UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 742-iv

HOUSE OF COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE THE

ENERGY AND CLIMATE CHANGE COMMITTEE

ELECTRICITY MARKET REFORM

TUESDAY 8 FEBRUARY 2011

PETER ATHERTON, CHRIS HUNT, SHAUN MAYS and SHAI WEISS

HARRY HUYTON, NICK MOLHO, DOUG PARR and ALAN SIMPSON

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 8 February 2011

Members present:

Mr Tim Yeo (Chair)

Barry Gardiner

Albert Owen

Laura Sandys

Dr Alan Whitehead

Examination of Witnesses

Witnesses: Peter Atherton, Managing Director, European Utility Sector Research, Citigroup Global Markets, Chris Hunt, Managing Director, Riverstone, Shaun Mays, Chief Executive Officer, Climate Change Capital, and Shai Weiss, Partner, Virgin Green Fund, gave evidence.

Q181 Chair: Good morning, and thank you very much for coming in. We can see your names and we know who you are, so I will dispense with the formal introductions. We are very glad to have you at this evidence session. This particular inquiry is well under way, and, as you may know, we’ve had several evidence sessions already. Obviously, it is an extremely topical and important subject. We have about an hour with you, if that suits you. We have another set of witnesses coming later.

I will kick off by asking a general question. Each of you may answer any question, but don’t feel that you have to answer every question. Do you think the present market arrangements make investment in low-carbon technologies too risky, or unnecessarily risky, and therefore unnecessarily expensive?

Chris Hunt: My name is Chris Hunt. I am from Riverstone, a private equity house that specialises in energy investments. We cover the full spectrum of energy, but, more so than most firms specialising in energy, we tend to invest a fair amount in renewable energy. So I am coming in wearing the hat of specifically talking about renewable energy.

If I am honest, the UK is investable. Under the current arrangements, we would come in and invest more money in the United Kingdom. In fact we have made several investments in the United Kingdom. We own offshore wind installation ships and a bioethanol plant, and we are investing in wind. So the UK is investable. However, I think that the electricity market reform will increase the amount of capital that we would be prepared to put here, not only because we would see the UK as a better place to invest, but in large part because I think our investors, who give us money, would see it as a safer place to invest.

Shai Weiss: I represent the Virgin Green Fund, which is affiliated with the Virgin Group and Sir Richard Branson. Like Chris, we invest only in renewable energy in Europe and the United States. That is not to say that we would not invest right now in the United Kingdom. To emphasise what Chris is saying, we have always said that legislation in this market has to be three things. First it has to be clear, so that people understand the rules of the game. The EMR should do that. It should also give clear signals to the markets that this is something that the UK really wants to invest in and incentivise. Secondly, it has to be very loud. Everybody should know about it, particularly the people who provide the capital and the people who invest the capital. So the ecosystem should be clear.

Thirdly, the legislation should be very stable. One of our recommendations is that we should choose a very good system and ensure that it is very, very stable for a very long period of time. Capital can adjust itself for risk/reward. You asked whether the UK is a risky place. Well, it is a pretty good place to invest in terms of risk/reward, but that risk/reward profile has to be extremely stable over the long run. If you give the markets these signals in a clear, concise and stable manner, you will see greater inflow into the projects; and when you see greater inflows into the projects, you will see that the ecosystems of companies distributed across the UK, not just in London and the south-east, will flourish based on that framework.

Shaun Mays: I am Shaun Mays from Climate Change Capital. We have more than 20 renewable energy projects in the UK. Our investor base consists of the big pensions funds and insurance companies, who are looking for stable, inflation-linked returns to immunise their defined-benefit pension liabilities or to back their annuity products.

To reiterate what Shai said, we think the existing system is fine, but it is obviously immature, so it hasn’t drawn in a lot of capital at this stage. If you are patient and hold your nerve, the return expectations will adjust to the system and you will see a larger volume. Our investor base is not that entranced by the offshore wind sector at the moment, because it sees technology risk, policy risk and construction risk. So don’t think that, just because today’s policy is under review, there aren’t other factors in offshore wind financing that won’t come to bear.

One of the crucial things about your review is whether, once the assets are operational, we can get the developer and construction cycle and the project finance money recycled into institutional money, because that is where the big pool of capital is, and they will want stable, predictable, probably inflation-linked returns. They will adjust the price and the cost of capital will come down if we can deliver that. That is the point we are trying to make.

Peter Atherton: I am Peter Atherton from Citigroup. For the lawyers, my usual proviso is that I speak for myself and not for Citigroup.

It depends on the technology. The current mechanisms and reward systems are very generous in many areas. Onshore wind works fine, if you can get planning permission. The current systems struggle where you have big construction risk and big technological risk, such as with offshore wind and, even more so, with new nuclear. In our view, new nuclear is uninvestable for private equity investors. Under the current mechanisms there is too much construction risk and too much power price risk. Offshore wind is in a borderline area, but onshore wind, for example, would be fine. Carbon capture and storage sits with new nuclear and offshore wind as being very difficult to invest in under the current arrangements.

Q182 Chair: I should have drawn attention to my entry in the Register of Members’ Financial Interests. I have interests in several renewable energy businesses.

Do you think that the general tone of the package-what is out there for consultation now-is moving in the right direction, or has this process introduced an unwelcome, though perhaps only temporary, element of uncertainty?

Shaun Mays: Any change brings an investment hiatus; we have to understand that. If are looking at the investment side, the one big variable is policy uncertainty. If you go back to the UK’s privatisation of traditional infrastructure, the thing that stabilised investment in that sector and brought large volumes was the fact that we had a regulated asset-based system with a five-year resource. We have to think about some sort of system like that, particularly around the carbon tax; the way the carbon tax is in the energy market forum at the moment looks like it is a bit too able to be adjusted at actual intervals.

There is a hiatus; people are waiting, and it is compounded by the fact that there has been policy risk in other geographies in this same sector, so institutional investors are sitting back and saying, "Until this is clear, I don’t think I have the ability to invest; it is just too risky and I don’t know what the returns look like or what might happen". You just have to understand that there will be, combined with the credit crunch, a different mindset. The credit crunch brought a different mindset to risk, and policy change also affects it. So we applaud the fact that you’re trying to do this quickly and we’ll get rid of that regulatory uncertainty.

Chris Hunt: I would say, on balance, that I personally welcome this package. I have been investing in renewable energy for over 20 years and was even involved when one of the first major reforms in the UK was introduced back in the ’80s. At that time, there was a different set of circumstances; introducing market reform and market-based mechanisms was definitely needed for the sector. But I think you can’t necessarily fault the system that has got us to where we are today. If you look at the underlying statistics of how much capital has flown to low-carbon investment, you have to acknowledge that now is probably the time for another change. The timing and sequencing of things are following a logical course; it is time to make a change, to go down the route of policy signals that perhaps by some will be considered a bit more directive, a little less market-oriented, but aimed at achieving a goal.

On balance, therefore, I think the timing and the general theme of what you’re intending to do with the EMR is very appropriate. It will open up quite a bit of capital that to date has been sitting on the sidelines, so I am very much in favour of this package. Most people who look at it from the perspective of investment and yield investments and safe investments are favourably disposed to it.

Shai Weiss: Just to add to that: what you can see from this package which, as Chris said, is kind of favourable for low-carbon technologies, is that there is a penalty on high-carbon. That is the first signal it gives you, which is a good thing, and you can debate how that is achieved. There are support mechanisms for low-carbon; the debate can go on in the Committee about whether, for example, a contract for difference or a feed-in tariff is the most appropriate, but that signal is a good one. Then there is an incentive for energy efficiency. When you combine these three things, it seems to address appropriately the market conditions and the change.

The only note of caution that I would sound is that there is a lot of focus on capacity payments, so building extra capacity, which is really taking a snapshot of today and trying to forecast it into the future, and inherently there is a big tension-or a small tension, depending on where you sit-between the existing utilities and the new entrants into the market and the investors. That tension, through this package, should also be addressed.

Peter Atherton: My answer is that I have no idea; it is way too early to tell. These are very big, complex reforms, interacting with a whole series of other, very big and complex policies. The question is whether these reforms achieve their goal, which is essentially about transferring risk. Essentially, the Government have decided that what they are asking the capital markets to do, predominantly through the utilities sector, is too risky for the rewards on offer. They can’t really increase the rewards on offer any more, because that will have such a profound impact on prices, and the affordability issue is dampening their ability to do that. So they need to transfer risk. What they are looking to do is transfer big chunks of the power price risk from the developers to the consumer.

Now, in principle, that should be good for the developers. However, it has a number of side effects. One is that you are also capping out returns, so it is not just a one-way bet: you are limiting returns as well as limiting risk. Secondly, you may be creating brand new risks, particularly to do with the direction of investment through the agency that is going to allocate the CfDs. How on earth will that actually work in practice? Is there some Government agency that will tell the industry what to build, when and where? Will those contracts be stickable with? What will the Government decide in future generations about the decisions made by their agency?

There is nothing about construction risk or technology risk either. In fact, this may be exacerbating the construction risk, because you are basically asking people to build on a fixed-price revenue line, which may not be that attractive. So, yes, in principle, one of the major problems-the power price risk-is being to some degree neutralised and to some degree transferred to the consumer, but actually that may not solve all the problems, and it may create other risks as well.

Chris Hunt: I agree very emphatically that it is still too early to say. I think the overall package that the EMR has introduced is the first of two steps. The broad general structure of it is perfectly fine. How it is implemented, how prices are set, what the tariffs are, it is still way too early to tell. One thing that I have learned in watching this sector over the last four or five years is that massive amounts of capital will flow to the market that offers the most attractive investment.

For example, take solar power-which may not be the best example for the UK, given the lack of sun. When Spain put forward a certain tariff level the market responded, and billions of capital flew into that market. When Germany introduced a feed-in tariff that was attractive, capital flew there. And Italy. We are talking literally many billions of dollars or pounds of capital motivated to a market in a very short span of time. We don’t yet know, under this package, exactly how tariff levels will be set, or exactly what the ultimate profitability will be, but the framework that you are setting up allows you to get to that point. Whether the capital actually flows depends on how you set the pricing.

