Select Committee on Business and Enterprise Written Evidence


Memorandum submitted by International Power plc

SUMMARY

  1.  International Power plc (IPR) is a UK-based FTSE-100 company with experience of operating and trading generation assets in a range of markets across the world—in the UK it controls a diverse independent portfolio of assets amounting to 7% of GB installed capacity.

  2.  IPR believes that that the GB wholesale energy markets are viable, competitive and relatively attractive to investors. The company has demonstrated its long term commitment to the market, and is an active trading participant.

  3.  It is concerned however with the potential increase in regulatory risk to its investments, as a result of the plethora of market reviews, investigations, and impact of EU proposals. We anticipate some change, evolution and ongoing scrutiny of markets, however, ongoing uncertainty over market design is unwelcome.

  4.  Although the market is in good health, we do believe that any additional consolidation amongst the six major vertically-integrated companies could be detrimental to competition and threaten liquidity.

CAPABILITY STATEMENT AND PERSPECTIVE

  5.  IPR is a fast-growing FTSE 100 company based in London, with interests in 40 power stations in 20 countries amounting to a net ownership of 18,824 MW of generating capacity worldwide.

  6.  In conjunction with its partner, Mitsui & Co. Ltd., it owns and operates a diverse generation portfolio in Great Britain, representing 7% of installed capacity.[279]

  7.  IPR's growth strategy targets key regions around the world (Europe, Australia, Middle East, South-east Asia, and the USA).

  8.  It has built up extensive knowledge and experience in a range of market environments, typically as an independent market participant, competing with utility incumbents.

In the GB market:

  9.  The company sells its output through the wholesale power market, and manages its fuel and carbon requirements through trading in the gas, coal, oil and emissions markets. It relies on sound liquidity, and transparency to support its business model and its remit is straightforward: it seeks to optimise its profits from these generation assets through active participation in the wholesale energy markets.

  10.  It has a substantial presence in the generation market, but its UK business remains much smaller than the main six vertically-integrated players. Without the diversity that having a significant supply business would bring, IPR is sensitive to the potential for large vertically-integrated players to influence wholesale prices such that they could undervalue generation costs, thereby cross-subsidising retail businesses.

  11.  Given that our experience and expertise in the UK is limited to the wholesale markets, this is where we focus our comments.

INVESTMENT CRITERIA

  12.  IPR's global portfolio is geographically diverse, and spread between merchant style markets, and those that offer long term power purchase agreements. The company's strategy is to seek profitable, and sustainable growth in power generation and associated markets. This means that its investments in merchant environments are considered very carefully against the company's rigorous investment criteria, and political and regulatory risks clearly form part of that assessment.

  13.  These investments are made for the long term, and IPR therefore seeks stability, predictability and transparency in market arrangements. It recognises that market design will evolve, and also that energy policy and security of supply remain highly political issues, but bases its investment on the assumption that this will not materially alter the fundamental economics of the opportunity.

OBSERVATIONS ON THE GB MARKETS

General

  14.  The GB energy markets have developed rapidly over the past 20 years, both in structure and in market design. The nature of electricity in particular (eg that it cannot be stored in large quantities) means that whilst commodity style markets can and have been allowed to form, some central controls are required to enable the market to balance and supplies to be delivered to the customer instantaneously. This is the basis of the NETA/BETTA market.

  15.  In general, there is much to be positive about with respect to the UK's energy markets. In comparison with other national energy markets, in the EU, retail competition is well advanced and market concentration is low. In the generation market levels of market concentration are even lower. Many of the continental markets are typified by one or two dominant firms, with few independents (in either retail or generation.) Market shares in the GB market are reasonably well spread between at least six players.

  16.  These views are supported by the government's own analysis, which concludes that the UK energy markets are the most competitive in the EU.[280]

  17.  However, as with all markets, there are imperfections and potential problems (eg inconsistent liquidity, volatility.) We are not convinced that these are material, and in any case, do not justify major market investigation and overhaul. This leads onto the next point:

Regulatory Risk

  18.  As a UK-based independent player with a diverse portfolio of global investments, we are increasingly concerned about the sheer volume of market change proposals, policy announcements, and major industry reviews (eg Transmission Access Review, Cashout Pricing Review, Industry Governance Review etc) that appear to be running in parallel in the UK.

