Session 2010-11
Publications on the internet

To be published as HC 742-vi




Energy and Climate Change Committee

Electricity Market Reform

Tuesday 15 March 2011

Lord Turner of Ecchinswell, Dr David Kennedy and Duncan Sinclair

AND Rhian Kelly, Audrey Gallagher and Richard Hall

Evidence heard in Public Questions 287 - 365



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Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 15 March 2011

Members present:

Mr Tim Yeo (Chair)

Dr Phillip Lee

Albert Owen

Christopher Pincher

John Robertson

Sir Robert Smith

Dr Alan Whitehead


Examination of Witnesses

Witnesses: Lord Turner of Ecchinswell, Chair, Committee on Climate Change, Dr David Kennedy, Chief Executive, Committee on Climate Change, and Duncan Sinclair, Director, Redpoint Energy, gave evidence.

Q287 Chair: Good morning, and a warm welcome back to the Committee. It is good to see you. This is a pretty wide-ranging inquiry we are engaged on at the moment, so lots of angles. Could I start by asking: you have set out the target of getting emissions down to 50g per kilowatt hour by 2030; should that now become explicit in the EMR consultation process? Would you like to see the Government accept that as an explicit target?

Lord Turner: I think that’s an interesting question and not one that we have formally considered, whether that should be made an explicit target. We certainly think that achieving a grams per kilometre of there or lower by 2030 is highly likely to be required as part of the path to the 80% reduction by 2050, and that is something that we have a high degree of confidence that we need to be around there. I think the difficulty would be saying, if somebody said, "Well, the optimal figure would be 60g or 40g", the range of precision of 50g. The calculations are not so precise as to be able to say it absolutely has to be 50g. On the other hand, a number of other targets in public life at the end of the day are created as stretching targets, even though the logic can take you to about that range, but not to precisely that figure.

We certainly believe that in the operation of the post-review structure, the Government will need to have a vision of roughly where it wants to be in 2030, because that will determine the amount of the quantity of low-carbon electricity for which it is effectively contracting through the process. So I think, as I say, we haven’t thought about what the degree of formality of that target should be. I guess there would be some value in setting it as a formal target and saying, "That is the aim." Certainly, I think when we get down to the detailed operations of the EMR, DECC will have to develop an effective operational target, because otherwise how is it going to determine how much contracting it places? David, do you want to add to that?

Dr Kennedy: We’re not saying, "Adopt 50g now" for the White Paper in summer, but we are saying in the letter that we sent to Chris Huhne last week, "A quantity-based approach is needed". It’s not that the Government can just set the price and then see what happens in the market. The Government has to have a view of: how quickly do we want to decarbonise the sector; how much investment are we looking for in low carbon? So what we’ve said is that 50g of CO2 is our best estimate now. Clearly, it should be less than 100g, but is it 50g or 60g, as Adair says? Well, we don’t know, and further analysis is needed and that would have to be done in the course of working out the implementing arrangements and developing the contracting strategy.

Q288 Chair: So would you say that you would like them to set something that is less than 100g anyway?

Lord Turner: Yes, definitely. I think that is clearly the range of what we think is required by 2030, yes. It’s how much lower than that.

Chair: It is how to raise the level of ambition that they currently have. They have to raise their level of ambition.

Dr Kennedy: They were working with a number of 100g, and I think they were working with that because previously we’d suggested 100g or less was appropriate. They took that as a given and they worked out: how can you get 100g and how much does it cost? Our new analysis suggests 100g is probably a bit on the high side, given the investment opportunities that we have.

Chair: Redpoint’s analysis was based on 100g.

Duncan Sinclair: Correct, yes.

Q289 Chair: Have you worked out what would need to change in the DECC proposal to get it down to 50g?

Duncan Sinclair: We have done some supplementary work and we have shown that it is possible. It depends on whether it is more nuclear or more renewables to get there. It does have quite a profound effect on the energy market itself, because at that level of decarbonisation, it’s quite a big impact on market prices. So although it sounds like a relatively small shift from 100g to 50g, it is quite a profound difference. We think it reinforces the need for feed-in tariffs with CfDs, but we think it is possible. I guess the key risk is around technology, that to set a target as low as 50g, all the technologies are going to have to develop and come to fruition in a timely manner. So there is some risk around that, but at this stage, it looks like it’s feasible and the cost of that isn’t excessive, given where carbon prices may well go under the Government’s forecasts.

Q290 Sir Robert Smith: Yes, I had better remind the Committee of my interest in the Register of Members’ Interests as a shareholder in Shell and also that I am an Honorary Vice-President of Energy Action Scotland, fuel poverty.

Just on this debate, it is quite often focused on where the new capacity is going to come from for supply. What analysis has the Committee on Climate Change done of how we can reduce demand: energy efficiency, distributed generation and demand side responses? Have you been looking at what measures could be used there?

Lord Turner: Yes, I mean, within our forecasts of total electricity demand, we have the assumption that we will continue to achieve electricity demand, use efficiency, energy efficiency improvements in electricity. A significant element of that comes through the residential appliance route, where there has been a rate achieved in the past that we have assumed can continue to be achieved in the future. It won’t occur naturally. It has to occur as a result of, for instance, continued regulation. I think this is an area where regulation, in simply banning the very inefficient level of appliances and continually increasing the grading system-when you buy a washing machine, moving up from A to A+ to AA+ and then slowly making the Ds or the Cs illegal rather than simply labelled-that is very important. But whenever we have-

Q291 Sir Robert Smith: So you think the consumer, left to their own devices, is not necessarily going to follow the price signal?

Lord Turner: I think that is right. I think the consumer, left to their own devices, the price signal for some consumers is not strong enough. I mean, the fact is that at medium or higher-income levels, the amount of electricity used on domestic appliances, although it’s still significant, is not a large enough part of the family budget that there is a very strong focus, left to themselves, on the price sensitivity. People seem to be somewhat more sensitive to needing the trigger of when they buy the new appliance, information and guidance and encouragement and an element of regulation that moves them away from the low-efficient ones and more towards the high-efficient ones. When they do that, they are aware that they will get a benefit from it, but they need to be triggered and encouraged down that route. Left to itself, it’s unlikely to do it.

The net effect of all the energy efficiency though is even with significant amounts of energy efficiency, we still believe that from the 2020s onwards, we will have rising electricity demand across the system because of two major new areas of use of electricity, one of which is in surface transport through electric cars, and the other is the application of electricity to, in particular, domestic heat through ground-source and air-source heatpumps. It’s those two new forms of applications of electricity that we believe will inevitably overwhelm even important and significant improvements in the efficiency in existing uses.

Q292 Sir Robert Smith: Do you think more can be done though to make the housing stock more efficient to reduce that demand for heating?

Lord Turner: Oh, yes, we undoubtedly need to do that. I mean, at the moment, of course, the vast majority of residential housing is heated by gas, not electricity, so at the moment, the improvements in the energy efficiency, the insulation of the housing stock, which are extremely important, translate into reduced gas usage. However, once we start moving to an increasing element of electrical heat, the improvements in insulation will be helping to moderate that increase. Indeed, it’s particularly important, because the efficient way to run with an air-source heatpump or a ground-source heatpump is to have low level of quite low background heat, which only works efficiently when you have a well-insulated house. They’re not very efficient in terms of the way that some people heat their house at the moment, which is to have a very inefficient house and then blast on some intense heat into a particular area. That way of heating your house just doesn’t tend to work well with the air-source or ground-source heatpumps.

Q293 Sir Robert Smith: Did the Redpoint analysis do much on demand side and efficiency?

Duncan Sinclair: We did, and we took DECC’s views on demand going forward, taking into account the Green Deal. We also looked at an overall flattening of demand shape associated with, for example, heatpumps or with electric vehicles, assuming that there were some price signals to encourage consumers to flatten their demand. We took that into account and we also recognised the possibility that the demand side could play in providing additional capacity and helping with the security of supply issue, so that was all taken into account. I mean, the big uncertainty is smart metering, with the roll-out of smart meters. There’s a lot of interest around what that could do in terms of changing consumer behaviour, and I think that is definitely a positive sign in terms of how security of supply could be managed, so there are some good opportunities there going forward. So we looked at it semi-quantitatively, but also looked at some of the qualitative issues around the technology unknowns at this stage.

Q294 Sir Robert Smith: How did you assess the Green Deal’s impact?

Duncan Sinclair: We didn’t assess it directly. We sort of took the assumptions from DECC in terms of what they felt the impact would be on electricity demand, so we didn’t get into the details of that. That was an input into the analysis.

Q295 Sir Robert Smith: Finally, was there any analysis given to the potential role of storage and interconnection to other electricity markets in Europe?

Duncan Sinclair: We included some additional interconnection. We took some relatively conservative views of the additional potential. That’s certainly again upside in terms of security of supply and may also reduce the cost of managing the intermittency around renewables. So that’s definitely an issue, but as I said, we took some relatively conservative views on the super-grid, for example, going forward.

Q296 Dr Lee: Putting Japan to one side and their short to medium-term need and desire for gas and so on, to what extent have you factored in possible imports of shale gas, liquified natural gas, into this? We have just been to the US and they were talking about changing a terminal potentially so that it started to export gas, as opposed to just importing. Do you see that causing any problems to your calculations?

Duncan Sinclair: The gas assumptions and the price assumptions were again DECC’s assumptions, and the central case has gas around where it is currently and rising gently, about 3% year on year in real terms to 2013. So that’s probably at the higher end of where some analysts are expecting it to be. We also looked at a low-gas sensitivity as well, and it’s clearly the case under lower gas prices the cost of some of this looks higher. But the risk is with low gas prices is we don’t achieve the decarbonisation objectives that we’ve set out to achieve, and therefore while the analysis could show with lower gas prices lower cost for consumers, it may also show that we haven’t reached the environmental objectives. So it’s a difficult question, that one.

We weren’t trying to evaluate the rights and wrongs of whether we should or shouldn’t invest this money in achieving these targets. We were just looking at the analysis around, if we are going to try and achieve those targets, what is the most cost effective way of doing it? That was the focus of what we did.

