Examination of Witnesses (Questions 380-399)
MR ROBERT
ARMOUR, DR
STEVEN RILEY
AND MR
IAN FOY
3 JUNE 2008
Q380 Miss Kirkbride: I still do not
quite understand your position. The big energy players could still
have money to invest in big plant, nuclear and all the things
that the government and the UK want them to do. Surely what we
are talking about is just having more small scale suppliers who
are not going to be investing in nuclear plant. They are just
going to be providing small scale energy supply and giving a choice
to the people we heard earlier from to go to them, to offer them
their supply of power. I do not see why these things are incompatible.
You could just have more people supplying while still having really
big players in the market who are doing the big infrastructure
projects. Why are those two things incompatible?
Mr Armour: I do not think they
are.
Q381 Miss Kirkbride: The inference
of your remarks seemed to suggest that they were. We can only
be a big guy because we want to invest in big things and therefore
we have to have a monopolistic position in order to that we can
then cash it out. That is how it sounded to us.
Mr Armour: I was going back to
the Chairman's quote from the Opus statement which said that in
an ideal world you do this. Alan Asher I think said the same thing
a couple of weeks ago. That is fine in theory but in practice
you have to balance what are the challenges facing us and is the
industry structured to deal not just with the short term but with
the long term.
Q382 Miss Kirkbride: I did not quite
understand Mr Foy's position either. If you have a vertically
integrated company so you have your power supply and your customers,
your argument was that as long as those two things do not cross-subsidise
there is not a problem. You have a wonderfully monopolistic situation,
have you not, where you are completely in charge of supply of
the market and complete control. No one really likes moving their
electricity supplier. Even Energywatch only does it to find out
what it feels like if you are a customer and how boring and difficult
it is. No one actually moves their electricity and gas supplier
because it is just too damned difficult, so you have got the market
cornered. It is a wonderful monopolistic position surely. It has
nothing to do with cross-subsidies.
Mr Foy: The issue is that, as
long as the big six remain of a similar size and they all get
into a group think and they do not take each other's markets,
then that is exactly what will happen.
Q383 Miss Kirkbride: It is all very
cosy.
Mr Foy: They look very stable
at the moment.
Q384 Miss Kirkbride: You are saying
it is all right as long as they do not cross-subsidise, but it
is not all right because, as we just said, it is all too cosy.
Mr Foy: Why do they do this? How
do they do this, if they are indeed doing it? They make themselves
potentially look like each other. They all take an equal share,
15% or 16% of the total supply market. They have a range of powers
stations which they can call on at any time. They do not have
to go out into the market, compete and buy power because they
know they have reasonably fixed customers. I do not know what
the answer is to fixed customers. You cannot force people to move.
Q385 Miss Kirkbride: I accept that.
Mr Foy: The down side of that
is you get inefficiencies within each of those vertically integrated
companies. To some extent you may even see it now in the market
where you have old, small, 250 or 350 megawatt coal fired power
stations which are base loading and other 500 megawatt efficient
units which are shutting down. You get this internalisation of
costs. If they end up internalising these costs and valuing it
how they value it rather than how the market values it, eventually
what you end up with is an expensive fleet of power stations in
the UK and generally rising prices. The vertically integrated
players are going to go out there and make these big infrastructure
decisions. Why cannot a small independent make these infrastructure
decisions?
Q386 Mr Binley: I am seeing an argument
which suggests that you as generators need to have a reasonably
secure market place based on a price that gives you the confidence
to invest in the future. That has created a scenario where average
wholesale prices in the UK, apart from other factors—and
I recognise those—are almost 30% more than they are on the
continent. That is a massive price for the consumer to pay to
guarantee investment and therein I think lies my concern and the
concern of some of my colleagues. In fact, you are not thinking
about your consumer at all. That worries me in a business. When
a supplier gets so divorced from the market place that there is
no thinking in his philosophy about the consumer, I get worried.
I have not heard any thinking at all about the balance between
the interests of the consumer and the interests of the generator.
Would you respond to that?
Dr Riley: Maybe part of the answer
to this is what do we do when we are thinking of investing in
a new generation station. Perhaps I can start there. That may
or may not be in the UK. At the end of the day, there is no investment
from us in a new power station if the customer cannot afford the
power that comes from that. If we build in Portugal, the Netherlands
or anywhere else, whether that is under a long term contract or
whatever the arrangement is, there has to be an offtaker for that
power. That is not likely to be us because we do not own a retail
business. We do not have long term customers. In Portugal we have
just started to build a new power station. That is with a Spanish
company coming in as a new entrant, in the retail to the market.
They are taking a view as to whether, at that price, they can
gain new customers from the incumbent. Ultimately, because we
do not have that direct interface with the domestic consumer or
even at the moment with the large, industrial consumer, it is
a bit hard for us to say do we have the customers' interests at
heart. At the end of the day, if customers cannot afford to pay
for electricity, we do not have a business.
Q387 Mr Binley: It is a sneaky argument
for further vertical integration, is it not?
Dr Riley: No. I am definitely
not here to argue for further vertical integration. I do not want
to see any further vertical integration.
Q388 Mr Binley: I assume you are
a capitalist and you believe in competition. I assume you believe
in serving the consumer. We are both businessmen. We have a sort
of basic philosophy and I assume that is yours. How then do you
explain a market place where one of the major users of your product
has not had a competitive approach in three years? If that is
the case, is there not something seriously wrong with that market
place that you say is not broken in any sense?
Dr Riley: I cannot answer that
question.
