Examination of Witnesses (Questions 400-419)
MR ROBERT
ARMOUR, DR
STEVEN RILEY
AND MR
IAN FOY
3 JUNE 2008
Q400 Chairman: That would be a bad
thing?
Dr Riley: That would be. We were
fairly clear in our submission that we would not like to see further
vertical integration, further consolidation amongst vertically
integrated players.
Q401 Mr Weir: We heard a lot earlier
about the situation particularly in the European market where
there has not been the level of liberalisation that there has
been in the UK. Obviously many of the big European firms, EDF,
RWE and E.ON, are operating within the UK. Do you think it would
be a bad thing for the market for example if EDF were successful
in taking over Iberdrola of Spain and ended up dealing with Scottish
Power at the same time, having a further concentration of markets
and fewer than six companies in the UK?
Dr Riley: Yes.
Q402 Mr Weir: Very bad?
Dr Riley: Bad enough that it should
not be allowed without some conditions being placed on it.
Q403 Mr Weir: Given what you are
saying about liquidity, do you think the UK government should
be considering selling British Energy to one of these companies
perhaps, like EDF?
Dr Riley: It depends on the government's
objectives, does it not? If the government is looking for a creditable,
reputable company to build new nuclear going forward, a sale to
EDF for example would probably achieve that objective, but that
should not be to the detriment of the current liquidity and the
current market players. It could not just happen without some
other conditions being placed on that which might be for example
that combined entity auctioning some of its power through the
market or possibly even forced divestments, not necessarily of
the nuclear plant but of the coal plant that would be in that
combined entity.
Q404 Mr Weir: What you are really
saying is that the government then has to make a political decision
against liquidity in the energy market as opposed to its desire
for more nuclear power stations, for whatever bizarre reason they
may have for that.
Dr Riley: I think they could achieve
both if they put the right conditions on the transaction.
Q405 Mr Weir: What conditions would
these be? Would it be simple if EDF were to sell off some of their
existing plant in the UK?
Dr Riley: Yes, that would help.
Q406 Mr Weir: Would that be as an
independent entity to one of the other big six? By selling off
to the other big six are you not just shifting the concentration
but still having a greater concentration in the market?
Dr Riley: No. If there were some
power stations, either individual or a small portfolio available
for sale in the UK, that would get interest from new entrants.
Q407 Chairman: Mr Armour, you are
in a difficult position, I appreciate, in order for you to comment
on these questions. My prediction is that to sell British Energy
to one of the big six without some kind of corrective action,
whatever that might be, would not be appropriate because of the
effect on market liquidity. What you can and cannot say is a matter
for your judgment, I appreciate, in the situation you are in.
Mr Armour: Thank you very much.
I am constrained. We did make an announcement on 16 May that we
were in discussions with a number of parties. We have scrupulously
not said whether those parties are big six or different parties
beyond. Logically, the time to look at the implications of any
deal is if and when there is a deal proposed which you can then
evaluate. Equally, that is something that inevitably the competition
authorities would look at if that deal came to fruition. There
is no guarantee that it will.
Chairman: I would like to press you quite
hard but I think that is probably as much as is reasonable to
expect you to say in the circumstances.
Q408 Mr Oaten: Obviously we have
heard about an awful lot of the issues that are taking place in
the industry. There is a number of investigations and inquiries
taking place. There is also talk of a possible Competition Commission
looking at this and I just wondered whether you would see that
as something which would come in whether people felt it was necessary
or not. We just need to clear the air. Would you have concerns
that any inquiry like that and indeed some of the other ones that
are taking place are going to get in the way of some of the big
investment decisions that are having to be taken at the moment?
Dr Riley: It is clear in the current
environment of high energy prices that people would want to have
a look at the market and assure themselves that it is working
properly, or not as the case may be. I have no doubt that when
there are a significant number of regulatory reviews going on
at the same time in the market that that spooks investors and
it does delay investment decisions. Again, sorry to hark back
to it but when we look at investment in any market because we
have a choice as to where we put our capital, the regulatory environment
is one of the considerations we look at when deciding whether
to invest in a market. At the moment in the UK we all understand
the reasons why we are where we are but there is a lot of regulatory
scrutiny going on. I think the answer is clear. That does play
a role in people making their investment decisions.
Q409 Mr Oaten: The phrase that you
have no doubt: could you harden that up to say you are definitely
sure and you have seen examples of people being turned away because
they are concerned about the pace of regulation?
Dr Riley: No. I am really saying
that it is my view that investment decisions that people are considering
at the moment are being delayed while these investigations are
going on. They will wait to see the outcome before they make those
decisions.
Mr Foy: It is tough. If there
are investigations ongoing then, yes, it may well put people off
investing. However, from what you have heard today and what you
hear everywhere else, there is this problem around vertical integration.
Is it a problem or is it not? The way the market is structured
and the way we deal in this market I do not think is particularly
bad but all that needs to be cleared up is how do the vertically
integrated players operate. It is not the market. It is just do
they have true separation of businesses; are they operating efficiently
or efficiently for the whole market? That should be able to be
done fairly quickly.
Mr Armour: If something came out
of Ofgem's investigation, perhaps that would justify going to
the Competition Commission. Otherwise, I would very much echo
what Dr Riley was saying. A prolonged Competition Commission inquiry
at a time when we are facing a generation gap is not helpful unless
there is some clear evidence as to what we are chasing.
Q410 Mr Oaten: This goes back to
the significance of cash out, which I am a bit reluctant to get
into. How many times do you have a situation where the company
falls short of the contract and how many times do you have a situation
where you are spilling over, just so that I can get a sense of
how many times this happens and how significant an issue it is?