Dr Kennedy: Just to say our analysis says we should not change the objective, the environmental objective. I think there is a myth around, which goes something like: we are going to have this low-cost gas, so we can decarbonise based on unabated gas fire generation. That’s not true, because you can’t decarbonise using unabated gas, because it is carbon intense, not as carbon intense as coal, but still carbon intense. Now, our analysis says, "Would you change the 50g target, for example, in a low gas price world?" and the answer is no. So the decarbonisation strategy is robust for a different set of scenarios for gas prices. Even in a low gas price world, you would still want to decarbonise the power sector. It tells you that gas CCS may be a very valuable option to have in your portfolio, and so we have stressed the need to have a gas CCS demonstration project, which then can sit in the mix going forward in the 2020s next to nuclear and to power agreements.

Q297 Dr Lee: I guess my point is that, if it wasn’t for shale gas, that would be a bit easier for the renewable market, wouldn’t it? The suggestion is that suddenly we found all this gas that we did not know was going to be there. If the gas had not been there, then the rest of it would then become, in the eyes of the public, more justifiable in that they would be thinking, "Well, we cannot get our power from gas, so therefore we are going to have to get it from renewable sources". I am just suggesting that this flood of gas-and it would appear that there is vast amounts of it-

Dr Kennedy: I think it makes it harder to sell the story that we need to decarbonise, because people think we can decarbonise with this cheaper source of fuel, but it’s not true.

Q298 Dr Lee: Do you think it would be perhaps, if you could choose, better to have a low-carbon target instead of a renewables target?

Lord Turner: This is something that we have to give advice on in May in our Renewables Energy Report. We clearly are attracted-as we were discussing earlier-to very strong targets expressed in grams per kilowatt hour. We also think that it is important to think about how much of the system should be zero carbon, whether nuclear or renewables, but we don’t think that we should throw away the aim of a renewables target as well, because in the long term, by 2050, we have to be close to zero grams per kilowatt hour in the electricity system. I think there are good arguments-even if you believe that nuclear was the cheapest option-for not putting all of your eggs in that basket. I mean, there are things to do with waste; there are things to do with over-reliance on any one technology, which I think says that even if you believe nuclear was the cheapest option, you would want a balance of nuclear and renewables.

So I think it is highly likely that when we come back in May, we will not be suggesting that we should no longer have a renewables target as well. We think that is a useful part of the story, but it certainly needs to be combined with an approach to all three of what we see as the key sets of a low-carbon technology, which are: renewables, in the way that that term is used, nuclear, and the application of CCS, particularly the gas. I think increasingly we think the long-term future of CCS may be applied to gas, rather than, as people used to think a few years ago, exclusively to coal.

Duncan Sinclair: I think it’s definitely the case that the 2020 target is pushing up the cost of the renewables, because it’s a very, very rapid timeframe and the analysis suggests that a sort of slower glide path, still going to where you would be in 2030, the same renewables, same amount of nuclear, but on a slower trajectory would be a lot cheaper. You have to pull out virtually all the stops to hit the 2020 target and that’s going to incur cost and cause pressure on supply chains and pressure on available sites. Then what you find if you hit the 2020 target, your rate of renewables deployment in theory could slow right down, and that’s not the most cost effective way of achieving it. So there’s no doubt the EU target does put additional constraints that are economically challenging, where the target for 2030 and the 50g a kilowatt hour could be achieved cheaper if that was not the case.

Q299 John Robertson: If you were to go from the 2020 target to the 2030 target, what is to say you would not go then for a 2040 target and a 2050 target? What kind of, shall we say, putting that into tablets of stone has to be there, because eventually you have to draw the line somewhere? If you take away the 2020 target, then do we have a knock-on problem?

Lord Turner: We see that by 2050, as I mentioned a moment ago, if the UK is to meet its legislative Climate Change Act 80% target, then electricity essentially has to be pretty close to zero grams per kilowatt hour or 5g per kilowatt hour, you know, a trivial amount, because the figures simply do not add up otherwise, given the difficult-to-reduce sectors, which include agriculture and bits of industry and aviation, areas where there are emissions to which we cannot see technological ways of entirely getting rid of them. Given those difficult-to-reduce sectors, we believe that electricity decarbonisation essentially has to be pretty close to total. There may be a small amount, because you may still have non-100% CCS gas plants providing the last margin of production capacity.

So when we talk about a target of, let us say, 50g for 2030, what we described-and we described in our fourth budget report last December-is that there is further steps thereafter. Having said that, of course, most of the steps are achieved by 2030. We are now on 490g per kilowatt hour, I think it was, 2009. It will then be at about 300g per kilowatt hour by 2020, below 100g by 2030. You know, we will have achieved most of what we have to achieve then, and then beyond that, there would be further progress on, in particular, hopefully CCSing any unabated gas. So, yes, we see that as a long-term path to 2050.

Dr Kennedy: There’s a practical reason to have a 2030 target, which is given the very long lead times for projects. If you look at nuclear, that’s a five-year construction, two-year development. What we do over the next 10 years will determine the power system we have through the 2020s and in 2030, and so we need that target to frame our thinking and our actions over the next five and 10 years.

Q300 John Robertson: I mean, it appears to me that you put CCS as "it must happen" rather than "it may happen."

Dr Kennedy: We need to see if it is technically feasible and economically viable, so cost competitive with renewables. It certainly will make decarbonisation easier through the 2020s and beyond. If you did not have CCS, that raises the question, could you still decarbonise at the same pace, and I think the answer is yes. It will be more challenging; it will possibly be more expensive, but we would do more of nuclear and renewables. Ideally, we’ll have CCS in the mix and that will help drive this decarbonisation.

Lord Turner: Without CCS, you’d have to do more nuclear, more renewables and it would increase the importance of the super-grid interconnectivity across Europe to balance the renewables, because you’d have a system that you couldn’t simply easily balance through the gas-fired.

Q301 John Robertson: Is there a plan B?

Lord Turner: There is a plan B. Most of the modelling says that if you knock out the possibility of gas CCS, it is still doable at a not absurd economic cost. It is a higher economic cost, but it doesn’t dramatically increase, but it is simply more difficult. The best way forward is with all these three sets of technologies to be part of the mix.

Q302 Sir Robert Smith: Lord Turner, you mentioned sort of in passing the future of the gas CCS being almost a swing generator, but apparently the first generation of CCS is going to be very much baseload, because it is not the kind of thing that likes to be switched off and on.

Lord Turner: Yes, well, you’re quite right, that initially, because CCS in itself is quite capital intensive, you can’t just use it at the swing.

Sir Robert Smith: Also the process itself.

Lord Turner: Yes, the process. No, I agree with that. Indeed, it has to be, and provided it gets efficient enough, it can be a part of the permanent baseload as well. I mean, the crucial thing here, which is one of the things that has to be focused on in CCS for the long term, is how efficient it is. Does it take out 80% of the carbon or 90% of the carbon? We sometimes talk of this as being sort of CCS or non-CCS. One of the crucial things that we are going to have to get down to is what percentage is achieved. If it can achieve very high percentages, then it can be part of the long-term baseload as well as the rest.

Dr Kennedy: We should stress though that the baseload that we have at the moment, which is kind of 30 to 35GW on the system, we envisage will increase very significantly over the next 20 years because of the demand for overnight charging of batteries for electric vehicles and because of storage heat that is electric. Now, the scenarios we have actually add the capacity to run as baseload, whether it is gas CCS or nuclear, so there’s a very significant increase in demand there.

Q303 Chair: Given the importance that CCS is likely to have in relation to achieving these targets, does it worry you at all that with the prize of £1 billion of public money available for competition, that competition only attracted one entrant?

Dr Kennedy: Well, I think the key is that we have four potential demonstration plants. We are very interested in the second competition, which is for the second, third and fourth demonstration plants. My understanding is that, in terms of expressions of interest, there are a lot of expressions of interest. Within that, there are some very serious project proposals that DECC is considering at the moment. So I think the test of this will be the second phase. I think it’s important to go on with the Longannet project and get that into construction, so to get the contract signed and to move forward, but also to move forward with the second competition and get those other three projects, of which one we stress should be gas CCS. So that’s the key for us, the second phase.

Q304 Christopher Pincher: Without naming names, are those expressions serious expressions of interest from members of the Big Six, because I spoke to two of them this week and last week and those two certainly were not interested, so that leaves you with four, of which one is already in there. What about the other three?

Dr Kennedy: As far as I know, not having looked at the details of this, there are some big players within the Big Six who are interested in doing demonstration projects; not all of them, but some of them. As I say, I think there are enough serious proposals that are there for consideration to make us feel reasonably confident about this. I think the bigger issue actually is confirming and securing the funding for this second set of demonstration projects. That is something that the Government, I understand, is going to comment on over the next several months.

Q305 Chair: Just reverting to the question of the technology mix, the challenging 2050 target and the possibility that we may flooded with cheap gas and therefore a lot of gas capacity is built in the next 10 years, do you think that a 35% contribution from renewables in 2030 takes us far enough to get to the near total decarbonisation in 2050?

Lord Turner: Well, this is precisely what we will be setting out in the renewables review. We’re looking carefully at precisely these figures; we were debating them just on Friday. Obviously, it crucially depends on how much nuclear you think should be in the system and the prospects for CCS. It is as simple as that. That’s the balance that you have to strike there. So that’s whether you need to put it higher, and then whether you can take it higher at a reasonable cost depends crucially on what we think is going to happen to the cost of offshore wind. Now, there are reasonable cases from forward-looking engineers that over time, this thing will come down in cost, in particular with, for instance, movements to very, very large turbines, for instance, even 20MW turbines and so on, and just the relentless process of engineering cost improvement that typically happens with a technology. If those are achieved, there will become a point, I think, by 2030 or so where offshore wind will not have the cost premium over nuclear-or maybe even over onshore-that it has at the moment. At that stage, you could then expand the renewables element of the total mix without facing a cost penalty.

As Duncan has said, there is, however, undoubtedly some cost penalty in the pace at which we are going to 2020, because over that period of time, you just do not have enough time for the cost improvements to work, and also there are some bottlenecks in the supply that drive up the cost. So we are looking at the issues. As Duncan has also said, at the moment, there is a danger that we have a ramp-up of offshore investment to 2020, then a drop and then a lower level in the 2020s, which certainly does not make sense in terms of a consistent supply industry slowly driving down cost. It is, therefore, possible that the optimal path might eventually, if these costs reductions are indeed achieved, have a slight moderation of the targets to 2020, but an increase in the long-term target.

