Examination of Witnesses (Questions 104
- 115)
TUESDAY 23 OCTOBER 2007
MR RAVI
BAGA AND
MR GRAHAM
MEEKS
Q104 Chairman:
Good morning, and welcome. Thank you for coming. Can we begin
on a general point really about how you think we are doing in
terms of renewables, in particular CHP, and how they are getting
on contributing towards the targets which the Government has given
to you?
Mr Meeks: I think slowly would
best be the way to describe that. As the Committee are probably
aware we have a target to reach of 10Gw of combined heat and power
capacity by 2010; we are presently standing at about 5½.
Interestingly Defra published on Friday last week a study which
suggested there was cost-effective potential to add not just another
target, say, 4Gw by 2010 but something around 8Gw. The reality
is that few in the industry actually believe that is a target
that is going to be achieved under the current set of incentive,
and indeed the incentives combined with the market conditions
that we are looking at today. Perhaps if you asked me for my best
estimate it would certainly be no more than an additional 1Gw
by the 2010 target date.
Q105 Chairman:
How much does the Climate Change Levy help in all of this?
Mr Meeks: It is often quite difficult
to tease out the impact of one particular factor or incentive.
Any investment in the power sector at the moment is going to be
affected by the underlying market conditions, the cost of the
fuels, the cost of the power, the competitiveness of other options
and also the other calls on capital the companies that are able
to invest could direct their investment towards. It has to be
looked at in that context. The Climate Change Levy itself is probably
only having a modest impact. It is a relatively small amount of
value that is being added, something as a maximum around £4.40/MWh
of electricity generated against the wholesale price that is typically
between £30-40. There is a general sentiment around the industry,
and of course it does vary depending upon site and application,
that in order to incentivise perhaps the sort of levels of investment
the Government would be looking for we should probably need a
level of incentive of something around £6-7/MWh. The CCL
provides at most £4.40, but in practice that value is eroded
through a number of other considerations—not least the discount
of 80% that is provided to Climate Change Agreement participants.
There are also other reasons why the value effectively leaks as
one tries to sell the power and realise the benefit. To realise
the benefit one has to sell the power to somebody else who is
paying the Climate Change Levy, thus realising the exemption.
Passing any commodity through a series of hands to reach the end
customer means that people take a margin on the way through, and
so we see an erosion of the value to the person who is actually
making the investment as we go through the supply chain. The practical
effect is very limited.
Mr Baga: If we just evaluate the
impact on investment in renewables then the buy-out price for
meeting the renewable obligation is £34.30 for the current
year. The value of a renewable obligations certificate for the
last year was £49.28 because there was a shortfall of about
2.1% against the dollar.[3]
The way the monies get recycled means that the value of renewable
electricity was worth an additional £49.28/MWh. In terms
of delivery against a target of 6.7% the actual performance in
the electricity sector was about 4.6%. If you compare the value
of ROC at £49.28 against the levy of £4.35, for which
suppliers can get an 80% discount the pull from the customer is
only worth £3, therefore it is an order of magnitude less
than the primary support mechanism for investing in renewables.
So in that sense the Climate Change Levy is not a primary driver.
In addition, when we are factoring in decisions on renewables
we will often question the longevity of the CCL mechanism, and
very often the value of that is discounted because it is by no
means certain that we will see the value of the CCL throughout
the life of the project. Looking at renewables investments it
is not really a great driver, and some of the prime obstacles
that we have got on renewables are more related to planning and
cost. That is all part of what we are here to discuss.
Q106 Chairman:
We are familiar with those kinds of difficulties certainly. Does
the fact they announced two weeks ago that the regime for both
the Levy and Agreements extends to 2017 have any affect on what
you have said at all?
Mr Baga: Partly, yes, but again
because the value is so low compared to the primary driver then
even at 2017 you are only looking at about six years of an operational
life and that is if you are deciding to build one today. It would
not be a significant factor in investing in renewables.
Mr Meeks: If I might just add
to that, Chairman. There was a statement in the PBR about the
extension to 2017; it still seems somewhat ambiguous as to whether
the Climate Change Levy is itself extended to 2017. There was
a statement on the Climate Change Agreements and one would ask
the question: if the Climate Change Agreements are in place, what
is the incentive to comply with one unless you are receiving the
benefit of an exemption? We are reading between the lines at the
moment, and we have written to the Financial Secretary to the
Treasury to try and get some clarification over that particular
point. I would also echo the comments that my colleague has made,
that this lack of visibility beyond 2012 is comprehensively undermining
the value of the incentive as it presently stands today.
