Examination of Witnesses (Questions 66-120)|
MATTHEW FARROW, DR JEFF CHAPMAN AND DR JOHN MCILROY
19 OCTOBER 2010
Chair: Welcome. As you
know, we took evidence on this subject last week. You may have
seen what was said then. Would you like to introduce yourselves
Matthew Farrow: Yes, good morning. I am Matthew Farrow, Head of Energy, Transport and Planning at the CBI.
Dr Chapman: I
am Jeff Chapman. I am Chief Executive of The Carbon Capture &
Dr McElroy: I am John McElroy. I am here this morning as the Chairman of the Environment Committee for the Association of Electricity Producers.
Q66 Chair: Would
you like to say what you think the purpose of an Emissions Performance
Standard should be?
Matthew Farrow: Shall I kick off perhaps, Chairman, if I may? I think there can be no secret that the CBI has never been a big fan of the EPS concept, precisely because it is not obvious to us what its purpose or what value it might add would be. I think there are two questions. The context that we probably all share is the need to decarbonise electricity very substantially by 2030. The question then is, would EPS contribute to that or not? I think, to my mind, there are two questions within that.
One is, does it add value to existing policy and a second is, does it increase or decrease uncertainty for investors? I think our view would be, with existing policy, given we have a policy established by the previous Government, which in effect would stop the permitting of completely unabated new coal without some CCS demonstration, it's not obvious what an EPS, unless it was set much tighter than that, would add.
In terms of uncertainty, I think our concern would be that a new piece of regulation, which could be changed possibly quite easily by future governments, is more likely to increase rather than decrease uncertainty for investors. I think those are the two questions the Government would need to address in bringing forward an EPS: what would it add to existing policy, restricting new coal build; and would it not increase uncertainty for investors?
Dr McElroy: Yes, I would agree with what Matthew has said. I think it comes back to where we are trying to get to in this issue. Ultimately, what we are trying to get to is a lowcarbon electricity system. The issue is, does the EPS help facilitate that and I think that is where we have major problems. EPS is essentially a moratorium on fossil plant, but the key issue for us is investment in lowcarbon technology. I think EPS on its own certainly doesn't deliver investment in lowcarbon plant. So the issue really is the market design and getting that right to stimulate investment, and EPS, if introduced in the wrong way, could be more of a barrier to the goal than a facilitator.
Dr Chapman: I would agree with those comments. I would like to take us forward to 2030, when we ought to be thoroughly decarbonised in the power sector. Of course, fossil-fuel power stations will never emit zero emissions. There will always be some emissions and they will have to be accounted for. So, in order for your fossil fuel power station in 2030 to qualify as an effectively zeroemitting power station, there will have to be an Emissions Performance Standard.
At the moment, though, our view is that we don't need Emissions Performance Standards. We have sufficient policy in place to take us into the next phase of transition. We welcome very much the energy market or the Electricity Market Review that John has just referred to. That is really very important indeed.
I would just like to point out that a lot of people think that an Emissions Performance Standard is some kind of way of introducing a nocost, or lowcost, option to decarbonise fossil fuel power plants. That is not going to happen because the cost of decarbonising fossil fuel power plants will ultimately get passed through to the consumer. Applying a stick like an Emissions Performance Standard is probably a fairly blunt instrument to do that and is probably going to result in a higher cost than alternative methods.
At the moment, if we rely primarily on the EU ETS, that clearly
is not going to deliver; the recession has exposed the cap as
being hopelessly loose. So you could have a situation where,
given the longterm nature of investment in power stations,
Britain continues to build power stations whose performance is
nowhere near going to be adequate to reach the goal we have to
in 2030. So we would then be faced with a much more expensive
system where we would be buying in huge amounts of allowances,
and the carbon price in the late 2020s might be quite high. The
folly of not taking action now would then be paid for by the next
generation of electricity consumers.
Dr McElroy: In terms of coal plant current policy, effectively, an EPS wouldn't add to that anyway because of the requirement to demonstrate CCS on any new coal plant. So I don't really see what an Emissions Performance Standard is adding in that area. Clearly, there are issues around CCS and gas and whether there is a role for CCS on gas in the longer term. I think we need to be careful there in the sense that gas is already considerably lower in terms of carbon intensity than coal and has a role to play in the transition. It also has a role to play as flexible plant in the system as well.
So it is a question of coming back and asking how we get there in a holistic manner. Emissions Performance Standards may have a role at some point, but I think how you set them is critical, when you introduce them is critical and making certain that we don't deter or scare off the right investment that we need is an absolute priority because we will need some gas plant in that system to help us get to a lowcarbon economy.
Dr Chapman: All new power plants must be built "carbon capture ready" and that may not be the most efficient way to do it because it is very important to integrate the design of carbon capture with the design of the power plant itself. But, for the moment, it probably is the most efficient because you couldn't fit every new fossil fuel power plant fully with CCS anyway; it just would be unworkable. We need the capacity. So we need to build new plants. So we need to build new plants that are "carbon capture ready" and can be retrofitted by design later on.
I think, Chairman, we shouldn't lose sight of your point about
EU ETS, which we still see as a core tool here. The purpose of
ETS is to deliver the cap at lowest cost and that is what will
happen. You are absolutely right to point out that, because of
the recession, the current cap for Phase III is not as demanding
as people had imagined it would be and that is why the price is
lower than expected. There is a debate about whether it is
providing a sufficient incentive.
I think part of the need is, as well as looking
at alternative measures in the Energy Market Review, to look at
how we can make sure ETS is performing effectively. So, for example,
with Phase IV, where the directive already has an indicative trajectory
for the cap, if we in the UK feel we need to be decarbonised pretty
much, as colleagues have said, by 2030, I would imagine that
is pretty much the same across Europe, given the overall European
targets. So you expect the phase for an ETS cap to be going down
to equate to virtual decarbonisation of electricity by 2030.