Shaun Mays: I think the market will adjust to risk, though. Don’t let us give the impression that our investments will not take root. What we have to do is give them a clear sight of what risks they are taking. So I think that the wholesale electricity market reform is also very important, because that is a very opaque market. Some of the things that have been proposed, like the clawback provisions and the way the CfDs are issued-we have to look at those and say, they could create uncertainty around volume, price and risk, and that will mean that the cost of capital goes up. Then investors will demand a higher return.

One of the challenges for you is to create a system where you bring the cost of capital down so that you get two things: lower expense of building and operating these projects, and secondly, bigger volume. That is the challenge, given that estimates are up to £200 billion by 2020. That is not an insignificant amount of money, even by the £3 trillion in the pension fund market-it is still a lot to allocate to this sector. The cost of a 1% or 2% change in the cost of capital therefore makes a huge difference to the amount of money that goes in. So we have to look at those elements and say that a lot of thought needs to be given to the clarity of the system-the transparency of it, in terms of volumes and price. Some of the things in the package at the moment suggest that those could be adjusted at the last minute, and all that will happen is that they will take the lowest common denominator-the lowest price-and any upside will go to the investors and not to the Government. We must think about that.

Q183 Laura Sandys (South Thanet) (Con): The enthusiasm of three of you for the reforms seems obvious, which is very good, because we need the investment. But your enthusiasm also creates a question for me: will the reforms that we are putting in place be sustainable at a price that fits your investment model and also does not have to be changed by us, or a future Government, due to changing circumstances? The energy sector is going through huge revolutions, not just in renewables, but in new technologies coming through, new usages, efficiency and so on. There will be a moment when we set fixed values to all the different indicators, but they will change due to the circumstances. What one can’t look at is something that is fixed for the next 30 years with a market that will, by definition, be on the move. I worry whether the point that we need the investment is going to be sustainable into the long term.

Chris Hunt: It’s a great question; thanks for asking it. I have a couple of thoughts. It might be a little discombobulating but I will try to present them as best I can. First, a lot of attention is paid toward the impact of renewable subsidies on the overall electricity price. One broad comment I will make is that every element of energy is a highly subsidised business. The only difference between renewables subsidies and subsidies in other parts of the energy business is that renewable subsidies tend to be more transparent. They tend to be talked about more and are more visible, but every element has them.

Generally speaking, if you look at the impact of renewable subsidies across a wide range of economies, and you look at how much it actually increases the end bill to consumers, generally the number is far smaller than you would expect. It obviously depends on the economy, but generally it increases the end bill only in the neighbourhood of 2%, 3% or 5%. In some cases, if you have a huge penetration of renewables and you have gone for more expensive types, that number can be higher, but in most economies that have gone down this road before and achieved reasonably high penetration rates of renewable energy, you are generally seeing the end bill to consumers going up by only 5% or less. That is over a long-term average of what you would expect energy prices to be. If an economy were to face an energy shock-for example, if we were to have a sustained period of two or three years of high oil prices in excess of $100 a barrel-that would far overwhelm, in terms of cost to the UK, the cost of those subsidies. When you sit down and get to the heart of costing the numbers, it’s really not that high.

My last comment on the subject is that what you are setting up with the EMR is a framework. When you put in place, for example, a feed-in tariff, and say to a wind generator, "We are going to give you a feed-in tariff and you will get that tariff for 20 years," the Government are still able within that framework to reduce those feed-in tariffs over time. You might offer a certain price for projects that are built today, and then as technology matures and costs come down, you can lower that feed-in tariff for projects that are built five years from now, and lower it again for projects built 10 years from now. So it is not as if you are giving up the ability to reduce the cost over time; you are just creating a framework that allows you to have the broad structure.

Shai Weiss: May I add to that? Chris is saying that the UK should benefit from that cost curve advantage. We are not saying that we are asking you to give up the advantage over time and simply give it to the investors, and the public do not benefit. It is fair to say that we are still in the very early days of this entire renewable energy cycle. Solar may not be attractive right now in the UK but could benefit the UK in the long run, just because of the improvements and gains in reduction of costs. Wind is improving all the time. Tidal has not even started; there is a huge technology risk there but it may ultimately benefit the UK, especially given its geographic location. All those things should be allowed for in a framework. Our enthusiasm is for a framework that is stable, that is rational and that adjusts, and fairly benefits both the public and the investors for gains. If that is achieved, I think you will see a lot of capital flow into the UK.

The last point, to amplify what Chris has said, is that the subsidies are always taken in the context of a transfer for the feed-in tariff, so the price over and above that at which you can buy electricity. However, when you calculate the cost of ownership and the gains to the economy and job creation and so forth, you will see that that should also benefit the consumers over the long run.

Q184 Barry Gardiner: Mr Hunt, you were saying that if the price of oil went above $100 a barrel for a significant period of time, that would have a far greater effect than renewables. But surely, if that were to happen and you had a premium FIT, the cost of the renewables would be even greater, wouldn’t it?

Chris Hunt: It would in fact, and our view is that that would be a windfall that is not necessarily appropriate to give to a renewable energy generator.

Q185 Barry Gardiner: You would want us to impose a windfall tax.

Chris Hunt: I actually don’t believe in a premium FIT. I believe in a FIT, for precisely the reasons you stated.

Peter Atherton: I-

Q186 Albert Owen: I am sorry, Mr Atherton; I’ll give you an opportunity in a moment. You have said that the current situation is quite high risk. We-or the Government-are only producing a framework here. Mr Weiss, you have twice mentioned stability: do you think this framework provides enough stability?

Shai Weiss: I think the elements in here, once agreed and once they come to a rational conclusion, should provide sufficient stability. I did point a caution on building capacity when capacity is unnecessary, which, in my mind, truly promotes coal and nuclear. That is a whole, to my mind, excess capacity that the UK may not need and it is really over-emphasising security of supply. If you handle that and build what is necessary and promote the right things, it looks like a pretty solid framework. It’s early days-

Q187Albert Owen: That is the point; we are at the consultation process. This review will be going on and on, it will come before Parliament, and different elements will be discussed and debated. We are asking, is the consultation document in itself robust enough to provide that stability?

Shai Weiss: I would say that it is almost too robust, in many ways. What you really want is a very simple framework, so if you just said to investors and to pension plans, "There is a feed-in tariff and it is fixed"-or a contract for difference, but not a premium, just a fixed feed-in tariff-"and the tariff is good. It promotes the following things, and you do it with a renewables obligation, grandfathering, and continue it," I bet that would be almost sufficient to improve the capital flows into the UK. Everything else is very important-that is the way it is done in the UK, in terms of the depth of the analysis-but I think simplicity here is key. The signals should be so clear that if somebody can explain it to an investor in 30 seconds, capital flows immediately.

Q188 Albert Owen: Do you want to comment, Mr Atherton? I cut across you earlier.

Peter Atherton: Yes, I was going to comment on affordability. My job is to speak to institutional investors-the 500 largest institutional investors who own the major utilities in Europe. I have probably met 120-ish of them to discuss the EMR since it came out. By far their biggest concern is affordability, because they have experienced what has happened in Germany, Spain and the Czech Republic over the summer. They are profoundly worried-the mechanisms are, frankly, irrelevant.

The fact is that we are going to try and put these very expensive, not very robust, very challenging technologies on the ground very quickly. If we do that, the price of energy will be high-I am for ever shocked that anybody thinks anything other than that-and what’s more, the profits are going to be high. What investors have to be able to imagine is a situation where, in 2018 or 2019, the Secretary of State is standing up to the media and Parliament and saying, "It is a really good thing that your bills have just gone up by 15%, and will be going up 15% next year, the year after and the year after. And it’s a really good thing that SSE and the other utilities have just reported record profits, and will be reporting record profits for the next 10 years." Institutional investors ask, "Do we have confidence that, when that becomes the case, the mechanisms will be supported and fully kept in place?" Maybe if you have contracts for difference, the mechanisms stay in place, but you can just tax them in another way.

To give you a feel for this, I actually ran it through my model of Scottish and Southern Energy last night-this is not a profits forecast, by the way.

Laura Sandys: We are taking notes.

Peter Atherton: Scottish and Southern Energy last year did 105p of post-tax earnings, so I thought I’d run through my model how much profit they would be making by the end of the decade if they were to do their proportional amount of this investment-around £4 billion a year. In 2015, their profits would have risen to 155p, but by 2020 they would be at 225p. Therefore, their profits are going up 15% or 20% a year at the end of the decade, just as bills are rising.

We represent different types of investors here. My colleagues’ here are predominantly people who can get their money out very quickly, whereas my clients are the investors who are there for a 10, 15 or 20-year payback period-they are the equity guys who will be sitting there into the long term. The question for those institutional investors is whether they have the confidence. They don’t really have the confidence that this kit will work, for a start-so they don’t have the technical confidence. They don’t have the confidence of being able to bring them online in time and on budget, and they don’t have the confidence that the policy mechanisms, whatever they are, will be sustainable. The green deal will perhaps offset that a touch, but don’t forget that people have to pay for the loans. The green deal is not a grant; it’s a loan. You are paying for the loan. Your overall energy bill may fall, but when you add the loan price back in, the cost doesn’t actually fall for the consumer.

Q189 Albert Owen: So the people you’re talking to will be feeding into this consultation and saying, "Do what?" and "Change what?"

Peter Atherton: I speak to hundreds of people, so it’s very hard to paraphrase them, because they have different views. Actually, their advice will be to change the targets. That is what is driving it all. The targets are too much, too fast, and that scares my side of the investment community profoundly. I don’t think that changing the mechanisms will necessarily release their flow of capital, because they just do not think that it’s going to be affordable for the consumer, and therefore they do not believe whatever mechanism will be put in place.

Maybe that can change. Maybe as you go through time, particularly as they become more comfortable with the construction risk and the technology risk, that will alter, but as we speak today, I think that would be a reasonable summary of what they say.