Q389 Mr Binley: I think I know the
answer. I think it is clear: "Of course it is right but I
do not want to say it." Is that not what you are telling
me?
Dr Riley: No.
Mr Oaten: You are asking the wrong people.
Mr Binley: I do not think I am asking
the wrong people.
Q390 Chairman: I think you are.
Dr Riley: We do not sell gas.
Mr Binley: The point I am making is that
the whole market place has closed down dramatically in the last
five years to six major players in the generation business and
not many more major wholesale sellers. It has closed down sizeably.
Chairman: Mr Armour is the biggest single
producer in the country.
Q391 Mr Binley: Vertically integrated
companies have aided that particular movement. We have arrived
at a situation where the market, we are told, has become massively
less competitive. You are involved in that process.
Mr Armour: I was surprised to
hear that, partly because we are the supplier currently supplying
Mr Tane. I certainly had expected other people to be competing
for that business because I know we competed pretty competitively
to get it.
Q392 Mr Binley: Does it bother you?
Mr Armour: It is very surprising
to me. That comment was not what I expected.
Q393 Chairman: What I am really puzzled
about is that new entrants are not building conventional gas and
coal fired generator capacity. The big six are. Why?
Mr Foy: We do not see how the
spreads can justify a reasonable return on a power station. We
are somewhat surprised that the big six are building them.
Mr Armour: You may look at prices
now but over the last five years we have been operating in a pretty
volatile market which equally has an impact on the ability to
take forward projects. Looking forward, there is a degree of uncertainty
on the price of carbon. The price of electricity going forward
will be volatile. All of that has to be factored into the market
which you are trying to invest in.
Dr Riley: There are other reasons
why that might be the case in the UK. The vertically integrated
players also by their nature are part of bigger European utilities
generally with big balance sheets, so they can afford to build
new entrants on their balance sheets. An independent power producer's
business model again is quite different and we would look to the
debt markets to raise a significant amount of project finance
to fund that development. Then you are into what you need in place
to raise that project finance in the first place, which is a medium
to long-term off-take agreement. Again, we go back to when we
make those investments in other markets. You are looking to do
a deal with an incumbent or with a new entrant to mitigate your
risk by taking some of the supply for a period of time. We need
that to raise the finance to build vertically integrated players
by virtue of the fact that they are parts of companies with big
balance sheets, not necessarily just because they are vertically
integrated and can finance that in a different way.
Q394 Chairman: If I understood Mr
Foy's answer correctly, inevitably the spread between fuel costs
and wholesale prices is an important determinant of an investment
decision. It has to be, by definition. There is an implication
that spreads could possibly be wider for the big six.
Mr Foy: Again, this comes back
to separation of businesses. If they are operating the business
in the same way as we are, they should be seeing exactly the same
spreads as us.
Dr Riley: The spreads that they
would observe in the market should be exactly the same for everybody.
The difference that there might be is that their return requirements
or their costs of capital might be different than other players
and therefore they might be prepared to build with the same technology
and the same spreads but they would see that that would deliver
a different return than their competitors.
Q395 Chairman: Should we be requiring
them to be separating out their accounts so it is clearer what
is happening in the vertically integrated companies?
Mr Foy: That is certainly one
way of doing it. You see where the value is. Again, if we have
a different cost of capital, it is slightly different. You would
also probably expect them to compete amongst each other, not just
with the independents. Do they try and take the market share of
the other vertically integrated players?
Q396 Mr Bailey: Arising from the
comments of Mr Armour about the volatility of the market, in the
context of some previous comments, as independent operators you
are relatively happy with the market as it has functioned. I hope
I am not putting words into your mouth. That is how I understood
the comments that you made. What concerns me is that there is
a general feeling that it would be beneficial to have more independent
operator suppliers within the market but that the existing market
volatility ensures that only the big six have the ability to raise
investment, to if you like provide more capacity; yet you as independent
operators seem quite happy with that situation. I find it rather
strange.
Dr Riley: I do not think you can
say that it is only the big six who can raise the investment to
build new infrastructure.
Q397 Mr Bailey: I am not saying that.
I interpreted that from what you said.
Dr Riley: We own five power stations
in the UK. Three of those have significant levels of debt on them
that we were able to raise in a merchant market without a long
term contract, which is normally what is required to allow us
to own and operate those power stations going forward. The market
will go through various cycles and there will be points in time
when we would hope we would be able to raise finance to invest
new in the UK. There is also a question I think around what you
would class as investment in new capacity. If I take Rugeley,
our coal fired power station which is quite an old power station,
we are currently investing over £100 million in flue gas
desulphurisation equipment there to keep open capacity that otherwise
would have closed in 2015. There is investment from independent
power generators in capacity in this market under the current
rules.
Q398 Mr Bailey: I welcome that. I
worked in Rugeley Power Station many years ago.
Mr Foy: You say we are happy with
the way things are. When I said I was happy, I was referring to
Mr Clapham's point about the mechanism in terms of cash out price.
As Dr Riley said, it is a secondary issue in terms of how this
market operates. I cannot see any great need to delve into those
balancing type rules. In the wider market itself, vertical integration
is a potential issue.
Q399 Mr Weir: We have talked a lot
about the big six and their place in the market. What do you think
the impact of the sale of British Energy to one of these big six
would have on market liquidity?
Mr Foy: If all that power got
tracked it would have a huge impact on market liquidity. That
would take an awfully big piece away and you do need volume. You
need a lot of players out there to make a market, to make it worthwhile,
brokers being in existence and everyone else. It will be a big
issue.
Dr Riley: Liquidity works, clearly.
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