There is a debate to be had, I suspect, about Phase III. Now, we haven't taken a view on whether you should actually look again at the cap at Phase III, but you can imagine people saying perhaps that might be a sensible thing to do. So rather than simply saying, "ETS isn't working, can we invent/create a new set of regulation to address those concerns?", I think one should at least look at ETS and make sure that it is functioning as effectively as possible.
As colleagues said, given that we have a policy which in effect prevents unabated new coal from being builtso that shores up the need to prevent a lot of new fossil fuel being builtand given that CCS demonstration support is going to be initially, at the most, for four projects, then we are going to see, at the most, four new coal plants being built in the next few years. So the debate then becomes around, would EPS do anything for gas?
I think, initially, we are clearly going to need some gas-fired power stations to provide energy security for the next few years or so. The debate is then about in the 2020s what happens to those gas stations. I think, as colleagues say, it is conceivable one might want to use an EPS at that point. It might be that a very tight ETS cap is doing the job for one, but at this point now it is not clear to us what an EPS adds over the existing coal policy.
I think it is a bit bizarre to say that relying on gas increases
energy security. It seems to me it is one of the things that
actually decreases energy security. It is clear from the figures
produced by the Climate Change Committee that unabated gas by
itself doesn't actually get us anywhere near where we need to
be. So if we start building loads of gasfired power stations,
in addition to exposing our dependence on the goodwill of Mr Putin,
we are actually going to deliver a system which doesn't meet
Matthew Farrow: The question, I think, is, certainly by 2030, if you had more than about, I think, 15% or 20% of unabated gas in the system, it becomes very hard to meet those targets. Then, as Jeff said, all the new fossil fuel power stations have to build "carbon capture ready". So the debate is around how one would incentivise/encourage the retrofit of CCS on those gasfired power stations.
My point about energy security is that in the short term, when we have so much capacity coming off the system, certainly our judgment would be we are not going to get new nuclear and enough renewables on to the system quickly enough by 2016/17 to make up for what is coming off. Given the policy on coal, we are going to need something to fill that gap plus something to back up the intermittent wind, and it is hard to see what else that could be apart from gasfired power stations.
Perhaps it is not our subject today particularly, but like yourselves, we in the CBI have had concerns and reservations about a heavily gasdependent system going forward, and our members' view is very much for a diverse system to try and balance energy security needs. But I think there are some developments in the international gas marketthe discovery of shale gas and exportation of shale gaswhich possibly make the international gas market a slightly more comfortable place to be than we had suspected. But I think the key is a diverse system, and that goes back to the Energy Market Review that we have all referred to.
Dr Chapman: The location of gasfired power stations will be very important in the context of being "capture ready" as will the ability to lay a CO2 pipeline from the station, principally to the coast, and principally to the east coast. It may well be that some of our existing gasfired power stations will become stranded because it may not be worthwhile providing a CO2 pipeline over that distance to outlying stations. So we will have to think very carefully in the future about how to ensure that new gas capacity can be decarbonised into the future.
Q69 Sir Robert Smith:
One of the things we were hearing last week was that the EPS would
have the benefit of sending a signal to the highly capital
intensive investments with low fuel costs, where the ETS is not
so effective in sending that signal. Is that something
Dr McElroy: I would question that. It certainly sends a signal to discourage fossil fuel plant, but the issue is, does it send a signal to encourage investment? I think this comes back to the fact that we need a range of policy issues addressed, both on CCS and on nuclear, to bring those technologies forward. Without that, an EPS doesn't deliver and doesn't actually provide any comfort in terms of the rate of return on those investments.
Dr Chapman: I think we have a policy signal. We have an 80% reduction target by 2050 and we have the Climate Change Committee recommending that, in order to get on the trajectory to hit that target, we need the power sector more or less completely decarbonised by around about 2030. That, I would say, is a sufficiently strong signal. We don't need the EPS at the moment because, as John said, it is likely to result in quite substantial unintended consequences.
Just explain why it is such a bad thing. I am not quite
Matthew Farrow: I will pick up the points I was alluding to earlier on. I think the question is: does it add anything to existing policy given we have, in effect, a ban on new coal without CCS?
What are the malign consequences, though? You may say it's not
necessary, but I can't quite see what damage it is going to do.
Matthew Farrow: My concern would be, and colleagues will have their own thoughts on this, that it won't add anything and what it will do negatively is it could increase uncertainty because, if you say to investors, "We have all existing policies, e.g. ETS, etc, etc, and we are going to introduce a new policy, a new regulation, which is a standard and that standard could perhaps be changed almost on a whim through secondary legislation of a Minister at some point in the future," as an investor I would be thinking, "How can I be sure my longterm asset is going to always be compliant?"
Why on earth would a Minister want to do something which would
destroy the investment? The car industry has been having this
special pleading for years, saying that they can't improve engines,
and, gradually, we have discovered they can improve engines.
Matthew Farrow: Again, colleagues will be able to give more detail on this, but with energy investments you have a long timescale. So you have to be convinced that your asset will earn returns over that timescale so that you get payback on the investment.
One of the judgments the investor has to make is the political risk around that investment in terms of change in regulations, and that might be the planning system, the carbon price and so forth. I think the potential negative of an EPS, introducing it at this point, would be if it introduced another uncertaintyanother policy mechanism in addition to the others, which could be changed, possibly quite frequently. I think if the Government does persist with the EPS concept they need to show to investors how it wouldn't be subject to frequent change.
Dr Chapman: Can I put some broad numbers on to this? Let's talk about coalfired power stations for a moment. A coalfired power station emits about 900g or thereabouts per kilowatt hour of CO2, and a gasfired powered station is about half of that. The current policy for a new coalfired power station is that you can't build one unless it is equipped with about 400 MW of carbon capture and storage. 400 MW out of a regular 1600 MW power station would be about quarter of the capacity and so it would reduce the overall emissions by about a quarter. It would reduce it by about 200, let's say.