Q190 Chair: On what you’ve just outlined, are there alternative areas of the world or alternative countries where the concerns that you have just expressed do not apply-in America, for example, where BP might think there is an element of political risk nowadays, or some of the Asian economies where there is perhaps a less regulated environment and a better expectation of economic growth?

Shaun Mays: Well, they will still have feed-in tariffs. To go on from what Peter was saying, we will have technological change that will improve the returns from these investments over the next five, 10 or 15 years, and you have to be able to adjust for that. We don’t want a Spanish situation or one like we had in our carbon fund with HFC-23, where the switch is on or off. We understand that volumes will increase, GDP rates change, wholesale electricity prices change and that technology changes. But it’s like driving a car. You don’t put your foot on the brake and then on the accelerator; as you’re going along the road, you adjust to take account of traffic lights and other things. You need to build a system that has a clear framework, but is adjustable-just as we did with CPI-x for the utilities system before. Everybody knew that, after five years or whatever, it changed, and we reset it and went to a better system. That is what we’re asking for here.

We all represent investors who want to be in this sector for the long term. They can see both sides. They can see how they risk-manage their existing portfolio out of dirty technologies and dirty power production and how they can have an opportunity to invest in the future and clean and renewable energy. They want to do it, but we have to give them a stable system.

Chris Hunt: Let me take a stab at the answer to your question in a slightly backward way. You have the benefit now of being able to look at the mistakes of other economies and their not necessarily better systems, and we can talk about what Spain and Germany did wrong. I agree with Peter in some respects. If you were to actually take a snapshot of Spain and Germany and ask whether it has worked, the answer is, in some respects, yes. They have both, as economies, motivated a tremendous amount of capital to go in and build low-carbon energy generation. However, they erred in a couple of areas. The main area in which they erred was that they tried to do too much, too fast. They went in at an early stage when costs of certain generating kit were very high.

To put that in perspective, we own a solar company, which is installing solar generating kit today at less than half of what it was two years ago. If we draw the clock forward another two years, it will be less than half that. Over a four-year period, we’re at a quarter of the cost curve. Germany and Spain, unfortunately, did not really cap or control the rate at which that investment went in, so whether they like it or not, they now have 20-year obligations at relatively high cost levels.

If, however, the UK is sitting here right now and wants to set up a framework that says, "Hey! We want to do this stuff, but, by the way, we’re going to manage this. We’re going to feed in acceptable amounts each year, and we’ll give you a 20-year tariff when we feed that in, but we’re going to actively manage that cost curve down," then you’re introducing this in a very rational and sane way, and the impact on the consumer will not be so bad.

Peter Atherton: But that’s not going to get you 20,000 MW of offshore wind by 2020 and 16 GW of new nuclear by 2024. I haven’t verified this figure, but I was told by one of the major German utilities that in the current year they expect solar to produce 1.2% of power in Germany and to account for 8% of the bill to the consumer.

Chair: That’s very encouraging, given the ridiculous tariffs we have for solar in this country.

Q191 Barry Gardiner: May I pick up on two things? The focus of my questions here is on the carbon price support mechanism, and I would invite you to put on the record your thoughts in relation to that. The Government obviously think that this will give good signals for investment into the market, but as a tax it’s precisely going to be easy for future Administrations to vary it, to change it and to become dependent on it. I just wanted your quick views about how much stability and confidence that gives you if you go down that route.

Shaun Mays: We’ve got a fairly large carbon fund, which trades in the ETS. In your report you hinted at the fact that you think that’s underpriced carbon and had it as an unstable environment. When I look through, you can’t really tell what the carbon tax price is when you look at the existing mechanism. The two guidances that I would give you from our point of view would be to set it for a reasonable period and properly inflation-link it, and then reset it again. That would be preferable to doing what you do, which is to tell us what the carbon price is after the event each year. That is the way it looks in your document.

We are not talking about for 25 years; it can be a relatively short period, but when we model our investments at least that period will be predictable. We will take the risk for the rest, and once there have been two or three resets we will start to understand how the resets are working. I think if you’re saying that it’s backward-looking and every year, that will not be an easy system to work with.

Peter Atherton: It’s hard to see what the carbon price floor achieves if you have the CfD in there as well except as a tax-raising measure for the Treasury, which may or may not be a good thing. I am not sure what it achieves in the context of the reform package.

Barry Gardiner: That was going to be my next question, only I would have asked it as a question rather than making it as a statement.

Chris Hunt: They are certainly duplicative.

Shaun Mays: But aren’t you using it as a signal that you want to make the transition to the low-carbon economy? That’s the way I viewed that particular element.

Shai Weiss: It’s slightly confusing politics with incentives. A political statement does not have to come through the form of taxes. It could come through the feed-in tariff, which is much clearer, much more precise and achieves probably the same outcome without the whole debate on it.

Q192 Barry Gardiner: Well, it will raise the wholesale power price, but it is nullified by the CfD.

Shai Weiss: That’s right.

Q193 Dr Whitehead: The whole question of carbon floor price, both as a signal and indeed as an actual incentive for low-carbon investment, seems to be very much bound around by several factors: by the duplicative process of measures in the EMR; by its relationship with ETS; and by factors such as the extent to which you could put a carbon floor price in and have an interconnector policy at the same time, where other countries perhaps don’t have the same carbon floor price policy that you have. Taking those factors into account, do you think there is a serious possibility that a carbon floor price really could drive investment in this country in the way that some people suggest it might? Peter Atherton, you speculated that the carbon floor price as far as nuclear investment was concerned would need to be much, much higher than is predicted at the moment, and they would then, presumably, potentially run into those problems that I have already outlined.

Peter Atherton: Sure. To make nuclear workable, they need a high electricity price. You might decide to get there through a CfD, for example.

I gave some figures to the Committee before Christmas; after the EMR was published EDF held a UK investor seminar and gave us two pieces of information. First, their latest cost estimate for a twin EPR is £9 billion overnight price in today’s money. Secondly, their cost of capital, taking into account the EMR, will be 10% post-tax nominal. Running that through our models, they would need a £78 per MWh electricity price to make that work-that’s in today’s money. If you roll in the cost of construction, ITC and things, they need about £105 per MWh to make it work. So those are the sort of numbers they would probably be looking to strike their CfDs at. Clearly if you get to those sort of numbers via a carbon price floor then the carbon price would have to be huge, though presumably you wouldn’t-the carbon price floor would be set fairly low, and it would be the CfD that gets you up to those sort of minimum prices.

Chris Hunt: The carbon floor price is a somewhat blunt instrument. My personal hesitation is that if you set a carbon floor price for a means of justifying a nuclear plant, I agree totally with Peter, it has to be very high to induce the investment you want. Personally, I’m not sure it is the best instrument to use-there are probably more efficient ways to get at what they’re trying to get at. If it’s truly the desire to build a nuclear plant, you can get there much better and much quicker in other ways.

Peter Atherton: But your general point is, if you can import power produced on continental Europe that has a much lower carbon price, then clearly people will, if they can.

Shai Weiss: Which I think is an important point altogether, because we are now thinking about this only as an isolated market, but over the future there will be an interconnect, and the interconnect will import energy from lowest-cost provider to highest-cost provider. That is why, for me, you can do the carbon price but not unilaterally, because you can see future Governments saying this is a transfer of wealth from one country to another via a tax on the residents of one country. That will clearly be a political problem that will bring us full circle to the point where Governments will want to change it. If you’re going on the carbon price, you are then in the realm of policy and politics-for example, between countries. I think there are other mechanisms to ensure that we are not doing things in isolation from the continent, where they will have, for instance, very efficient nuclear.

Peter Atherton: But it’s not just the carbon price itself, it’s the whole set of policies and targets. At the end of the day, if they are successful-and we have offshore wind, onshore wind, solar, nuclear, in 10 to 15 years’ time-the UK will have a very, very high fixed cost, very, very high operational cost, low variable cost power system. If that differs from our trading partners across the interconnectors, and fossil fuel prices happen to fairly modest at the time, then of course we will import a lot of power, and we should, because it will be an awful lot cheaper to do so than to produce it from our own very high operating cost system.

Shaun Mays: I think you have to be a bit careful about time frames here because I was very surprised, in my working life, that there is an interconnected power system. The way I viewed the carbon tax was quite simple. First, I though it was a political mechanism, obviously, a political signal that we are doing something about a transition to a low-carbon economy. I think that is an incredibly important signal. Secondly, it’s a financial mechanism for taking money away from dirty coal producers and allowing that transfer to the clean energy producers. So I think it is an important and necessary signal. In 20 years’ time, when we are connected to the rest of Europe in a supergrid and power gets sucked into that system with no energy losses, and energy efficiency and smart group technology is phenomenal, there might be a change required. But at the moment it is an important signal, and I would think that we are a long way from importing power from Germany or France, although I could be wrong.

Peter Atherton: Sure. We have a reasonable amount in sketch already: the 2,000 GW for France, Britain is now on, and Norway is almost certainly going to go ahead; 3,000 GW or 4,000 GW already is quite a reasonable amount.

Q194 Chair: Just pursuing the logic of what you were saying there, would it be better for us, instead of tying up a lot of money in some low-carbon technologies that are sometimes slightly unproven but undoubtedly very expensive, just to have another a dash for gas so we don’t mind being exposed to imports? That will get us through the next 10 years-to where we need to be-and then maybe the other stuff will have got a bit cheaper and we can put the investment in then.

Chris Hunt: Do you want to go first?

Peter Atherton: Well, we are straying slightly into the political arena rather than just the-

Chair: Come on, stray.

Peter Atherton: My lawyers are listening.

Laura Sandys: From an investment perspective?

