Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 180-199)

PROFESSOR KEITH PALMER

6 JUNE 2006

  Q180  Mr Hoyle: Presumably, one can ensure cost certainty if one is using the same design of new build all the way through. Do you think that process could be undermined if different firms carried out different new build?

  Professor Palmer: I suppose that the first question for the Government and country is whether they are to have new nuclear plants. If so, will they have more than one? If the answer is that there will be more than one the question is whether one has competing consortia or one group that unfolds a sequence of similar plants over time. I do not believe that the question about risk-shedding through design and build contracts is the most important aspect in answering that. I think that the markets will expect the builders of these plants to be able to deliver to a fairly certain price. But there will always be some aspects of the price in a nuclear station which it will not be possible to fix because the Nuclear Inspectorate has a degree of involvement, quite rightly, that makes fixing certain costs a little tricky, but I think that in any event using design and build to share with the producers some of the risks of building these things will be common, whichever way we go forward.

  Q181  Mr Hoyle: Do you expect to see similar off-the-shelf designs that keep the price in check?

  Professor Palmer: Yes. I think that because it helps to keep the price in check, it is also the logical way to do business, because we all know that the first plant incurs cost that is not incurred by successor plants. The more one can roll out a series of similar technology, the more one gains from learning by doing and reduces cost over time, which benefits everybody.

  Q182  Mr Hoyle: Is there any particular shelf that you would expect to look at first?

  Professor Palmer: No. There are a couple of well known leading designs in the marketplace and I know that they are all vying for an opportunity, if a decision is taken, to make their offers. But the proof of the pudding is, as you suggest, whether they are prepared to start taking some price risk on their offers. At the moment, the conflicting numbers that one hears are all just talk and at some point people have to put their money where their mouth is.

  Q183  Mr Hoyle: To what extent do you believe the price of gas will determine the viability of nuclear new build? Can gas prices be predicted for the lifetime of a nuclear power station?

  Professor Palmer: The future price of gas is fundamental to the economics of nuclear. I started by saying that what drives the economics of nuclear is that it must be competitive with combined cycle gas-fired plant. Even at the very elevated gas prices at the moment combined cycle gas plant is so efficient that before account is taken of the cost of the carbon that it puts into the atmosphere it is still a very inexpensive form of generation, and that should not be overlooked. Clearly, nobody can predict what the price of gas will be for the next 40 days, much less the next 40 years which is the life of a nuclear power station, but, frankly, that is just one of the uncertainties that everybody in the energy business deals with all the time. Oil and gas prices have always been volatile and more or less impossible to predict. People make judgments. If the question is whether one can finance these things because of that degree of uncertainty, the answer has already been given because lots of plants have been built in a market context in the United Kingdom where there has been great uncertainty about fuel prices. We cannot predict it but people make their best judgment and take some risks. If one gets it wrong one's plant may not be as economic as one had hoped, but these are not unusual risks for people who are in the business of funding energy investments.

  Q184  Mr Hoyle: Obviously, price is important. How important is security of supply?

  Professor Palmer: Security of supply is extremely important, but the way one addresses it is by having a diverse means of accessing supplies. As the United Kingdom becomes more dependent on gas imports it is building LNG terminals and more pipelines to Norway, where there are huge supplies of gas, and making interconnections with the continent to connect us to arguably more risky markets in southern Europe, North Africa and to the east. For me, the security of supply issue is about diversity of supply of gas, as well as not becoming overly dependent upon it.

  Q185  Chairman: Perhaps I may put a question to which I think I know the answer. For the record, you talked about the huge risks involved in any energy investment given the uncertainties in the market. If one of our next witnesses—the industry is to come next—decided to make a massive investment in nuclear and there was an unexpected change in technology and world supplies and electricity prices collapsed and that investment effectively bankrupted those companies, what would happen to the nuclear power plants?

  Professor Palmer: I deal with that in two ways. Before I deal with the actual question you ask, rather like a good politician perhaps I may answer a slightly different one. We need to put the question in context. You talk about it going wrong and bankrupting the company. The first big nuclear power station that is built will be an investment of several billion pounds sterling and that cost will be shared between a number of parties because such plants are always built on a consortium basis. No party will be picking up the whole of that investment. Ask your next witnesses what their balance sheet values are and you will see that they are companies which can absorb this risk. Indeed, one of the reasons they are so large is that they need to be able to absorb the very considerable risks in their business. It would not bankrupt them at all. Let us assume that that was not the case. One would need to have in place regulatory arrangements that ensured continuity of the use of the services from the nuclear power station, even if the party who happened to own it had lost all his money and had gone off to the sun to retire. There are lots of examples in the United Kingdom of regulatory arrangements called special administration which are mechanisms to ensure that the public interest is protected if the owner of an essential asset goes bankrupt. They cannot take the asset away; they have to transfer it to somebody else who will run it. I think that an important part of the Government's policies is to ensure, first, that that is not ever likely to happen but, if it did, that there is a process to protect the public interest.