So that would bring it down to about 700g. You can impose an EPS of 700g and end up with the same policy, but if you impose an EPS of 500g or 400g to bring it down to the same level of gas, then nobody will build that station because there isn't a policy in place to provide the incentive to do so. Subject to what the Treasury says tomorrow, we are going to be struggling even to justify the incentives on the four that are currently proposed.
Dr McElroy: I think, adding to that as well, in terms of the whole CCS strategy, an Emissions Performance Standard is essentially a standard imposed at one end of the chain. We have the whole issue then of transport, infrastructure and networks. We have the whole issue of the storage end. If you impose standards at one end of the chain without having the necessary policy framework, establishing the liabilities and the other aspects in terms of, "What's the cost of accessing the network going to be?", there is a whole host of issues which need to be resolved if you are serious about the CCS option. I think it comes back to the need for any EPS to be set within the context of a coherent policy framework, not just on CCS but on lowcarbon policy in general.
Q73 Laura Sandys:
What you are also saying is that there are too many different
regulations and too many different layers, but, John, you are
also proposing that there need to be layers right the way through
the whole supply chain. If one, let's say, parked EPS, what are
the drivers that are going to really truly jumpstart the
investment in CCS and other technologies that make you think that
EPS is merely an additional distraction? Where do we get to and
what policy framework do we need to deliver that investment and
to deliver the targets that we need to achieve?
Dr McElroy: I think
there are a number of issues here. There is the market framework,
first of all, which is vitally important, so, "How do we
ensure a return on that investment?" There is the planning
framework, and the consultation on the NPSs was launched yesterday,
so having a planning framework which we know delivers. There
is the whole issue of liabilities and making certain that those
are clear so that we know what the endoflife liabilities
are on CCS, on nuclear, etc. We need to understand the boundary
conditions and also have a market framework in which the
investment can be delivered.
Q74 Laura Sandys:
But what you are saying is that EPS only covers one end of the
socalled regulatory framework.
Dr McElroy: Yes.
Q75 Laura Sandys:
But what you are now also saying is that we have got regulation
right the way through that framework. So why is it not possible
to have something that is specifically environmentally driven
rather than just market driven?
Dr McElroy: I think it comes back to this issue of doing things piecemeal. I think what we are saying is it needs to be thought of holistically and the policy framework needs to be rolled out.
Q76 Laura Sandys:
And holistically it would work within a framework?
Dr McElroy: If we knew the technology was deliverable. We are in a demonstration phase. That is an important consideration with CCSexactly what performance will be delivered on coal, on gas, etc. So it is unusual in any technology to be trying to introduce performance standards when we actually haven't demonstrated the technology commercially anywhere. So that is unusual.
Can I add that I think the most important thing of all is
the incentive to build CCS? I think CCS, however you look
at itand you can only look at it in theory in the sense
that we haven't built the plants yetlooks set to be a considerably
costefficient way of reducing this country's emissions.
Therefore, compared with many other instruments of policy that
are supplementary, if you like, to the EU ETS, CCS would not cost
very much on the public purse and could be encouraged into existence
with the right incentive very easily.
Q77 Christopher Pincher:
What are those right incentives?
Well, as it happens, in
Q78 Christopher Pincher:
You're ready for the four stations, but there is no guarantee
that will continue. If it does have to continue, that surely
is going to feed into the cost price for the consumer.
Dr Chapman: Yes.
Q79 Christopher Pincher:
So what is the major cost incentive?
Dr Chapman: As I think I mentioned before, whichever way you do this, it is going to cost the consumer, and the consumer will be paying, if you like, for premiumgrade electricitythat is, electricity without emissions. So, yes, it will feed into the consumer.
What I would like to draw attention to is the fact that here in the UK we have invented a mechanism, that will support CCS investment, which is probably uniquewell, it is unique in the world. A lot of other countriesand they have to be congratulated for doing soare throwing a lot of money at CCS, such as, for example, Canada, which on the face of it is very much ahead of the UK, having already selected four projects and put $2.5 billion towards them, so it looks like it is further ahead.
But we have in the CCS levy an excellent mechanism which can be applied to the first four projects but then to the retrofit of the rest of the stations where the first four projects are and also to more projects as they come along. This mechanism can be tailored to the market as it moves forward and can be fitted in to whatever comes along in the Electricity Market Reform, which we are all looking forward to.
Matthew Farrow: It's perhaps worth adding, if I may, that obviously most of the CBI's members are energy users, so price is perhaps a key concern, but we also feel CCS is such a crucial technology for decarbonising our system in a secure way that we have supported the policies which Jeff has outlined.
So, even though a CCS levy will clearly add a slice of cost to all users, we think that is a price worth paying, as it were, to actually get CCS moving. We have lobbied the Chancellor very directly and very strongly on the need to retain all four projects. There's been lots of press speculation that that might be scaled back. We feel it would be a big mistake to do that, and obviously hopefully tomorrow we will find out whether we have been successful in that. But, as I say, despite the fact most of our members are users and therefore concerned about cost, we think actually the CCS levy is the right thing to do.
Q80 Dan Byles:
Just on that, on the cost, do you think there are any steps that
the Government can take to try to minimise the potential impact
on energy prices for consumers, and of course for industry, because
what we are talking about here potentially is us running ahead
with developing premiumgrade electricity that is going to
saddle the rest of industry with higher energy costs than perhaps
some of our competitors who may not be running ahead quite so
quickly towards this premium energy.
