy in the UK. ScottishPower believes that renewable
technology has an important part to play in meeting the Government's
targets and as such are currently developing a range of technologies
and rewiring the electricity networks to accommodate more remote
and diverse sources of generation. It is our belief that renewable,
nuclear energy and clean coal are not mutually exclusive. No matter
which large generation plant the UK deems to be most effective
for meeting all requirements, including security of supply, renewable
generation should and can play a significant part.
The low carbon economy will come at a price—however
it is constituted, the future generation mix that delivers the
Energy White Paper's aims will require significant further investment.
ScottishPower has stated consistently that delivery of the White
Paper is likely to lead to a rise in unit prices of at least 15%
in real terms by the end of the decade. Clearly, this excludes
the recent effects of gas and coal prices on the wholesale markets.
The costs associated with implementation of the environmental
measures have yet to be fully factored into end-consumer tariffs
and therefore there is potential for environmental legislation
to impact upon the White Paper's other objectives around fuel
poverty and UK competitiveness.
Whatever the options pursued, each will have
its costs; and all of the possible options will cost more than
UK consumers currently pay. Investor confidence in the future
development and direction of policy is therefore critical. Under
any future scenario for the UK's energy needs, long-term signals
will be required from Government in order to create the conditions
for investors to discriminate between market risks and regulatory
and environmental risk, and to ensure that these investments do
not run the risk of becoming stranded assets by sudden or unexpected
shifts in policy.
2. FUTURE GENERATION
CAPACITY
In the UK, estimates of the likely shortfall
in electricity generating capacity caused by the phase-out of
nuclear plants and some existing coal plant prompts important
questions about the security, diversity, and—importantly—the
flexibility of future energy supply.
The majority of independent studies point to
a tightening supply margin in generation in the next five years
or so, with the possibility of a generation shortfall occurring
in the medium term.
ScottishPower has its own views on the likely
shortfall in generation in the future, but our views of the generation
gap correspond broadly with independent analysis of the issue.
In our view there will be a need for new investment in the medium
term.
The gap in future generation can be filled in
a number of different ways, depending upon the energy market scenario,
which develops. The measures taken by Government to address the
UK's predicted shortfall, and industry's response, will determine
future generation mix.
Under all possible future scenarios, there is
a strong role for further renewables development and action to
deliver greater energy efficiency:
— on renewables development, the 2020
20% renewables target is challenging yet achievable with certain
targeted measures (including an upward revision for the RO target
beyond 2015). Delivery will mainly come from onshore sources such
as wind and biomass (which we foresee will meet the majority of
the 2010 targets) with the remainder met by offshore, marine and
tidal. We broadly agree with the resource estimates identified
by Government within the recent renewable obligation review, but
at the same time highlight that additional measures are necessary
to stimulate the offshore wind sector, and that it is imperative
that market stability is maintained if onshore wind's contribution
is to be fully realised.
— on energy efficiency, the Government's
challenging targets will require a significant step change in
activity. There is much progress to be made in reducing energy
consumption as a means of curbing carbon emissions, as the White
Paper envisaged, and Government must lead the battle for "hearts
and minds". With this in mind, ScottishPower is engaged in
the work of the UKBCSE in their consideration of tackling fuel
poverty and maximising benefits in energy efficiency.
ScottishPower is firmly committed to tackling
energy efficiency and we were successful in exceeding our obligations
under the first round of the Energy Efficiency Commitment. Although
EEC has been a successful programme, relative to the performance
of other programmes across Europe, the 1% reduction achieved through
EEC is not sustainable and a doubling of energy savings under
EEC2 will be challenging to deliver without a market mechanism
to create more tradability and provide greater incentive for innovation.
To achieve greater energy efficiency gains,
the UK needs to go beyond EEC. We agree with assertions that there
is the potential for 40% energy efficiency gains—but again
the real challenge in respect of energy efficiency is convincing
consumers of its value. Reductions in electricity use must be
customer driven, as the market alone is not going to deliver a
step change. Unless the Government can address, for example through
fiscal measures, the slow rate of progress in this area, it is
unlikely that the 40% reduction will be achieved.
The Energy White Paper rightly identifies security
of supply as key to the UK's future energy interests. The national
importance of security of supply suggests the need for a mix of
generating types.