  Q186  Miss Kirkbride: You referred to the regulatory process and what might need to be done. You talked about the public interest being protected by the regulatory process so that a power plant is not lost if it becomes unviable for the operator. Is there anything else that you want to add as to what needs to be done from that perspective? Equally, does any regulatory process need to be undertaken or changed from what is there at the moment to give investors the confidence to invest from the perspective of their balance sheet?

  Professor Palmer: If we are talking about regulation of the producer who is building and running plant, I do not think a great deal needs to be done. The Nuclear Inspectorate has extremely specific and wide-ranging powers to check every single step of the construction of a power plant to ensure that it is being done properly and, after it is commissioned, to go in at any time to ensure that if something is not being done right it is fixed. I think that in its behaviour in relation to British Energy, it has shown itself to be a fierce mob. One of the risks that the markets will have to face if they are being asked to fund nuclear is that the activities of the Nuclear Inspectorate cause the construction to be much longer than expected or more costly because the Inspectorate requires changes to the design during that stage. Those are very real risks but I believe that they are understood by financiers. There is an understanding that the Nuclear Inspectorate must do those things, and I believe that people will go along with them. There is not a great deal more. There is stuff to do with planning on which I am not an expert, but from the financing perspective the risks in relation to planning are out of the way by the time the big bucks have to be raised. They are a big problem for the companies in trying to progress development. They are not a huge problem for me in trying to raise the funds, because I would expect people to hand over large sums of money only at the point the planning had already been resolved. My short answer is: not a lot.

  Q187  Miss Kirkbride: That was to be the next question. Everyone is speculating that because of the concerns about nuclear power, planning will be the big nightmare and it can become very uncertain with public inquiries and so on. You were somewhat dismissive of the planning problem. Do you think that companies will not be put off by it? They are not looking to the Government to have some sort of guarantee that everything can be put on hold until the big moment comes. Are you quite relaxed about these matters?

  Professor Palmer: You must ask them about that. One has a planning process and one progresses the design of the power station in parallel. One funds it to the extent that one needs external finance that does not come off the company's own balance sheet only at the point where a lot of the uncertainties at the front end, which would include planning, have been resolved. I am certainly not saying that planning is not an important issue but that it is not a constraint on raising the funding if that is done at the point where those problems have been dealt with. The only other obvious point I make about planning is that if it were decided that new nuclear should be built at existing nuclear sites presumably those issues would be very much mitigated.

  Q188  Miss Kirkbride: Do you think that that would apply also to licensing?

  Professor Palmer: I do not think that it would, for licensing. It might help a little bit because some aspects of the safety environment and so forth would already have been addressed at the existing sites. To the extent there were new design aspects—the new stations would have them—I would expect some additional things to have to be done anyway, wherever the site was located.

  Q189  Chairman: But planning and licensing issues are fundamentally ones that affect the company's decision whether or not to seek funds, but not access to funds?

  Professor Palmer: I should have put the point that well myself.

  Q190  Mark Hunter: Is the fact that several different government departments have a role to play—DTI, Defra and DCLG, formerly the ODPM—in bringing forward new nuclear build a matter of concern? Are there any issues about consistency of approach that may cause you and others concerns?

  Professor Palmer: Several government departments being involved is always a bit of a nuisance. It would be wrong to think that there is anything particularly unique in the nuclear area in relation to that. In just about every major investment that is undertaken and financed by the City several departments are involved. I have hardly ever been involved in government when the Treasury has not been at the table. There is always the lead department and, in this case, several other departments would have important responsibilities. It is something that makes progress more cumbersome than one would like, but that is life. I do not think that it is material particularly either to nuclear or to a decision to spend the time trying to get through this process. These companies have a strategic long-term interest in seeing new nuclear built and they will stick at it.

  Q191  Mark Hunter: Given the involvement of the different departments, do you think it has been helpful that the Prime Minister has himself made comments in support of a nuclear option at this stage?

  Professor Palmer: I am sure you will understand if I do not comment.

  Q192  Mr Weir: It has been suggested that the current structure of the electricity market provides a disincentive to consider long-term factors. In the press at the weekend there was a suggestion that the nuclear industry was looking for a guaranteed price for some years ahead before it would go ahead with any nuclear new build. Do you think there have to be changes in the market to provide long-term certainty for any new nuclear build?