Matthew Farrow: I have two points to make in response to that. I think the first is that the best way to try and ensure the increase in costs is as small as it can be is to have an efficient market system, and so that is why I think all of us are so concerned about the need to have an orderly process of energy market reform and make sure that we have the right sort of framework and the right sort of policiesthat we are not throwing policies at the problem without thinking through the implications.
In terms, then, of the specific cost on industry, our concerns are very much focused around the socalled carbon leakage sectors, so there are sectors such as steel, cement and chemicals which are competing often on price with competitors outside the EU, and, as you say, they are facing potentially, certainly going forward looking at the projections, increases in prices above what their competitors face.
I think the Government has recognised there is an issue here and the debate around free allowances under ETS is a way to try and protect those sectors. I think for the economy as a whole, while the cost will be unwelcomeand all of us dislike paying moreit is a manageable cost. I think there will be particular sectors who are quite exposed, and increasingly we will need to look at specific ways to try and provide a level playing field for those sectors. Free allowances is part of that. The ETS directive allowed Member State Governments to pay compensation for cost price increases and so on, and I think we are going to have to start looking at that sooner or later.
Q81 Dan Byles:
Do you have any concerns that this whole approach could lead to
reducing the diversity of energy supply within the UK, with the
knockon effect that not only do we become more exposed to
price shocks in certain types of raw energy, raw materials, but
also, of course, we have already talked about energy security,
and the less diverse our domestic supply, the less secure we are?
Matthew Farrow: I think again colleagues will have their own views, but my view would be potentially it does; it needn't necessarily, but potentially it does. Our settled view is that the best way to protect us against energy insecurity is to have this mix of generationso nuclear, renewables, fossil fuels. If we can get CCS demonstration up and running, that gives us some new coal on the system. We are going to need some gas, clearly. If an EPS led to only certain types, if it made new gas very difficult to build, for example, I think that would be a shortterm concern.
Dr Chapman: This is very much where the reform of the electricity market needs to come in because the nuclear generators will be generating flat out on base load; the wind generators will be generating intermittently; the public will be consuming electricity intermittently; and the fossil-fuel industry has got to fill that gap and has got to be very, very flexible.
What that means is that very few fossil fuel power stations will be running on base load in the future. Many of them will be running at midmerit, i.e. a proportion of the time. Some will even be running for a very, very few number of hours each year, and that is something that we need to look into. But what it means is that those stations, especially those stations running on midmerit, will be even more expensive because they are equipped with carbon capture and storage. So what we have to do is to create an electricity market structure that compensates power plants that have been built specially to be that flexible, and we don't have that at the moment and that is what we need into the future. We need to be able to pay for the availability of capacity to keep the lights on as well as for the kilowatt hours of carbonfree electricity.
Q82 Dr Whitehead:
CCS means gasfired power stations, base load only?
Dr Chapman: You could say that with current technology. It is not always going to be the case. Coalfired power stations used to run on base load. Look at what they do now.
Q83 Sir Robert Smith:
But you would say it with current technology?
Dr Chapman: Yes.
Q84 Dr Whitehead:
But we don't know what technology might come to the rescue of
base load gasfired power stations running on CCS.
Dr Chapman: And also we don't know how yet we will improve current technology.
Q85 Dr Whitehead:
Isn't that rather a significant considerationthat
if all gasfired power stations for the future are retrofitted
with CCS, they, on present knowledge and understanding, effectively
become gas versions of nuclear power stations?
Dr Chapman: There are plenty of engineering ideas and engineering ways to make fossil fuel power stations with CCS flexible. The first thing we have got to do is to build some running flat out and make sure that we are on the case to begin with.
Q86 Dr Whitehead:
As far as the incentives, however, to get to a position where
CCS might be deployed on a far wider basis than the initial
demonstration projects, what is clear is that you would need some
form of convergence between the likely cost of CCS on that retrofitting
and then the decisions that that plant will have to make to enter
the electricity market
Dr McElroy: Yes.
Dr Chapman: Yes.
Q87 Dr Whitehead:and
the likely price of carbon which will cause those decisions easily
to be made. What is that convergence point? What is the likely
price of carbon that would cause that sort of decision to be made
and that power station to operate easily in the sort of market
arrangement you have described?
Dr McElroy: I think that is a very difficult question to answer because it will depend on what the price structure in the market is at that time. There is a lot of talk about capacity mechanisms at the moment and how capacity mechanisms might play in. There is the issue of what the flexibility of the fleet is.
Equally, I think the other part of this equation, when we get to looking at what is the role of flexible fossil plant in the longer term, is what happens in the demand side and how responsive can the demand side be, because, if through the rollout of smart metering and decarbonisation of transport and heat and other mechanisms, we can use demand-side response to manage intermittency on the supply side, that can change the whole economics of the supply side as well. So I think it is actually a very difficult question to answer in terms of what price signal you think you would need to justify CCS on a peaking plant.
Q88 Dr Whitehead:
I appreciate that that is difficult, and certainly the question
of smart management of the Grid, for example, could make a big
difference, but I would have thought it would be possible
to have a go at a range. Perhaps we could try some
ranges. Higher than £20?
Dr McElroy: Yes, absolutely.
Q89 Dr Whitehead:
Higher than £40? Higher than £60?
Dr Chapman: That should
Q90 Dr Whitehead:
Okay, so we are talking about higher than £60 and maybe,
Dr McElroy: And maybe more than that. It really comes down to exactly what the market structure is at the time.
Q91 Dr Whitehead:
So we are agreeing a range of, say, £80 to £100.
Dr Chapman: Well, McKinsey did a report a couple of years ago that came up with a range for the first round of plants of 60 to 90 and later on they would expect the price to drop down to 30 to 50. I think everybody expects that those figures are probably a bit on the low side.
Q92 Dr Whitehead:
Dr McElroy: And
they also reflect base load rather than our peaking capacity.
Q93 Dr Whitehead:
I imagine you would probably agree that it is extremely likely
that EU ETS by 2020 would be nowhere near that level.