Peter Atherton: From an investment perspective, yes absolutely because it’s a proven technology, it’s very simple. I think if the market was left to itself they would gradually and incrementally develop wind and offshore wind and things, and they would build a reasonable amount of gas. Does that leave the UK vulnerable? Potentially, of course it does. However, I would question this whole point of vulnerability. At the end of the day, you want to be like your trading partners. There is very little advantage in being very different. Sure, if we have a tremendous renewables-based system and in 20 years’ time there is an oil price shock, then the transfer mechanism into the UK economy is through trade. We will have a recession like everybody else. Our recession might be slightly different from everybody else’s but it probably won’t be very different. France’s ability to sustain the oil shocks of the ’70s, because of their large nuclear fleet, was tiny. They did not benefit greatly from it. Where you run the real risk is, you build all this stuff, you lumber yourself with incredibly high fixed costs and a not very robust high-operating-cost system, and-you know what?-fossil fuel prices are modest. Nobody else has built it or nobody outside Europe has built it. That is your real danger. You want to look like everybody else; being in the middle of the pack is where you want to be on this.

Q195 Chair: That sounds like a fund manager wanting to keep his job.

Chris Hunt: I’ll take a slightly different perspective on the issue. First, I’ll comment as a firm that owns just as many megawatts of gas-fired generation as of nuclear generation. We are, frankly, agnostic between the two. There is tremendous vulnerability to the economy of being too reliant on a single generating source. If you look the world over at rates of penetration of gas versus coal versus nuclear, for example, the UK, if it had another dash for gas, would be on the extreme of having an over-dependence on a single fuel source. We are talking about renewables as if they don’t work and they are unproven. The truth of the matter is that we have had wind turbines up for 15 to 20 years, we know what they can produce and they are not unproven. Biomass plants are the equivalent of boiling water. We know how they work and it is not like it is new-fangled technology and something that doesn’t work. Solar, admittedly, is on the newer side and is on a cost curve, so perhaps on solar there is some benefit in waiting. Certainly on tidal there is some benefit in waiting. But we do have options here to diversify and at an expense that is not extraordinarily higher than another dash for gas. So, on balance, while there is always some benefit in waiting, it would be a dangerous move to sit back and just allow another dash for gas.

Shai Weiss: If you look at our counterparts, China last year invested-sorry, "invested" is a strong word here. They gave subsidies of about $37 billion to their solar companies by way of cheap loans. You don’t have to wait much longer for the Chinese to promote solar, which they are doing; likewise on wind and many other technologies. There are great benefits from these alternative resources such as security of supply, which everybody knows. We should not forget, whether one believes or not-some people do believe that there is global warming, and we haven’t talked about this at all. But if you do believe, then there are benefits from reducing your reliance on fossil fuel-based economies. Natural gas clearly right now is in vogue. It is very cheap and very available and very productive. We always think that it is good to have multiple sources of energy to avoid those shocks, and to be able to achieve other aims than just the lowest costs at a specific point in time.

Shaun Mays: Decentralisation of the system is an important factor here. You have to look at the UK’s competitive advantage. We will never be a big producer of solar power; Spain has a natural advantage over us. I think there are some elements where you just have to say the UK has an advantage; doing offshore wind and being able to get there first has been a big advantage. The financing challenge is not insignificant. I think the estimates for Hornsea alone are about £13 billion. It is almost the same as all our onshore wind put together. We need to create a system that can recycle capital. I agree that there is an opportunity for the UK to be at the leading edge of the competitiveness curve. We have to be realistic about time frames and the amount of money it takes to do that. There are some GDP reasons why you would do these things as well.

Peter Atherton: I struggle to see where these benefits are. These jobs are costing a fortune. The ROC scheme has cost £1 billion a year already. That is money out of consumers’ pockets that would create jobs if the consumers were left to spend it themselves. Where is the cost-benefit analysis that this creates more jobs than it destroys? It is a tax on consumption-a tax on energy. Having reliable and affordable energy is a really, really good thing. We are in danger here of forgetting that and letting other priorities completely dominate. We would all agree about some diversity and some development of these technologies. But the targets are driving the rate of change and that rate of change is creating the challenges and the risk; and now we are trying, mid-implementation of the targets, to reallocate that risk while trying to maintain affordability. That is an extraordinarily difficult balancing act to do mid-stream, when you have already set the actual targets.

Chris Hunt: I think the data will prove out-they have proved out across economies that have taken this step. The impact, while it sounds like a big number, is not as big as we think and if you take price shocks into account-there are plenty of data; I could quote some-it comes out surprisingly low.

Shai Weiss: And when you look at the cost curves of these alternative energies, they are coming down and competing on par with the basket of goods coming from traditional energy-definitely at the prices we are seeing today, and with further benefits yet to accrue.

Q196 Laura Sandys: On feed-in tariffs specifically, some people have voiced concerns about the move away from the renewables obligation to feed-in tariffs and say that that will undermine investment in renewable electricity across the board. I add one other aspect of this. We have lots of different mechanisms and obviously, the feed-in tariff is an important, core one. Are all these different mechanisms relating, creating different and conflicting behaviours? In many ways, you will be looking at it from different investment perspectives and all these mechanisms will create different investment outcomes. How important is the feed-in tariff, how important is the renewables obligation and how do you see the move from one to the other impacting?

Chris Hunt: Obviously, if the Government were to change the policy every five years, it would make things very difficult for investors. As long as there are relatively few approaches on the system at any given time, that is useful. When we invest in a project, we invest in the expectation that we’re going to hold the project for 20 years-that is the useful life of most of these projects. When we invest, we make that investment decision based on the assumption that, whatever regulatory environment we invest in will be there for the duration of our investment period. The concern of people with the RO is that they invest in one scheme and if the system changes, they are worried that the fundamental basis under which they made their investment will be gone. That is a perfectly justifiable worry.

As the data have shown, and as you look at the price curve for renewables obligation certificates, they all tend to be gravitating towards a certain common price, so in general terms, most of the people who have RO-based projects today probably have a reasonable degree of certainty that they will be coming out okay if you make a move over to feed-in tariff systems. It is a fair concern-they invested in one thing and want to make sure that they see a pay-out on their investment over an extended period; but generally, most people are satisfied that they’re going to be okay. The FIT system still needs to be defined as to exactly what it’s going to be, but as long as we go in with a system and stay with it for an extended period of time, it’s a structure that’s simple and people will get their arms around it and will put the development dollars and capital behind it.

Shaun Mays: And I think you’ve got a pretty clear signal when you see that grandfathering is an important thing. If you invest on one basis and it changes halfway through, like Spanish solar has, it makes a big difference. I can see two risks with the ROC system. We’ve got quite a few projects now with ROCs. When the whole question mark over ROC grandfathering for biomass came up, we had two projects where we couldn’t get finance: finance evaporated. That meant that other projects didn’t go ahead-have gone completely, we will never do them now. So there has got to be a careful look. We try to entice finance into these areas, whether it be project finance or long-term pension fund money, and they do take these blips as a problem. The second thing I can see is, there could be gaming at the end between a ROC and a FIT, and you’ve got to find a way to prevent those of us who’ve got these projects from doing that little tweak at the end to get that little bit of extra return because there’s more margin in the FIT than in the ROC. Again, I’d caution you to think through that.

Q197 Dr Whitehead: The suggestion that has been made to us on capacity payments as one of the pillars of the EMR is that in other countries where they have been introduced they have often been changed significantly, after they were put in as part of the scene. First, do you think that the regulatory risk and the investment uncertainty may well be substantial, should there be a period of potential change in capacity payments? Secondly, on that basis, do you think there is perhaps urgency in nailing that down-particularly since we know that the increased intermittency, for example, of a substantial element of offshore wind in the system will mean quite a lot of additional stand-by capacity, the exact composition of which remains at present rather uncertain? Do you, for example, try to extend existing plants or effectively commission plants that are really never, or hardly ever, going to be run? Do you go for other forms of, say, interconnector storage which can actually provide that underpinning? Do we need to make some clear lines at an early stage for what I think is probably going to be a strange investment challenge in terms of underpinning that future capacity?

Chris Hunt: I’ll take the first shot at that question. Speaking with my gas-fired generation, rather than my renewable-fired, hat on, the capacity markets here could stand an overhaul. The system as it is now is uncertain; you’re taking a fair amount of risk in just going forward and building peaking capacity in this country. But that said, the UK is not alone. I could point to virtually any open market in electricity-particularly in the US-where the capacity markets are very uncertain and hard to build into. So it is an endemic problem in the electricity industry or in the open electricity industries about how to get capacity payments right.

Speaking more from the perspective of the US, the US divides itself into multiple different regions, so there are about 12 different electricity regions; five or six of them are what you would call open systems like the ones you have in the UK, and the other five or six are traditional state-controlled electricity systems. In the five or six open systems, we have been trying to get capacity markets right for 15 years and we have not got it right. You could look at the rules on capacity payments, and they would probably be four times the thickness of this bundle of papers. It is inordinately complex, and prone to regulatory review and change almost every other year. Fortunately for the US, it is in a slightly different circumstance because, in that country, if you don’t get the capacity payment rule right, you can always rely on a neighbouring state to bail you out. There is much more interconnection capability there, just by virtue of lines connecting across states, than there will ever be here in the United Kingdom.

I think this is an inordinately important part of this whole equation and you do need to do it, and you need to do it relatively quickly. Right now, there are a lot of different themes going on: you have National Grid out there, trying to arrange its own capacity through short-term operating reserve contracts; you have the overall system trying to set up its capacity payments, and you have yet another system now coming in through the EMR. It is ripe for rationalisation. You need to do it soon, because it takes a while for us to respond to it. If you make the rules now, we’re not going to be in a position to be able to build for another five or six years. So I think your point about getting on with it is pretty important.

Peter Atherton: I would agree with that. The only thing I find slightly odd about the proposals is that they don’t allow existing fossil stations to benefit from the capacity payments, as I understand it. I find that very odd. Keep the oilers and there is your capacity back-up there and then. They will only run 2% a year, but keep them. Don’t shut them down-you don’t need to do anything else. Just keep the oil plant.

Q198 Dr Whitehead: What, the six oil plants that are going up?

Peter Atherton: You might need a bit more eventually, but yes-

Dr Whitehead: Mineral oil?

Peter Atherton: Yes, but they won’t operate much; they will only operate for a very short period of time. They serve that function now; they are the super-peakers on the system now. Just keep ’em.

