Examination of Witnesses (Questions 280-299)
DR DIETER
HELM
13 JUNE 2006
Q280 Roger Berry: Given the difficulties
with the EU Emissions Trading Scheme, given that to some extent
this would be a leap in the dark, and given that it would cost
the Treasury money rather than raising it, does not a carbon tax
in those respects appear to be somewhat more attractive? What
are the costs that you estimate the Treasury would have to pick
up if it pursued a carbon contract arrangement?
Dr Helm: It is not necessarily
that the Treasury would have to pick up any costs. Someone would,
but not necessarily the Treasury. If you do not like the idea
of the Treasury being the intermediary in this framework between
potentially an EU ETS in the future to offload the contracts and
the investors who are building low carbon plant, you simply assign
the costs to the system user charge of the electricity transmission
system. In the end we are all going to pay in one way or another
for having low carbon technology, there is no escape for the British
economy from that, the question is who? Do you want taxpayers
or customers to underwrite the risk? It is only underwriting the
risk, we will pay for the energy as customers. I am indifferent.
It is slightly cheaper for the government to underwrite the risk
than perhaps customers but you can tie it to the system user charge.
There is no necessity for any cost to the Treasury if they are
so minded to avoid having such a cost. That is a different question
from the question about nevertheless does the carbon tax have
some advantages. It is true that the carbon tax would make lots
of money for the Treasury but that is also its potential disadvantage
because what you are interested in here if you are an investor
is knowing what the future carbon tax is going to be. If governments
find that it is a major source of revenue, the incentive to use
it as an instrument of fiscal policy as opposed to a clean, clear
energy policy instrument would be very large indeed and it would
be Treasury determined, not by an agency, not by DTI, and in consequence
we would end up playing a game of predicting where politicians
are going on that rather than the market. It might turn out okay
in the sense of you might think the government is going to be
so strapped for cash that they are going to have to ratchet up
the carbon tax a lot through time and that might provide an incentive
but it is political and regulatory risk which you are transferring
to the private sector then and, broadly, that is not a good idea.
Q281 Roger Berry: In terms of saying
a long-term carbon tax, you say what government should do is set
the target and then debate about the instruments, and I understand
that, but the problem with a target in terms of reduction of carbon
emissions by, say, 2050 is that is premised on some assumption
about what carbon emissions would be without the policy, so you
make a big guess about what the situation is going to be in 45
years' time or whatever, and of course that could be wrong.
Dr Helm: The point here is in
the carbon contract proposal I am not saying that you look at
the target you have got and take the whole lot out as contracts.
I am saying whatever you do over the next 20 or 30 years you have
got a carbon problem. You have got 20% of nuclear power dropping
off the system, you have already got emissions rising, and they
have been rising since 1997. The only reason we have overall lower
emissions is because the coal industry contracted and that had
nothing to do with the climate change policy at all. The underlying
story is not a good one. What I am saying is some of the carbon
reductions that you may have to make we can make through carbon
contracts. For example, you could take the 20% that comes out
from the closure of the nuclear stations. You do not have to auction
a lot of contracts, you could decide how risk-averse you want
to be. That does not require forecasting forward that you are
going to have to reduce by 60% by 2050. It merely says even if
you want to hold your own, even if you just want to keep emissions
constant, you have got to find a major source of large scale carbon
reductions in the next 20 or 30 years. The way to do that is to
take that amount, auction it and that should provide, I hope,
a most efficient outcome and certainly will reveal the difference
between people saying that things are cheap and low cost and the
reality of what they put on the table when it comes to their money
that is being invested.
Q282 Roger Berry: In relation to
other areas where inaction leads to greater carbon emissions,
and I am thinking of energy inefficient homes, the transport sector
and so on, do you see a role for carbon contracts in relation
to dealing with those sources of the problem?
Dr Helm: There could be, but this
is a flexible arrangement. We have the EU ETS, which is a narrow-based
emissions trading scheme, and aviation is likely to be brought
into it. Can we expand an emissions trading scheme to bring in
other sectors? Yes. Should we do it in one big go? No, we should
do it in an evolutionary way because the difficulties of designing
these schemes are really quite complex. I had in mind quite large
scale and relatively simple contracts but if you want to make
it more complicated and add in other sectors earlier on, fine.