Dr Chapman: But I think if you convert, for example, the cost of providing ROCs to offshore wind into pounds per tonne of CO2, say, then you are still talking about CCS being good value compared to that. I don't want to put these in competition because they are complementary.
Q94 Dr Whitehead:
But it becomes good value at a certain point of a carbon price.
That is what I think is the key point.
Dr Chapman: Yes, well, we just don't have the carbon price to encourage any particular investment in Europe at the moment, do we?
Matthew Farrow: If I might pick up the implication of the question, I think we are all agreeing that one would need mechanisms to ensure decarbonisation into the 2020s. I think my starting point would be let's not give up on the EU ETS. An enormous amount of effort by Governments, politicians and businesses has been put into ETS. The Phase IV cap has yet to be set. Logically, if you wanted a decarbonised electricity system by 2030, you would set the cap to deliver that, and, of course, for investors it is the expectations of future carbon price that is importantnot the price today.
Having said that, if ETS is not delivering that market signal, we are clearly going to need alternative mechanisms. I think my view would be, "Well, let's see whether the Electricity Market Reform the Government is planning to bring forward can deliver that", but, if an EPS is needed as part of that in the future, then I think that would be legitimate. I think the CBI has no ideological opposition to an EPS. Our opposition is to a policy where the need is not clear at the moment and may not be needed at all. Let's wait and see whether we need it at the time as opposed to putting it in now, given that it might have some negative effects.
Q95 Christopher Pincher:
As to the design of the EPS, that is crucial if one is going to
come. There is a lot of debate about what a good EPS
design should be. Should it be plant-based, which could remove
from the picture fossil fuel burning plants, potentially? Should
it be fleet driven, so should the performance standard be across
a particular supplier's generating fleet? Should it be carbon
intensive? What is your view as to the most desirable, or least
undesirable, EPS design?
Dr McElroy: If we start at the UK fleet end, which is the energy intensives, etc, I think the issue there is we have the EU ETS, and trying to introduce something within that covering such a broad range is going to get incredibly difficult, and all sorts of potential complications could arisearbitrages, etc. I think then you are looking at individual portfolios, and I would say that that is very difficult as well because of the nature of the range of individual portfolios within the UK and the very different mix of plant.
So that could actually be quite discriminatory in terms of how it was introduced. Then we get down to plant level. I think there are real issues there, particularly during the demonstration phase, as to what size is the overall plant and what proportion is abated and what is the performance of that abated plant. So it is quite a complex issue in terms of how you would set that, particularly at this stage in time given the state of the technology. Ultimately, I think it comes back to what is it that you are really trying to achieve at the end of this and what is the role of an EPS in achieving that?
Q96 Christopher Pincher:
It is entirely possible that if you go for an abatement EPS then
you are going to possibly increase the gap in the energy market
because you are taking existing plants out of production. They
need to be filled possibly by a "dash for gas".
So you are either creating a difficulty for your energy
security, potentially, or you have that energy gap.
Dr McElroy: I think part of this comes back to the question that Dr Whitehead raised earlier in terms of the peaking plant as well, because that is another aspect which you would have to take into consideration in terms of whether a peaking plant needed to be abated or not.
Q97 Dr Lee:
Moving back to the CCS technology and getting it on stream as
soon as possible and the potential economic benefits of it, we
are talking a lot about reducing our CO2, but,
as I understand it, there are some economic benefits here
if we get up to speed and then we can start rolling that out.
Do you think the Government's current demonstration programme
on its CCS levy will make us technology ready by 2020 for wider
Dr Chapman: Assuming that we get positive things tomorrowand I fully expect that we willthen I think the programme at the moment is proportionate. We need to get on with it immediately, and, incidentally, if we do get on with it immediately there is a good chance that we will win about 50% of the capital funding for three of those projects from Brussels. So that is a very good reason to get on with it now. I think it is proportionate for now, but immediately, as soon as we get these plants on track, we need to start thinking about how to roll it out because we don't have time to hang around if we are going to meet those Climate Change Committee targets.
Q98 Dr Lee:
I am struck that the carbon price matters hugely here, doesn't
it? I have been looking at this briefing and the Committee on
Climate Change projection of a carbon price at 56 per tonne
by 2020, and its current analysis says 22 per tonne. That's
a pretty big difference, isn't it, trying to work out what
the carbon price is going to be? They've done that because of
the impact of the recession. We are going to have recessions
in the future; we haven't got rid of boom and bust, have we?
It sort of comes and it goes. I think with that sort of
backdrop, how do you incentivise deployment? What has to happen
to the carbon price?
Dr Chapman: That's why, potentially, we have an excellent mechanism in the levy. Incidentally, we don't actually know how it will be dispersed yet, and we have some views on that, but we will have an opportunity to share those with DECC another day. But, potentially, there are the bones of a very, very flexible mechanism in which the dispersal can be tailored each year to just the amount that is needed to incentivise CCS across the whole rollout.
Q99 Sir Robert Smith:
I have just a quick question on the development of CCS. Are the
other barriers being got out of the way fast enough, such as regulations,
knowing what you can do in terms of sharing pipelines, and, in
the future, of what can be happening under the North Sea in terms
of international agreements? Is there enough urgency in that
side of things?
Dr Chapman: There could be more. We still have some outstanding. The most important thing that has happened recently is that we have had to look at the liabilities on storage operators, and whilst we have achieved a huge amount of movement with the European Commission in their regulation in this respect, we haven't got to the end of that piece yet.
So we still have something left to do. In the main, the international maritime legislation is almost there. I think, for down the road, our biggest problem is likely to be that the London Convention prevents transboundary movement of CO2, but that's not going to stop us storing CO2 in our own territory. We in the UK have a considerable lead on the rest of the world in terms of our own regulation, and so we are in a good position generally, I would say.