But what that illustrates, I think, is that while you need a broad direction of change, and while we’d certainly say that there needs to be a minimal renewables target that should form the contracting within the new market review, you do not need to be precise. You need to know that, as part of your strategy, you want it to be at least 30g or 35g by 2030, but you do not need to decide whether the balance in 2050 is 35g, 35g, 35g between renewables, nuclear and CCS or 40g, 30g, 30g. You do not need that. Indeed, there is a loss of flexibility by setting things too far in advance, even if you set certain minima to drive the development of the technologies.

Duncan Sinclair: I would agree with that. I think that at this stage, it’s just too early to say. We are on a path of learning on multiple technologies here, and by the 2020s, presumably we will not be in the situation we are now. I would expect that two of the three technologies will be demonstrated to be a low-cost option and we will start gravitating more towards those options. So at this stage, we are talking about a balanced portfolio in CCS, nuclear and renewables. It may well be by the time we get further on-10 years’, 15 years’ time-the winner is a bit more obvious and we’re starting to sort of consolidate on the lowest cost option. So I agree with Lord Turner. I think to say explicitly, "You have to have this target for X, Y, Z" is probably wrong at this stage. We need to have some flexibility there as well.

Q306 Chair: Your analysis showed a roughly-what was it?-a similar level of renewables, whatever the scenario. Was that because we do not know enough or because you simply built in a 35% assumption for renewables?

Duncan Sinclair: That was just because that was an assumption given to us by DECC, so we kept that constant across the cases, because I think if we hadn’t done that, then the different costs in renewables would have then kind of drowned out the messages with respect to the effectiveness of the different policy options. So we deliberately kept that fixed.

Q307 Albert Owen: Yes, can I just try and consolidate what you have been saying about unabated gas? You have commented on a number of occasions indeed, Mr Sinclair, today that too much unabated gas from power stations might jeopardise the UK’s long-term targets, and can I bring you back to our inquiry on EMR and the EPS within that? Do you think that the EPS will allow unabated gas plants to be built as in the consultation documents?

Duncan Sinclair: Certainly at the levels set out in the consultation documents, yes. Obviously, there’s a concern from investors that once the legislation is in place, that could be tightened up, so that does create some risk for them. But it’s one of those things that I think, given security of supply is another key issue here, it seems to me very unlikely that the EPS is going to be assessed at a level that jeopardises security of supply. Therefore, if we need new unabated gas for security of supply, I think the assumption should be that that should be allowed, or else we are going to have a security of supply problem. So I think the EPS in some ways is an added backstop. That’s not entirely necessary, given the other measures, but it is there as a backstop.

Q308 Albert Owen: Phillip Lee mentioned that we had been the States on the shale gas thing on another inquiry that we are doing. Do you think there is a possibility of another dash for gas in this country? What analysis have you done of that and how that will impact on the targets?

Duncan Sinclair: I do not think there’s a risk of that currently, because I think everyone is nervous around-

Albert Owen: It depends what we are talking about "currently". You say in 2020, 2030, 2050. I mean, if the dash for gas was to come onstream relatively quickly, then it is going to impact on your targets.

Duncan Sinclair: It would do, but again, it depends on what happens with the feed-in tariffs. If the feed-in tariffs are being offered and plenty of low-carbon technology is coming forward through that mechanism, then the room for gas is going to be squeezed and that’s going to put pressure on price and that will deter investors. So by definition, the CfD policy is failing if we end up with a dash for gas. I think that’s the case.

Dr Kennedy: It comes down to the credibility of the new arrangements. If that carrot that says, "If you invest in low carbon, we will pay you for it", if that works, then we won’t have a dash for gas. If nobody buys that story and wants to sign these contracts and bring on the low carbon, I think there’s a risk that you get some portfolio investment instead with some nuclear, some renewables, but also some unabated gas. That’s why you might want to consider, "Well, what can we do in terms of stick, which says, ‘We don’t want unabated gas on the system behind a certain time’?"

Q309 Albert Owen: Sure, I mean, some of the experience that we picked up in the States was basically that, although they had invested heavily in renewables, wind, now the dash for gas was pushing that back and there are less ambitious targets. This is the danger. Do you see that?

Lord Turner: I think the answer is: it entirely depends upon the tightness of the overall policy framework. I think given the possibility-not certainty, but possibility-of the scale of the supply of shale gas in particular, it’s certainly possible, indeed, I think likely, that if we didn’t have a Climate Change Act, an Electricity Market Review and a set of constraints, we would, as it were, see a new dash for gas or an intensification of the dash for gas. I mean, gas is the safe option in terms of the balance between marginal cost and capital intensity. So the issue is simply what are the constraints that constrain that through the renewables objective, through the details of a target for grams per kilometre, through the scale of the contracting, the contracting for differences for effectively the feed-in tariffs for low carbon? Those are all mechanisms that essentially constrain it. In an unconstrained world, yes, the supply of shale gas might well mean that people would build less renewables and less nuclear, because if the forecasts of large supply are there, then that is quite a new, pertinent fact.

Q310 Dr Whitehead: Mr Sinclair, you mentioned the role of an EPS as a backstop. What is your view on the relationship of the levels that are being consulted on in the context of the idea of a backstop? It appears certainly that the high level would permit only very marginally greater coal, perhaps even by the addition of some biomass, and the lower level would permit pretty widespread unabated gas. Therefore, it might appear that this is not a backstop but a non-stop. Would that accord with your analysis or do you think there is a role for EPS at those sorts of level?

Duncan Sinclair: To be honest, I think it potentially is redundant, because with the Carbon Price Support and with the support for low carbon through CfDs, naturally the higher emission plants should be pushed off the system through the basic economics, because they get pushed out of the merit order. If they are not, that implies that we need them anyway for security of supply, and so if anything, the EPS is an unnecessary complication that could threaten security of supply. That is my own personal view. You know, EPS as a mechanism, as a stick, is a possible option, but you might want to pursue that if you were not going down a Carbon Price Support or a CfD route. It does seem a little bit like overkill to have both in place, in my own personal view.

Dr Kennedy: We have had a slightly different perspective, which is we agree with you. The wording in our letter to Chris Huhne last week says, "At the level proposed, it will not have a material impact on investment decisions". We have suggested a tighter level. For example, the alternative proposal in the consultation, which I think was about 450g rather than 600g, that would tell you, if you’re thinking of investing in unabated coal, you better be planning to retrofit it, which is an important issue. Then a tighter performance standard still would tell you: do not invest in unabated gas beyond a certain time. So there is a potential usefulness in those backstops.

We have not suggested you necessarily would introduce them straight away, for example, in the case of CCS, to prevent investment in unabated gas. It may be that the market arrangements pull through low-carbon investments and you don’t need it, but what we have said is that certainly you shouldn’t rule those things out at the moment.

Q311 Chair: In that letter, you suggested an alternative, which would be a forward contract for low-carbon capacity, alternative to an EPS. Would you like to enlarge on how that would work?

Lord Turner: Well, we certainly think that the quantity-based instrument is absolutely fundamental here. Essentially, what we are proposing-but also the Government is heading towards this in its response-is a mechanism whereby an investor in low-carbon plant has the certainty of a future quantity times the future price. That can be done. You can do that by directly setting it up as a feed-in tariff, or you can essentially do it by having a contract for difference from a fluctuating price.

We see that as the absolute core of the way forward. We think all of the debates about the EPS are whether or not there is a useful ancillary set of policies, but the core policy we believe is these effective feed-in tariffs. We are arguing that they need to have a quantity element to them, that people are assured of the ability to deliver a certain quantity at a particular price, rather than simply a price but no assurance of quantity.

We also believe that this is preferable to premium feed-in tariffs. Premium feed-in tariffs essentially give you a little bit extra above the fluctuating price, but can be quite expensive ways of buying low carbon. You can end up paying more through that mechanism than you would if you simply did a straight feed-in tariff or contracts for difference.

So essentially, we are saying we need to get as close as possible to-and essentially, all the way to-a mechanism where for a certain proportion of their output, a low-carbon investor knows in advance, or has reasonable certainty in advance of the ability to deliver a certain quantity of electricity at a certain price, and to us, that is the core of what needs to be achieved in the Electricity Market Reform.

Q312 Christopher Pincher: Can we talk a little bit more about CPS? You mentioned, Mr Sinclair, the play-off against using EPS against Carbon Price Support. Lord Turner, with your previous hat on in the City, EU ETS is a mechanism for setting a carbon price, but the view is that that is too low to change behaviours demonstrably; therefore, further CPS is required. I just question whether applying that price unilaterally will have a deleterious effect on industry, on the economy, and if it does have that effect, will investors not be less likely to want to invest in it?

Lord Turner: Well, a couple of points. First of all, I think the difficulty with the EU ETS is that it is at the moment far too weak an external constraint. I think there were always some concerns as to whether the total quantities set in the ETS, and in particular the ability to meet them through clean development mechanism purchases, was too soft. But the impact of the post-crisis recession, which therefore decreased total production and demand, has led to a situation where the prices within the EU ETS are simply too low to do the pull-through of a low-carbon economy. That is point one.

The second point is that I think if you go back to Nick Stern’s work on the economics of climate change and whether you best incentivise low-carbon technology through a fixed-price instrument, where you-the Government, as it were-sets the fixed price of carbon, or a quantity instrument, which constrains the quantity and allows a fluctuating price, you’ll see there and in a lot of the economics literature, a suggestion that the optimal way forward is always probably a hybrid. It’s to have some quantity limit with a fluctuating price, but with some carbon underpin within it.

So to us, the ideal way forward here would be if we could get our colleagues across Europe to agree to a tightening of the European EU ETS, with moving to a 30% target, combined with an underpin price within the EU ETS. That should still be our objective.

In the absence of being able to get that, we believe there is a strong case for a carbon price underpin in the UK. You are absolutely right that you then have to think what about the effect is on the competitiveness of potentially mobile industries. In relation to electricity, broadly speaking, it is not a highly potentially mobile industry, which is why, for instance, across Europe we’ve been able to move towards auctioning within EU ETS the permits, and people have argued very strongly against that in the non-electricity sectors. So a carbon price underpin, as it relates to the electricity sector, can work well.

Obviously, there are then difficulties of how to apply that and at what level to the non-electricity sectors. And if you get it wrong, and if you get it too high, then yes, you could start inducing a movement of steel production from one part of Europe to another, which would be neither beneficial to the economy, nor of any benefit in terms of the carbon emissions. So I think there is a crucial distinction there between electricity and non-electricity sectors.

