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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