Examination of Witnesses (Questions 92-115)|
RACHEL CARY, SIMON LESS, SIMON SKILLINGS, AND TIM
25 JANUARY 2011
Q92 Chair: Good morning. Thank
you for coming in. You will have heard what we have discussed
already, and we will be dealing with some of the same issues again.
Just looking at the time, we have got a maximum of about an hour
before we start to lose a quorum, so we will try to be concise.
Can you start with a general comment about whether
you think the overall electricity markets reform package is ambitious
enough to achieve what are clearly some quite challenging goals?
Simon Skillings: One of the particularly
refreshing things about the session you have just had is that
nine tenths of it was talking about what you might call energy
policyexactly what the goals are, and perhaps what they
should berather than the details of market rules and the
tool box to deliver them. So, my answer to your question is that
I don't actually know what the objectives are. They are implied
in the consultation documents, but they are certainly not explicit.
What are the objectives with regard to carbon
reduction in the power sector over the next two decades? What
are the objectives with regard to technology deployment? We all
have views, but we do not actually know what the objectives are.
If they are as challenging as a lot of people think, we need a
fundamental electricity market reform package built around long-term
contracting, as Dieter mentioned, and therefore they would be
appropriate. If we are not going to be ambitious, we certainly
Simon Less: I echo some of those
points. On the face of it, one of the three objectives is the
carbon objectivethe 2050 target. But in fact this is interpreted
far more narrowly. It is interpreted as a target in one sector
of the economyelectricityfor one particular level
of carbon at 100 grams per kilowatt hour and at one particular
date. This narrowing down of a wider carbon objective to that
very narrow intermediate target leads to much of the shape of
the package, which, in my view, moves very much into a central
Another objective, which is not in the tripartite
objectives but is clearly driving some of this, is the renewables
target, and Dieter has already talked about that. That is a different
objective from carbon. It is not in the tripartite, but it is
driving this. The third tripartite objective on affordability
and cost-effectiveness is again narrowed. It appears not to be
applied to all aspects of the electricity market. It is narrowed
to looking for cost-effectiveness in the operation and construction
of generation, but not cost-effectiveness in the choice of different
generation technologies and the timing of when we build them.
To summarise, there is a lack of clarity in the objectives.
Q93 Chair: Accepting that,
if we were to say that there has to be a significant reduction
in the carbon element of electricity generation, and that it seems
inevitable that electricity demand is going to rise as the economy
grows and we gradually decarbonise heating, buildings and surface
transport, whether it is 100 grams per kilowatt hour by a specific
date or not, there has to be a substantial downward trend over
the next 20 years or so. Given that that is an objective, if not
terribly well defined in the document, do you think that the general
approach and the chosen or suggested interventions in the market
are the right ones?
Simon Less: If we interpret the
objective in that more general waywe do not need all elements
of this packagethe Treasury document that sits alongside
the DECC consultation document, which consults on carbon price
support, does some modelling that shows that a £40 per tonne
carbon price in 2020 and £70 in 2030 is sufficient to deliver,
on central assumptions, 105 grams of carbon dioxide per kilowatt
hour in 2030. But there are risks around that. If you pay a different
gas price, that might change to 160 grams if you happen to have
a low gas price, so that in broad terms that policy alone will
deliver the outcome that you want. Yet DECC brings forward a whole
set of other policies, because it appears to be driven to target,
to have certainty around this timed target of 100 grams.
Simon Skillings: Can I comment
on that? I am not sure that it does say that. I think it says
that if you believe that investors are going to be very confident
about the length of time that that carbon price signal lasts,
and if you maintain an extremely aggressive renewables obligation
package, believe that gas prices will not become too low, and
are not worried about maintaining security of supply, it is okay.
However, I think it fails in all other measures, and the modelling
clearly demonstrates that.
Tim Tutton: Between
ourselves, we have previously talked about one of the key ambiguities.
It was echoed in some of what Dieter said in that it is not absolutely
clear throughout the document whether the objective is to hit
a volume target and try to minimise the price of achieving it,
or to spend a certain amount of money and chuck it out the system,
and the volume is whatever comes out of it. Let us look at the
FITs chapter, for instance. Essentially, it starts with price,
like the carbon price stuff. When you move to the implementation
section of the consultation paper, it introduces the concept of
auctions, which is a volume concept. You set the volume and you
try to get the volume at least cost.
The paper as a whole is handicapped by an ambiguity.
It is interesting because when it comes to talk about capacity
mechanism and security of supply, rightly in my view and, I think,
in Dieter's, it starts with volume. It says that we will need
a certain amount of volume of flexible plant, or whatever, to
keep the system running, so we should go out to competitive tender
to secure that volume. I got the impression from reading the
paper that it was written in one sense starting from price and
seeing what happened on volume and, at some point quite late in
the drafting, it was felt that perhaps it was better to start
with volume because that was the objective. Things were therefore
put in at the end of the paper that completely unbalance it.