Dr Kennedy: People have said, "Well, if you have these long-term contracts, why do you need a carbon price underpin done, because it’s the long-term contracts that will drive the low-carbon investment". We have highlighted four benefits of a carbon price underpin in the context of the long-term contracts. They are: first, it gives you the signal not to invest in unabated coal generation, you have to think about retrofitting it, which we have suggested is a key issue; secondly, I think it will strengthen consensus for energy efficiency improvement; thirdly, it will help investors make choices within these new arrangements about investment in coal CCS and gas CCS, where you need to know what the carbon price will be in the future; fourthly, I think it is consistent with the Government’s objective, which we think is a sensible objective, to increase the share of green taxes within the overall tax take. It will provide a revenue source to finance low-carbon innovation, and particularly CCS demonstration.

Duncan Sinclair: I think, overall, the cost of decarbonisation is going to be fairly high upfront, and hopefully the savings will come later. So that is the thing that’s potentially going to have an impact on competitiveness and consumer bills. So that is kind of a given. The Carbon Price Support is an element of that. The problem with it, or potential problem, is it created unintended consequences, because we have an interconnected electricity market and we are going to have the possibility that we have more imports into the country from emitting plant from elsewhere in Europe.

Q313 Christopher Pincher: It does not have any Carbon Price Support and, therefore, benefits from our high prices, but is not any cleaner.

Duncan Sinclair: Yes, I think that is a problem with it. The other potential problem with it is that, while it is generating additional receipts for Treasury and that is fine, we are estimating at about 25% of the cost of the CPS is going to inflate profits for existing renewables and nuclear generations, so that is increasing the rents for those players. So there are some downsides with it. As David has mentioned, there are some potential advantages, but those have to be considered quite carefully in the context of the additional cost to consumers in the near term.

Q314 Christopher Pincher: You mentioned downsides. What do you think is the biggest downside?

Duncan Sinclair: I think the biggest downside is we distort the economics of the electricity markets across GB, Europe, and also in Ireland as well. That is an unintended consequence and that’s not achieving any additional carbon reduction. It is not probably achieving any additional low-carbon investment, because we have the CfDs. Therefore, it is increasing cost to consumers. It may be we can shift taxation in other areas to compensate, but we have an interconnected market. It is going to get more interconnected. By far the preferable solution, as Lord Turner suggests, is that we have a European-wide mechanism and a European-wide underpin and then I think it’s a viable option, but to do it unilaterally, it does incur significant risks.

Q315 Christopher Pincher: Do you think we are doing enough to prepare the public for the potential, or indeed, the likely higher prices, given that there is much more likelihood of that than getting a European agreement?

Duncan Sinclair: No, I do not think we are. The question is an intergenerational question here, which is the extent that consumers over the next 10 years are paying more for their electricity to save consumers in the following decades for the cost of their electricity. That’s quite a significant shift. I think that needs to be probably understood and the public need to be aware of what those costs and trade-offs are.

Lord Turner: Though that is a slightly different issue or a wider issue than the specific one of a UK unilateral carbon price underpin, because that cost would still arise from a European carbon price underpin, or indeed from a contracts for difference or anything that involves a carbon price and a commitment to low-carbon technology, to the extent that that is higher cost. I mean there are non-trivial increases in electricity bills that are going to occur. I think we believe those are small in the context of the total economy, but they are non-trivial and they will be noticed. I think it is important for us to be honest with people that that is part of the cost of achieving progress towards a low-carbon economy.

Q316 Chair: Given that even in Phase III the EU ETS is unlikely to drive very significantly a high enough carbon price and to tighten the limits in Phase III requires unanimity, and we are not going to get all 27 countries signing up, do you think we may have a problem here? If for perfectly normal reasons we introduce a carbon price, which critics will say is much higher than the EU ETS price and, therefore, we are simply penalising British consumers and making us less independent, is that going to be a political challenge, do you think?

Lord Turner: I think the crucial thing there is to explain that this is also producing a revenue flow for the Treasury, without which there would presumably be higher income taxes or higher taxes elsewhere. This has always been the challenge with green taxes to explain to people that, within a fixed total amount of revenue that the Treasury needs, more tax from this is presumably at the benefit to something else that is lower elsewhere. That is the overall case that I still think needs to be made more effectively for a shift towards green taxation, of which, however, we are strongly supportive.

Q317 Christopher Pincher: Lord Turner, you mentioned that prices are going to go up and you said that the impact will be non-trivial.

Lord Turner : Yes.

Christopher Pincher: Granted that it is your opinion and that , if you increase the tax take , there are ways in which you can then offset the increased costs, what would your view of a non-trivial uplift in prices be?

Lord Turner : Can you remember the actual figures? David is probably closer.

Dr Kennedy: Order of magnitude over the next 10 years, we would expect the carbon price impact within electricity prices to be less than a 5% increase. I think the impact from financing offshore wind under the renewables obligation, again, about 5% there.

Lord Turner : So it could be a 10% increase.

Dr Kennedy: That is electricity bills. I think you need to bear in mind electricity bills are a small percentage of energy bills. If you translate that into energy bill impacts, I think you are looking at 3% or 4% through the combination of the carbon price and the renewables obligation.

Lord Turner : The problems get most acute of course with a subset of the housing stock that has electrical heating in it, often correlated with relatively low-income people. That is where these figures become much more important and significant. For many people who heat their house at the moment with gas central heating and are middle-income people, that 10% on their electricity bills is not trivial but it is not a major threat to their household budgets, but there is undoubtedly a subset where there is. That is why we need to continue to have policies and an element of targeting within the Energy Efficiency Policy, which tries to make sure that we are improving the insulation and the electricity of those houses in particular.

Dr Kennedy: There is enough energy efficiency potential to largely offset those price increases. The question is: can we unlock that potential through the Green Deal? I think that is an open question.

Duncan Sinclair: To reiterate, it is a timing issue that the Bill will seem to increase in the near term, but the analysis we did for DECC suggested that from the mid-2020s onwards the prices would be less, under the CfD in particular, because consumers are protected from the increase in fossil fuel prices and carbon prices going on from there. So it is that trade-off between paying now potentially for gains later, but of course that critically depends on what you are seeing gas and carbon prices will do in the future.

Q318 Dr Whitehead: Could I take the question of CPS and interconnection a little further? At present, interconnection counts for something like 3% of our electricity supply in any one year. With the proposed introduction of new interconnectors, and possibly even the emergence of a European super-grid, have you done analysis on the point at which the supply, as a proportion of UK electricity, undermines the potential of a Carbon Price Support to the extent that it becomes a brake on that interconnection; that is, is there a point at which you either go for interconnection or you continue with Carbon Price Support, assuming it is UK as opposed to European CPS?

Duncan Sinclair: Yes, if the Carbon Price Support level is consistently higher than the EUA price that potentially will stimulate further interconnection. Most of the interconnection investment at the moment is looking at the opportunities of arbitraging between two markets, because the generation mix of some of our near continental neighbours-France excepted-is quite similar, so the concept is very much around balancing around wind, and so on. If there is a systematic bias that gas or coal-fired generation in GB is a higher cost than elsewhere, then that will naturally lead to greater flows into the country rather than out of the country. So I am not sure whether that answers your question, but it potentially could have an impact going forward.

Clearly, interconnection is a good thing, to the extent that it helps security of supply and it is a more efficient and cost effective way of balancing interconnected markets. It is not an economic solution if it is being built to address distortions created by unilateral policies in one market or another.

Q319 Dr Whitehead: I think the thrust of my question is that eventually, if you wish to pursue a unilateral CPS arrangement, at what point would you have to discourage interconnection in order to maintain that policy.

Duncan Sinclair: Oh, I see what you are saying, yes.

Sir Robert Smith: Where is the tipping point?

Duncan Sinclair: Yes, good question.

Lord Turner : It is a perfectly valid point. When I described electricity earlier as primarily a non-internationally competitive market, that is-you are absolutely right-based upon the fact that the interconnector is a relatively small part of it. If you had a significantly different carbon price in the UK than elsewhere, over a period of time in which people could respond to that by building gas plants somewhere else, and building the interconnectors to do it, yes, you could have a problem. You are absolutely right. I do not think we have calculated at what level of price, or at what level of interconnection, that would occur but you are logically right to spot that as a problem.

Dr Kennedy: We do want significantly increased interconnection over the next two decades to balance intermittency. This could become more of an issue. We have not looked at that particular cut off. I think it takes you towards saying we should not do this in a vacuum, and we should be looking for a set of arrangements at the European level that make us confident that Europe is decarbonising its power system, partly through a tightening ETS cap, but possibly through the kind of arrangements that we are looking to introduce here, which is the low-carbon contracts. We know that there is a lot of interest in Brussels in this issue and the kind of reforms we are looking at here, with a view to making those a model for Europe.

Duncan Sinclair: There is another related issue, which is perhaps even more significant in the long run, which is: if we are supporting our low-carbon investment here and we are driving down our own electricity prices, we could be exporting power to continental markets. That could be at the cost of UK consumers who are paying the additional support prices. So I think the general message is that we cannot really afford to be too far out of whack with what our interconnected neighbours are doing or else we are going to have economic distortions, which perhaps are not sustainable. So I think the UK taking a lead is kind of where we are at. It is going to be a good thing if everyone follows suit. If they do not, it is going to become harder and harder to sustain a unilateral policy.

Q320 Sir Robert Smith: Would you say that the priority is probably the super-grid or a highly interconnected market? It is probably a better long-term solution for the problems we are facing.

Lord Turner : A highly interconnected market, with a tighter EU ETS and a carbon price underpin across Europe, is policy nirvana.

Q321 Sir Robert Smith: If you cannot get the tighter market, do we then have to become unilateral and not become part of a super-grid and go it alone? That is the process.

Lord Turner : I think we have to find a way to be part of a super-grid because eventually, at the whole European level, I think there are some significant, potential efficiency improvements from greater interconnectivity, particularly the higher you push the renewables percentage. It is the renewables in particular, with their intermittency, where you need the interconnectivity to reduce the cost at the margin.

Dr Kennedy: As well, are we going to be out of whack with Europe? If we look at the 2050 Pathways work, which was published I think last week, it says that they are aiming to decarbonise at the European level. In the view of the Commission, that is what they should be aiming to do, possibly at a slightly slower pace than we are here because of the differences in capital stock in the UK and on the continent, but as you get into the late 2020s and into the 2030s, we would broadly be in the same place.

