Examination of Witnesses (Questions 120-129)
MR DAVID
PORTER, MR
JOHN MCELROY
AND MR
ANDY LIMBRICK
28 NOVEMBER 2006
Q120 Colin Challen: The proportion
to be auctioned in Phase 2 is 7%. Do you have any thoughts about
Phase 3 and what proportion of allowances should be auctioned
in that phase?
Mr McElroy: I think that is an
extremely difficult issue because, ultimately, I think we recognise
that the whole point of emissions trading is to internalise the
cost of carbon. That is what it is all about, if it is going to
work. However, the simple fact of the matter is that Europe cannot
act in isolation. There are significant issues in terms of international
competition which are associated with auctioning, and I know that
other witnesses will be much more able to speak about that than
we are. Equally, there are issues regarding security and diversity
of energy supplies. Those all have to be taken into account in
deciding how you want to move to auctioning and the rate at which
you want to move. I think it is important that we see some sort
of consensus across Europe about the rate of that transition and
that it is managed in a sensible way which has to recognise the
competition and security of supply aspects.
Q121 Chairman: I put it to you that
it is an extremely simple issue as far as the electricity industry
is concerned. The only way we are going to drive forward a sustainable
power price and incentivise investment by the industry in lower
carbon electricity generation is to move as quickly as possible
to 100% auctions across the whole of Europe.
Mr McElroy: I actually disagree
with that for fundamental economic reasons. It is the scarcity
of allowances which drives the market and which drives investment,
not the method of allocation. The method of allocation is all
about winners and losers. If you talk to economists they will
tell you that it is through the cap on the scheme and making certain
that we have an efficient and liquid market where all parties
are engaged in that market that we will deliver those emission
reductions at least cost. The method of allocation is second order
in terms of the objectives of the Emissions Trading Scheme.
Chairman: On the contrary, because 100%
auctioning effectively puts a zero allocation and is rather a
good way of driving the price forward. Anyway, Desmond?
Q122 Dr Turner: You are concerned
with the post-2012 period and you want a phase after that lasts
at least 15 years—this presumably does not have to be a
single phase; it could be stepping up as it goes along—because
you are concerned that any plant that is already there is going
to be running for 40 years, so you want a stable platform. What
do you think needs to happen to ensure that the ETS mechanism
incentivises investment in lower carbon infrastructure? Is it
simply a question of drastically lowering the cap?
Mr Porter: The cap has to come
down, but the most important thing, apart from what level the
cap is set at, is seeing what we are calling a trajectory that
goes well into the future that all the participants can understand
and believe in. The absence of that at the moment is quite serious
for the industry. If you were to be contemplating building a new
power station today in the UK, you would be looking at it—if
it were something reasonably straightforward and you could get
planning consent, which is a question for another select committee
I think—beginning to produce electricity probably in 2010.
At the moment as you sit down to make your investment plans, you
have absolutely no idea whatsoever what your CO2 emissions
allowances are going to be beyond 2012. Your investment timescale
for your new power station, however, will run probably over a
period of 15 years and you will be expecting it to have a life
of a great deal more than that. Some of our stations still running
today are 30 or 40 years old. This mismatch is a cause of quite
a bit of uncertainty and increase in business risks at the moment.
The Government recognises it and we have had discussions with
them in the course of the Energy Review, but the problem is that
this is a European scheme and to get an effective solution you
have got to get the countries of the European Union around the
table to agree on something and the pressure is on; they need
to be doing that as quickly as possible.
Q123 Dr Turner: You still seem to
be thinking in the old CEGB mindset of chunks of power station
and half a gigawatt here or a gigawatt there. If we are looking
to a much more renewable future, it is not going to be like, is
it, it is going to distributed maybe 50, 100 or 200, at most,
in various places? It is a quite different mindset and a quite
different approach, which is possibly quite desirable. Well, it
is very desirable from the environmental point of view. What do
you think the ETS can deliver to encourage that?
Mr Porter: I do not think that
the ETS at the moment has a very big influence on the type of
power station, whether it is small or large. As the renewables
sector in the UK grows, given certain regulatory conditions, we
may well see large-scale renewables offshore and marine technologies
so they may not all be small and widely distributed.
Q124 Dr Turner: That is my point
exactly. But how can you change the ETS to encourage that?
Mr McElroy: I have to say that
the design of the Emissions Trading Scheme is not about picking
technologies; it is about providing an efficient market to drive
investment. It will be other policy instruments which sit alongside
the Emissions Trading Scheme which will influence whether particular
technologies come to the market or not, as well as the fundamental
issue of economics. I think our concern is that the EU ETS should
not be used as a market for picking winners. It is supposed to
drive emissions reductions at least cost.