Are you trying to get volume or to constrain
how much you pay for all of it? That is the primary question in
many ways, and it does not really surface in the paper until quite
late, implicitly through the capacity mechanism, which is a different
issue, and through the discussion of having an auction mechanism
for implementing FITs. When you talk about the ambition of the
paper, what is it? As Simon says, it is ambiguous.
Rachel Cary: It is interesting
to talk about the objective being decarbonisation. I have argued
that setting it out as quite a clear objective is key. It has
not come out of nowhere. If we are thinking about affordability
to consumers across the whole economy of decarbonising, the Committee
on Climate Change has said that if we are to meet our 80% reduction,
pretty much the simplest and the cheapest way is for consumers
to go for rapid power sector decarbonisation. If we take that
as given, it is then interesting to look at the four policy tools
to see whether that will achieve the objective. We would welcome
long-term contracts in real low carbon generation. Equally, the
capacity mechanism is the sort that fits well in a low-carbon
world. It gives an equivalence to demand and supply sides, and
reflects the need for flexibility.
What is interesting is whether we need a carbon
price and an EPS to drive the high-carbon stuff off the system,
and whether the EPS as it is set does anything additional to existing
planning. We could do it for a carbon price, but as the Treasury
document clearly sets out, because it raises the wholesale price
of electricity, it is actually a high cost for consumers. We
suggest that a far more intelligently targeted regulation could
be more effective at driving high-carbon plant off the system.
Dieter covered whether we want to be proactive
and, for example, go with CCS deployment. If we want to do that,
we need to think ahead. As with the supply chain for nuclear,
we need to think about developing a UK supply chain for CCS.
Relying on a price signal that will take a long time to materialise
and will be far less significant than fluctuations in the gas
price is a risky strategy. If we want people to start thinking
about where they base their fossil plant and making sure that
it is near clusters and things like that, some sort of targeted
regulation that makes it clear by which date they need to start
thinking about changing the technology could be much better.
That is the bit of the package that we would have questions about.
It was bizarre that the modelling done to accompany
the consultation considered only an unrealistic EPS, which would
drive up all coal and some gas. We need modelling done on a more
intelligent EPS that would actually be far less dramatic, but
bring forward investment in things like CCS.
Chair: We will pursue some of those individual
Q94 Dan Byles: To take up
your EPS point, you heard my question to Professor Helm about
the current two options. They have been criticised from various
directions. One suggested that it would not make any difference
to the current system. The other said that, as a result, it would
effectively lock in gas and fossil fuels for the long term. Do
you have a view on that? How would you see a more intelligent
Rachel Cary: One of the things
you want to do is reward early movers. So, for example, you might
have an EPS that is set at a higher level for plants commissioned
up to a certain date, with a lower level after that. That would
really encourage people, because we are asking them to go forward
and trial out quite risky technology in terms of CCS and deploying
the full supply chain, and I do not see how the current proposals
do that. Also, because you are covering only coal, how you are
suddenly going to drive unabated gas out of the system in a 10-year
time frame in the 2020s is a worry.
Q95 Dan Byles: You wouldn't
be talking about grandfathering, so new plants that come online
between now and 2020, for example, would know that from a certain
date in future they would need to retrofitted. Basically, you
are building retrofitting into the system.
Rachel Cary: Yes, exactly.
Tim Tutton: One of the good things
is the paper's recognition of the importance of grandfatheringit
is crucial. As the paper points out, huge damage was done in terms
of policy changes failing, which changed the rules of the game
not only for new plant coming on, which would have been less disruptive,
but for existing plant. In the paper, grandfathering is rightly
regarded as simply a cost that you have to bear.
It may be that you find you have brought stuff
on that is expensivethat will happenbut that was
the deal at the time. If people do not think that that is going
to be the deal, and there is not an effective long-term contract
underpinning what they are going to do, it will discourage them
from bringing stuff on.
Simon Skillings: I think that's
right. However, Rachel's point about the supply chain is very
important: grandfathering does not help those who are sitting
in the supply chain and are, we hope, developing that capability.
You might be a manufacturer who is developing high-efficiency
gas turbine technology now. You are right that the EPS proposals
don't do anything at the moment, and they say they are not trying
to do anything other than back up what is already there. However,
they also say, "We might change this in future and tighten
it up, and, if you are already built, or have reached financial
close, it won't affect you." That is not helpful from a supply
chain perspective, because those in that chain are interested
in the orders coming down the road in the next few years.
That seems to be an unhelpful way in which to
put EPS in place. I believe that the EPS is an important instrument,
because it creates a clear long-term market volume signal and
is, therefore, something that the supply chains can go at. It
should be established clearly over time scales to which the supply
chain can respond. The current incarnation, in which it is not
doing anything, but might do so in future, fails on all counts.