Sir Robert Smith: In earnings, but maybe not in mechanisms, I suppose is the problem.

Dr Kennedy: I think the next stage for Europe-and certainly DG Energy has to come up with its 2050 analysis by the end of the year-and it will start to consider the kind of things we are thinking about here in the UK and respond to that.

Q322 Dr Lee: My policy nirvana would be-and I would be interested to know your comments-why do we not disconnect continental mainland Europe; connect with the Norwegians; double our nuclear build; reduce our energy need by 20% through efficiency programmes? In view of the fact the Norwegians have n o t maximised their hydroelectricity output at all , t hey have a vast amount of gas, which is the cleanest extracted gas on the gas market .

Lord Turner: The answer is that does heavily depend on your attitude to nuclear. At the moment with the figures we are looking at, it would look that nuclear might be the lowest cost low-carbon electricity right now. There are some figures that suggest that that is not necessarily the case in 20 years’ time, once other things have gone down a price reduction path, and I think the attitude of the committee is that there are some disadvantages in a strategy, which is, as it were, the French strategy of going for 80% of your electricity from a nuclear basis. You can clearly. It is clearly technically feasible.

Dr Lee: I am not advocating that.

Lord Turner: All right, well, then it becomes a matter of balance because, if you are not advocating that and you are still limiting nuclear, and you are still committed to achieving the 80% overall reduction Climate Change Act by 2050, which requires the decarbonisation, then you still need a very significant element of renewables. Then there is a value in that being able to balance, not simply against Norway, but against other bits of Europe as well.

Q323 Dr Lee: If you have gas CCS, hydroelectricity and nuclear, you are not using carbon.

Dr Kennedy: It depends on what potential there is in Norway to export hydro-

Dr Lee: You are not using carbon, are you?

Lord Turner: Of course, that crucially depends on the gas CCS.

Dr Lee: Yes but, with respect, everything does.

Lord Turner: No, no, absolutely.

Dr Lee: We are all fingers crossed, aren’t we, with CCS?

Lord Turner: I return to the point we made earlier: given the uncertainties, we think this is absolutely an environment where sensible policy does not limit itself to two of the three main categories of options. As between nuclear, renewables and gas CCS, all of which are different ways to a low-carbon future, we believe that a rational policy has a significant element of each of these in the mix, with the precise amount of it not something that you can or should fix at this time. So that is our approach.

Q324 Dr Lee: My point is this renewables target, which is Europe dictated, seems to be pushing us down a path of increased subsidy, something that maybe we should not be doing. Maybe if we extracted ourselves from the European mainland and its approach, and physically disconnected because the reality is we are relying upon all of our European partners behaving themselves with regards to how they generate electricity. By doing that, are we not more likely to get to a situation where we do meet all our carbon targets and, at the same time, retain some stability with a secure neighbour, such as Norway?

Duncan Sinclair: Norway is connected to other European markets-

Dr Lee: Of course, it is.

Duncan Sinclair: So it would not want preferential treatment.

Dr Lee: Yes.

Duncan Sinclair: Historically, why do we not have more interconnection than other European countries? It is a geography thing-all the other European markets are interconnected and flows over the interconnectors between those markets are very large. So it is an historic thing and history has proven that is a cost-effective way of managing and balancing an electricity system. To separate ourselves because of some policy differences flies in the face of what rational economics would say in terms of a least cost solution, so that would be very extreme.

Q325 Dr Lee: You think what we are getting at the moment is based upon rational economics?

Duncan Sinclair: No, it is not. It is based on an objective to try and decarbonise. There are different views on how to do it, but here we are today and things are going to change over the next few years so it is hard to say.

Dr Kennedy: There is a possible role for imports in decarbonising. So if you can have additional investment in Norway, or if it is in North Africa for concentrated solar power, that could make a contribution. I think we should open up these electricity market reforms to consider: could you give a contract for difference for something that is imported into the UK? I think you would not rule that out at the moment, whether it is Norwegian or North African or anything else imported.

Q326 Dr Whitehead: Turning to feed-in tariffs, do you think the introduction of feed-in tariffs, in whatever form, would encourage or, as some suggest, rather discourage and marginalise CCS energy and electricity storage?

Lord Turner: We believe that, although CCS is important, we cannot rely entirely on it and a sensible mix requires elements of nuclear and elements of renewables as well. Therefore, we believe that the feed-in tariffs achieved, either directly or via contracts for difference, is a key way forward there. Obviously, the more that you are effectively buying through those feed-in tariffs and contracts for difference, you have somewhat reduced the amount of the market that is gas CCS, but that is just how much you buy. If we did the electricity market reform and then the Government chose, we would not advise it at all to say, "We are now going to have contracts for difference and feed-in tariffs for the entire amount of our demand". Then there would be, by definition, no space for gas but that just becomes how you sensibly allocate the quantities you are buying on this.

On the issue of storage, David, do you want to comment on the storage point because I was not quite sure what you were getting at there?

Dr Kennedy: Storage is a crucial part of the story and so in our fourth budget advice, which we published in December, we highlighted the role of, for example, the importance of having car batteries as a store on the system. Now, it does not have to be car batteries; you can simply have storage on the system that you can then put back to balance intermittent generation. Is it the feed-in tariffs that will drive investment in storage? I think it is a separate-

Dr Whitehead: I think that is precisely the point, isn’t it ?

Dr Kennedy: It needs complementary policies.

Q327 Dr Whitehead: E ssentially , storage relates to what might be determined as surplus electricity. Surplus electricity, by its definition, would not come within a contract for difference very easily and therefore would have to be perhaps issued by separate mecha nisms such as capacity payments.

Lord Turner: Yes, I understand now, you are basically saying if you over did the feed-in tariff approach you could remove the incentives that we want people to have to drive storage, which enables them to sell at the high price arena. With a contract for difference, they are still able to shift it during the day, aren’t they?

Dr Kennedy: There are two things that will drive the storage story and they are-

Dr Whitehead: It only becomes equipment when it is no longer surplus and is put back into the system after it has been stored.

Dr Kennedy: Yes, smart meters are key, and the roll-out of smart meters in a way that will support storage and putting stuff back into the system is very important. The second thing, as you said, is the balancing market and possible capacity mechanisms and allowing those to bring in demand-side flexibility, as opposed to unabated gas-fired balancing.

Q328 Dr Whitehead: If the Government did indeed choose to go down the contract for difference path, how would the Government set the prices for that contract for difference? Indeed, Mr Sinclair, I think you may have done some analysis, for example, on the extent to which non-competitive baseline suppliers, under a contract for difference, could essentially receive large amounts of free money, as the arrangements progressed without effectively bidding into a contract for difference market. Did you do that analysis and did it appear in your final document that was published by DECC?

Duncan Sinclair: We didn’t quantify it. We highlighted it as a significant risk. The problem with this is-

Q329 Dr Whitehead: Did that highlighting appear in the final document or did it disappear?

Duncan Sinclair: What we said was that, to the extent to which the prices were set above the level they needed to be, that could have an impact on consumers. I think we estimated for every £5 a megawatt hour the price was higher than what was needed, that would cost consumers on average about £5 a year additional cost. So that is not insignificant. So there is that risk.

That risk exists today with the renewables obligation because we are assessing ROC bands based on imperfect information. It is going to be the same challenge with nuclear and CCS. Inevitably, although auctions are a long-term objective and potentially are a good solution, in the near term that is not realistic. Given the number of potential players, that has to be bilateral negotiation and that is going to be difficult, but over time moving to auctions is possible. It may well be that the Government will have enough information to be able to set the CfD strikes based on technologies that are more established, for example, onshore wind and maybe by then offshore wind. They can set the price as effectively as they are doing today.

It is a big challenge. There is no doubt about it. There is a risk of making mistakes, and mistakes will inevitably be made and consumers will pay more because of it, but the flip side is not going down that route and not achieving the decarbonisation. So that is the price that we may have to pay.

Q330 Dr Whitehead: You mentioned, Lord Turner, in your recent letter to the Secretary of State-and you have touched on this issue-that since different low-carbon technologies are at different levels of maturity, you would need some form of differentiated technology support, which is not easy to see how that might be incorporated into at least certain forms of FIT or contract for difference. What is your view on that and what did you mean by the different levels of technology support that we need?

Lord Turner: Of course, we have different levels of technology support at the moment, by the ROC banding mechanism.

If you simply said the Government wishes to make sure that there is a certain amount of low carbon, either capacity or delivered power, and organised an auction for a contract for difference for that quantity, that would not assure a particular support for particular technologies, because one technology might be able to bid the lowest price in terms of the contract for difference. So the way that this would essentially work is that you would have to say, "In total, we are going to want to purchase this amount of low-carbon capacity or generation and we are going to ring-fence an element of this".

There are then two ways to proceed: there is either ring-fenced auctions, right, where you are essentially saying, "The only people who can enter this auction are people who are willing to do offshore wind, but nuclear cannot enter this bit of the auction", or some process of quasi-administrated mechanism where you are trying to work out what a fair price is.

As Duncan has said, the long-term vision, the ideal, would be it is all in one pool and it is all done through an auction, but I think realistically we are going to have something where there is a willingness to have some subsets of quantities for particular technologies and, to a degree, some administrative processes of setting the price, rather than a pure auction technique. Having said that, that is not really a level of complication beyond what we have at the moment, where we have to set the ROC bands. The ROC bands are themselves an expression of different support for different technologies.

Q331 Dr Whitehead: Except, of course, as you have observed, we presently have ROC bands. There will be no ROCs under FITs.

Dr Kennedy: There has to be some kind of banding mechanism, effectively.

Dr Whitehead: So is this FIT s with a bit of ROC added to it?

Lord Turner: No, they would be FITs that would vary by technology. You would need-

Dr Whitehead: Variable FIT s, banded FIT s.

Dr Kennedy: There would have to be a price in the contract for difference depending on the technology, so if it is nuclear it will be £70 a megawatt hour, for example, is what we think the underlying cost is for offshore wind. It might be £100 or £110 a megawatt hour.

Q332 Dr Whitehead: Would it not be determined by market trading, but nevertheless it would still be banded, I assume?