Chris Hunt: There are people out there now building under contract to National Grid, who are going to be building 1 MW and 2 MW power plants specifically for that purpose. They are no different from a farm tractor engine, there to operate, maybe as you say, one or two hours a year. That is not the most efficient way to solve the problem.

Q199 Barry Gardiner: Turning to emissions performance standards, it seems there are two problems. One is that they are toothless. Secondly, if they are not toothless and you ramp them up to do more than just get rid of unabated coal, they may fluctuate and be subject to change. How much, from an investment point of view, would you be taking notice of them now? At what level might they kick in so that you do begin taking notice of them? How much would the grandfathering of them-if that were introduced-change your investment appetite?

Peter Atherton: For the existing utility companies that are already operating under LCBP and the IED and emissions performance standards on top of that, it causes tremendous problems for them and their investor base. We are for ever shortening the life of their existing assets. Anything that significantly threatens their gas fleet in our modelling in terms of the valuation would be profoundly unhelpful to the share prices of those companies. Forget about security of supply issues. The share prices will all go down if we start assuming that all the gas plants have to have a major refit or closure in the early 2020s, which we certainly don’t at the moment. We assume that they will carry on merrily through to the 2030s and beyond, with some re-planting of the turbines.

If you start raising doubts in the minds of the shareholders of the major utility companies that the existing assets will operate, it is already very, very complicated. That is one of the reasons why the share prices have been performing so poorly. It is profoundly complicated already for investors to take a view on the life of assets that are on the ground at the moment. How are they going to operate over the next 10 to 15 years in terms of load factors and what their cost bases are going to be and so on?

When we this model this stuff-investors do the same modelling-you can get wildly different outcomes in terms of valuation of plant. At the end of the day, these utilities are the sum of the parts of how much we think their power stations and their networks are worth. If we add that up it comes to a sum-of-parts valuation and that gives our share price target. If we start shortening the life of assets or assuming those assets are going to produce far less power than currently assumed, those valuations will fall, which means that the companies can invest less. There is a feedback loop through share prices.

Q200 Barry Gardiner: Just to come back to grandfathering, for new assets grandfathering on an EPS would be something that you would see as de rigueur.

Peter Atherton: Yes.

Shai Weiss: But when you grandfather you really need to make sure that the incentives from that mechanism actually end in further investments, prioritising what we are trying to achieve. Grandfathering becomes an extension; then an extension becomes a new investment.

Q201 Barry Gardiner: At the moment, how much incentive do you think there is for building new renewables from the existing EPS?

Shai Weiss: I would say, not much. All you have to do is look outside; there is not a lot of it. If there is not a lot of it, I presume there are not enough incentives. Clearly, we do not represent the utilities, but the utilities are inherently-and we have no cloaked share in public securities-objecting to change. They like stability, so do their shareholders, and they are incentivised by capital investment in their existing assets and new assets of the same type. That mechanism can go on for another 20 to 50 years unchanged. We are talking about introducing change and uncertainty into this market. Clearly, that is going to have some kind of adjustment in terms of share prices. If done well, it should not hurt-if grandfathering is permitted-if they are incentivised to promote newer technologies within their basket of goods.

Shaun Mays: I have had a lot of conversations recently with equity portfolio managers of the big pension funds-the same side that Peter deals with-and I would say that they understand the equation of having a lot of capital tied-up in old technology and having a vested interest of ensuring that that gets a return for a very long time. It’s a capital-intensive business, and you have to acknowledge that. You invest for the very long term. Institutional investors are looking for a pure play into, for example, mature onshore wind assets, where they can invest in new technologies, which will offset the investment in a bundled-up old and new technology company. We have to look at it that way. We can’t switch off-nor should we switch off-all the existing technologies, so we have to preserve and manage that. I realise that it’s a delicate issue, but we need to move. We’re only in the clean side, so it’s easier for me to say, "Switch all the coal technology off, and let’s get cracking on offshore wind." I can see that it’s a delicate situation to manage.

Chris Hunt: Grandfathering is important. If we see a circumstance where, after a plant is built, the rules change, it raises the cost of capital for all of us. On a technical point about the emissions standards, at what point do you declare an old plant a new plant? That is a mistake that the US got caught up in, which was very important, and it has been a mistake that we made that we haven’t actually been able to reverse. In some cases in the United States, for example, you had a coal plant, and the US came in and said, "We’re now going to impose higher standards on new coal plant builds." So what happened is that people who had old coal plants were reticent and hesitant about making any improvement to their plants. They didn’t want to install scrubbers or desulphurisation or any of that, because if they made those improvements, they would be designated as new coal plants and would therefore be subject to a different regulatory regime and different emissions standards. As a result, that gave people the perverse incentive of doing nothing with their plant, which resulted in the worst coal plant possible.

Where is that relevant in the UK? It is relevant around coal plant improvements generally-some of that is covered by the large combustion plant directive-but it is also relevant for biomass. If you wanted to take your existing coal kit and then convert that to be able to burn biomass, either in whole or in part-maybe 10% or 15% of your feedstock being biomass-we have to ensure that that does not make that coal plant be deemed to be a new plant and then be deemed to have to adhere to a higher standard. It’s a technical point, but it’s actually a very important one.

Q202 Barry Gardiner: Thank you. That’s very interesting.

May I get a final question in here, Chair? I know that you want to press on. This is looking at different kinds of risk. Mr Atherton, if may just quote yourself back to you, you said, "I warn you that it is not a question of making the rewards more and more, because the more you make the rewards, the less trust investors will have that those rewards are going to be sustainable." If one looked at the alternative of a sort of regulated asset base and guaranteeing a regulated return where you could transfer the off-take risk, the electricity price risk and construction risks away from the generator, is that a more attractive way of doing this?

Peter Atherton: Well, it’s a different set of attractions, and it would all depend on the terms of the regulation. If it was very similar to the regulation of onshore networks-National Grid, for example-those assets are well supported by investors. The step up in investment that we’re seeing in networks is generally well supported. The Ofgem regimes are generally considered to be okay. We have a new regime appearing in a couple of years’ time with the Rio system and things, so there will be some issues around that. Generally speaking, however, regulated networks are an attractive proposition. Companies can, are and have rounded up substantial amounts of new capex into them. Obviously, from the policy perspective of making offshore wind a completely regulated activity, you are transferring an awful lot of risk and you are capping out return. There will be issues around that in exactly how you deal with construction and things like that. It is, however, clearly an option. The Government looked at it, as far as the EMR, and they said that they would rather not go down that way, because they don’t want to remove all the disciplines of individual companies making individual decisions and things like that. That is a reasonable decision, but would you get more built faster? Probably-at least in the short term.

Shai Weiss: This is now going into macro-economics. If you look at regulated markets, they tend to be efficient in the short term and inefficient in the long run. There are no incentives to improve, and there are no incentives to pass on cost reductions or efficiency improvements. We see that as having a significant damping effect on the competitiveness of the market and, because of that, on the effectiveness of the companies supporting it. So it becomes less attractive in the long run.

Q203 Barry Gardiner: Even though your first remarks to the Committee today were about the importance of stability?

Shai Weiss: Yes. Stability in the framework is key. All we are asking is that you tell us the rules of the game, so that we understand them. If the rules are half fair, we will play in the game; and if they are not, we will find other places to put our capital to work.

Barry Gardiner: Thank you very much.

Chair: Unfortunately, we have run out of time. It has been a very useful and interesting discussion from our point of view. Renewed thanks for coming in and giving your time to us this morning.

Examination of Witnesses

Witnesses: Harry Huyton, Head of Climate Change, RSPB, Nick Molho, Head of Energy Policy, WWF-UK, Doug Parr, Chief Scientist, Greenpeace, and Alan Simpson, consultant to Friends of the Earth, gave evidence.

Q204 Chair: Good morning. Welcome to the Committee. I think most of you have been listening to the previous evidence session. Without offending the other three of you, I particularly welcome Alan. It is nice to see him back here. He is familiar from our previous discussions on these issues. If I may say so, he was much missed.

We know who you all are, so we won’t have formal introductions. I can see the nametags on this side, and I know those of you who are on the other side. I start with a general question about the objectives of the electricity market reform process. Some witnesses have suggested that it should be more specific, do you agree with that? Should there be goals for decarbonisation and security of supply? Should they be built into the process?

Nick Molho: I would agree with that. It could be more specific, but it could also address other areas that are not currently addressed in the electricity market reform. Starting with that particular point, the one key area that, unfortunately, is not currently addressed by the electricity market reform is the potential for reducing energy demand in the long term. The reductions on the demand side could play a key role not only in reducing costs for consumers by achieving our decarbonisation targets, but in significantly helping the UK’s economic recovery.

Just before the green deal proposals were put forward in the Energy Bill, Chris Huhne said that an ambitious green deal could deliver up to 250,000 jobs by 2030. So there is significant potential for cost reductions, both for consumers through demand reduction measures and for the UK economy through the demand sector, that is not being considered.

Alan Simpson: The position of Friends of the Earth would be the same. Ideally, the focus has to be on energy security and sustainability, but, beyond that, the terms of reference have been quite narrowly cast. It ignores the huge opportunities for demand reduction, and it seems to cast a narrow light on gas-there is a danger in owning the wrong type of gas infrastructure. It misses out on the huge opportunity for the UK to be a world leader. In that sense, our disappointment is about the lack of ambition in the EMR proposals, rather than the presence of a grand vision.

Doug Parr: Yes, let me build on that. It seems to us that there is an opportunity to explicitly recognise the important role that we can play in certain key renewable technologies. It has already been acknowledged by the Prime Minister in his recent speeches. And the former Secretary of State, now the Leader of the Opposition, has made similar remarks about the role of marine renewables. They should be more explicit about the decarbonisation target for the grid. We should also be explicit about playing a role in fostering a decarbonised EU, both through setting an example of market rules and how an economy can transform and, of course, in interconnection and the creation of a North sea grid.