Q96 John Robertson: Professor
Helm was not very complimentary about EPS. However, I still cannot
believe that you could just do away with it yesterday, rather
than even tomorrow. How do you view his line on gasthat
we should just start building a lot of gas-powered stations and
that we would eventually be better off doing that than investing
Simon Less: I broadly agree with
what he said and with the calculation that he highlighted of saving
perhaps £90 billion if we were to build gas and then scrap
it, rather than building offshore wind.
Another point, which Professor Helm did not
make in support of his argument, is that the offshore wind that
we build this year has a lifetime of about 20 years at best. We
do not know much about the lifetimes of wind turbines that we
have put in harsh environments; we only know about the past 20
years. That means that by the time we get to around 2030, we will
need to replant this offshore wind in any case. That puts the
need into contexteven if we were to have to scrap the gas
Q97 Laura Sandys: Going back
to feed-in tariffs, what lessons can be learned from FITs in other
countries? How could they be integrated into our reform programmes?
Tim Tutton: One of the lessons
from other countries is that having very generous feed-in tariffs
produces a big effect. In several countries that have applied
them, especially those with more capability of having onshore
wind than the UK, there has been substantial supply response.
The question that Dieter was asking was about
whether that was the cheapest way of doing it, as well as actually
producing the response. His answer, which I agree with, was that
you start from the other end. You say, "This is the volume
we want. Now come and bid for the long-term contracts to build
that." Assumingit may not be the case in nuclearthat
there is a reasonable degree of competition, that will deliver
it cheaper than the other approach, which is explicit in the consultation
paper. That says that the other alternative is that we do some
modelling and decide what these things will cost and offer up
a price that we think will deliver the volume that we need. You
are not using the market to discover whether that price is right
Simon Skillings: I think the idea
that auctions are some panacea is rather false. We are looking
at technologies where for nuclear it is absolutely inconceivable
that you will have a competitive situation and for CCS it is probably
inconceivable that you will have a competitive situation. You
either have that situation, where auctions are clearly inappropriateyou
need to have a bilateral negotiationor you have a situation
where there are many providers of the technologies, and where
you pretty much know the costs. The question there is whether
the administrative burden of the auction is worth while compared
with the benefits you can create.
I echo the point that volume is key. It is about
volume, and returning to the point on technology, it is so important
that we move this away from a yah-boo-sucks, "I like this
technology, I don't like that technology" debate. It is about
how we manage the risks of delivering our climate security objectives.
Different technologies have different cost and deployment risks.
Some of them might cost a bit more, but are more reliable in deployment.
Some of them may cost a bit less, but have huge deployment risks.
We have to have that debate and discussion before we can get into
this "Is it gas? Is it nuclear?" debate and move on
from the rather superficial debate we have at the moment.
Q98 Laura Sandys: This is
for the others to answer as well. Do you not feel that we have
a situation with many different mechanismsall of which
will have to be stress tested by the investment communitysuch
as the technology, our potentially failed projects, successful
projects and the affordability issue? If you have an auction mechanism,
there will in some ways be much greater transparency and clarity
than all those different levers, which might create very different
behaviours when they are out there in the marketplace. Is this
system too complex to deliver clarity and transparency?
Simon Skillings: Two quick answers.
I agree that we are spending too much time dabbling around in
the tool box. It is not until you are clear what you are trying
to deliver that you know whether the tools are right. The CFD
instrument they describe is clearly not appropriate for all the
technologies. The main answer to your question is that the technologies
are all very different. If we believe that we have such a challenge
that we need to draw on all technologies, including the demand
side, the cost characteristics, the timetable and the investment
risks are all so different. I cannot imagine what a technology-neutral
auction would look like. It is bound to favour one or the other.
We have to be clear, therefore, on the volumes that we are looking
for from these technologies, perhaps just as a minimum, which
can then form the basis of those long-term contracts.
Simon Less: I agree with Simon's
point. I cannot see how auctions could be technology neutral,
although I draw a different conclusion. They will inevitably draw
the Governmentthe central plannerinto making a whole
range of decisions, which, hitherto, have been made by the market.
The Government will need to decide what overall capacity we need,
what technologies we need, what the timing of those technologies
is, and make a whole range of other decisions, including on the
price, assuming, as Simon sets out, that the auctions cannot reveal
those prices in an efficient way.
We should not be under any illusion that the
CFD element of this package is a major step towards central planning
and away from market decision making, because of what we are saying
here. The conclusion that I draw is that that's a step we should
not be takingwe should certainly not take it lightlyand
we should, therefore, be looking first and foremost at how to
strengthen the carbon pricing framework. How do we get a long-term
credible carbon price, within which system the market can operate
flexibly to take decisions about technology types, the timing
of technology and the order in which we put in technologies? For
example, making such decisions as in Dieter's exampledo
we do gas first and offshore wind later, rather than doing offshore
wind very expensively now? Let the market decide these things.