In all of these areas you have to define a baseline and the baseline
is not without controversy: what would have happened in the absence
of this? What is a genuine saving? In any event, all of those
questions arise under the EU ETS now so there is nothing new in
those problems, but baseline energy efficiency, for example, is
quite difficult.
Q283 Roger Berry: From the Government's
point of view, it if it were to pursue a carbon contract arrangement,
it obviously wants to get the best deal possible and needs to
encourage people to stick in low bids. You have rightly said that
in practice you would have to sequence this anyway, whether it
is every couple of years or five years or whatever, or even more
frequently. What advice would you give in terms of how the carbon
contract policy should be pursued in terms of trying to maximise
the chance any government gets the best deal out of the system
because in the past we can think of bidding systems where the
government has done remarkably well, surprisingly so, and other
areas where they have not?
Dr Helm: In the proposal for carbon
contracts which I and my colleague, Cameron Hepburn, have put
forward we deliberately have a two-stage auction. The reason we
do that is in the first stage people bid the kind of contract
they would like to bid. This is quite common in construction and
other areas. So you first of all reveal a lot of information about
how people would like contracts designed before you go to the
stage of having the formal auction itself. That is because government
does not know very much about how to design these things. That
is what we learned through the EU ETS, it takes time to evolve
these things. Ask people first of all what kind of design of contract
they would like, then stand back and look at it and decide the
auction itself. The lesson from the 3G licences is these design
questions are complicated but they do have solutions and the solutions
depend on the context in which the contract is set. I do not see
that as an insuperable barrier. It is important. It could be got
badly wrong, but it is not impossible. Err on the side of simplicity
too. You mentioned bringing in energy efficiency and lots of other
things. The more things you want to bring into the frame in one
go before you have had any experience of doing it, the more likely
you are to make mistakes. My judgment is start simple and then
add more things rather than start complicated. Again, maybe do
not auction too many contracts to start with.
Q284 Roger Berry: As I understand
it, and correct me if I get it wrong, the bidding process involves
government, or a government department or whoever, saying "Right,
put in bids for reducing CO2 emissions by X" and you clearly
take the lowest bid, but for companies making those bids presumably
they have to demonstrate that they are meeting that particular
target. How do you see that happening in practice when it is not
just the immediate impact on carbon emissions that a particular
energy source might create but obviously there are the energy
implications of inputs? We have all heard "is nuclear really
carbon free?"—it clearly is not carbon free but it
is low in terms of carbon emissions. How do we ensure in these
contracts that the energy implications of the source of supply
are taken into account?
Dr Helm: There are two points
here. The first point is these are payments for carbon reductions
delivered, and if you do not deliver you do not get paid. That
is crucial when we come to nuclear technology because what I am
trying to avoid in almost any circumstance is the government underwriting
the construction and performance risk of a nuclear project. That
is what we used to do in the past and that was what went very
badly wrong. It has to be delivered. The question is, have we
taken in the full effects? The answer to that question is it depends
whether you have got a carbon price through the full chain and
depends what you have included within it. At the moment the answer
is of course we have not got it fully included for any of the
fuels. Does it help if you make an incremental step in the direction
I have described? Yes. Should it go further down the supply chain?
Yes. For example, there is carbon used in producing wind turbine,
that is not included in the Renewables Obligation, and there is
carbon produced in all kinds of mining operations associated with
other technologies. The further you can broaden out the economic
instrument the greater the grip over those things, but it is incomplete
and it is incomplete for all the current technologies.
Q285 Roger Berry: This is my final
question because I realise that time is passing. If carbon contracts
operate throughout the chain and all the major countries are engaged
in this I can see the effectiveness of the system but realistically,
of course, that is not going to happen. Nor, indeed, is there
evidence, to the best of my knowledge, of carbon contracts as
of today working effectively. There is the European Emissions
Trading Scheme but that is about it and it has encountered lots
of problems. Theoretically I understand what you are saying but
in practice do you believe such a system could be got up and running
quickly enough for it to have effects reasonably promptly? Is
it a runner in practice?
