Select Committee on Environmental Audit Minutes of Evidence


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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