Can I pick up a point Rachel made earlier: the
problem with that approach being that we can't be certainor,
rather, market players can't be certainabout the level
of the carbon price in the future? As Dieter said, it is the level
of the carbon price in the future that is most important. One
important option has not been considered in the package, as far
as I can see: instead of having a contract for difference around
the electricity price, leading to all the central planning, why
not have a contract around the carbon price, if the problem is
certainty in what the future of the carbon price will be? So,
the Treasury is saying that it will target a certain carbon price
at some point in the future. DECC could then simply write a contract
with all generators to say that the Treasury will stick to its
word, and if it doesn't they have this contract to come back to
us on. In that way, we can extend the horizon of confidence that
investors have in relation to the carbon price, making it a more
tenable policy on its own in driving the carbon targets.
Q99 Sir Robert Smith: On that
carbon price support, the Treasury's own analysis suggests that
nuclear would be the big winner, so it wouldn't necessarily be
Simon Less: Saying that one technology
under the modelling would be a winner is not necessarily saying
that it is not neutral. I have not looked at the modelling, or
seen it, but I presume that the reason that it brings support
to nuclear is because, in part, the cost characteristics of nuclear
make it favourable. That is applying a neutral criterion of cost.
It is saying that offshore wind is more expensive than nuclear,
therefore offshore windlogicallyought to come further
down the line.
Q100 Sir Robert Smith: But
would carbon price support risk being dead weight in rewarding
Simon Less: You would need to
make an adjustment to, say, the banding in the renewables obligation
if you introduced carbon price support, to mitigate windfall to
those renewables already in receipt of it.
Q101 Barry Gardiner: Turning
back to capacity mechanisms, do you think that the case is unequivocal?
Do you think we should wait and see what the demand side will
do? Basically, the same question you heard me ask Dieter.
Simon Less: On capacity mechanisms,
I am in the wait and see camp. I don't think that the evidence
put forward is convincing and that we need to make this intervention
in the market now. The projected difference between what we think
capacity will be and what we would like capacity to be is quite
smallbetween 5% and 11% projected, with 8% to 12% being
optimal, according to the consultation. There is not a huge gap.
There are a number of changes, such as sharpening up, balancing
prices, and indeed the carbon price itself, which would help to
close that gap.
Then, there is the uncertainty. We don't know
how much intermittent wind will be built, and that is a big driver
of the problem. We don't know how fast and how smart metering
and other demand-side response technologies will come in, and
how effective they will bestorage as well. There is a whole
set of unknowns. The problem, in any case, is largely in the next
decade; it doesn't seem to be very large.
Also, introducing a capacity mechanism is not
without risk. The document itself goes into a number of the risks:
the risk that you dampen pricing and therefore choke off demand-side
responses; what is called a slippery slope risk, in which investment
doesn't come forward because it would prefer to be inside the
capacity mechanism, so, gradually, the capacity mechanism has
to grow; or the risk that we overpay for a level of certainty
that we don't need. Because of those risks and because the case
isn't made, my preference would be to wait and see what happens.
In the end, to build the sorts of peaking, back-up plant that
would solve any problem that did arise, the lead times are not
very longthey tend to be low-capital and high-operating-cost
Tim Tutton: It depends
Barry Gardiner: Can we let Rachel in?
She has tried a couple of times.
Rachel Cary: I would say there
are risks in "wait and see" both on the supply and demand
sides. On the demand side, we can put up some gas turbines very
quickly if we have problems with intermittency, but we know that
the demand side solutions will save us money. A targeted capacity
mechanism, where the system operator starts going out and contracting
with the demand side, trialling those new commercial arrangements
and new technologies, will benefit the innovation. We are more
prepared and we have our inevitable high proportion of intermittent
wind. Equally, on the supply side, if we say we will wait and
see which technology is developed and do not go for a degree of
central planning, whereby we develop things such as CCS, we will
not develop offshore wind, certainly not in a strategic way. That
would be a real shame, because the UK has fantastic geographic
resources. There is a risk to the UK economy in just waiting until
you have to bring in lots of nuclear plants, or missing your opportunity
to develop new industries.
Tim Tutton: Echoing Dieter's comment
earlier, what is the question to which the capacity mechanism
has an answer? The capacity mechanism in the consultation document
is used in a very specific way. In other words, capacity over
the system as a whole, in terms of volume and megawatts, is actually
being sold by FITs in this paper. You are throwing money at it
and bringing forward capacity. In the process, you are skewing
the type of capacity that is out there. You are skewing it towards
intermittent and inflexible capacity, and you are then creating
a problema lack of flexible plant in the system. So, in
the consultation paper's case, it is using the capacity mechanism
as the answer to a much narrower question. It is a bit like a
medical diagnosisyou start with the ideal. As Simon says,
you could, ideally from a market point of view, just fix the carbon
price. But the paper does not like that. It therefore says, "Well,
no, it's going to be too expensive and it's going to cause too
much intermittent plant", so you have FITs, which try to
solve the first problem, and the capacity mechanism, which tries
to solve the second.