Dr Helm: Its very practicality
is what makes it very do-able. If governments and politicians
do not want to have a credible carbon target then none of this
is necessary. If you want to reduce CO2 emissions then you have
to decide the level at which you want to do that. If you want
to do it at the EU level, then emissions trading has to be defined
at the European level. If you want to have a domestic target then
you do it domestically. Internationally, if you want to have any
arrangement that brings the Chinese, the Indians and the developing
countries into a post-Kyoto world you will have to contract for
carbon, you will have to use the clean development mechanism.
These are all carbon contracts. The Emissions Trading Scheme itself
is a carbon contract. What is proposed here is a remarkably simple
bridge between the problems up to 2012 and the time horizon of
the kinds of investment we need to make. Supposing you do not
do it, supposing there are no carbon contracts, what is the consequence?
You endanger your target. You may not mind that but if you really
credibly want to achieve it, it is the simplest, cheapest way
of doing it. If you are going to go forward and say, "We
are going to have a nuclear programme", if you want to create
a playing field in which nuclear is properly rewarded for its
carbon characteristics but the government does not go around underpinning
its other features, then the carbon contract is the simplest way
of focusing down on that bit of the level playing field which
you might want to take into account. I think it is eminently practical.
It is not perfect from a theoretical point of view but practically
it works.
Q286 Chairman: Just a point of pedantry
from me. The UK Government can go ahead and produce this system
but it has an incentive to ensure the EU ETS actually endures
and succeeds as well.
Dr Helm: If it does go down this
route it has a fantastically powerful incentive to do everything
it can to make sure the EU ETS succeeds because that is its route
for handing on the contracts subsequently, but it might decide
for other reasons it wants to go down a particular route, like
nuclear power, and if it is so minded to do that then this is
the way of handling one particular component of it. If you do
build a nuclear power station, someone has got to pay the cost.
You do not escape that because you do not have a carbon contract
arrangement.
Chairman: Let us do the other half of
your proposal now.
Q287 Mr Wright: In terms of the capacity
market your memorandum has outlined the need for a capacity market
to create security of supply. Could you explain the proposal to
us and, also, why is it needed in addition to carbon contracts?
Dr Helm: The carbon contract deals
with the carbon problem. That is your objective, that is your
instrument. You must have at least as many instruments as targets.
Carbon is on that side. The other problem, which I think was seriously
ducked in the 2003 White Paper, is security of supply. There is
no point in any intervention unless there is a problem, and the
problem here is the following: in security of supply what we require
is excess supply. We require a margin of plant which on average
probably will not be used and we need a margin of gas storage
that on average probably will not be used. No rational capitalist
will invest to create excess supply: it reduces the value of all
their existing assets because it drives down the price. Therefore,
almost all electricity markets in particular over the 20th century
had an energy price and a capacity price and a separate market
in capacity to pay investors to provide that margin. We have not
got that in NETA, which followed on from the abolition of the
capacity market which arose under the Pool. The capacity market
under the Pool was a very ill-designed capacity market but it
does not follow that because the Pool had a badly designed capacity
market, that all capacity markets are bad. Under NETA, we have
a single uniform market. Because we had a large scale excess supply
of gas, of power stations, we were awash with the stuff and we
had a system in which we had a low fossil fuel price as well,
there was no security of supply problem, and therefore there was
no need for a capacity market to address it. Now we have it with
a vengeance, and that is why I advocate the strategic storage
of gas as a requirement on the system and that people get paid
for that, and in electricity I recommend we have a separate capacity
market which is added on to the existing arrangements to address
precisely that question of making sure investors get paid and
then ensure we have adequate supply going forward.
Q288 Mr Wright: Would you see that
the capacity market would reward particular types of generation
more than others?
Dr Helm: No. The capacity question
is like the carbon question: we can either fix the price or the
quantity. If you have a fixed quantity target for carbon then
you are fixing the quantity and you want to find an instrument
that backs that up. In energy, security of supply at the margin
is about quantity, not price. You fix the quantity and then you
auction it. Anyone can bid, but you have to deliver and there
are big penalty payments if you do not. Similarly in the gas storage
market or, indeed, the oil strategic storage market, firms can
bid to provide that service. Let all the technologies compete.