Q107 Joan Walley:
In terms of trying to get that clarification what would your preferred
arrangement be?
Mr Meeks: Very much in the short
to medium term—given that the CCL is there, it is on the
table and it is something that people know and understand—we
would look to see a very clear statement from the Chancellor that
the Levy would stay in place over that timeframe. I would not
say it is necessarily the ideal outcome, but in terms of what
could be delivered over this very short timeframe through to the
Budget next year and given that we are at a period now where people
are considering investments, or considering new plants which would
only become operational shortly before 2012, we are looking for
something that is deliverable in the very near-term.
Q108 Colin Challen:
I am now getting the impression that CCL has done very little
to encourage new investment in renewables and combined heat and
power, but it has encouraged take-up of existing sources in that
regard. Is that correct? Is there no new investment flowing from
this at all; or is it now something that seems very useful?
Mr Baga: The CCAs and CCL I would
describe as a "good start". They were one of the first
climate change policy instruments designed to incentivise energy
efficiency. However, I think the difficulty is that they do not
recognise the ultimate objective, which is a cap on CO2 emissions.
So as currently structured you have a projected baseline and the
value you get is the reductions you achieve against that baseline
without any consideration of what the absolute constraint is that
you need to work within. In our view, it is an opportunity now
to realign this instrument so that we can meet the ultimate objective
of an absolute cap on CO2 emissions. In our response we outline
that we think the carbon reduction commitment, or the CRC, which
is due to come on-line in 2011, would provide an effective instrument,
even though we recognise that you would be paying for carbon twice—first,
protecting the price of your energy, certainly on electricity
[through the EU ETS], and, second, through the mechanism in the
CRC. We recognise that it is necessary to drive behavioural changes
to achieve energy efficiency, because as it currently stands we
do not think the pricing is strong enough. In the last two or
three years we have seen energy prices rise significantly, and
that has had some impact on energy consumption, but on its own
the CCL is not costly enough to really drive energy efficiency
changes.
Mr Meeks: If I might just add
a comment in direct response to Mr Challen's question. You can
probably look at the impact of a CCL and say, "What would
have happened if it hadn't been there?" The answer is that
we probably would have seen even less investments in CHP. It has
probably helped to incentivise those projects which were closest
to becoming economic without it, but it has not had a huge impact;
so one has to look at what would happen if it was not there. We
would see marginally less investment. The other danger that we
would have seen would be a plant which is already operating actually
switching off, or becoming something different; ceasing to become
a combined heat and power plant; changing to operate as a power-only
plant; but changing how it operated so that it could chase the
higher power prices that are available during peak times of the
day. Of course that works commercially; but it does not deliver
the environmental benefits that one would imagine the Government
is seeking. There is also some evidence from the report which
Defra published on Friday which I referred to earlier. Even in
that modelling it suggests that the impact of the Climate Change
Levy on their future projects is a maximum of 10% over their baseline
projections. Even with the CCL in place it would only increase
the amount of CHP that we would see by 10%, and I think that is
because of a number of failings in the system; perhaps the fact
that it is not reflecting some of the underlying objectives and
value that we should be looking to realise.
Q109 Colin Challen:
Just looking back to one of this Committee's inquiries a few years
ago, we had heard about the impact of NETA on CHP and how that
had been quite a bad thing for the development of CHP. Has the
Climate Change Levy in any way counterbalanced those impacts in
the past?
Mr Meeks: It has gone some way
to address that, but certainly a CHP plant has faced increased
risks operating under the new electricity trading arrangements.
The arrangements themselves look to reward flexibility and predictability
and a plant which is able to respond to those signals. CHP plant
will typically operate as what we call a base load; running for
the maximum amount of time; it will be designed to work with its
heat load, be it in an urban environment or be it in an industrial
environment; and in doing that it tends to be producing the low
value electricity under these market arrangements. It is fair
to say that in providing some value the CCL has addressed something
of that; but has not been sufficient to deal effectively with
the changes of the new electricity arrangements and, of course
the fundamentals—the fact that gas prices and other fossil
fuel prices have gone up. That is a generic problem.
Q110 Dr Turner:
You have already referred to the fact that two aspects of the
Climate Change Levy have tripped themselves up, in that the 80%
discount on the Levy under the Climate Change Agreements largely
cancels out the incentive of the Levy exemption for renewables
and CHP. How big do you think this effect has been?