Harry Huyton: It won’t surprise you that we agree with that. We all collectively see EMR as an opportunity to confirm this Government’s commitment to decarbonisation of the grid. So the Climate Change Committee has recommended that we should aim for 50g CO2/kWh by 2030 and EMR should have that as a central aim. If we ignore that then we will further sow the doubts that appear to be arising in people’s minds about the future of renewable energy. We heard some of that in the evidence session before our own. So I think that needs to be put to bed with a clear overall target around decarbonisation and the role that renewable energy will play.

To echo what has been said, some fairly substantial parts have been left out of this, including demand management but also sustainability. Our energy mix, going forward, will have significant repercussions for the natural world in the UK, and we would like to see that acknowledged. There are certain things that we could do through the EMR to take that on in terms of technology choice, but there are also things that need to happen outside EMR, which perhaps are not happening yet, to minimise those impacts.

Q205 Chair: But it is clear that if we were to achieve the target set by the Climate Change Committee, the consequences for consumer prices are alarming. Furthermore, what would be the penalties for Britain if we went much faster than our competitor countries in this direction? Would we not have a double whammy in terms of very high consumer prices, and very painful that would be, enormously increasing the problem of fuel poverty and, secondly, handicapping Britain in competitive terms by having higher domestic energy costs than our competitor countries?

Nick Molho: We need to look at both sides of the equation: action on the demand side and action on the generation side. On the demand side, we know from the UK Energy Research Centre’s 2050 project last year that it is technically perfectly feasible to reduce energy demand in the home and transport sectors in the UK by 50%, compared with business-as-usual levels, by 2050 and that this could reduce the costs of delivering a low-carbon system in the UK by up to £70 billion. So clearly, first of all, we need to find ways in which we can maximise on efficiencies on the demand side to limit the increase in consumer prices that come through measures on the decarbonisation side. Now this takes us first of all to the question: how can we deliver those energy demand reduction targets?

The first point to make is to refer to the experience in the PJM markets in the United States, which Rachel Cary mentioned to the Committee a couple of weeks ago. The experience in that market showed that if you treat long-term energy demand reductions on equal par with low-carbon generations through your long-term contracts, in 90% of the cases the energy demand reduction targets are delivered. In terms of a first concrete suggestion, that is one thing that, unfortunately, the EMR is not doing at the moment, although Redpoint Energy, who carried out the underlying analysis made a recommendation for this. So we should look at ways in which we could include long-term energy demand savings in those long-term contracts as a key way of ensuring that we deliver those targets.

There are clearly also ways in which energy efficiency measures throughout the different sectors of the economy, not just in the home sector, which is currently the subject of the green deal, can be realised. The key question here is how can we fund those energy efficiency measures? There are different ways in which we can do that. If, for instance, the carbon floor proposals go ahead, we have estimated that the sum of EUA auctions and of the carbon floor price could amount to roughly £4.5 billion by 2015-16, and then £8 billion by 2020. That would be a very good source of revenue that you could recycle through the green investment bank into energy efficiency projects. Now, on the generation side, clearly we need to focus on creating the best possible frameworks on the technologies on which we can have a natural advantage.

I think it is worth referring here to the low-carbon innovation report from the Committee on Climate Change, which came out last July. Precisely what that report did was look at a whole range of low-carbon technologies and figure out which ones we should develop and deploy, as opposed to just import and deploy in the UK. The report found that offshore winds and other forms of marine technologies, as well as CCS technology, were three areas in which the UK had a natural leading edge through our experience in the offshore oil and gas industry, which we could bear to fruition and in which we could become industrial leaders.

To give an example of what could be achieved here, the offshore valuation report, which was put forward by Government as well as leading energy companies-from Statoil to DONG Energy and RWE-found that by using just 29% of our practical offshore resource, we could get to a situation where the UK could become a net exporter of electricity. The figure for 2030 is an installed capacity of 116 GW, and this could generate up to 145,000 jobs for the UK and around £62 billion of annual revenue.

So for those technologies where we can have a leading edge, if you combine action on the efficiency side-which is absolutely vital-with action on the generation side, the overall cost to the economy can be contained. The evidence that Chris Hunt gave in the previous session is very interesting in that respect.

Alan Simpson: I think it would also be worth the Committee looking at a report published by Deutsche Bank a year ago last November, which was a sort of global take on the introduction of feed-in tariffs and the specific audit of how this had affected Germany. Their figures for the 2008-09 financial year showed that the introduction of feed-in tariffs and the shift into renewables was saving the German bill payers money, rather than costing them money. The real financial gains were to be found in the merit order effect, which is the avoidance of high-cost, high-carbon energy at the margins. If you built that into the equation, even before you fed in the jobs element, this turned into a real economic gain rather than an economic cost both to the public and to society.

The second point I would make is that it is also worth looking at China and the National Grid calculations about UK potential for biomethane injection. We have one pilot scheme that has opened at Didcot in Oxfordshire. There are a total of five pilots in train. China has 3,000 cities operating on city-wide biomethane plants and plans to have 6,000 by 2020. If this was replicated in the UK, it could deliver 50% of our gas needs from renewable gas. You would get that if you had priority access to a system that transformed it and which set emission performance standards that were tough, transformational and set a premium on the shift into renewables and priority access to systems for renewables. That is the widening of the agenda that I think we would collectively want the Committee and Parliament to address, because there is huge potential for gains that would vastly outstrip the costs of change. In real terms it is the long-term costs of staying where we are that are the scary prospect.

Doug Parr: Of course I agree with all that. To quickly supplement, I think the important point is, what is the overall package that large renewables growth would deliver? Take, for example, the scrappage scheme that was introduced on cars in the emergency Budget. That was effectively giving people taxpayers’ money to get something they might have got anyway, but because it was in support of the car industry, it still had a fairly wide amount of support. There are analogies with the possible rises in costs to bill payers that would come from that if there is an industrial base here, as one would hope there would be.

The scope for effective demand-side measures is significant. We already know about local authorities that are potentially interested in a capacity mechanism that would allow them to replace fluorescent lights in street lighting with LEDs. Those closer to this industry than me say that if there were an appropriate capacity mechanism where people could bid in, the possibility of reducing demand from supermarkets and data centres would also come into play. Some of those costs would inevitably, in a competitive industry, be passed on to the consumer. If properly structured, demand reduction can drive reductions in costs elsewhere as well.

Harry Huyton: May I just add that on costs we have to be careful to compare like for like? You cannot simply take the investment required for x GW of gas and compare it with x GW of offshore and onshore wind. You have to think about the long-term costs if we take our decarbonisation goals and our 80% target seriously. You have to account for the costs of retiring those plants early, or retrofitting CCS to them, if we want to meet our 2030 targets and beyond. You also have to account for the costs of exposing consumers further to international gas prices; we don’t know what will happen to them.

So, you have to look at costs in the round but you also have to consider benefits. The Government talk a lot about the benefits and the potential jobs we could get from an offshore wind industry, but I think that needs to come together. I guess I’m a bit concerned there is not an overarching strategy for green growth. That appears to be missing, and I think that’s reflected in EMR and in the other flagship policies that are coming out of Government on climate policy at the moment. We have the green deal and the green investment bank; alongside EMR, in all of those what’s proposed is well short of the ambition required to deliver targets, because there is not an overarching commitment and strategy for green growth.

Q206 Dr Whitehead: May I take some of the points that have already been raised about demand reduction a little further in the context of the EMR itself, with the four pillars that are at the heart of it? Which of those do you think, if any, positively foreclose on demand reduction? It may well be possible to incorporate what you have mentioned about demand reduction into EMR, but if certain pillars actually prevent that incorporation or work against it, one may then say that the issues of demand reduction and of EMR are two different spheres and you may pursue those by different means. Do you think, in terms of those pillars, the demand reduction suggestions that you have made could be incorporated into something like the architecture of EMR as it now stands?

Doug Parr: As I understand it, there seem to be several different suggestions for the capacity mechanism, and at the moment they are perhaps not broad enough to account for the innovation that could take place on the demand side. I don’t think specifically the current framework rules it out, but it just doesn’t emphasise the opportunities enough. That’s where I would draw the distinction, because of the possible variety of capacity mechanisms on offer-yes, it could be included, but if you look at the actual EMR proposal, not much is on the demand side. It’s as if that isn’t terribly well understood and the opportunities aren’t terribly well flagged up.

Q207 Dr Whitehead: We could say that to some extent the green deal, as currently proposed, looks like a suggestion that demand reduction may well be pursued as a parallel device running alongside an EMR mechanism. I think I may anticipate your response to this, but first, do you think that demand reduction measures in EMR may not be necessary if the green deal works as well as some people consider it might? Secondly, if you don’t consider that it will work that well, to what extent do you think that measures relating to the green deal might then run in alongside demand reduction measures within EMR?

Doug Parr: Although my colleagues may want to add something, I see the green deal and what is going on within EMR as complementary, but parallel, because so much of what is going on within the green deal is focused on the building stock and the condition of the building stock, rather than power usage within buildings. That’s not to say that we are not supportive of the green deal. We would hopefully see a higher level of ambition in it. We are, however, missing some innovation on the demand side, to do with power use-and specifically that, because power use is the focus of the electricity market.

Alan Simpson: Chairman, at the risk of repeating a conversation that Alan Whitehead and I had in an earlier session, which was specifically on the green deal, I think the green deal is likely to end in tears. In the economic circumstances, it’s hard to see the fuel-poor wanting to take on personal debt at a time when we are encouraging them to reduce national debt. If the interest rates are above something like 2%, most families will face what is not a pay-as-you-save scheme, but a pay-as-you-pay scheme. I doubt that there will be a queue of people lining up to make themselves poorer. How we deal with demand reduction and the inclusion of the fuel-poor is absolutely critical. It is critical for the Government, because all the projections about how we meet the 2050 carbon reduction targets suggest that two thirds of that progress will have to come through demand reduction. Therefore, we are going to need a much more robust framework to take us there than the green deal appears to offer.