I do not know whether a wind farm would be better for this or
a peaking gas plant or an existing coal station with particular
characteristics, or something else. Certainly the Government does
not know the answer to that question, so you use the market to
bring forward a solution. The objective is clear, politics sets
the security of supply objective, and the delivery is by auctioning
and making people reveal not what they would like you to believe
but what they are prepared to put their money to and do the investment
with.
Q289 Chairman: How would microgeneration
fit into that structure?
Dr Helm: Microgeneration as a
term covers all sorts of different things. If at its bare minimum
it is a small-scale generation option, it is perfectly possible
that it offers essentially a peak service, that it manages the
margin, and you could think about that backed up with consumer
tariffs which allow consumers to behave like industrial customers
do and turn the power off when it becomes expensive. I suspect
customers do not want to do that, but in principle the backing
up of a capacity market feeds all the way through to people being
able to auction in demand-side effects, which is the offer to
reduce demand at peak points rather than the offer to produce
new supply. It could be completely symmetrical between the demand/supply
side and the market. Microgen could fit into that frame.
Q290 Chairman: I am sorry, I am sure
everyone else in this room understands everything about this and
I am being the dense one, so just help me a little bit, please.
What this means is the Government will make a prediction for how
much generation capacity we need.
Dr Helm: They will have a capacity
margin requirement, say 20%.
Q291 Chairman: Going forward how
many years?
Dr Helm: At the moment, and this
is to illustrate this is not a new blue sky thought, the National
Grid Seven Year Statement goes forward for a period of about seven
years. You would probably have a seven year horizon but an indicative
framework beyond that. It depends on the time horizon for investment
to meet the requirements. When you identify shortfall, what is
the time horizon that takes you to get some kit that can meet
that shortfall? Seven is the time period used for the National
Grid Statement.
Q292 Chairman: Do you think someone
would invest in a new nuclear power station in a seven year time
horizon on the security of supply contract?
Dr Helm: No. The question then
becomes: do you set up a regime which tells you through time that
capacity margin will be maintained. It is not the time horizon
that binds upon it, it is whether you believe it is credibly going
to be the case that government is going to commit to a framework
which produces that level of security of supply. If someone comes
along and offers a long-term basis for that there might be people
who want to arbitrage, take the position long on the bet that
other producers will not be on the system. There might be a need
for a long-term framework. The energy agency would have to sort
that out. I am against blueprints which emphatically define the
future in some kind of cast iron way 20 or 30 years ahead and
then just turn it on to automatic pilot because of course conditions
will change, and we do not know what demand will be like in that
period.
Q293 Chairman: The Government has
to say "we reckon we need 110% of what we think might be
used"?
Dr Helm: A 20% margin has been
perfectly normal.
Q294 Chairman: 120%, a 20% margin
and you know the Government is thinking about the long-term so
how long the actual contracts last for is less important than
the structure's endurance.
Dr Helm: It is only making a reality
of what is already there. We have always had a guideline margin.
The problem is over the last few winters we have been in danger
of being significantly below that and in part that is because
nobody has been particularly concerned about that because we have
lived in a world of excess supply where we have comfortably exceeded
these things for 20 years.
Q295 Chairman: How quickly can you
introduce this?
Dr Helm: It is part and parcel
of the energy agency. If governments were minded to go down this
route then it seems to me you would do it in a stepwise fashion.
You would set up the agency. The carbon contract is a matter of
some urgency. Grafting on a capacity market takes a bit of time,
but it is not rocket science. There are loads of capacity markets
around the world and many jurisdictions in the US either have
capacity markets or are quite desperately searching for ways to
introduce them because this problem is not a British-only problem.
It will take some time to put those bits in place. We need pretty
close to semi-emergency measures to worry about next winter, and
nothing I propose is going to solve those problems. Thinking out
over the next three, four or five years most of this can be put
in place.