Q100 Sir Robert Smith:
If we can get the finance for it.
Dr Chapman: It is the finance.
Q101 Sir Robert Smith:
Dr Chapman: It's the finance.
Q102 Tom Greatrex:
I think we've all heard your wariness about an EPS, but I just
wonder if I could give you an opportunity to crystallise
your point in response to something which has been raised by quite
a few respondents to this inquirythe suggestion that
an EPS would increase regulatory certainty. A map would
therefore, in turn, support development of CCS. I have got
a flavour of what I think your view is on that, but
if one of you would like to crystallise that into a succinct
point, that would be useful.
Dr Chapman: Matthew, I think you've said it before.
I think it's not clear to me what EPS would add over the
existing coal policy, and the concern would be that, if an EPS
is there as an instrument which Ministers in the future can tweak
and change fairly easily, there will be a concern among investors
that will see continuousor not continuous, but periodicchanges
to an EPS in the future which will actually make it harder to
judge the value of investments. I think if the Government
are to persist with an EPSand they have said they wish
to do soa priority for them is to try and find a way
to reassure investors that it would not be changed in a frequent
I think the other point I would make is that
what has made the whole debate about EPS a slightly unusual
one is that there's a consensus among business in the energy
industry that we need market reform and new market mechanisms
to enable the lowcarbon investment to come forward, and
there is a lively debate in industry about the combination of
instruments and about floor price capacity mechanisms, obligations
and so forth. The Government has said, "We'll consult on
all those but, regardless of the consultation, how it's written,
the responses, how the debate goes, an EPS is part of the answer."
I think our concern is, "Well, wouldn't it make sense
to look at all the mechanisms and how they might interact?"
If everyone agrees EPS is part of the answer, that's good and
that will reassure investors, but why prejudge your own consultation?
Q103 Tom Greatrex:
Then is your concern more about timing and how things fit into
other mechanisms than about the concept of an EPS at all?
Matthew Farrow: That is the prime concern. I think we would expect the Government in the consultation to have things to say about an EPS, and, as I say, we are not ideologically opposed. We can't see at the moment how it would actually add value to policy without creating uncertainty, but I think we are willing to have that debate with the Government. As I say, what seems slightly curious is that the Government has said that, regardless of all the other possible mechanisms and how they might be used, an EPS is always going to be part of the answer.
Dr Chapman: Mr Greatrex, I wonder who has been suggesting that EPS would bring regulatory certainty. Would they have been investors or would they have been people who are more observers than investors? I think what you have got here are representatives of investors saying that it doesn't.
Q104 Tom Greatrex:
But Dr Chapman, your organisation said in your submission
that the introduction of an EPS in California had positive outcomes
for CCS development. So is there a difference between what you
are arguing about for the UK and what happened in California and
what are the reasons for those differences?
Dr Chapman: I think there are peculiarities in California in their regulatory regime. EPS seemed to work in a certain circumstance. I am not even sure that it would work as a general rule rolled out even in California, but in California there are lots and lots of associated support mechanisms that are bringing forward, for example, the BPsponsored project.
Q105 Tom Greatrex:
Right. So again it is about going back to the point you were
making before then. It is about what other mechanisms exist in
the environment long term.
Dr Chapman: If the financial support isn't there, industry will not invest. You have to make a return on your investment.
Q106 Tom Greatrex:
Okay. Just quickly on investment decisions. I think the
CBI submission, and others, suggested that once CCS is proven
then investors will use CCS technology without any form of mandation.
What kind of fiscal and regulatory framework would need to be
in place for that to be the case, do you think?
Matthew Farrow: Again, I think this comes back to the Energy Market Reform. It could be that the carbon price is sufficient to drive that, and, as I say, this comes back to the Phase IV cap and how that is set. It could be that some combination of capacity mechanisms or lowcarbon obligations, perhaps, like a reform of the RO, might be the way to drive it.
As I say, I think our view is let's have a look at the Energy Market Reform and see how we can best use that to get the initial investment in nuclear and renewables and so on to gather momentum. Let's aim to make ETS then the overall framework for the 2020s with a tight cap that drives investment in the right way. If ETS is not providing the right signal, and for whatever reason the other mechanisms that are put in place are not either, it would be legitimate at that point to look at an EPSthis would be my viewand see if that is the final piece of the jigsaw. But, as I say, it is not obvious at this stage what an EPS would add to the situation.
Q107 Albert Owen:
Just to keep on the theme and pin you down on some of the answers
that you have given earlier, you say about "other incentives"
and you mentioned that you were looking forward to the Electricity
Market Review and possibly carbon floor price had been a mechanism.
Do you see that as complementary? I heard what you have
just said in your previous answer that "maybe if these things
don't work," but that is a bit of a risk, isn't
it? You want certainty. What I am saying to you is, is
EPS necessary with a carbon floor pricing, given how you
understand the carbon floor pricing mechanism might develop?
Matthew Farrow: I will try and give a sense of our general member view on this and then again colleagues might want to add some specifics. We published a report in the summer last year called "Decision Time" which looked at the whole question of decarbonising electricity and energy security.
What we said in that report was that a consensus had emerged among our members, collectively, users and suppliers, different generators and so forth, that the current market wouldn't drive the investment in a lowcarbon generation and we needed some reform to the market to do that and there were various options which could be looked at. A floor price is one; lowcarbon obligation is another; capacity mechanisms is another. We didn't single out EPS because certainly no member was saying to us that would make the key difference. What we also said was different companies have a slightly different perspective or view about the right combination of mechanisms. My sense is, at the moment, the view is that a floor price alone would not be sufficient but it would probably need to be applied
Q108 Albert Owen:
Sorry, Mr Farrow, my question is: do you think an EPS and a floor
mechanisma carbon floor priceare complementary?