Back to, "Do you do it now or wait and
see?" The point about the consultation paperto the
extent that it is successful and to the extent that FITs and the
other policies produce loads of intermittent and inflexible plantis
that you will need, probably, a capacity mechanism in the narrower
sense in which the paper defines it.
Dieter would probably say, "Well, that's
the wrong question." And the question is, "Should you
be looking at the global capacity and long-term contracts if you
are looking at some sort of central planning approach?",
which is his energy agency route, in which case you do not need
the local capacity mechanism to solve the flexible plant, because
it is being dealt with as part of the global mechanism. If the
paper is right in saying that we are going to offer huge incentives
to build intermittent and inflexible plant, you probably will
need an additional side-effect countering mechanism, which encourages
flexible plant to be built. I agree with Simonthe slippery
slope means that you will probably end up with all flexible plant
actually being contracted to that capacity mechanism.
Simon Skillings: Can I add one
last dimension to that argument? If you are funding large amounts
of low-carbon generation with long-term contracts, they effectively
have a capacity payment in them. If you want to avoid shortages
and very high prices, it is absolutely essential to have a capacity
payment. I do not perceive "wait and see" as credible.
The key point is, we are moving to a very different world from
the traditional way of looking at the electricity market. The
products and services we need in that residual part of the market
are going to be different. There will be much more of a requirement
for flexibility of different sorts. An exploration of that is
the key thing that we have to tackle here. As Rachel says, we
have the opportunity to drive an innovation policy, which not
only, though very importantly, includes the demand side. It is
an opportunity to lock the smart grid piece in to deliver some
of the market developments that it is there to deliver. Technologies
such as storage can be hugely important, as well as the flexible
generation that exists now, so I think that that is a very important
Q102 Albert Owen: Can I ask
about some of the limitations of this market reform? The objective
of EMR is to produce low-carbon, affordable, secure electricity,
but is there not a danger that we are focusing too much on new
generation and not on reducing demand?
Simon Skillings: Yes, absolutely.
The principle of equitable treatment between the demand side and
the supply side is important. That is talked about with the capacity
mechanism, which is fine, but it looks at demand response. Traditionally,
there are three elements to the demand sidedemand response,
demand reduction and distributed generation. We would expect demand
reduction and distributed generation to be potentially cheaper
alternatives to low-carbon generation. It seems to me, therefore,
that the demand side should have a fair crack at the FIT side,
as well as the capacity payments side, of the equation.
Rachel Cary: I agree with Simon.
On reducing demand, we should make sure that energy efficiency
is not only part of the contract for difference mechanism, but
something that is really pushed. Whether or not it is the agency
that determines those volume contracts, on which they are scrutinised,
are you really doing as much as you could to go out and contract
on things that are going to reduce long-term energy demand? It
is also the wider piece, and Dieter mentioned, as, indeed, does
the consultation, that you talk about reducing demand across the
whole economy, but you are mainly focusing on the green deal.
While that is still in play, there are so many other measures
and instruments that we will need to use to target different sectors
of the economy to reduce demand. The first thing that we should
do is to make all this affordable for the consumer. There are
other activities that need to take place, in addition to EMR.
Simon Less: The key thing to drive
demand reduction is to price carbon properly, by pricing in the
environmental externality. On the CFD proposal, I find it hard
to get my head around how the Government would go and contract
with demand that then does not happen. They are contracting for
something not to happen in the futurefor that demand not
to materialise. I fear that under the CFD mechanism, the supply
side will have an advantage and that all the focus will be on
the make-up of the generation capacity. To the extent that CFDs
are part of the package, which reduces the focus on pricing carbon
properly, that will be detrimental to the demand side.
Can I also say something that is relevant, when
we are considering the carbon price driving demand, about the
effect on prices? Clearly, putting on a carbon price drives up
prices. That is its purposeto create energy efficiency,
so that the lower-value uses for energy are driven out. But the
flip-side of the way that it is being proposed is that there is
a tax receipt. The proposal is to support the carbon price using
a taxation mechanism, so there will be receipts. So the overall
effect on customers depends on how the Government choose to use
those receipts. They could return them to customers through having
lower taxes elsewhere, or they could return them directly to energy
customers. The overall impact can therefore be mitigated, but
you still have the sharp incentives not to use energy that you
do not need to use.
Rachel Cary: Can I respond to
that? I would agree with the hypothecation point that some of
the revenue should really be spent on energy efficiency measures
and such things. But on the idea that the demand side is not reliable,
I just think that evidence from US markets with capacity mechanisms
shows that that is not true. It is a perception issue. If you
have both energy efficiency and demand-response measures, while
some in a portfolio will not deliver, some will over-deliver,
and they have been shown to be 90% reliable. That is one of the
hurdlesI have talked about why we need to start thinking
about contracting the demand side earlier rather than later, because
there is a perception that it is unreliable, but it is not, as
if it is aggregated it can be really reliable.