The strategic importance of flexibility in supply—as
well as security and diversity—is often overlooked. It is
a prime consideration. As the UK moves to a position of increased
capacity from renewable generation and reliance on gas fired plant,
it is imperative that the overall generation mix takes account
of the issues with availability, flexibility and fuel sources
in securing energy supply.
3. FINANCIAL
COSTS AND
INVESTMENT CONSIDERATIONS
Financial Costs
In recent years, costs studies from a range
of sources have produced an equally diverse spread of estimates
for the cost of different generation technologies. Across the
board, however, taking into account differing cost assumptions
(carbon, waste, support mechanisms), our view is that the aggregated
costs of different technologies can work out broadly in line.
The costs of generation and benefits of the
associated carbon abatement are widely reported in a variety of
previous independent studies. Our considered view reflects a range
of costs for new generation plant, which for electricity, will
occur within the following ranges (costs shown below prior to
inclusion of environmental externalities):
There is no lack of technological options. Adoption
of technologies will be determined by timescales, and by the support
mechanisms introduced/continued by Government. In defining its
approach to differing generation solutions, Government should
avoid confusing energy supply objectives with economic development
objectives: the market should be concerned with the deployment
of working technologies, rather than the pursuit of uneconomic
or immature ones. Government should recognise the sensitivity
of the market to any support for particular generation types.
There should be a clear demarcation between the market structure
and the support mechanisms for different technologies. As an example,
ScottishPower believes that the Renewable Obligation Certificate
Scheme has been a successful and effective mechanism, in that
it delivers a market response to a Government policy objective.
Investment Considerations
As outlined above, delivering the low carbon
economy requires a climate of stability, clarity and long-term
commitment from Government if industry and investors are to be
able to make investment decisions.
Investors need the security of long-term revenues.
The risk of political interference or policy revision can undermine
severely market and investor confidence. Wherever possible, market-based
mechanisms to deliver policy—such as the Renewable Obligation
and the EU ETS—should be enshrined in legislation and operated
on a long-term horizon (perhaps 20-25 years). Continuous reviews
of policy mechanisms can have the effect of damaging confidence
in the long-term market, and thus threaten the very targets they
are intended to support.
Developers will enter the market depending on
risk appetite, cash rates and the expected rate of return. Existing
mechanisms, such as the Renewable Obligation, should not be disrupted.
In that sense, parallel mechanisms in support of other technologies,
such as clean coal or nuclear, should not be regarded as competing
with renewables.
Given the age of the UK's generation plant and
the impact of environmental legislation, the long-term legislative
stability is particularly important at the current time. Decisions
about whether the UK will be a leader or follower in respect of
technology are becoming increasingly pressing. Government has
the ability to introduce additional mechanisms and support methods
to determine this position. However the policy context will drive
the adoption of a single or multi-technology solution based on
the decision that Government makes in relation to the generation
mix required.
Opportunities exist in the commercialisation
of a number of different technologies. Depending on the attitude
of Government and industry the UK could play a role in their development.
It should be noted that if the UK is not a technology leader,
then there will be an impact on the timing and cost of new technologies
entering the UK market.
4. CONCLUSION
ScottishPower believes that BETTA market functions
effectively in creating an openly traded market. Current issues
and uncertainty in the market place, including security of supply,
are often as a result of political and regulatory uncertainty.
We believe that Government should set a broad market framework
with clear and consistent market mechanisms and regulatory environment.
Where possible such measures should be enshrined in legislation
and be long term in nature. The market should then be left to
deliver within the framework, with industry and investors managing
market risk and Government managing political and regulatory risk.
It is our view that such arrangements and stability
will allow the market to deliver security of supply. It is clear,
when looking at the Renewable Obligation, that it has been successful
due to the long-term commitment of the mechanism and the extended
lifespan keeping investment interest and support.
However, we would suggest that there has to
be a focus on joined-up Government working, both at regional and
local level, if policy objectives are to be delivered. As an example,
the Renewable Obligation has suffered due to local Government
slowing down the planning process and regulation, for example
transmission charging, making investment decisions uncertain.
30 September 2005
363 "Creating A Low Carbon Economy: second annual
report on the implementation of the Energy White Paper",
page 18, Department of Trade & Industry, July 2005. Back
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