Matthew Farrow: Would that drive? Not necessarily, because, as colleagues have said, an EPS by itself doesn't drive investment. It simply limits certain forms of investment which are limited already. So my view would be no, but, again
Dr McElroy: I would agree with that point. I think on carbon floor price, the general view certainly within the electricity sector is that on its own it's not sufficient to deliver and it comes back to the issue of, if you were going to set a carbon price, a carbon floor, what would be a politically acceptable level? I would suspect that the level at which you would need to be able to set it would not be politically acceptable.
So the issue is how can you target efficiently the design of the market to bring forward that investment? It comes back to the point that Matthew madethat an Emissions Performance Standard is not an incentive for lowcarbon technologies. Therefore, what we are saying is that you need something in addition to a floor price, and the general view of the electricity industry is that that needs to be something which is market-aligned, which takes you into areas such as a lowcarbon obligation of some kind.
Dr Chapman: I think you must bear in mind that there are kind of floor price proxies in a way in the renewable obligation, and in this context the levy will be a floor price proxy. To actually put a floor price on carbon in the UK is a unilateral act within the 27 countries of the EU. I am personally not sure how that works. But in every country in the EU, pretty well, there are carbon floor price proxies, whether it is feedin tariffs, renewable obligations or whatever.
Q109 Albert Owen:
That answers it, and I know Dr Whitehead wanted to come in
on that one, but can I just again pin you down and arrive at a conclusion
that you think EPS is a disincentive? Let us be clear about
that. That is what you are telling us in a roundabout way?
Dr McElroy: It is certainly a disincentive at this stage in time, yes.
Albert Owen: Yes, thank
Q110 Dr Whitehead:
You are looking forward to the Energy Market Review and one of
the big issues, I guess, with the Energy Market Review, as
has already been mentioned, will be the question of how the energy
market will change in order to incentivise the emergence of peaking
power plant in a way that has assumed to be a part of
the market mechanism itself currently, which is that inefficient
plant retires and then becomes available for peaking within the
existing market system.
That will not be the case in the future and therefore,
presumably, part of the process of the review would be how to
incentivise, as it were, that plant to come on stream just for
peaking purposes. You have suggested that, if those plants are
abated, not only can't they be easily available for peaking but
perhaps there should be specific exceptions within the review
for that to happen. Is that your view?
Dr McElroy: It comes back to, I think, the point I made earlier in exactly what is the role of peaking plant in the market in 2030? I think that is very hard to describe, and to actually develop market incentives for that now, I would suggest, is very difficult and probablygiven that no market arrangements have survived more than ten years or sopremature. I would very much say that the priority of the Electricity Market Reform is to get investment in lowcarbon technologies underwaythat is the absolute mustand to get on the path to 2030 we have got to get CCS demonstration up and running. We need first the next generation of nuclear. We need to make certain that that is the priority for delivery in terms of the Electricity Market Reform.
Q111 Dr Whitehead:
Do you think part of the review, however, in terms of that question
of howand I mean a combination of developing
abatement and getting peaking plants into the systemrequires,
as has been suggested already this morning, an extension of the
levy beyond the four demonstration projects so that, as it were,
the difference between what the EU ETS price comes out at, what
a carbon floor price might look like, the price at which
it becomes feasible to consider incentivising CCS on the basis
of price alone, that gap might be covered by a continuation of
the levy? And if that is the case, would the levy as it presently
stands cover that gap even if it is extended?
Dr Chapman: If
we take ourselves forward again to 2030, I would just like
to get over this concept that people will be buying decarbonised
power; it will be a premiumquality product to that
extent and they will be paying a bit more for the power because
it is costing more to produce decarbonised power than power with
CO2 emissions. At that time, if we and the rest of
Europe have decarbonised our power industry, then there won't
be very many emissions being traded in this business. So the
impact of the ETS at that time will not be even as it is now,
when it is very low; it will be something different. So we have
got to think about that and we have got to plan for that, and
that is where the Electricity Market Review comes in.
Q112 Dr Whitehead:
Yes. In a sense that takes us to the starting gate but what
does it actually do? What might it actually do in order to put
those, in a sense, assumptions into place which enable the
outcomes that you have described to actually happen?
Dr Chapman: I think, in my opening statement, I said that at that time in 2030 we will need an EPS just to say, "This is a decarbonised power station." There will have to be incentives put in place between now and the magic 2030 date to encourage the investment that takes us there.
Q113 Dr Whitehead:
And that might be a CCS extended way beyond the
Dr Chapman: That
might be the CCS levy. It might even last that long, with a gradual
winding down. As the electricity price comes upwards to meet
it, the CCS levy will wind down.
Q114 Dan Byles:
Do you think under an EPS we will ever see a new coalfired
power station built? You actually mentioned earlier, you very
briefly said, there could be some small new coal, or you did actually
allude to it.
Matthew Farrow: Yes. I think what I was saying was that under the current policy, where you would only permit a new coal station if it had, is it, 300 MW, whatever the precise level is, of CCS demonstration, and at the moment there is only funding for, at the most, four new CCS demonstration plantsand they may not all be new; some will be retrofit therefore under existing policy one wouldn't see unabated coal built without any CCS demonstration and not a lot of new coal even with CCS demonstration. Obviously an EPS could reinforce or enshrine that in some sense in a new regulatory mechanism, but I think my point was that the existing policy, which I think is well understood by the industry, and the sort of permitting arrangements behind that already ensure that.
Q115 Dan Byles:
But do you think there is a risk to that? I'm getting back
again really to diversity and energy security. Do we need a certain
percentage of coal production in our mix going forward and do
we need to try and make sure that the system we put in place doesn't
stifle development of new coal?