Mr Meeks: I think it has been
hugely significant. You go from £4.30 to 0.2% of that, so
80p if you like becomes the value of that incentive. As I said,
in the Government's own modelling they have seen the impact of
that discount and, therefore, largely discounted the impact of
the Climate Change Levy.
Mr Baga: It really comes back
to one of the reasons why we are proposing some fundamental reform.
If you take CHP as an example, CHP has two products, one is electricity
and one is heat. Whereas the point on NETA is to do with electricity
sales, there is no real mechanism for recognising the carbon intensity
of the heat that comes from the CHP. The risk is that if we continue
to promote instruments which have confused objectives then these
are the sorts of results we will get. Therefore, we believe it
is an opportunity to refocus the instrument entirely on carbon
emissions and not on energy use. As a company we have made a commitment
to help reduce our customers' CO2 intensity by 15%. Therefore,
having an instrument which brings CO2 into the boardroom, such
as the CRC is hoping to achieve, then that would be very helpful
in focussing attention on carbon emissions. The way it would work
in practice is that potentially you could set the CCL rate for
electricity to zero, because people are paying for the carbon
in the electricity price that they are paying; and until such
time as we have an inclusion of gas in an equivalent trading scheme,
or have the carbon emissions associated with heating and gas accounted
for, then the CCL could provide that price signal to equalise
the carbon costs of heating and allow carbon-free technologies
or low carbon intensity technologies to compete on a level playing
field.
Q111 Dr Turner:
Another unfortunate thing is that, by definition, the industries
covered by the Climate Change Agreements are precisely those that
use the most energy. What would you like to see done to increase
demand by these companies for electricity from renewables and
CHP?
Mr Baga: I think the ultimate
objective is a reduction of carbon emissions. Therefore, having
agreements which do not place caps on carbon emissions is unhelpful.
I think EDF Energy supports the implementation of the carbon reduction
commitment because it will impose a cap on the carbon emissions
from the energy being used by large organisations. Until that
happens, or if that does happen, then that will provide a much
more robust constraint on carbon, lead to a stronger carbon signal
which will then in return provide a much stronger signal for investment
in low carbon technologies or low carbon intensity technologies,
both in heating as well as electricity. Our view is that we should
have streamlined policy rather than overlapping policy which does
not really address the fundamental issue.
Q112 Mr Caton:
Can we look briefly at Enhanced Capital Allowances that came in
at the same time as the Levy. What part have they played in encouraging
combined heat and power and microrenewables?
Mr Meeks: If I can speak for the
combined heat and power part of the question. The answer is mixed,
and it really does depend upon which the party is that is looking
to take the benefit of the Enhanced Capital Allowances. The Capital
Allowance, you understand, is an accelerated Capital Allowance
but it is available subject to a number of restrictions. The first
one of that is that effectively the party that is making the investment
does have the tax capacity to actually exploit the benefit. If
the business unit or the entity that is making the investment
does not have the tax capacity to actually realise the benefit
of the Capital Allowance then it is not able to realise that benefit
and it can be deferred into subsequent years, but the further
one defers it the less the value becomes. That is one restriction.
The second restriction is really on who the party is, and one
of the conditions of the state aid ruling in respect of the Enhanced
Capital Allowances is what we refer to as the "own-user test",
in that the investment has to be made (I paraphrase) to primarily
meet the energy needs of the site, deliberately therefore tending
to exclude schemes which may export a significant amount of the
power that they generate. At one level then that is a failing
to realise the opportunity. The benefit of CHP comes because there
is a big heat load there and one should really look to maximise
the amount of electricity and heat that one can produce simultaneously;
that is where you see the most carbon savings. There is also a
level of discrimination which gets introduced here, because what
it has tended to mean is that utilities, who tend to be the parties
most likely to invest in new power generating capacity of any
type, have been excluded from accessing Enhanced Capital Allowances.
If we look at the pattern of investment in combined heat and power,
or the opportunity for investment by the industrial sites, many
will not do it because it is a very large capital expenditure
item. It is not core business, and therefore they would look to
another party to make that investment effectively on their behalf
and then pay for that, finance that, through the charges that
they will pay for their heat and their power. That third party
more than likely would be a utility, or it could well be a utility.