The second point I wanted to argue is that we
know with energy efficiency that price signals are one of the
things that do not work. There are lots of disincentives. Everyone
knows that they can save money saving energy. There are often
so many other barriers that just saying we can price the carbon
adequately and that will be our solution to energy efficiency
is a fallacy.
Q103 Albert Owen: There might
be a difference. You are all of the opinion that reducing demand
may be sidelined. We need to deal with it. Other issues not in
the EMR are planning and grid connections. Do you think that there
should be? Should they all be in one market reform Bill or are
you comfortable with how this Government and the previous Governments
proceeded with planning first? How do you feel about grid connection?
Do you think that it should be part?
Tim Tutton: The combination of
the so-called transmission access reviewthe main Government
initiative in that areais probably the solution that most
easily underpins the volume objectives underlying decarbonisation.
In other words, it effectively concerned whether there were real
physical constraintsmainly planning constraintson
building the grid. The question was always whether you stopped
people then connecting if there was no good there or let them
connect, accepting that there will be transmission constraints
and that some will have to pay for them. That solution was adopted.
It says that, if you are a wind generator in Scotland and can
literally get a physical connection to the system, you will be
allowed to connect. You will be allowed to generate and, if you
are constrained, you will be compensated for that and everyone
will pick up the cost of the constraint.
A pure economist would have a few issues with
that position and say that it would cause inefficient connection,
but from the point of view of hitting a volume target, it is probably
the right solution.
Simon Skillings: The one element
of the grid side that is most obvious as an omission involves
the interconnection agenda with Europe. One the one hand, we have
a programme looking at building a North sea grid and improving
interconnections, yet the EMR is in the context of an island system.
It is hugely important and it actually reinforces the importance
of long-term contracts. One thing that will become obvious is
that there is no right answer in market arrangements, balancing
rules, capacity payments, carbon pricing, renewable subsidies
and so on. As we begin physically to interconnect the European
market, you will find that everybody is in a different place on
those issues, and that gives rise to perverse assumptions.
We mentioned earlier the single electricity
market in Ireland as a result of the carbon price underpin meaning
that southern Ireland generators were very happy with the carbon
price because of the perverse incentives it created. You know
that an integration agenda means that we will have to change all
such things going forward. We shall have to harmonise balancing
rules, renewable subsidies, capacity payments and carbon pricing
to avoid perverse incentives. The only way in which we can drive
forward investment against that sort of uncertainty is by locking
it out through long-term contracts. I believe that contracts are
absolutely key if we are going in this direction, and I do not
know anyone who thinks that it is not a bad idea to integrate
the European market.
Rachel Cary: I think that interaction
with planning is interesting. The UK has a lot of objections,
for example, to onshore wind, which is very cost-effective and
perhaps one of the reasons why we are having to go so much offshore.
How we set up the support mechanisms for low carbon, how simple
it is, how much community ownership and how much local buy-in
we can get to renewables is really important. I feel for DECC,
but one of the things that it tried to do by moving away from
the ROs was to go for something more simple. I am not sure how
a contract for difference with a complex auctioning process would
be that simple or that easy, for example, for community groups
to engage with, so you might want a two-tier approach to expand
the threshold for FITs bits and make it simple up to say, 25 MW.
That might be one approach. You are really going for the auction
approachthe contract for difference approach, certainly,
whether it is an auction or notfor the more complex, bigger
players, because I think that is key in the UK.
Q104 Chair: On the question
of interactions, which is clearly extremely complex, do you think
that the Government's document has paid enough attention to the
possible interactions? We are dealing with a sort of water bed
hereif you do something here, it produces a consequence
over there, which might not be immediately predictable.
Tim Tutton: It will always be
messy to some extent when you are trying to hit multiple objectives,
but yes. One of the ways of tracing the line through as a medical
analogy is saying that you start with one solution and you are
then for ever putting sticking plaster over the problems that
each of those solutions will create. Putting words in Simon's
mouth, he would probably say that he preferred to see much more
of the heavy lifting done by the carbon price alone, for that
reason in part.
Simon Less: It's a complex package.
As I was outlining earlier, it will take the Government into making
an awful lot of decisions, and things will happen that neither
we nor the Government can predict. There will be unintended consequences,
and the risk of that will create a lot of regulatory uncertainty.
That itself will drive up the cost of capital and the risks for
investors, so there is merit in a package that is simpler than
this. I have set out what I think that should be.