Matthew Farrow: Yes, which I think comes back to the importance of having all four CCS demonstration plants. Our view is coal is a very useful element of the system, for all the reasons we well understand. Equally, large amounts of unabated coal into the 2020s clearly are incompatible with carbon targets, which must be met. So the reason we have been lobbying so hard recently to try and preserve all four CCS projects is that that gets some coal on to the system, with CCS demonstration, and then, as we all hope, if the demonstration is successful, costs start to come down, and possibly, with the CCS levy extended, coal can remain a component of our energy system in the future but with CCS.
Dr McElroy: I think, as the Association of Electricity Producers, we would see coal as having a role to play in the future. It comes back to the point that the priority is demonstration because, without demonstration, we don't have a technical option and, without commercially-available CCS, then the opportunities for coal are severely limited post 2020 and EPS doesn't get you there. It is actually demonstrating and making certain that the technology is commercially available.
Dr Chapman: CCSA is obviously not aligned with either gas or coal but we do believe that it is important to have a mixture for energy security, and I would just like to remind everyone that there is no better energy store than a big pile of coal and it has been proven in the past.
Dan Byles: And we've got
a lot of it.
Q116 Dan Byles:
Briefly on this filling the gap that we have alluded to, some
people have suggested that perhaps an EPS should not apply to
any gasfired power stations built before 2020 in order make
sure we don't disincentivise the "plugging the gap'"construction,
as it were, but that the downside to that would be the potential
"dashtogas" where we will lock in a larger
amount of gas capacity that is not subject to EPS. Do you have
any thoughts on that?
Matthew Farrow: I think, as perhaps Jeff said, all new plants have to be "CCS ready" so the option of retrofit is there. I think it would be extremely risky to prevent newbuild gas being an option for the market given, however quickly we are able to press ahead on new nuclear, which the CBI supports, or renewable rollout and so on, we're clearly going to need, I think, some additional capacity beyond that. Given the coal policy we have all been talking about, newbuild gas is the only obvious way you could fill that hole, as it were. So if an EPS came in which prevented that, it is very hard to see how we could build sufficient new capacity to ensure energy security. The question is more about, can we demonstrate CCS and then can those gas stations be retrofitted at some point in the 2020s?
Dr Chapman: It just exemplifies, doesn't it, the urgency to get on and get some experience of CCS so that we learn from our mistakes and we know how plants have got to be built into the future so that they don't become locked in?
Q117 Sir Robert Smith:
I should remind the Committee of my entry in the Register of Members'
Interests as a shareholder in Shell who are involved in CCS projects
in this country.
One of the concerns some people brought forward is the legality of an EPS depending on how you read the European Directives. Have any of the witnesses got any views on the impact of European Directives on the legality of EPS?
Dr McElroy: I would suggest that it is a bit of a minefield in some respects. I think there are two issues. We have moved beyond IPPC. We now have the Industrial Emissions Directive, which is about to be adopted by the Council at some stage in the relatively near future. There is some very interesting wording in the Industrial Emissions Directive which effectively says that where emissions of a greenhouse gas from an installation are specified in the relevant annex of the EU ETS Directive "in relation to an activity carried out in that installation, the permit shall not include an emission limit value for direct emissions of" greenhouse gases "unless necessary to ensure that no significant local pollution is caused".
I would have to suggest that in the case of carbon dioxide local pollution is a bit of an unusual concept in that the impacts of carbon dioxide are at the global level. I think there are also issues around the Lisbon Treaty as well in that does allow Member States to go beyond EU requirements, but I think it is the question of being able to demonstrate the environmental benefit and the case for environmental benefit of going beyond. Of course, in the case of carbon dioxide unilateral action to restrict CO2. it effectively means that that CO2 is emitted somewhere else in Europe because the cap is the cap. So I think there are some challenges around EPS at the EU level, but as they say the devil is in the detail.
Matthew Farrow: I would just like to add to that, if I may. I don't know the detail of this, and who knows, but the fact that there is some uncertainty about it reinforces our view that we should only be introducing new policy mechanisms if there is a clear need for them, and again it comes back to that uncertainty point. If there is some doubt about the legality and how it would be overcomeand perhaps it can be overcome, I don't knowagain it just adds a more complex picture for investors.
Q118 Sir Robert Smith:
Who do you think would take a legal action?
Dr McElroy: Who would take legal action? It could be the European Commission.
Dr Chapman: Sir Robert, we included for this in our original submission and then we withdrew it after we were advised that there was some controversy over this, and we don't know where it stands. I would suggest that the next panel might be able to help you.
Q119 Sir Robert Smith:
Just returning to what Dr McElroy said about the rather fundamental
economic thing, if you are in an ETS, anything you do unilaterally
to affect the carbon makes no difference to the European emissions
because of the trading of the ETS. So is there not some fundamental
reform of the ETS needed if we are going to get anywhere?
Dr McElroy: I think, as Matthew has already alluded to, what we need to see is a more robust EU ETS at European level. There's the whole issue of, what is the cap? Going forward, there is very little visibility beyond 2020in fact no real visibility beyond 2020 and the simple fact of the matter is we are sitting here talking about the CCS investments and the lead time for those. We are very much talking about investments which will come on stream after 2020, and I must admit, at the moment, there is just no visibility on carbon market from an investor's perspective.
Q120 Sir Robert Smith:
I have one final EUrelated question. We have talked about
reforming the electricity market here. We have been, collectively,
as a country at the vanguard of liberalising or attempting
to liberalise the rest of Europe. Have we gone so far in terms
of the fundamental rules of Europe, even if they are not being
applied by other countries, that it might be difficult for our
own market reforms to be restructured?
Dr McElroy: I think
there is an issue around how it is done and how compatible that
is with the EU energy policy. Again, it is a complex area
and difficult but it is certainly something that officials are
looking at fairly closely in terms of Electricity Market Reform.
Chair: Thank you very
much for coming in. We look forward to seeing you again.