Mr Foy: Traditionally so far,
the market has been what is called long. The suppliers spill a
small amount of power. That is how they protect themselves. Obviously,
you are never quite certain how a customer is going to take the
fluctuation but the situation tends to be long. For us as generators,
our big problem is we lose plant instantaneously, so a plant trips.
At that point, you are going to be exposed to these cash out prices.
If you are lucky, it is just a couple of pounds above the price
of the power you have sold so it does not hurt. If you are unlucky,
it may be £500 or £600 a megawatt hour, ten times what
you have sold it for.
Q411 Mr Oaten: Is it happening lots
of times?
Mr Foy: Power stations are falling
off and units are falling off all the time. I remember some report
by NGC many years ago which was four hours hence, if you look
at the plant that is running, 400 megawatts will go missing within
that four hours. There are 120 units around the system. A couple
go missing every day and a couple come back every day. You will
be exposed to imbalance almost immediately when you trip and you
go to market immediately and repurchase power.
Q412 Mr Oaten: Is that worse in the
UK from mainland Europe?
Mr Foy: We do not trade in mainland
Europe. I do not know how that operates.
Dr Riley: The cash out mechanism
is just an integral part of the market design at the moment. I
would have thought almost at every instance suppliers will be
slightly out of balance and generators will be slightly out of
balance, so you have to have that mechanism there to ensure that
both parties are managing that as tightly as possible to reduce
the overall costs.
Mr Armour: This is why the vast
majority of trades are in the short term market in the run up
to gate closure and people are balancing their portfolio, trying
to get themselves in the right position to go into that last period.
Mr Binley: One of our prime objectives
is to discover whether the current market structure encourages
effective competition in the retail markets for gas and electricity,
as you know. My particular concern is business because I think
that unless we start thinking much more about wealth producing
sector—I am sure you would agree with me—we will be
in serious trouble in 30 or 40 years' time. I was pleased to hear
you say that you would not want to see more vertically integrated
companies in the market but, when I read that the building of
non-incentivised generation capacity—ie, large, conventional
new builds such as gas and coal—is noticeably dominated
by vertically integrated companies or joint ventures involving
vertically integrated companies, that brings me back to you. When
I also have evidence that tells me that the competitive margin
in the sale to industry is 0.5% of total costs, we have a problem.
That problem is partly of your making. I just want an understanding
of that because you are also involved—
Chairman: That 0.5% was a gas figure,
not electricity.
Q413 Mr Binley: Okay, but you are
also involved in creating an integrated market. You are happy
with the market place as it is. I see really quite distinct contradictions
here.
Dr Riley: Just for the record,
that was not our submission.
Mr Foy: That was ours.
Q414 Mr Binley: I know but it is
true, is it not?
Mr Foy: Yes.
Q415 Mr Binley: That is what counts.
Mr Foy: The passage is that the
majority of plant being built is being built by the vertically
integrated players. Everything, as far as we know, that is currently
being built is by vertically integrated players and not independents.
Mr Binley: I just do not understand why
you are not taking more concern from that perspective.
Q416 Chairman: I do not get a sense
from you that you are itching to increase your own ability to
generate. You are not burning with a passion to put more liquidity
into the market yourselves. Dr Riley, you have given some helpful
indications as to why that might be the case but I worry why people
are not burning with this desire. The small Opuses of this world
are complaining that they cannot buy electricity. They buy it
from you, Dr Riley, but they are complaining they cannot. Why
are they not putting small scale generating plants in themselves?
What is preventing them from becoming their own generators? Why
is the market looking so rigid from my perspective?
Mr Foy: I do not think it is looking
rigid. When you look at the numbers they do not seem to justify
building power stations.
Q417 Chairman: What is the smallest
power station you can build? CHP systems of course are quite a
prospect.
Mr Foy: The CHPs have similar
problems in this market. They tend to be relatively small but
they tend to be dominated by the heat load rather than the electricity
load. Most of the power stations that are probably going to be
built are going to be 800 megawatt CCGTs.
Q418 Chairman: What are the capital
costs of one of those?
Mr Foy: 500 or 600 million.
Dr Riley: I would say the total
installed cost would be over £500 per kilowatt.
Q419 Miss Kirkbride: The price has
gone up. Therefore does the price have to go up even more to make
it economical? Secondly, how come it would appear that in Europe
they can have more independent producers? What is it about England
that the barrier to entry is the price of building power stations?
Mr Foy: I do not know about Europe.
The price of power has gone up an awfully long way but so have
the fuel costs. The international cost of the fuel that Drax buys,
coal, from last September to now has doubled from about $70 a
tonne and I think it is now approaching $160 a tonne, so the margins
are staying relatively strapped in a tight band. Most of the commentators
in the market are saying they do not meet the new entry costs.
Dr Riley: There is a number of
questions there but I think the common theme is, if I put it directly
to us at International Power, why are we not considering investing
more in generation in the UK? I thought I had answered that partly
before by saying that we have invested money in Rugeley to keep
that open. If you take a look at what we have done since 2000
when we were created, we have increased our share of the generation
capacity from 500 megawatts to over 5,000 megawatts. That has
all been through acquisitions so far. We are doing that in partnership
with Mitsui & Co which is a big Japanese trading house. There
is a strong partnership there which is very interested in increasing
its exposure to the UK market and it is then just a case of finding
the right opportunity with the right risk profile before we could
do that. I do not think again that you should go away with the
conclusion that this market is not of interest to independent
power generators because that is not the case.
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