The other thing about it is that it is a very individualised process. It fails to capitalise on the positive experience that we have of such things as warm zones and strategic whole-area approaches that have, in the past, been much more successful. Those are the learning curves, and I don’t think EMR engages with that at all. It’s hard to pull out any single pillar. It’s just that the four cornerstones of the house leave me feeling that the house has been built in the wrong place. Actually, a fundamental rethink of what market reform is to deliver is what has to be addressed. It is unlikely to break the closed energy market that we have in the UK. The Government’s commitment to increased competition is laudable, but it is not going to be found in here. Many of the opening proposals are structured to favour the continuing interests of where we are today, through the big energy companies. It won’t deliver a shift into a change of thinking towards demand reduction and sustainability.

Q208 Dr Whitehead: Some people have suggested that the substantial emergence of a greater level of distributed energy-to some extent, that is anticipated by measures in the market reforms-could, in itself, drive substantial demand reduction. How local authority generation is combined with demand reduction district power arrangements may be relatively efficient in recirculating energy. It has been suggested that that, in itself, could be half an additional pillar, as far as EMR is concerned. How do you react to that?

Alan Simpson: It would certainly be a phenomenally important addition to widen the thinking. In Berlin at the moment, for instance, the local energy company provides 40% of its own energy needs from renewable sources, and across continental Europe, the presence of distributed energy systems has on average, an ability to reduce the peaks and troughs by about 15%. So that aspect of decentralised systems is really important, but it also gives the opportunity to take the debate into different spaces.

I would really encourage the Committee to look, for instance, at what is going on in Hamburg, where their own energy appraisals said the city needs perhaps 2 GW of additional electricity to give energy security in future. After a long debate, they decided that they were not going to build any of the power station options that were on the table, and instead have come up with a scheme called LichtBlick. That is a partnership with Volkswagen to install 100,000 CHP boiler systems in people’s homes, schools, factories, libraries and so on. They provide the individual needs, and at the same time, when the city has an additional energy requirement, the central control unit simply sends out an instruction and all the boats in the harbour just come up with the tide-

Q209 Dr Whitehead: At the risk of cutting you slightly short Alan, how might that sort of idea link in with what Doug was mentioning a moment ago-and maybe you want to comment on this Doug-about the role that the capacity payment element of EMR might play? That is, the extent to which you are providing bid for capacity payments, either for a whole lot of backup gas-fired power stations, or maybe providing that capacity payment backup for different forms of backup for the energy section as a whole? If that is what you are suggesting, how would that work, in terms of the capacity payment systems that are presently proposed in the EMR?

Alan Simpson: My answer would be a returned question. There is a choice of capacity payment mechanisms, and instinctively I would say that unless you have mechanisms that widen the participation within the energy market and introduce a genuine sense of competition, you will be left with the same set of extended cartel interests that have driven-or failed to drive-UK energy policy to where we are now. So the question is, what sort of system does the Committee and Parliament want to have for the decades ahead, in what will be very turbulent times?

I will just finish on that point about Hamburg. One of the great advantages there is that, at a participation level, citizens, businesses-whatever they are-get to know when the city has taken a contribution from their system when they receive cheques in return. The transformation of the energy debate shifts from the corporations to citizens, in the process of driving energy security for the future.

Doug Parr: Let me just add a couple of comments, because it is a good question about how all these pieces of policy would work together at the implementation level. First, the capacity mechanisms would have to be structured differently in terms of giving demand-side response, which we understand DECC are looking at quite hard, and demand reduction, which is more akin to baseload than some kind of flexibility mechanism. We support the extension of CHP for a number of reasons, including flexibility, but also future-proofing in terms of fuel shift and so on, so there are advantages to the deployment of CHP.

Secondly, however, their deployment-for example, with a heat store to allow greater levels of flexibility-is a different kind of mechanism. This would need to be thought about in relation to the green deal, vis-à-vis the long-term, baseload type demand reduction mechanisms that I was talking about-for example, through better and more efficient data centres or changes to street lighting.

So there are two different parts that a capacity mechanism would need to account for, but I think it’s important because at the moment there is no innovation in that space. There is not the opportunity for companies to identify the opportunities and go in and try to make a bid for sorting them out, because as we know very often these things are actually cheaper than adding new generation capacity. I would say that is the key thing about the capacity mechanism: to be able to open up that innovation.

Nick Molho: If I could just concur with one finding that goes back to the start of your question on the role that EMR could play on demand, it is very important to realise that if we want to reduce energy demand, we need to look at realising efficiencies across all sectors of the economy, not just the home sector, albeit the home sector is an extremely important one. That is where the EMR can play a very helpful role. If you look at what happens, for example, in the United States, you have companies like Wal-Mart who can enter into a long-term contract to deliver x amount of energy reductions by a particular date. That is a very helpful tool; it gives you the contractual certainty of any energy demand reductions, savings by big businesses, by a particular point in time, which helps you plan your baseload mix on the generation side as well.

Q210 Laura Sandys: I am interested in how UK and EU policies come together. When we look at the ETS, one of the things we have been having many discussions about is, first of all, the impact of the interconnector; and secondly, the European objective of the ETS stance and whether the measures in the reforms are actually just going to hit the UK, while, in many ways, letting the rest of Europe off the hook. What do you, as the environmental groups, feel we need to do about that pan-European debate? How do we ensure that we don’t end up, not only not on a level playing field, but also not increasing the pressure on those ETS figures?

Nick Molho: There are a few points here. First of all, it is worth remembering that a lot of what the UK does in the energy sector tends very often to be implemented afterwards at EU level. The privatisation in the 1990s was a good example of that. We then had a series of pre-internal market directives at EU level to try to emulate what the UK had put in place. Our European policy office is already being asked regular questions at the moment by the EU Commission and different departments about exactly what is happening in the UK with electricity market reform. What is happening in the UK at the moment is being followed very closely in Brussels, and it is worth bearing that in mind.

Clearly, while it is important for the UK to take the lead, and that can have an influence on other European countries, action is needed at EU level. As a first concrete step, continuing Government efforts to get a 30% emission reduction target by 2020 would be an improvement, given that we know from the Commission that the current 20% target does not require any real emission reductions in the 2012-20 period, because the recession has basically already given us enough additional allowances to get there. Therefore, the increase to a 30% target is really important.

But it is not just the UK looking to decarbonise its power sector. In fact, just a few weeks ago, the German advisory council on the environment-the leading science-based think-tank in Germany that advises the German Government on environmental and energy issues-issued its report recommending the move in Germany towards a 100% renewable energy system, arguing that it was not only technologically and economically feasible to deliver that, but it was also the only option in terms of sustainably decarbonising the German power sector. So the German Government are taking that very seriously.

We also know that the French Government announced back in October that they were going to launch their first big offshore wind programme as well, so there is a fair amount of momentum, albeit currently not co-ordinated across the EU, but clearly, both through a combination of leading by example and continuing action at EU level, we are very unlikely to end up in a situation where it is just the UK focusing on decarbonising its power sector with the rest of Europe doing nothing.

Alan Simpson: I think you’re on the horns of a dilemma here. The Government have no choice other than to press, at an EU level, for the highest set of common standards. That is morally and ethically the right decision. Is that likely to happen? I would say, not a cat in hell’s chance. The measures that could be implemented were set out in a joint letter from organisations to the Treasury and those stand-if the EU were serious, those would be the things that would be done. My gut feeling is that they won’t happen. There has been huge cheating in the EU ETS; there has been fraud at a massive level, and I think that is likely to continue. The question then is, does the UK have a default position?

One of the things that I hope the Committee is able to do, if DECC is not, is to push for a fundamental rethink of what needs to be done. I do not believe in carbon pricing, and I have to confess that I am only a lapsed economist. If you cast your mind back to when the clean air Acts were introduced in the UK to tackle air pollution-some of us at least are old enough to remember them-the Government of the day didn’t say, "Well, we’ve got this problem, because we don’t have a decent market price for soot." They told industry that it had to raise standards and change the game, which is a bit like the arguments we are making for the emissions performance standard. You have to go in for game-changing mechanisms and let industry and the market deal with that against the certainty of moving to a higher set of standards. In a way, the arguments you heard in the previous evidence session were precisely the arguments that were being used in the ’50s and ’60s against the introduction of the clean air Acts. What transformed the game was that Government decided to set a different rules base.

Q211 Barry Gardiner: But with respect, there wasn’t a market in clean air. The question that the Chairman asked earlier cuts back in again, because, through interconnection, there will be the problem that the artificially high prices, tariffs and barriers set here in the UK are undermined by energy coming in from the continent. That presents exactly the problems on which the Chairman was challenging Mr Molho earlier on. I thought he gracefully finessed him away from it, if I may say so, but he didn’t really tackle this issue.

Alan Simpson: I think the interconnector is an issue of mutual interdependencies, which has to be addressed. How you weigh the carbon content of imported energy is a separate and technical matter, but my point about the UK is that we have the capacity to become a net exporter of energy. The trouble is that we are being driven into rerunning the past by a set of old energy presumptions. All the really exciting opportunities are for a game-change. The arguments on the clean air Acts were about precisely that.

Q212 Barry Gardiner: The costs and the disincentives in the UK are such that knock-on costs for goods and employment-as well as the potential for unemployment-would result from a differentially high cost of energy here in the UK when compared with the continent. Do you not think that it would be a problem for us, rather than a solution?

Alan Simpson: Well, I think you should talk to the Germans about the job consequences of making that shift. For them it has delivered almost 300,000 new jobs. The late Hermann Scheer travelled to California to talk to them about whether the shift to renewables would bring about colossal job losses. Within two weeks of being there, he had convinced both of the major parties and pretty much all of the pension funds in California that it was almost suicidal not to make that shift. The same arguments are to be found pretty much everywhere you look. Real job gains will come from a bold leap into renewables in the way that Germany is suggesting. The real substantial long-term costs to bill payers, to taxpayers and to the economy are to be found in trying to crank up the old mechanism and pretend that it is new.