  Professor Palmer: That is not something that is easy to answer in one short sentence. We evolved a new competitive electricity market in the late 1980s and early 1990s. It evolved into the New Electricity Trading Arrangements (NETA) a few years ago. It is doing a pretty good job of getting a balance between serving consumers by forcing prices down, which is what markets are supposed to do, and dealing with the volatility that inevitably comes with markets and the increased risks. It raises questions about the ability to finance future generation capacity, which we must all have if the lights are not to go out. I do not think this is a question that is related entirely to nuclear; it relates to all new generating plant. There are huge uncertainties now reflected in our electricity market that do not exist to anything like the same extent on the continent. There is great uncertainty about gas prices. Should we or should we not build another gas plant? It is a difficult decision because of the volatility of the marketplace. Nuclear is a similar but larger problem because of the greater upfront capital sums and the longer life of the plant. We are talking about a 40-year life for a nuclear plant, and possibly more. Is there a structural problem with the electricity market? I do not think anybody really knows. My best guess is that if we do not fundamentally change the NETA rules but provide some certainty about the carbon premium, which is a separate matter, probably these things can be built. There are, however, some things that can be done to reduce uncertainty in the market, not just nuclear but across the board, for all new generating capacity of whatever type and reduce the risks of not getting the right amount of new generation when we need it. Unless you want me to, I do not particularly want to go into what those might be, but there is a debate among experts about whether further evolution in the electricity trading arrangements is a price that we ought to be paying to get more certainty about security of future supply.

  Q193  Mr Weir: If nuclear is looking for some guarantees for the long term, how does that impact upon Ofgem's principal duty to engender competition, which was the whole object of NETA and now BETTA?

  Professor Palmer: I do not believe that it is consistent with the whole approach to competition in energy markets and the duty of Ofgem to give a preferred price to any particular technology. If indeed they are asking for that I certainly never said I supported it.

  Q194  Mr Weir: If I may summarise your view, you do not believe that nuclear should have a preferred price in future; it should be left to the market and investors to decide, if they want to invest in nuclear, what they will pay for any electricity generated from any source?

  Professor Palmer: My view is that if the Government and the country take seriously the need to abate carbon, which is the key climate change issue, we should have a policy that gives a premium in the electricity market to whatever generating sources produce electricity but not carbon. It so happens that nuclear is one of them, but there are many others. All the renewables that we are more familiar with and talk about are the same. It seems to me that the objective should be the cheapest possible electricity with no preference for any particular technology consistent with meeting our carbon abatement targets. That is the end of it. Some may say that that is a subsidy for nuclear. I do not agree. Very obviously, we need to support non-carbon-emitting technologies because of climate change issues, and a consequence of doing that is that nuclear will be one of the beneficiaries, along with a lot of others. That seems to me to be a level playing field in a carbon constrained world with no preference for nuclear.

  Q195  Mr Weir: But you mentioned earlier possible changes in the current system as operated by Ofgem. One of the problems, perhaps a particular one for Scotland, is transmission charges on the grid. They seem to work against renewables which clearly are low carbon or carbon neutral. Do you believe that Ofgem would have to change those sorts of regimes in order to create a market for all low carbon electricity generation?

  Professor Palmer: If there are perverse costs built into the system which make it unreasonably difficult for renewables in Scotland obviously they need to be addressed. I do not see that as different from what I am saying. I think that all non-carbon-emitting technologies, of which windmills in north-west Scotland are a part, should be getting more or less equivalent benefit from the fact that they do not put carbon into the climate.

  Q196  Mr Binley: Initially I came from the small business sector. Volatility of energy prices impacts heavily on occasions, particularly of late. In that respect there has been some concern about the introduction of the New Electricity Trading Arrangements that you talked about. That introduction contributed to British Energy seeking a government bail out, quite frankly. Has the Government rebuilt trust in that respect with the investment community sufficient to convince it about the viability of future nuclear generation? Are people really going to take a risk on what you describe as pretty much the freest market in the world in this respect?

  Professor Palmer: The proposition that I shall keep repeating until you shut me up is that if we create an environment in which the least cost generation can flourish with each of the technologies benefiting or being punished according to how much carbon it puts into the climate then we shall see. My belief is that if we can provide a degree of certainty around the market's premium price for carbon then people will invest in nuclear. You should not underestimate the extent of serious commitment on the part of people to whom you will be talking next to demonstrate that they can build these technologies, absorb the risks and do what they say they can. What they cannot do is know how much they will be paid for their output in a world where carbon premiums are very uncertain. I do not think that trust is a big issue for nuclear generators; the big issue is the future price of nuclear electricity, including whatever premium for carbon they can get.