Rachel Cary: I think one of two
processes going onit will be interesting to explore the
connectionis the networks development, as well as the market
reform. We have talked about grid connections for transmission
scale, but there are things like the low-carbon network fund,
which is all about deploying all these smart technologies on the
distribution networks. The capacity mechanismFITs, this
targeted, flexible mechanismshould give us business revenue
for those sorts of technologies, so it will be interesting to
see how the two connect and how we go from pilots of smart growth
and demand-side response through to bringing them to market. That
is an interesting crossover.
Q105 John Robertson: Thinking
of the costs and getting back to the professor's points about
gas and how much investment should be in gas, I know we have invested
a lot of money in renewables, but my worry is that the cost of
connection of all these renewables, which are obviously on the
periphery of the country in relation to the grid, is suddenly
not cost-effective any more. Should there be another process,
therefore, for localised electricity feeds from these areas, rather
than connections to the national grid? Should it be treated as
completely separate from what we could call the core-type energy
that is supplied?
Tim Tutton: One of the problems
is that, just as the UK system has traditionally exported electricity
from the north to the south, for coal-type reasons in the past,
so it is with the wind distribution and with the availability
of sites because of planning permission, which mean that the wind
generation is quite a long way from the demand. As long as you
have got that, and as long as you effectively see offshore wind
as the core technology doing most of the lifting for renewables,
then it is hard to see how you can afford heavy transmission investment
to get that electricity to customers.
John Robertson: So that brings us back
to whether we should actually be investing in renewables.
Rachel Cary: The thing to think
about is that, whatever we do, the transmission network requires
a lot of upgradinga lot of it is coming to the end of its
life. In a way, we have got a bit of a blank slate to start with.
Another thingfor example, we talked about nuclear fleetis
that it costs a lot to upgrade the transmission network to accommodate
a new nuclear plant, so it is not just renewables that raise that
issue. I think you are right about the issue of distributed generation,
and it shows how difficult it is. We think about supporting generation
based on the costs of supply, but we have then got to think about
the network costs. When we are thinking about how these proposals
support distributed generation, it is very tricky, because the
contract for difference is very much about bringing on the big
stuffCCS or offshore wind.
Q106 John Robertson: My problem
is that if you look at any line that has been on the go for 10
yearsit is still nowhere near being completedthe
cost 10 years ago was a lot less than it will be in the next two
or three years, or whenever it is actually completed. Should we
even be thinking of investing in that extension of the grid to
peripheral areas, where we will hit the same kind of problems
that we have had in the major line?
Simon Skillings: This is one of
the key values of the North sea project. We are not talking about
major onshore lines; we are talking about identifying how to put
together an offshore grid and how to land that effectively into
the onshore infrastructureI am sure that we will need some
form of infrastructure. I do not know the answer to your question,
but it seems to me to be one of the very important questions that
the North sea project should explore, which is exactly how efficiently
we can tap the North sea resource and what the appropriate infrastructure
is to deliver it.
Tim Tutton: One of your key points
was the question you posed just a moment ago. Grid costs reinforce
Dieter's argument, basically. Effectively, if you are looking
at power station costs, his argument for gas now, wind later is
reinforced, when you add in grid costs.
Q107 John Robertson: So how
are the feed-in costs going to be developed? Whereabouts does
this appear in the system? Who pays?
Tim Tutton: Everyone pays.
Q108 John Robertson: How is
Tim Tutton: It goes into transmission
network use of system charges, which are charged to all generators
Q109 Chair: In terms of the
interactions, what effect will all this have on our attempts to
couple our markets with neighbouring markets in France, Holland,
or even Ireland, and trying to promote interconnection? In that
respect, there will be some interactions that will not be entirely
Simon Skillings: Having spent
a bit of time recently in Brussels trying to explain it to them,
the first thing to say is that they are very interested. The UK
is definitely seen as a country in which other countries want
to know what is going on with our market. They want to understand
the direction we are going and they want to understand how that
fits with their own context and what it may mean going forward.
My second point is just to reinforce my earlier
point that if you believe in physical interconnection, you also
have to believe in harmonisation of rules, because it becomes
absurd otherwise. In Europe they are beginning to toy with the
question, "If the UK is doing this, while facing an investment
issue, and other countries are facing that over the coming years
and will need to start thinking about these problems, how do we,
as Europe, identify the need for harmonisation and the progression
of harmonisation in these rules, such that we get the benefits
of a unified single European market?" That question is just
beginning to be asked in Brussels.
Q110 Dan Byles: I have to
go in a moment, so I apologise for asking the question then possibly
rushing off. Everything seems to come back to the phenomenal levels
of investment that are requiredsome £200 billion over
the next 20 years. Professor Helm referred to £100 billion
in nine years on offshore wind. There will be a nuclear power
station coming online every nine months from 2017. We are talking
two channel tunnels a year for ten years. That is a phenomenal
amount of investment from a very limited number of companies in
a limited industry, which is already at capacity and highly leveraged
and which is also being asked to build new nuclear power stations
in China, Japan, France and Germany. Do you think that this package
of reforms will do what is needed to bring the investment that
we need here in the time frame that we need it?