Lord Turner: You essentially will end up with some sort of banded FITs. I think that is a reasonable definition of what you will end up working with. You will end up with a variant of banded FITs, rather than banded ROCs, but there still could be a price discovery auction process, within a particular technology for what that price is.

Q333 Dr Whitehead: So might the bands then be determined to some extent by auction discovery?

Lord Turner: Yes, but within a particular technology.

Q334 Dr Whitehead: So how far away is that actually from the ROC trading system?

Lord Turner: It is still significantly different from the ROC trading system, yes.

Dr Kennedy: The ROC trading system is effectively a premium feed-in tariff, which we have been very clear is a bad thing because it is unnecessarily expensive for the consumer. So it should be very distinct from that.

Lord Turner: The ROC is essentially on a banded basis determining how much extra you get as a price above whatever the future price of electricity is; a contract for difference based feed-in tariff is essentially determining what price you will get in future, independent of what the rest of the wholesale price is.

Q335 Dr Whitehead: It is mediated by auction discovery.

Lord Turner: Yes, but that price can be to a degree informed by auction discovery. That is the ideal, and I think one simply has to pragmatically work out how much of that one can do while still supporting reasonable technology. For instance-let us be clear-the difficulty, in relation to the nuclear bit of that upfront, is going to be how real an auction you can have when you have only a small number of players. Therefore, these things may have to have an element of judgment and negotiation as to what is the appropriate, effective feed-in tariff, rather than believing that it can all be determined by a perfect auction.

Q336 Dr Whitehead: Is that not where the free money argument comes in at that point?

Lord Turner: That is absolutely right, that if you get it wrong you can be handing over free money, but I think we have to realise that all these policy instruments have the danger of free money, both carbon prices and ROCs; almost any other instrument has a danger of free money. One of the things we are trying to do is minimise it. That is the challenge here.

Q337 Chair: I am afraid we are running out of time. Could I conclude with a question about how we measure the success of all this, EMR, and how it is going to pan out. Do you see a role for your committee, monitoring and reporting on the costs and impact of the various alternative interventions?

Lord Turner: As a committee, every year we have to produce our monitoring report to Parliament against the Budget. We have in the past and would propose in the future to comment, not just upon the emissions last year, but the development of the policy frameworks and whether the policy frameworks, in principle, look like ones that would be delivering future developments.

I am sure, as part of that monitoring, within any particular regime, we would be looking carefully to what occurred. So, for instance, if there was a contract for difference scheme put in place we would then be very carefully looking, in 2013 and 2014, at what volumes of contracts had been contracted, because that would give us powerful forward indicators of what was likely to happen in 10 or 15 years’ time. One of the things that we are very focused on within our monitoring reports is how do we get things that are forward indicators of what is going to happen in the future, rather than indicators now.

So, to a degree, there is an element to which we naturally do that. It would be up to the Government whether it wishes, in addition to those regular reports, which are written into the Climate Change Act, to ask us to do a more detailed investigation of the particular impact of the regime.

Q338 Chair: What are the metrics you think the Government should use to assess whether it is achieving its objectives as set out in the EMR?

Lord Turner: We certainly think that grams per kilowatt hour is a very important one, but I think one also has to look at degrees of certainty as to what the future grams per kilowatt hour will be. You do that by tracking, as we try to, how many offshore wind platforms have gone into planning; how many have gone into construction, because that tells us how many will be in place in two or three years’ time.

I think one of the values of the contract for difference techniques is that that will give us a very concrete form of forward indicator, because once you have contracted that someone is going to have that contract for difference applicable in some future year then that significantly increases that certainty. So I would say the three categories of things are: the grams per kilowatt hour, now and prospective; the physical indicators of what people are investing in and what that tells us about the future; and the balance of the contracts that have been struck and what that tells us about the future.

Dr Kennedy: We probably want to look at costs and price impacts as well. It is obviously important.

Duncan Sinclair: Yes, I think tracking consumer bills against the European average would be an interesting metric and of course security of supply is going to be key to track that as well, both in terms of where we are today but also projections going forward.

Coming back to the investment question, clearly there is a lot of nervousness in the City right now about the impact of this change and I think in near term the thing to measure is going to be the level of activity over the next one to two years to see if we do have a hiatus in investment while people try to absorb what is going on with these changing rules. So I think there are some quite near-term things that have to be tracked quite carefully.

Chair: Thank you very much indeed. We could have gone on for another couple of hours, I am sure, but we much look forward to your report on renewables. Thank you for coming in.

Examination of Witnesses

Witnesses: Rhian Kelly, Director for Business Environment, CBI, Audrey Gallagher, Head of Energy, Consumer Focus, and Richard Hall, Principal Policy Advocate, Consumer Focus, gave evidence.

Q339 Chair: Good morning and a warm welcome to the Committee. I am sorry we are running slightly over time. We are quite tight today. Could I start off by asking a general question on whether you think affordability of electricity for consumers has been given enough emphasis in the EMR consultation process?

Audrey Gallagher: I think probably our immediate reaction would be that there was not the same degree of emphasis on affordability as there was, for example, on decarbonisation. Clearly, the challenge that we have at the moment is to try to balance the three objectives coming out of the EMR, around security of supply, decarbonisation and affordability. So I would say an immediate reaction to that would be that more should have been done. We have 5.5 million people in fuel poverty. It is not as if it is an insignificant issue for consumers.

Q340 Chair: Obviously energy efficiency can help people with bills. Do you think the Green Deal will deliver as much reduction in demand as the Government expects?

Audrey Gallagher: The Green Deal is clearly still in its development stage at the moment, so it would probably be unfair to be overly critical of it, but I think there are definitely some questions that we think we need some reassurance on. One of the challenges we have is how we make this attractive to consumers. So there is an issue at the moment where consumers are clearly not that bothered with energy efficiency. There is not massive attraction there. So what can we do? In the earlier session, we spoke about how we can incentivise that. Whether it is through regulation, carrot-stick approach, there are quite a lot of things we have to do on that front.

Q341 Chair: Is price not a concern for business as well?

Rhian Kelly: Yes, sure, it is absolutely the case that part of the discussion we have been having with businesses is around the affordability and the impact on businesses. I think for some, particularly if you are competing in the UK market and it is only a small proportion of your costs, then the direct impact from the EMR package for competitiveness should be manageable. We are concerned because there are certain sectors where competitiveness will be a challenge, particularly if the costs rise to more than their competitors’ internationally.

Some of the work that the Treasury did indicates a list of sectors that might be at risk. We think more needs to be done to look at the impacts in more detail in these sectors. It is not enough just to say, "Well, they will be able to manage the costs." The concern we have heard from many businesses is the fact that they will not be playing on a level playing field internationally and this is a big concern for them.

Q342 Chair: Is there a danger that the very high energy users might in fact want to relocate abroad if they find there is too much disadvantage here?

Rhian Kelly: I think it is a risk. Some of the indications-we have evidence from certain companies, so for example a major chemical site has said that one of the impacts of the carbon floor price might well be that its earnings before business interest, taxes, depreciation and amortisation go up by about 50%, so therefore will be thinking, where should it make its investments? If it is to make its investments somewhere else, it could mean the emissions from that site go up by two times. So, clearly, we need to make sure that we are able to insulate some of these sectors from the price rises.

Q343 Sir Robert Smith: I wanted to ask you again on the Green Deal. Do you share maybe the view of the previous witnesses that, to achieve really serious reductions in energy usage, especially in the domestic market, it is more going to be achieved by regulation than by price mechanism?

Audrey Gallagher: A t the moment, because there are so many questions over the finance mechanism and whether or not it is going to stack up to an attractive proposition for consumers , we have to probably do something to incentivise them. Some of the things that we have discussed are potentially doing something on c ouncil t ax rates or even on stamp duty that incentivise people to take this up.

I think there is a whole other area that we could probably put some attention on, and that is the private rented sector where lots of houses on really low energy efficiency ratings are being rented out. Arguably, with the Green Deal, where there is no upfront capital cost to the landlord, that could be a mechanism. Again, in order to do that we might have to think about whether or not we allow houses below a certain rating to be rented out, for example. So I think there is definitely a lot that can be done around incentivising consumers through regulation.

Q344 Sir Robert Smith: Certainly , my experience of Warm Homes Week for the last 13 years is that even with free insulation it is quite hard to sell to some people because of the upheaval or the disruption, or the lack of understanding of the long-term financial benefits.

Audrey Gallagher: I think we spoke before about these reforms and the impact on consumer bills , how we can engage consumers in that debate, what is the pace and the scale that they can accept , and what is going to be the trigger to change behaviour. I think we have to explore all of those things, but also around much more co-ordination on why the Government schemes and mechanisms to mitigate increasing costs . I do agree with you . One of the sayings in the industry at the moment is, "Y ou can’t give it away for free " , so what is the likelihood of somebody taking on quite a significant financial obligation for a number of years when it is a completely unproven technology? So that is probably why we have to look at how we engage consumers, what the communications message is , h ow we do that centrally, and how we engage them in areas where there are potential triggers -s o whether that is the installation of smart meters, which has already been mentioned, or around moving house, getting an extension, fixing the house up . I t is about taking advantage of those. So I think we really do have to have a think about how we can engage consumers in this debate and get them involved to see the behaviour change. Quite a lot of that is predicated on, on people doing something definitely.

Rhian Kelly: If I could just come in there , because we commissioned some really interesting work with Ipsos MORI at the back end of last year, looking at what consumers understand and what information they have available. Some of the output from that research indicated that one of the challenges is there are a couple of different debates going on: there is a debate of policy makers and businesses ; there is the discussion that consumers are having. So we sit and talk about climate change, environmental impact and consumers are thinking e nergy efficiency and cost to run . It is s omething about the way in which we package the information, particularly inside the Green Deal, in order to make sure that we are talking the right language.

Sir Robert Smith: A money saving deal maybe.

Rhian Kelly: It might work better, for example. The conversations we have had because the Green Deal will not just be for households; potentially it is also for businesses, particularly SMEs. I very much pick up the points that Audrey made that there is a real concern that actually businesses are not just going to do it. They need to have some incentives in the same way that consumers did. It might be that there are appropriate points where there is a use for regulation like, for example, displaying energy certificates might be very helpful in this, then particularly linking into the trigger points when property changes hands, for example, or in the case of consumers if you have a baby where it might change the way in which you use your homes. So I think picking up those things inside the way in which the Green Deal is designed will be very important for making it effective.