Q296 Mr Wright: Can I just come back
on that particular point. The same thing was said last winter
but never applied. Obviously the gas supply from the Langeled
field in two years' time will probably resolve the problem with
gas.
Dr Helm: With respect, I think
that is almost wholly wrong. People think insecurity of supply
means will the lights go off or not—but that is not the
issue. It is what happens just before the lights go off. It is
the volatility and sharp prices. Everybody in this country had
a security of supply crisis last winter and they paid for those
spikes. That is what you want the margin for. It is not just physical
quantity security, it is the stability of price that provides
that buffer. That is why you want strategic gas supply. I think,
and I feel very strongly about this, it is not only wrong but
very misleading for ministers to say, "People said there
was going to be a problem last winter and there was not".
They have redefined the problem as meaning the lights going out
but the competitiveness of economy, the bills to households, volatility
of pricing, these are consequences of running the system in a
way which is tighter than is optimal for our economy and our society.
Will we have those problems again next winter? Yes. Will the lights
go out next winter? Probably not.
Q297 Chairman: Do you need security
of gas supply contracts too, like electricity generation?
Dr Helm: The gas supply side is
complicated by a number of features. First of all, long-term take
or pay contracts are quite normal in the gas supply side and that
is part of the row between Europe and the large players in the
European Union and between Europe and Russia. Secondly, in gas
the immediate requirement is to focus on storage, which I think
the Secretary of State has indicated he is focused upon. I think,
and I advocated in the Hampton Court paper for the EU summit,
that we should move towards strategic gas reserves like in the
oil market, and that is in the European Green Paper too. Naturally
there is resistance to that from the oil and gas companies but
you have to ask whose interests are best served by a world in
which prices are volatile and high.
Chairman: There is some insistence from
the European Community that gas should be stored as well, it seems.
Q298 Mr Weir: You have made it pretty
clear that you see the way forward as the government basically
setting objectives and leaving a lot of it to the market. Given
that we are not in that situation, and not likely to be in the
foreseeable future, and the energy review is due to report fairly
shortly, if the Government decides to give nuclear the green light
is it credible to suggest that it should also give some indication
to the industry as to how many reactors it expects to be built?
Dr Helm: I, like you, I am sure,
read the press and what is being suggested is there will be no
financial assistance for any new nuclear projects. If that is
true, and if the three things Government does is address planning,
licensing and waste, in that context how can the Government indicate
how many power stations it wants to build? If it is the private
sector building these things and it is private sector money and
there is no financial support for them, the answer will turn out
to be whatever the private sector is willing to do. That is a
market solution. All I have suggested in that framework of the
market should be a level playing field. Some people in the nuclear
industry argue that in such a level playing field they could build
lots of nuclear power stations and I am agnostically sceptical.
Okay, let us create the framework, let us see if they want to
do them, but in the end these are billion pound investments and
people are not going to make those investments unless they are
convinced that these are attractive investments to make, and in
that context it is crucial that they carry the construction and
the performance risks that go with those. I am not sure what it
means to say 10 nuclear power stations, or five or 15, in a context
where you have already said it is the market that is going to
decide.
Q299 Mr Weir: In the evidence we
have had it seems to be the case, perhaps a bit like yourself,
they are looking for forward carbon pricing and some idea of the
cost some years in the future. I know you have been advising both
Defra and DTI on sustainability issues, do you believe these departments
are joined-up enough to deliver forward pricing of carbon?
Dr Helm: It is partly for the
reason that historically Defra, or whoever has had the environment
department, and the DTI have had, let us say, significant elements
of tension between them. Energy efficiency is an area par excellence
but we had it with the EU ETS last time around. I wanted to take
it away from that framework and sort out target setting and delivery.
Right now I am not convinced that the Government is capable yet
of even addressing the question of credible targets, let alone
the bit that follows from it, which is the carbon contract. The
idea that energy policy should be run between government departments,
between Defra, DTI and Treasury, is not a recipe for creating
clarity for the market out there to try and predict what the incentive
structure is going to look like. It is partly dissatisfaction
with the structure of government at the moment which leads to
the suggestion that an agency might be appropriate.
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