Simon Less: There are lots of
large numbers here, but the total amount of money, getting on
towards £100 billion in generation to 2030, is small, compared
with the global pool of capital. The global pool of capital is
so much larger than that and it will go where the risk-reward
ratio is attractive. That is what we need to focus on. Does this
packageboth in terms of the financials and the risk-reward,
but also in terms of non-financial factors such as the planning
regime and grid access, which have already been discussedstack
up to a favourable prospect? I think that an important part of
trying to incentivise low-carbon investment is having a long-term
credible carbon price into the future, because that can be plugged
into calculations of risk and reward.
Simon Skillings: Can I add that
I agree with that? There's plenty of capital; it's about making
sure that it fits the risk-reward appetite. We must not forget
the significance of the green investment bank proposal, because
EMR de-risks the earnings stream from operational assets. It does
not help to take away construction risk, which is very significant
for many immature technologies. It is extremely important that
the green investment bank is established in such a way that it
can raise capital and that that is secured by the Government.
Interestingly, in a very similar way to the CFD proposals that
are in the EMR, it is very important that consistent thinking
is applied so that the green investment bank can be used to de-risk
those parts of an investment that EMR cannot.
Q111 Sir Robert Smith: The
green investment bank has to be a bank, not just a fund.
Simon Skillings: Absolutely. That
Q112 Sir Robert Smith: Finally,
on trying to take all this forward, a number of the energy companies
have been keen to see some kind of road map for its implementation.
Do you see stages through which the reform has to go to achieve
Simon Skillings: Shall I have
a quick stab? We haven't talked about institutions in this section;
I know that it was talked about in the earlier session. It is
so important that we clarify the policy objectives, and set in
train the institutions that need to be established, which could
take some time. Who is going to be the contracting body? What
is the governance under which it will operate? Where are the regulations
under which it will operate? That will take time, and it is very
important to set it in train. I would prioritise that rather higher
than continually refining the tool box, because until you are
actually clear about what people are trying to do and what degrees
of freedom they have, it seems a little pointless to go in to
shine the tools that they will be using.
Q113 Sir Robert Smith: How
soon would you need to do that to meet all our obligations?
Simon Skillings: I actually think
that it is already too late to say, "Well, let's just put
everything else on hold and wait until we've got this in place."
What is essential is that we have dual policies: one in which
we establish the enduring situation; and the other that is focused
on ensuring that investments continue to flow through. We need
to ensure that we have transitional arrangements in place that
ensure that investors know that they are not going to be any better
off by waiting. It is absolutely critical that no investor sitting
here thinks, "If I wait a couple of years, I might be better
off." That option has to be taken off the table.
Simon Less: In terms of meeting
all our obligations, I have hardly met anyone who believes that
we can meet our contribution to the EU renewable energy target.
I don't think that this package, or anything similar, can enable
us to meet it, because the factors against us are physical and
practical in the remaining nine years that we have. This package
will not help us meet that target, and nor will any other that
On the longer-term goals on decarbonisation,
as I have already said, I think the key reform is the carbon price,
which is something that could be put in place relatively straightforwardly,
compared with some other aspects of the package.
Q114 Sir Robert Smith: So,
the message is almost, would you say, that trying to achieve the
goal is distorting?
Simon Less: Trying to achieve
the renewable target is distorting and incredibly costly, as Dieter
illustrated earlier, but it is legally binding. Between now and
2020, there will come a point when it is absolutely obvious to
everyone that we won't meet it. The question then is what do we
dodo we try to renegotiate it? That may depend on how many
other countries are not meeting it. How much money are we going
to put into trying to meet it in the meantime?
Q115 Sir Robert Smith: One
final question. How is the target legally enforced?
Simon Less: In theory, we can
be what is called "infracted" and fined by the European
Commission for not meeting it. I am not a lawyer, so I cannot
tell you what all the ins and outs of that are. There is, however,
a question over the limit to the fine, which I cannot quote off
the top of my head, so that even if we were fined at that limit
every year for a very long time, it would probably still come
to less than £90 billion.
Simon Skillings: What the law
tells you is that this is not a binary decisionthat we
are going to meet it, so we should plough ahead; or that we are
just going to fail, so we might as well give up. It is clear that
whatever penalties there are will very much depend on the extent
to which we have tried to achieve the target. Therefore, I don't
see this idea that somehow or other views on whether or not we
are going to deliver it affect our efforts in delivering it. It
is those efforts that will affect the fine more than whether we
achieve a particular number.
Chair: I think we have run out of time
and almost of a quorum here; although three is a quorum. Thank
you very much for your attendance and comments, as well as for
your patience, which we much appreciate. This is a very important
subject for us, and I am sure that we will benefit a lot from
what you have said.