Examination of Witnesses (Questions 349-359)
MR ROBERT
ARMOUR, DR
STEVEN RILEY
AND MR
IAN FOY
3 JUNE 2008
Q349 Chairman: It seems that two or three
of my colleagues have taken the opportunity for a brief respite
from the intensity of the question session and they are returning
as I speak. Can I welcome you gentlemen to the second part of
today's evidence session. Thank you very much indeed for what
you have put in writing and what you will say to us today. Can
I begin as I always do by giving you a chance to introduce yourselves
and explain who you are one-by-one.
Mr Foy: My name is Ian Foy and
I work for Drax Power. Drax Power owns Drax Power Station which
is the largest, cleanest, most efficient power station in the
UK. We supply 7% of Great Britain's electricity needs. We sell
power in all markets from half an hour ahead to several years
ahead. We operate in the wholesale market. We do not carry supply
business; we are a pure generator.
Dr Riley: My name is Steve Riley
and I work for International Power plc which is a FTSE-100 listed
company. Our business model is quite simple: we own and operate
power stations in various markets around the world. My responsibility
is for the European assets which include five stations in the
UK. Again in capacity terms that is about 7% of the wholesale
market. In energy terms it is a fair bit smaller then Drax because
it is a portfolio that is more peaking and mid-merit in nature,
so it is not a base load generator.
Mr Armour: My name is Robert Armour
and I am from the General Counsel of British Energy. We are primarily
a nuclear merchant generator. We have eight nuclear stations and
a coal station in Yorkshire. We supply about 17% of the British
market. We do not supply to the retail market. We supply to the
wholesale and the industrial and commercial market.
Q350 Chairman: I think you have largely
answered in your opening questions helpfully the first couple
of questions of who do you sell to and how do you sell but possibly
not quite about long-term contracts, spot markets and that kind
of thing. What kind of contracts do you have, Mr Armour in particular?
Mr Armour: We try and build up
a portfolio of contracts over a period of time. As I say, we sell
about half our output on the industrial and commercial large business
sector and about half into the wholesale market which tends to
have as counter-parties either financial institutions or other
utilities which will sell on, so that is where we are. We try
and build up our contract portfolio over a period of time. In
many cases it is quite difficult to get contracts that are much
over a year to 18 months, except perhaps with some financial institutions.
Q351 Chairman: Does anyone else want
to answer that question?
Dr Riley: I will add something
to it probably. Again, we would sell all of our power through
the wholesale markets and we would trade with probably about 30
different counter-parties. Ultimately all that energy would get
bought up by the suppliers to the domestic or the commercial sector,
but there are probably about 30 counter-parties that we can trade
with. We would probably agree that in terms of liquidity we could
sell as far as two years out some of our output but not all of
it. Within year we could probably sell all of our output if we
wanted to.
Q352 Chairman: I think it is helpful
of you to explain that link and I think that has helped build
a picture of the nature of what your businesses are. Mr Armour,
you are presumably absolutely a price taker given that you are
basically a generator?
Mr Armour: Nuclear generation
tends to be a price taker. We have a coal station which provides
some peak and shape to our electricity. I suppose the market price
is set largely by gas rather than coal, so it is pretty rare.
Q353 Chairman: Dr Riley and Mr Foy,
how do you describe your positions as price takers or price setters?
Dr Riley: I would comment that
we do not really see that there are price setters and price takers
in the same way that there were in the previous version of this
market. All of our sales are done bilaterally through the wholesale
market but in terms of our portfolio of plant, as I said earlier,
that is more mid-merit and peaking in nature, so under the old
rules you would have considered those to be price setters.
Mr Foy: We tend to be, if you
can describe it that way, a price taker given that we are a highly
efficient coal plant.
Q354 Chairman: The retail market
holds no attractions for you?
Mr Foy: In terms of Drax, our
expertise is generation; that is what we know and that is what
we are good at. If you do look at the retail business it appears
that in order to take part you need a volume of customers and
probably what are sometimes referred to in other places as sticky
customers. We believe that going to market and trying to buy those
is probably quite difficult, it is whether any of the big six
would let them go; and we would very much doubt it.
Mr Armour: You need a different
set of skills and to put in quite sophisticated systems to deal
with large volumes and numbers customers, and that is something
we have not invested in.
Dr Riley: In terms of domestic
customers, we have no real interest because we do not think that
is a business you could grow organically. That could only happen
if another supply business or one of the current six came up for
sale for some reason, we think, because you need some sort of
scale. We do have a small investment in one of the small independent
retailers, Opus Energy, but that is very much us trying to get
an understanding of how the retail market works in that sector,
which again is in between the large industrial sector that the
gentleman on my left operates in and the domestic sector that
you will be talking to the vertically integrated players about
some time later.
Q355 Mr Binley: Why do you particularly
want an understanding in that market at that depth? What do you
intend to do with that understanding?
Dr Riley: If I revert back to
International Power's business model, our risk mitigation is by
having power generation in different markets (which may or may
not be correlated) so the risk mitigation we get for our quality
of earnings long term is through that diversity of portfolio.
Clearly there are other ways of mitigating those risks in various
markets, and retail might be one of those, so we would like a
better understanding of what is involved.
Q356 Mr Binley: So an option is to
grow vertically?
Dr Riley: That is an option but
I think it would be more in the industrial sector or the small/medium
enterprise sector rather than the domestic.
Q357 Mr Clapham: We have seen various
changes from the early pool system right from NETA and now the
current cash-out arrangements. Could you tell us how the cash-out
arrangement, which operates in both the electricity and gas market,
actually works and what your concerns are about it?
Mr Foy: I will explain. We do
not deal in gas so I will not comment on gas. The cash out arrangements
with electricity which were introduced in 2001 were designed to
stop any cross-subsidy, it was integral to NETA that we had a
dual cash out price, so production and consumption accounts were
kept separate. In our opinion, they work reasonably well. They
do what they are supposed to do. There is some talk or some desire
possibly to go to a change in these cash out arrangements where
we go to single cash out. It is probably our view that that is
a bad idea and that will lead to more short termism. What you
will get is more and more plant being taken to the day ahead stage
and just picking up the index price, trading off the back of that.
Eventually you end up back at something that probably looks like
a pool with the risk of industries getting caught up.
Q358 Mr Clapham: Is that the view
of you all with regard to the cash out regime?
Mr Armour: There is some debate
within the industry as to whether a single cash out—
Q359 Chairman: What is single cash
out?
Mr Foy: If you fail to meet your
contractual obligation—ie, the power does not meet your
contract position—and if you produce too much power onto
the system, you effectively spill onto of the system. NGC pay
you so much for that power. If you are short and if you have not
produced enough to meet your contract position, NGC will effectively
go and purchase that power from very short term markets and supply
you with that. These two prices are different. If you are short,
if you are not supplying enough, the price tends to be punitive
and tends to be higher than the price you could have achieved
in the forward markets. If you spill or throw power onto the system
that is not required for contract, it will tend to be lower than
the price you can get in the market or maybe equivalent, so it
encourages contracting.
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