Doug Parr: May I come at this in a slightly different way? Is some of this stuff going to cost money? Well, of course it is. It is going to cost quite a bit of money. What is the alternative? The alternative being touted seems to be that we just throw up some cheap combined-cycle gas turbine plant. There are a number of problems with that. First, as Ofgem’s Project Discovery pointed out, one of the most expensive scenarios is that we build a lot of gas and then find that gas prices have gone up. That is more expensive than taking a green approach. The other thing is that we have to think of ourselves in terms of-

Q213 Barry Gardiner: When you say it is more expensive than taking a green approach, what is more expensive: the cost of the new kit as opposed to a renewables kit? What are you saying is more expensive?

Doug Parr: The scenario where we take a business-as-usual approach, and then prices go up compared to the green scenario, which had a variety of measures including heavy renewables and energy efficiency.

Q214 Chair: Have you calculated what the gas price would need to be to match the solar tariff?

Doug Parr: No.

Q215 Chair: I think it would probably be about 25 times what it is today, but I don’t know either. I understand your criticisms of another dash for gas-we all understand that. The danger is that it would produce some stranded assets in the 2020s that would have substantially lower carbon than coal and substantially higher carbon than some of the alternatives. But I think Barry asked you a question that you haven’t fully answered. It is not clear to me, if we have a free European market, why we wouldn’t simply buy lots of cheap energy from other countries-perhaps nuclear-powered electricity from France-if it was much cheaper, because we invested a huge amount of money in hideously expensive renewables in this country? That seems to be the question which you haven’t adequately answered, and it’s a gamble. Of course if fossil fuel prices go very much higher, then we would be in a better position. There is, however, more and more evidence that there is going to be a big decoupling between oil and gas prices now. A tremendous number of uncertainties underline your side of the argument, although this Committee does understand and sympathise with it; we just have to work out what the consequences are for consumers and the competitive position of Britain.

Doug Parr: I agree with that. The point I was trying to make-perhaps not clearly enough-was that there are significant uncertainties associated with the alternatives. If there were another dash for gas, as you articulated, and we remained heavily dependent on gas in the heating sector, then effectively we would be transferring at least two of our energy objectives-security and affordability-over to the international gas market. Now, does that strike you as a wise policy move?

Barry Gardiner: I think the clear answer to that rhetorical question is "No".

Doug Parr: Exactly.

Q216 Barry Gardiner: The point surely is this: one can see the dangers of the dash for gas, and it would appear that the EMR is being structured to try to get a diversity of supply, precisely to avoid putting all our eggs in that one basket. But on the other hand, the evidence that you and Mr Molho and Mr Simpson have given us this morning has very much been that we should put all our eggs in a different basket. Obviously, the responsibility of the Committee is to probe the flaws in that argument as well, and that is what I feel has not yet been satisfactorily countered by you. As the Chair said, all of us are sympathetic to the place you want us to get to and we all want to get to, but the question is, how do we overcome the problems associated with your singular alternative?

Nick Molho: I would like to make just one point. Going back to the interconnection question, we have to realise that I don’t think anyone here is advocating one singular technology. Renewables is a combination of several different technologies; it tends to be treated as a single basket, but actually it is made up of onshore wind, floating offshore wind, fixed offshore wind, wave, tidal, solar and, potentially, other alternatives.

Q217 Barry Gardiner: Mr Molho, if you were to break that down, though, would you accept that by far the vast percentage comes from wind, and by far the vast percentage of that comes from offshore wind?

Nick Molho: At the moment, yes; in current technology, given the stage of development at the moment, you are absolutely right. That is precisely why, from an R and D perspective, the Energy and Climate Change Committee called in its low-carbon innovation report for focusing not just on improving economies of scale for offshore wind, but on improvements in wave and tidal technology. But what-

Q218 Barry Gardiner: Sorry-I hope it’s helpful to develop this into a dialogue. I don’t wish to frustrate you.

Nick Molho: No, that’s fine.

Q219 Barry Gardiner: I am really trying to tease things out here, because it seems that we’re talking about a fairly short time scale in terms of the solutions required.

Nick Molho: Absolutely.

Q220 Barry Gardiner: Ofgem has said that £200 billion is required over the next nine years. We’re looking at that sort of transformation in our energy infrastructure and energy economy. While one might say, "We need to do more in these other areas," you are attempting to counter my suggestion that you are over-investing or asking the country to over-invest in one particular technology, and I have accused you of not being diverse enough. You are saying that you are being diverse, because there are all these other technologies. My push-back against that is that none of those are yet at a sufficient stage-certainly if you look at wave and tidal-to be producing the capacity that we would require by 2020 and beyond.

Chair: Please answer very briefly, because we are rapidly running out of time. We can amplify the answers in writing afterwards.

Nick Molho: Okay. You need to look at this step by step. We know that we have roughly 85 GW of capacity today. We know that we will lose between 20 GW and 25 GW, according the national policy statement, over the next 20 years. Two years ago, the WWF and Greenpeace did a report with Pöyry Energy Consulting, which showed that if the UK met its renewable energy and energy efficiency targets by 2020, there was no need to build further base load generation until then. What is interesting to know here is that that report was based on estimations of energy demand that were much higher, because they were pre-recession levels, and it also did not take into account those gas plants that had been consented but not yet built. So that is the first step to 2020.

In the period from 2020 to 2030, it is important to note that we know that we can expect a fair amount of new offshore wind on the system while, as you say, wave and tidal technologies are being developed and brought up to scale. From the offshore evaluation report, we know that if you use 29% of our practical offshore resource, the figure that you could get, in terms of total offshore renewable capacity by 2030, is 116 GW. If you take the average load factor in 2009 for offshore wind, which was 35%, that gives you a net capacity of 40.6 MW.

Actually, the truth is that if you look at the proposed projects for round 3, for instance, the wind speeds are expected to be higher, because those projects are going to be further offshore. If you add the technological developments that will take place, you can expect increased load factors of between 40% and 50%, which could give you a higher net capacity. If you combine that with increases in onshore wind capacity, increased combined heat and power, energy efficiency measures and a clever use of the existing plants that we have on the system, there are a lot of parameters that could help you reach the answer without going down the nuclear route or the new dash for gas route. On the increases in onshore wind capacity, the DECC 2050 pathways look at a range of 20 GW to 30 GW by 2030. On combined heat and power, we currently have 7.5 GW on the system and that could easily double over the next 10 years. On energy efficiency measures, as we suggested to the Committee in the EPS inquiry, for example, some of the old plants on the system could have derogation from a strong EPS and just operate at times of high demand, and a lower renewables factor.

Chair: Okay. We are very short on time. We’ll have one question from Alan and one from Laura, and then we have to be out of here in seven minutes.

Q221 Dr Whitehead: I am going to try to help you out. An interconnector, by and large, is a balancing mechanism not a fundamental growth mechanism, which means that it tends to balance what else has been produced against peak demand. It presumably will continue to do so unless it is suggested that interconnection actually play a far larger role in the energy mix of the UK. That may also have a hand in things such as developing storage, and we heard from other witnesses that, for example, the interconnector to Norway could be used as a storage mechanism.

Alan, you mentioned the Deutsche Bank analysis of the extent to which renewable power might be judged against peak cost. How might you put those factors together in terms of the pillars that are in EMR, the arguments about energy demand, the use of storage, possibly, and interconnectors and the overall trading picture? As Barry has emphasised, that is what we need to look at fundamentally. What will the trading position be as a result of these reforms?

Alan Simpson: Sorry, are we taking both questions?

Chair: Laura, is yours sufficiently related?

Laura Sandys: Mine is a bit more radical.

Chair: Let us have the answer to that last question, then.

Alan Simpson: The debate needs to come back to something broader than the four pillars. That is part of the problem. If you stick with the four pillars, the likelihood is that the UK will end up with the same closed, rigid energy market that it has today. It will be stuck with a system of quite regressive long-term subsidies, rather than transitional ones. All the learning curves from elsewhere around the planet about the falling cost curve for renewables are being missed in the nature of the debate.

It is worth looking at North Carolina, where last year the unit costs of electricity from nuclear was coming in at 16 cents per kW, and that was the crossover point with the unit costs from PV. Their projections are that by the end of this decade, while nuclear costs will have risen to 24 to 27 cents per kW, PV will have dropped to 5 cents. In a sense, the debate fails to move the UK into leading-edge technologies, learning-curve processes and subsidies that are presumed to tail off, rather than trying to shuffle new subsidies to old nuclear. If that is where we end up, then we have lost sight of what the real balancing mechanisms are about.

Q222 Laura Sandys: The Clean Air Act is an interesting thing. I have a family interest in that piece of legislation. The issues are about game-changes. While we are talking about looking at the sector as it is today and tweaking it, we had an interesting suggestion from Dieter Helm that instead of valuing carbon generation, we should look at carbon consumption. Is that a game-changer? In a strange way, what you are talking about is not necessarily even enough of a dramatic game-changer. If you start to look at carbon consumption, you get around some of the issues about energy transfer from Europe, because it will be in the total price-the total value-rather than in its generation aspect. There might not be a short answer to that.

Doug Parr: There isn’t a quick answer to that, no. The analysis is correct in the sense that the UK in many ways has not cut its carbon emissions very much. Therefore, responsibility for these emissions still sits with us. It is not much of an extension to say that we should be responsible for the emissions we produce, even if they are produced in the power market offshore.

To come back to the point that Barry and Tim were making, I take this quite seriously. If we are keen on fostering our own industries-again, there seems to be cross-party consensus about the need for the stimulation of these new technologies in offshore-the case histories of Germany and Spain are that they had to protect their home industries to make them viable. In Germany they did it by insisting on technical standards for wind turbines that nobody else could meet. In Spain, they had local content rules. In the classical economist’s view of the world, these are bad, bad things; but look what they have got in exchange! Denmark had similar provisions. If there would be a cost, then we need to be clever about finding ways of ensuring that we have a domestic industry that can build on the back of what would be a higher level of interconnection with the continent, which we thoroughly support.

Alan Simpson: I-

Q223 Chair: Right. Sorry to cut you off, but we have some deadlines to meet. Thank you very much indeed. It has been a very stimulating debate from our point of view. I know that it will continue. We may want to ask you to develop one or two of these things in writing afterwards. Thank you very much for your time.