Q125 Mr Caton: Following on from
Dr Turner's question, you mentioned the Energy Review and of course
in that the Government describes the EU ETS as "the central
element of the UK's emissions reductions policy framework".
How well do you think the Government's strategy on climate change
and its energy security strategy are working together and can
the EU ETS deliver them both?
Mr Porter: That is a good point
and from our position we want the EU ETS to be the main driver.
We want to stick with it. People have criticised it in its first
two years, but we still see it as valuable and the instrument
that we want the politicians to have faith in. The reasons for
that are fairly simple. One is that it is about cap and trade
and the cap actually ensures that you reduce your emissions, and
the trade ensures that within that cap that you deliver it efficiently.
We are in the very early stages of the scheme at the moment and
if it can be extended long term and people have faith in it, it
can be a major instrument of dealing with climate change in Europe.
John, would you like to add anything?
Mr McElroy: Absolutely in the
sense that getting a long-term carbon price signal is fundamental
to delivering both climate change policy and delivering energy
policy but, equally, one of the concerns is that if there is a
wider energy policy vacuum it may tend to narrow the range of
technologies in the market, which could impact on security of
supply. Sitting alongside EU ETS I think the whole area of research
and development and demonstration of emerging technologies is
just as important in terms of delivering the range of technologies
that we might want to see participating in the Emissions Trading
Scheme in the longer term. Generators at the moment are developing
the options—there are clean coal options for carbon capture
and storage being developed, there are marine options being developed,
there are offshore wind options, a range of things are there—but,
quite honestly, at the moment generators are saying, "We
will take these options forward but we cannot take decisions about
where we are going to go until we know what the policy framework
decision is post-2012," but we are not sitting back and doing
nothing.
Q126 Tim Farron: Looking again at
fuel switching, in your memo you say Phase 1 allowance prices
do not provide sufficient incentive for generators to switch from
coal to gas. What level would allowances need to be at to provide
the necessary incentive?
Mr Porter: That is a good question
but, of course, it is not an easy one to answer because you have
got three things to consider. You are looking at demand; you are
looking at the fuel price; and you are looking at the carbon price,
and the relationship between, for example, the price of gas and
the price of coal is very significant. You could have circumstances
where it might be necessary for the carbon price to be double
anything that we have seen so far before anybody would switch,
but in other circumstances there could be reasons for a generating
company to switch, even if the price was perhaps zero euros per
tonne. It is a difficult question to answer because of the dynamics.
Mr McElroy: The simple fact is
that in the first year of the trading scheme for a large part
of the time you would have needed to have seen allowance prices
of €40 or even €60 per tonne to drive switching. The
peak in the allowance price was around €30 per tonne and
the average was around €20. The fact is that the difference
between coal and gas prices is driven very strongly by the demand
for gas, which shows seasonal impacts. Gas prices tend to be highest
in the winter and lowest in the summer and they can vary sharply
from day-to-day or even hour-to-hour. So whilst the market initially
in the first six months seemed to be showing some correlation
between carbon price and the annual average cost of switching,
the short-term carbon allowance price was not reflecting short-term
movements in gas price, so the price was never really sufficient
to deliver anything other than a relatively small amount of switching
in the first year.
Q127 Tim Farron: Moving on a little
bit, what would be the impact, in your view, of carbon reductions
in the UK if carbon allowances did incentivise that kind of switch?
Mr Porter: You still have to take
account of fuel prices and customers' demand and the time of year
and so on, but broadly, I suppose it is fair to say, the higher
the carbon price the greater the movement over time towards lower
carbon technologies. However, I have to be very cautious with
the answer because it is not just a question of the carbon price.
A great deal is expected of the electricity industry and included
in the expectations are things like keeping prices as competitive
as they can be and, just as important as that, keeping the lights
on.
Q128 Dr Turner: What is the physical
potential in terms of the existing plant in the UK?
Mr McElroy: It is determined by
the capacities of the relative technologies.
Q129 Dr Turner: You know how much
coal plant there is and how much gas plant there is; you must
be able to do that calculation.
Mr McElroy: But the other factor
you have got to put in there is demand because ultimately the
demand has got to be met and that will ultimately determine the
amount of switching that you can do because you can only switch
on the slack capacity, the marginal capacity. Yes, we could give
you some idea of the switching potential and come back to you
on that.
Dr Turner: That would be very helpful.
Chairman: That has been quite a helpful
and certainly a revealing session. We are grateful to you for
coming in and we have managed to wind up just on the dot of five
past 11.
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