By keeping the utilities out of the equation, if you like, through
this restriction what we have done is cut off perhaps one of the
most straightforward ways of actually realising the opportunity
and addressing the problems of access to capital that the industrial
sites would themselves have. Utilities have capital which they
would put to work investing in power stations, not manufacturing
paper, or biscuits or whatever else it might be; so that is their
core business; that is what would be the logical outcome. What
we have seen is that opportunity has tended to be limited and
the value has been restricted and cut off from utilities. One
caveat there: you can work around it; there is a scope to work
around it but it involves setting up further companies and further
administrative complexity; and every time one creates a new company
you have to license it; there are a whole plethora of licences
and overhead costs that would come with that. While you can access
the benefit then it will again be devalued by all these additional
costs that would come with it. In summary, ECAs are not universally
applicable and a simplification of the Enhanced Capital Allowance
regime to ensure that any party, irrespective of who owns it and
what their primary business is, if they were able to access it
then I think it would be a far more effective mechanism in driving
forward CHP in particular.
Q113 Mr Caton:
You mention the state aid rules, for CHP to really benefit would
we need to go back to get those reformed a well?
Mr Meeks: We would need to go
back and revisit this with the Commission certainly, correct.
Mr Baga: In our written response
to the Committee we did not really comment on this primarily because
we see it as a distraction. Enhanced Capital Allowances, depending
upon how they are structured, may or may not benefit individual
projects. I think the overarching aim is wanting to deliver a
robust carbon price signal which should bring investment forward
on its own right rather than relying on sweeteners provided by
the tax system.
Q114 Chairman:
EDF have made a submission suggesting reform of the whole thing.
Would you like to explain to the Committee briefly what you think
the advantages of that are and the fact that the regime may be
extended to 2017?
Mr Baga: The announcement that
it was being extended to 2017 did take us by surprise. Fundamentally
the question is still: do we think the existing mechanism is working
and do we want reform? In that sense our position has not changed.
The primary reason for reform, as I said earlier, is that the
current mechanism does not provide a cap on CO2 emissions; that
is one of the fundamental objectives that needs to be realigned
with the rest of the climate change policy instruments that are
being developed. Defra has published a consultation on a policy
instrument called Carbon Reduction Commitment. The carbon
reduction commitment will capture medium and large-sized businesses,
and it would place a cap on the CO2 emissions both from their
electricity use and from their gas use that is used in heat. In
essence we think this is a good opportunity to, if you like, abandon
CCAs and use the caps that will be driven through the carbon reduction
commitment to drive energy efficiency behaviour. Our proposal
is that from milestone five in 2010 CCAs are not extended. The
Climate Change Levy would continue for gas because we still do
not have a mechanism to price carbon in the consumption of gas
for industry; but the CCL rate for electricity would be set to
zero because consumers are paying for the carbon cost of their
electricity by the prices coming from EU ETS. As the carbon reduction
commitment develops, the initial phase of the proposal is that
all of the revenue that would be raised from the sale of allowances
in the carbon reduction commitment would be recycled back to industry,
but in the longer term if that revenue was not recycled and there
was a genuine price signal on the emission covered by the organisations
involved then that would give an opportunity to set the CCL for
gas to zero as well. In essence what that would do is force all
businesses and all types of energy to be driven by the same carbon
price signal. On the other two points, on renewables we see the
renewables mechanism as being the primary mechanism to deliver
investment renewables. There is some reform underway to recognise
the costs of different technologies. We believe that should be
concluded as soon as possible so that investors can get on with
the plans that they currently have in investing in renewables.
For CHP I think if we can get the CRC right, so that we have an
effective carbon signal on both heat and electricity and we have
a single carbon price looking across both of those, then CHP will
compete in its own right, given the merit of its carbon intensity.
Q115 Chairman:
The CHP Association are more relaxed about having the Levy operating
alongside in support of the ETS, is that right?
Mr Meeks: I think we are more
near-term in our outlook. What we are concerned about, I suppose,
is a short-term disruption to the pattern of incentives that we
see in front of us. I think in the long-term the movement to a
transparent, equitable, common carbon price across the market
which is the principle that my colleague described is probably
the sensible way to go, and one which we will invariably move
towards. The question is: how do we get there? I suppose the concern
for my members at the moment is managing the transition and providing
continuity in that process. As I say, my focus is perhaps somewhat
more short-term, rather than necessarily "relaxed",
Chairman.
Chairman: Thank you both very much for
coming in.
3 Note by Witness: For the last year the value
of the Renewable Obligation Certificate was £49.28 as there
was a shortfall of about 2.1% against the target, not the dollar
as indicated during the evidence session. Back
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