Q345 Sir Robert Smith: Businesses, though, who at least have a finance department looking at the bottom line, are they more up-to-speed on energy efficiency?

Rhian Kelly: Yes.

Q346 Sir Robert Smith: Are there also still challenges for certain scales of business and maybe for certain kinds of properties where the lifecycle of the property doesn’t work for longer - term efficiency.

Rhian Kelly: From the perspective of our members, yes, all businesses are engaged in energy efficiency. You have things like climate change agreements; you have climate change levy; you have the CRC to help that along, yes.

Audrey Gallagher: I would suggest, though, that probably for micro-enterprises it is not the same. We kind of recognise that in lots of ways they are dissimilar to domestic consumers, in terms of the knowledge and skills available to them and even the time. From switching and competition, probably micro-enterprises are switching at a rate of less than half the domestic consumers because there is lack of transparency around pricing offers; there are different contractual arrangements that lock them in. So we do have some disparity between the small end of the non-domestic market, the micro-businesses, and some bigger companies that are going to be resourced to cope with these things. They are going to be much more engaged.

One particular concern we have around the Green Deal is that you reference there a potential change to usage. So what we are seeing at the moment is the fixed deal charge being a fixed charge on property, regardless of how that is used and, therefore, what the energy consumption might be. There are potential limitations if a business changes hands and is used for something differently, something much more energy intensive or less energy intensive as the case maybe. There are some limitations. So I think we have to make sure we get the protections right around the Green Deal.

Q347 Dr Lee: To be blunt, do you think there is a danger-and excuse the pun-of insulating the consumer from the realities of the world that we inhabit?

Audrey Gallagher: On a personal level, I think one of the concerns I have is there has not really been any meaningful consultation, for want of a better word, or discussion with consumers about the need to decarbonise and the costs associated with that. We are looking at real fundamental changes in the retail energy supply market, going forward, with the introduction of smart meters, with the Green Deal and all these other initiatives that we are seeing.

What we are pushing for is a much more central communication that gets the message out to people, because we need to tell them; we need to get them on board, because for example the impact assessment, the benefits case around smart meters, about 40% of that is predicated on consumer behaviour change, either taking up time-of-use tariffs or energy efficiency measures. We cannot expect that people are going to do that without any kind of prompt or without any appropriate engagement.

Q348 Dr Lee: Yes but, forgive me, petrol prices are going up at the pumps at the moment. You do not have to be brain of Britain to realise it is best to have an efficient car at the moment that goes 50 miles to the gallon as opposed to 30. I sometimes think this is over-complicated. If I am looking at my bills at the end of the year, do I not think, "Well, how can I save energy because all the costs are going up?" I am not following the need. In business, if you talk to a number of businesses, they are getting in consultants now to say, "Right, where can I save energy?" and they are taking 20% off their energy costs, thereby increasing their profit. It is pretty obvious what they are doing, they are trying to maximise their profits by reducing their energy. Is running a household not exactly the same? I do not know what more engagement you need to make with people, other than: do not waste energy.

Audrey Gallagher: I think the difficulty we have is that, historically, it has been so difficult to get people to engage in this. There will be a whole range of reasons around about that. One is that potentially people want to spend money on things they can see; things that will have a benefit to the house. If you ask anybody, they would take a new fitted kitchen probably before they would take loft insulation they cannot see. So there are some definite economic behaviours.

Richard Hall: There are things around things like, for example, security of tenure for private rented tenants where essentially the payback time for making an investment in a property-

Q349 Dr Lee: Yes, but on that specific case, if you as a landlord had a flat with an energy rating of A and a second flat with an energy rating of D, I would suggest that the market ’s approach to that would be that it would be cheaper to rent one or the other.

Audrey Gallagher: One of the things that we have looked at is energy performance certificates and the visibility of those on either house sales or new tenancies, and only one in five consumers currently even sees the energy performance certificate. So the information that is available-

Q350 Dr Lee: You can lead a horse to water. Ultimately, if you are looking at your balance sheet as a household, I do not think it is beyond the wit of a great majority of our population to say, "Right, I am going to rent that house because it has a better energy performance certificate." I don’t know what more you have to do other than say, because then you are passing the cost on to the person who holds the asset; the person who owns the property, so they could take a long-term view, and the person who is on a short-term view because they are renting can take their view on the basis of the energy rating.

Rhian Kelly: Interestingly, when we did this research with this Ipsos MORI, we asked questions around that and 70% of people do not consider energy efficiency when renting or buying a house.

Q351 Dr Lee: That is their fault then, is it not ?

Sir Robert Smith: We suffer because we have to provide the energy generating capacity.

Dr Lee: Of course, but if the price goes up because they are wasting it-I am just getting a sense of baby feeding going on . W hen the reality is that most people , when they look at the cost of their car or the cost of their Sky Digital, whatever it is, they make judgments about what they are prepared to pay and what they are not prepared to pay , i t appears to be suggested that somehow they do n o t really understand energy, so therefore we are going to have to - I don’t follow, sorry.

Audrey Gallagher: I can understand your point, in that what often seems obvious, consumers do not always act in completely rational ways. I think we have seen that across a number of markets. We know the situation. We know that people do not act on the information. It is either not relevant to them or they don’t have access to it, so I think we need to make sure that there are ways to encourage that.

A lot of the stuff in the EMR, for example, is looking at how we can incentivise low-carbon generation, but should we be thinking about more ways in which we can incentivise the demand side? It might be that providing them with better access to information or simply spelling it out to them that this is where it is going, because there is a big debate on at what level bills have to be before it is going to act as the nudge, if you like, to make people change their behaviour. So right now we are not seeing it. What does it have to be? Do we just keep building more and more and more or do we try and intervene with consumers to get them to change their behaviour, either through a carrot-or-stick approach or providing enough information?

I completely understand what you are saying, but consumers are not acting in that rational way, so we need to try and help them do that.

Dr Lee: Okay. Thank you.

Q352 Dr Whitehead: What impact do you think the CMR proposals are going to have on fuel poverty overall? Some people have suggested that the figure might rise from the present 4.5 million to about 7 million in fuel poverty, as a result of these proposals. Is that your view?

Richard Hall: I do not think we have a view on the final figure that is likely to be reached, but certainly the modelling appended to the impact assessment suggests that fuel poverty figures will rise, certainly from where they currently are. I think all the scenarios modelled are predicated against the baseline that forecasts that electricity wholesale costs will approximately double in real terms by 2030. It seems unrealistic to expect that disposable incomes will increase by a similar fraction, so one would certainly forecast a deterioration in fuel poverty.

It is difficult to put any precise figure on that, though, because there are so many variables within the market that make coming up with any kind of precise forecasting any distance out, very difficult-at the risk of being very spurious, to be honest.

Q353 Dr Whitehead: Do you think the Government programmes that there are at the moment and proposed programmes to tackle fuel poverty will significantly mitigate those sorts of impacts? Have you done any modelling or had any thoughts on the relationship of proposals, such as ECO and the p overty p remium, and so on, and the extent to which they will make inroads on that, possibly increasing fuel poverty or will they simply flatten it out ?

Audrey Gallagher: We have not done any specific modelling. We have done some modelling on how much it would cost to provide specific levels of energy efficiency, so bringing some minimum standards into the housing stock, which is going to help on fuel poverty, some of the costs of that. The impact of some of these clearly depends on what the final figure comes out at.

We have some concerns. Hypothecation is not something that the Treasury is massively interested in, but clearly we do have concerns about the costs associated with carbon price. Ways that we think we could mitigate the cost of decarbonisation: one is we do not have any real co-ordination across Government schemes at the moment. On things like warm homes discount, whatever the energy company obligation is going to be for low income consumers, because obviously Green Deal is not necessarily going to be any help at all to fuel poverty, some of these things have definite eligibility criteria for a start. There are big issues on the amount of money that is wasted in trying to find these customers and targeting their spend. Given that consumers are funding these measures, we want as much of the money as possible going to the people that need it.

Some of the things we are trying to explore at the moment is whether the data sharing that went on around pensioners being identified for warm homes discount can be extended to try and identify the wider, broader group that would be eligible for warm home discount. Also, on smart meter roll-out, should we have an assisted package for low income vulnerable households to make sure they get as much information as possible to help them change their behaviour and make their homes more energy efficient? Can we be targeting the super-priority group and the energy company obligation through better data sharing? We think there needs to be much more co-ordination across schemes, so that we do not waste money on the administration and the people that really need it actually get it.

Ideally, we would be looking at any tax revenues raised to be used to either underpin the finance on Green Deal for people that would not necessarily be able to access finance through the markets. That might be one opportunity. Also looking at micro-generation and what is actually included in the Green Deal, what measures are included? There is quite a lot we can do to better co-ordinate and target existing programmes to make sure that we get the best from them.

Richard Hall: As an additi on to that, I think also the extent to which we need to find ways to mitigate costs is dependent on the methodology, which is approached through EMR. So you have a range of measures on the table, and certainly some of them would appear to be more cost - effective than others. So, for example, in a world where you have FIT s with contracts for difference, i t is quite questionable exactly what the amount of the carbon price approach is, but if you go down the route of increasing carbon prices in the short term that is likely to create consumer detriment in its own right. The shallowest of the tax trajectories modelled by the Treasury suggested receipts of about £200 million to £400 million per year in direct taxation. So that transposes to about £10 to £20 per household . That is for the lowest tax band . C learly , the fact is that the additional tax take will increase any heightening of the carbon trajectory beyond the lowest we have modelled.

Ultimately, one would expect those additional costs flowing through to increased wholesale costs to ultimately find their way through to retail bills. So, essentially, the decisions you make about the extent to which you want to inflate wholesale prices will have an impact on the extent to which you need mitigating measures elsewhere to try to manage affordability.

Q354 Dr Whitehead: What you appear to be suggesting is some form of hypothecation and recycling of receipts from, for example, carbon floor prices, carbon tax, into mitigating the effects of EMR on fuel poverty. The Government impact assessment did suggest that lowest income deciles and single pensioners would be hardest hit. Would you envisage some form of rebate coming to those groups, or do you think an extension , as you suggested , of energy efficiency measures that are already under way might undertake that mitigation effectively?