  19.  Furthermore, the lack of uncertainty regarding the future shape of the EU Emissions Trading Scheme and the adoption of the EU Renewables Targets creates longer term price uncertainty in the power and carbon markets and threatens timely and efficient new investment in the industry.

  20.  These factors necessarily affect our willingness to invest, pushing up risk premia, and serving to deter potential new entrants that could deliver valuable competition to the incumbent players.

  21.  Therefore from our perspective, we perceive the issue of regulatory risk to be a much more serious issue for competition, and ultimately consumers, than any market imperfections.

  22.  We very much hope that this inquiry, and the separate inquiry into retail markets being undertaken by Ofgem, do not lead to significant market reforms. This would damage investor confidence.

Price levels

  23.  It is important to note that increases in wholesale prices seen in recent years do not necessarily indicate a more attractive market to independent generators such as IPR. Market value to generators is actually driven by the available spreads between price and fuel costs. Since the introduction of the New Electricity Trading Arrangements in 2001, IPM has not seen spreads sustained at levels where it would be prepared to invest in new build projects—high fuel costs have reduced margins available to wholesale generators. However, the company has pursued such projects in a range of other markets across the world where margins have been more attractive.

  24.  We therefore do not believe that any analysis of the wholesale market undertaken by the BERR committee could conclude that prices are "too high".

  25.  In any case, if higher prices were coupled with higher generator margins, this should, from time to time, be a natural feature of the market cycle, encouraging new investment when it is needed, and allowing operators to recover (material) capital costs. Any regulatory actions designed to suppress prices at these critical times are likely to be detrimental to customers in the longer term.

Liquidity

  26.  Liquidity in gas and carbon emissions is strong and does not warrant examination. However liquidity in the power market is less consistent. Under the NETA market when it was launched in 2001, traded volumes were slow to build, largely due the impact of the collapse of Enron (and subsequently British Energy amongst others) and the associated credit concerns.

  27.  In our view, despite improved confidence in trading since then, power market liquidity has not recovered to the levels that it would be expected to reach. This is in no small part due to the increased levels of vertical integration in the market—meaning that many trading opportunities are now internalised within vertically-integrated organisations. The design of the market is based on the external trading of a net position, quickly incentivising consolidation in order to reduce risk.

  28.  This does tend to limit strategic bilateral trading opportunities for standalone generators such as ourselves—increasing reliance on liquidity in uncertain, short term markets.

  29.  However, we do have confidence in the power market as it stands to deliver sufficient liquidity for our portfolio. We would become more concerned if market concentration was allowed to increase further, through potential M&A activity (eg EdF and Iberdrola.) between the large vertically-integrated players. This could start to seriously marginalise independents to the point where new entry would not occur.

CONCLUSIONS

  30.  IPR believes the GB wholesale energy markets are fundamentally sound, and the sector is one of the most competitive and liberalised in the world.

  31.  Regulators need to be wary of the threat of any increased consolidation amongst the main vertically-integrated players, to this position.

  32.  Regulatory risk is a growing concern in the UK to potential investors such as International Power. Regulators and politicians should be aware of the impact of unnecessary market upheaval on competition and ultimately consumers

March 2008







279   The portfolio includes the 1,000 MW coal-fired station in Rugeley, Staffordshire, a 500 MW gas-fired CCGT station in Deeside, North Wales, a 1,200 MW cogeneration plant at Saltend, Hull, a 140 MW oil-fired plant at Indian Queens, Cornwall, and 2,088 MW of hydro-electric pumped storage capacity at the Dinorwig and Ffestiniog power stations in Snowdonia. Back

280   Energy Market Competition in the EU and G7: Preliminary 2006 Rankings, by Oxera for BERR. Back


 
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