Examination of Witnesses (Questions 212-219)
MR ALISTAIR
BUCHANAN AND
MR STEVE
SMITH
22 NOVEMBER 2006
Q212 Chairman: Welcome to this further
evidence session on our inquiry Climate change: the "citizen's
agenda", and we welcome Alistair Buchanan, the Chief Executive
of Ofgem, supported by Steve Smith, Managing Director of Markets,
which will make an interesting discussion as to what markets you
are the managing director of, but no doubt we will find out. I
have outlined, Mr Buchanan, to the Committee that you and I had
a very interesting conversation in which you briefed me on some
of the work of Ofgem and some very interesting information which
you had elicited, particularly about the use of public resources
in the context of energy saving programmes, and indeed renewables.
I was impressed by what you had to say and invited you to give
a short presentation to this Committee by way of introduction
to the subject and as a precursor to your evidence. You very kindly
sent round—and I think every Member of the Committee has
a copy—the presentation you are going to speak to.[2]
So could I, in formally welcoming you and thanking you for you
written evidence, ask you if you would speak to this additional
piece of evidence.
Mr Buchanan: Thank you, Chairman.
If you could go to page two of the very short presentation I have
given you, there are four areas where I think Ofgem can help the
debate, and I hope you feel the same after we have left today.
The first is in discussing the financial contribution by the citizen
and an awareness of the costs involved in the renewable debate
by the citizen, as I have put here, the best value per pound invested
and spent. The second is on regulatory barriers. That is more
naturally home for Ofgem. The third is how Ofgem can help to empower
the citizen in their homes; and finally, I think one of the areas
which I sense you are very interested in and possibly excited
by as well is the role of heat going forward. Let me take the
first issue, because in many ways this is the key element of my
short presentation. I think there are three key issues which spin
out of an analysis of the financial contribution. The first focuses
on the Renewable Obligation Certificates (ROCs). As you will see
on page three, ROCs as confirmed by the NAO, is the most expensive
approach to pounds per tonne of carbon and equally you will see
on the second table on page three that the subsidy of £470
million in 2005 will rise to £1.6 billion by 2015. So the
Chancellor will be looking at having to find that in 2016. Then
I have put the customer impact as a sense test for you at the
bottom.
Q213 Chairman: Let me be clear—and
there may be other colleagues who may want, if we may, to interrupt
for clarification—the ROCs as such, is that electricity
generator companies' money or public money? Let us just be clear
what the terms are here.
Mr Buchanan: This is subsidy money.
Mr Smith: This is customers' bills,
basically electricity customers paying this directly, and gas
customers.
Mr Buchanan: As we will come on
to in the next stage.
Q214 Chairman: In other words, it
is a subvention out of what we all pay for our power, so that
if the generator knows that they cannot generate enough renewable
electricity to meet the obligation themselves they build into
the price which we pay the cost of them buying the ROC?
Mr Buchanan: That is absolutely
correct. So I think the first issue I wanted to bring to your
attention was the scale, and again coming back to this issue of
best value. The second issue, which I think is the big strategic
core for you in policy, is the potential decision to make between
whether you look to put your subsidy all towards the renewable
schemes or whether in time some of that subsidy is going to be
focused on page four schemes, which are the local generation or
distributed generation schemes. The schemes which I have listed
in the middle of page four, micro wind, solar, ground source heat,
combined heat and power within the home, these are schemes which
effectively will need a degree of subsidy through an energy export
equivalents in order to make them compete within the marketplace.
One of the intriguing issues which I have, looking at what you
do, is where you get to the point where you say we can have over
£1 billion for the renewable subsidy, and we can also have
subsidies to promote the local generation schemes, or whether
you are in fact saying there is a defined pot and at some stage
we may have to make a choice between the renewable schemes (many
of them in the northern part of Scotland, which will come down
wires, where you will have transmission losses and SF6 emissions),
or whether you will actually play the subsidy towards the local
generation. The second financial issue which I was asked to address
was the degree potentially of return and profit made by those
who are enjoying the ROC. Again, the National Audit Office has
been very helpful to us in the report it issued last year, because
it said that both onshore wind and landfill will make substantial
profits excessively above the hurdle rate; indeed the figures
they used were 15 to 26% IRR. So when we look at the degree of
earnings power here, the NAO then asked Oxera whether in fact
a lower ROC price could give a decent return and Oxera said, "Yes.
They shouldn't be using £30 per megawatt hour for the ROC,
they should be using 15." This, I think, again might be an
issue which comes to the fore as companies start to release the
kind of money they are making here. Another important comment
from the NAO was that by 2026 (if the scheme is run through to
2026) they believe that a third of the return which the companies
are making is effectively super profit from the ROC.
Q215 Chairman: Is that because in
terms of the types of renewable power source which would have
been "subsidised" by virtue of the ROC, by whatever
write-down or life they would have had they would have paid for
themselves, and so if they last beyond that point where the economics
runs out then it is pure profit and they are getting the ROCs
on top of it? Because the ROC is a continuing obligation, I presume?
Mr Buchanan: There is that, yes,
and yes. I think the other thing is to step back a little bit
in history and say, when was the ROC put in place? The ROC was
put in place when electricity prices had fallen from £30
per megawatt hour to £14 per megawatt hour and in that decline,
around 2000 to 2002, of course British Energy got into terrible
financial trouble. At around 2002 the Government was seeking to
promote renewable energy and it could not do it at £14 per
megawatt hour, so effectively it assessed that a £30 ROC
plus the £14 you would earn in the market would give you
a return. The price of electricity today is £50 per megawatt
hour this winter and a ROC is around £40, so effectively
your potential wind farm operator is now earning £90 plus,
when of course they had originally calculated that the return
requirement would be more like £44. So there is an issue
there.
Q216 Chairman: Is there anything
in the legislation to allow variation to take place according
to market conditions?
Mr Buchanan: What we are waiting
for at the moment is that the DTI, as you know, is doing a major
overhaul of ROCs and a review of the banding of ROCs, and it could
be that within that overhaul and within that review of the banding
they will come to some decisions about whether it is right to
maintain the same level of ROC for a particular form of renewable.
I would just point out that these two schemes have been used in
Holland and in Spain and within the last year the Spanish have
withdrawn it and the Dutch have changed it.
Q217 Chairman: When you use the term
"banding", I presume that is the value of the ROC in
relation to the type of power generated?
Mr Buchanan: That is absolutely
right.
Q218 Lynne Jones: What about other
renewables? You have just mentioned wind, but the other renewables
are not yet competitive so—
Mr Buchanan: The work that the
NAO did was that you would barely make an adequate return on offshore
at that level, but of course bear in mind that that level was
two to three years ago rather than the current prices which we
are seeing.
Q219 Lynne Jones: There are other
renewables, for example wind and wave and tidal.
Mr Buchanan: Indeed, and their
economics may well need a higher ROC. Indeed, Scottish Power in
the past has said it needs to see £100 per megawatt ROC to
make wave at Orkney financially viable. I have got no grounds
for questioning that, but you are absolutely right, it is one
of the issues.
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