Richard Hall: I think that is possibly an answer in two parts, if I can take one part and pass the second over to Audrey. I think I would highlight that simply our preference would be not to go forward with the Carbon Price Support mechanism in the first place. Seeking some kind of hypothecation or means of targeting the tax revenues raised back to consumers, they must be at least a second-best choice or a least-worse choice. It would be preferable to avoid putting yourselves into a situation where you needed to mitigate the effect of a significant and direct tax hike, but if you were to, that is perhaps the bit where-

Audrey Gallagher: Yes, I think we can understand what the potential difficulties around that might be, in terms of knowing what the levy is going to be from year to year because of the link to the EU ETS. I think probably where we are coming from, and loads of people say this, it is a fairly regressive way to raise tax if it is on low-income, single pensioners who are probably not in the tax system at the moment, but they are now having to fund this through bills. So I suppose there is a question on: how do we collect this through bills?

Quite a lot of the environmental levies at the moment are on a per household basis, rather than a per unit basis, so regardless of how low your income is or what energy efficiency measures you have adopted to try and reduce your running costs, you are still being hit with this fixed cost. So there is a question about how we collect some of these, whether it should be on a per unit rather than a per household basis. I suppose that is one.

The other thing if we did move to hypothecation, clearly it could be about mitigation. Now, whether that is through an extension of warm homes discount, an actual reduction of the bill, or whether it is the longer-term more sustainable solution, which is investment in energy efficiency, because, in the future, it does not appear that we are going to have any taxpayer-funded energy efficiency programme. So that is certainly one use where we could put the money.

Q355 Chair: Do you think that consumers realise how much their bill is going to go up in the next decade?

Audrey Gallagher: I do not think so. To me, there does not appear to have been a huge amount of engagement on it, and it is not something that is immediately apparent. It is quite an intangible thing when you speak about the structure and the operation of the wholesale energy market. On people’s engagement with their supplier, if you’re lucky, there are round about 50% of people that have engaged in switching supplier, because I think consumers see that as the main mechanism to save money, that you switch supplier.

We did some research with consumers around some of the proposals for the Energy Bill about putting additional information on customer bills, so lowest cost tariffs and comparators against neighbours. When we did the focus groups for consumers, even the top income quartile, there was absolutely no concept that the same energy supplier would charge different prices for their customers. Nobody realised that they could save money by moving onto a different tariff or paying in a different way with their existing supplier. So I would suggest that generally consumers are not tremendously engaged in energy. Arguably, why would you be? It is an essential-for-life service. It is just there. It is not something that people give a tremendous amount of thought to, so I do think we have to think about how we can engage consumers more on this and educate them more.

Q356 Chair: Does the Government have a role, a responsibility, to try and help this process?

Audrey Gallagher: So, what we have said is we are going to have a mandated roll-out of smart meters, which is a Government programme. There will be in-home displays in meters in the house, which is basically a Government programme for consumers. Clearly, there are advantages; that Government has to do that properly. We have another flagship programme, which is the Green Deal. For that to be a success, we think there needs to be half-decent communications and a central co-ordination programme, so there is definitely a role for Government. How it wishes to discharge that function remains to be seen, but I do not think that we can just put stuff out there and expect that, en masse, consumers are going to take it up. There has to be an engagement strategy and a communication strategy.

I know, for example, on Green Deal, there is quite a lot of hope being pinned on high street retailers coming in and really selling this proposition. I suppose at this point in time we just do not know. So I think we need to do something and maybe the "wait and see" approach is not going to drive the behaviour change that we need fairly urgently, as we see quite quickly increased bills coming down the line.

Richard Hall: I do not think it is necessarily possible, or practicable, for Government to force consumers to help themselves, but I think Government can have a role in helping consumers to help themselves. So, for example, if you look at issues around tariff complexity, or the extent to which there are issues constraining consumer’s ability to choose between suppliers to save themselves money, there is still more that can be done in that area. If you look at the market structure, we still have very liquid wholesale power markets, and it may be that by looking at structural remedies there that allow additional entry into the marketplace you could open up a process of increased competition in both the upstream and downstream sectors, which would be something that would be of benefit to customers and is something where I think Government could play a role.

Q357 Sir Robert Smith: Could you remind me-I’m trying to remember-when data sharing was first mooted as the response to fuel poverty, and how long it has taken us to come this far?

Audrey Gallagher: Probably a couple of Energy Bills ago, I would have thought, with all these discussions on social tariffs or social price support. Then I think the vehicle for providing that was in the Pensions Act. Having learned from that, we hope it could be extended but also extended out into wider programmes.

Q358 Sir Robert Smith: Do you think a bit more urgently?

Audrey Gallagher: I think we would look for this coming Energy Bill or welfare reform to try to address that.

Q359 Chair: Looking at the various EMR packages, are there some that are more threatening to our competitiveness than others?

Rhian Kelly: I am going to go through the four bits of it. From a CBI perspective, we like the low-carbon feed-in tariff proposal and think it will encourage new investment. We think that it will probably be appropriate to have different arrangements for different technologies.

On the pillar of the EMR around the emission performance standard, we do not think there is any need for an emissions performance standard.

On the third bit of the package, the capacity and demand response, we think more work is required on that to understand that in more detail.

On the fourth bit, the Treasury consultation or the Treasury work around the Carbon Price Support, as Government is going to introduce it, we think there are a number of things that it needs to do to mitigate business concerns around price impacts.

Q360 Chair: Do any of these more difficult ones threaten jobs at all?

Rhian Kelly: I think it depends on what we do to remediate some of the concerns. One of them from our perspective would be to ensure that if a carbon floor price mechanism is introduced, it should start at a low level and build up towards the anticipated EU ETS price by the end of the decade. We also think there is more work to be done on climate change agreements, in terms of ensuring that they protect certain sectors from the cumulative costs of policy. We think that also there is a role protecting the economics of CHP and, as under Phase III of the EU ETS, that CHP is exempt from the carbon price mechanism. Finally, more work is to be done to look at long-term contracts and how they could play a role in ensuring we remain competitive.

Q361 Chair: Does the rather limited capacity of the interconnectors mean that there is no real risk of capacity being located abroad, as a result of policies in this country?

Rhian Kelly: It is something that we have thought about and looked at. I guess one of the challenges is that we want to have an EU liberalised market. We want to make sure that whatever we do in the UK, we have a more liberalised market for the whole of Europe.

Richard Hall: I think one of the complexities in looking at that kind of issue is, because essentially you are creating different taxation regimes at opposite ends of the interconnector, on the margin, it may mean that it is more attractive to import electricity into the UK rather than export it, but because essentially the EPS is a variable tax rate to top up to a trajectory and we do not know at this stage exactly what that tax top-up will be in any given year, it is quite hard to forecast what the impact will be on investment decisions. It does definitely make it more attractive perhaps to invest in plants slightly outside our borders than it has been in past.

Sir Robert Smith: Offshore.

Q362 Chair: Professor Grubb suggested to us that, although there may be lots of companies that would like to procure green electricity, they do not do so because under the double accounting rules they cannot claim any credit for that in their own environmental reporting. Is that a problem?

Rhian Kelly: It is a bit of a tricky issue, to be honest, and we have not previously supported recognition of renewables of self-generation within the carbon reduction commitment or carbon reporting because you get double accounting. You will already have low carbon; you already have the RO and that is already taking account of it. There is a risk that, if you then allow it to happen inside the user scheme CRC carbon reporting, you just get double accounting.

Q363 Chair: It may be that the demand for green electricity, low-carbon electricity, is greater from business than the present structure permits to be exposed.

Rhian Kelly: I think there are definitely businesses that are keen to explore this in more detail. Our work inside CBI, with the wider membership, has always been that. It is the renewable obligation and the upstream policies that are driving low carbon and energy, not the carbon reduction commitment necessarily or the carbon reporting and green tariffs.

Q364 Chair: On another positive aspect, we understand Sainsbury’s is planning to install dynamic demand management technology into some of its stores. Are there opportunities for businesses like that to bid into a capacity mechanism, so they are providing a demand-side response? Is that something that your members would like to see?

Rhian Kelly: Certainly, one of the things we have said is there needs to be a bit more work on the demand response mechanisms. We think that you could do it by capacity mechanisms, but we think that there ought to be more work with Government and business to explore all the options. Capacity mechanisms is one; flexible mechanisms is another; and there are another couple of ideas around. We ought to be thinking in more detail about what would be the most appropriate mechanism.

Richard Hall: Yes, but on that point, the balancing mechanism we have in place does allow the demand side to bid into the market as well as the generation side, but in practice that theoretical ability to bid in does not seem to have manifested itself much in practice. It is still generally the case that it is large-scale generation resources that offer the flexibility either to increase production or to decrease production.

Understanding the reasons for that are problematic, but a lot of anecdotal feedback from small suppliers suggests that the difficulties in essentially going through the due diligence process, or being fully licensed in setting up the trading systems to integrate with the balancing mechanism, that those costs certainly run into hundreds of thousands of pounds and may possibly run into the low millions.

So, if we are to create an environment in which small-scale demand response can integrate the market, we may need to look at whether it is possible to adopt a slightly lighter touch regulatory regime for those kinds of assets or see if there is some way to facilitate demand aggregation, recognising the fact that individual premises may not have a product that, in itself, is of interest for a system operator, but when taken in aggregate they may well be able to provide quite a valuable service.

Certainly, facilitating a demand-side response should help to shave peaks on demand, which could help to reduce the amount of network investment that is required and also defray investment in generation assets. In an environment where increasingly almost all forms of generation are subject to some form of public subsidy, a handout seems extremely desirable.

Q365 Sir Robert Smith: Looking at the CBI, a lot of the talk is about all the business opportunities that could come from meeting the new methods of supply. Do you see, if we go down this road quickly or slowly, us importing the technology that is going to meet our low-carbon future or do you see us growing our own supply market?

Rhian Kelly: At the CBI, we have always tried to talk up the opportunities for businesses based in the UK over the next 20 years, and think that it could be a massive opportunity for UK manufacturing if we can get the package of EMR right. I think getting it right will allow us to understand better where we can grow UK opportunity and UK manufacturing and supply chains, but also understand better where it might be that we need to buy in some of the technology.

The ideal solution would be that the UK is able to take advantage of existing strengths and build those into the need to renew our ageing infrastructure in the next 20 years.

Chair: I think we are running out of time and almost a quorum. Thank you very much for coming in. We have covered some very useful ground.