  Q197  Mr Binley: To put a very simplistic question, does one come back to guarantees—a sort of bottom to the marketplace as we used to have, and still have to a certain extent, with agricultural subsidies?

  Professor Palmer: The United Kingdom has already moved so far away from that that I think it inconceivable it will want to go back in that direction. If one has a level playing field where one gives all technologies the same opportunity to get the premium because they are not emitting carbon, and it is at a sufficient level, nuclear will put its money where its mouth is; it will invest and take the cost risks of it not being economic. All other non-carbon-emitting technologies will benefit equally. It seems to me that that is very far from a world in which one guarantees prices to anybody. It is a world in which society says, "We are prepared to put a particular value on non-carbon-emitting technologies and make them equally available, whether to nuclear, offshore wind or marine technologies in due course."

  Q198  Mr Binley: I am relieved to hear your comments. In an industry which is dominated by a few vertically integrated generation and supply companies, do you think this market structure is best placed to deliver new nuclear build? What would you say to those who argue that it is undermining consumer choice and, therefore, reducing competition?

  Professor Palmer: At the moment we have a more or less vertically integrated generation and supply industry. That is split up more or less between five companies which are the major players in the marketplace. It is a compromise, as it were, between atomistic perfect competition, where everybody is running around trying to do it, which has never succeeded in the energy business because of all the risks that we have talked about, and monopolistic industry where all the costs end up passed on to the consumer, which is what tends to dominate in many parts of the world. As long as the competition authorities have a mandate to keep a close check on these companies and Ofgem and others have no evidence of market abuse it is working relatively well. Whenever one is asked whether something is an ideal market structure one considers the alternative and it seems to me that either of the extremes is not possible or desirable.

  Q199  Mr Wright: What changes do you see as necessary to the European Union's Emissions Trading Scheme in order for it to provide low-carbon electricity generation, if any?

  Professor Palmer: Let me pose the problem and then tell you what we have with ETS. I guess that the answer will be teased out. What one needs to know if one is investing in any of these generation technologies is what carbon premium is to be paid or what carbon cost one will have to incur if one is a fossil generator. Fossil generation incurs cost under the ETS and has to abate carbon, and non-carbon-emitting technologies benefit because they receive a price premium but do not have any extra costs. That is the way it works. The company that is investing needs to know what that premium will be for its output over the life of its power station. In a conventional or combined cycle gas turbine plant one is talking about probably 15 years, but given nuclear's very long life technology one needs to know for 40 years, or ideally a little longer. What the ETS does for the first time, very commendably, is establish a price in the market for abating carbon. The price that one can get for selling a certificate in the ETS is the amount of money that one is paid for not putting carbon into the atmosphere. However first, that carbon premium is known for only a couple of years because the ETS runs for only that length of time and we have no idea what will happen in the second phase. Secondly, the price is incredibly volatile because one is starting something new. No one quite knows whether the allocation of certificates was right. There is now a good deal of evidence to show that they were not right and that some of the United Kingdom's industries have suffered as a result. It is not possible to form any judgment about how much premium one is likely to get over the life of one's plant, even a combined cycle plant, by looking at the very short-term volatile price in the ETS. One needs to know how to get greater certainty for a longer period about what that price is going to be. It is a price that is fixed entirely by governments. The carbon premium is there only because countries or their governments acting for them have decided to make it costly to put carbon into the atmosphere. There is here a real problem in that there is no market solution to certainty about the carbon price. This price will be made by you (Parliament) in the United Kingdom and by other governments in the rest of Europe. What one really needs is a mechanism that will circumvent the inconvenient fact that one simply does not have any certainty at all about what the carbon premium will be for even a few years ahead, much less for the life of a plant. How does one deal with it? One approach which is noble but, I fear, unlikely to be successful is to persuade all of our colleagues in Europe collectively to come together and to produce a much better designed and longer term ETS which establishes a forward price for carbon. That is a challenge certainly I would not want to shoulder. If one accepts the notion that one needs to provide a measure of certainty around the future carbon price one needs to look at UK arrangements which will do that for all UK emitters of carbon but which is compatible with a subsequent stage of the ETS. It is by no means an alternative to ETS so much as a degree of assurance that the UK is able to provide certainty for itself which could be shared with the rest of Europe, if and when they ever became persuaded that they wanted to adopt a similar approach.


 
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