Examination of Witnesses (Questions 116-157)|
JULIET DAVENPORT, DARREN BRAHAM, DOROTHY THOMPSON,
DR STEVE RILEY, AND DR GORDON EDGE
2 FEBRUARY 2011
Q116 Chair: Good morning and
welcome. Thank you very much for coming in. We've quite a lot
to cover and about an hour to do it, because we have a second
set of witnesses, whom we expect to move on to at about 10.45
am. We will try to reflect that sense of urgency and time pressure
in our questions, and we would obviously much appreciate it if
you did the same in your answers. You can by all means all respond
to the questions, but don't feel you have to each time if you
don't have a burning view you want to get off your chest.
Let me start with a general question. Is it
your view that this whole electricity market reform process is
necessary if we are to achieve more secure and more low-carbon
Dr Riley: The short answer is
Dorothy Thompson: I would strongly
Juliet Davenport: I think that
there are definitely parts of the current market that will not
allow the significant changes that we need to see, and they are
not fit for purpose to precipitate that change. It is not all
broken, but if you really want to get to the low-carbon economy,
quite a lot of things need fixing.
Q117 Chair: We will get on
to some of the details of it in a moment, but are there any omissionsany
big elementsthat should have been in the consultation that
are not there?
Darren Braham: It is important
to have a co-ordinated approach, so we have a lot of work on the
generational and supply side, but we need to focus on the demand
side, and to bring in the work that Ofgem is doing on liquidity,
which is a big piece that is missing from this area of work. Unless
you free up the wholesale market and generate liquidity, it is
very difficult to encourage competition at the retail level.
Dorothy Thompson: I strongly agree
on the liquidity point. I would also suggest that, in terms of
capacity, the consultation looks only at peak capacity and does
not consider the problem of intermittency.
Dr Edge: We are quite disappointed
that the benefits of continuity in the policy that is out there,
particularly the renewables obligation, are not reflected in the
consultation. As an industry, we will work with what is on the
table, but we would have preferred the option of keeping that
mechanism, which is working. It should have been kept in the mix,
and it should have been meaningfully assessed in the consultation
Q118 Chair: Right. You all
come from quite different businesses, so you are likely to have
divergent views on some questions. Do you think that what is proposed
offers enough improved support for small and decentralised generation
and for other low-carbon electricity sources?
Juliet Davenport: What is interesting
about the document is that it does not seem to consider size in
its conversation. We discuss three types of FIT mechanism, but
not how those are implemented, which depends on the size of technology
that you are talking about. We currently have two FIT mechanisms:
a fixed FIT for very small; and a premium FIT for slightly larger.
The size of the technology is quite important, so something like
a CfD will be very hard for small generators to manage, and potentially
the administration costs will be significant. We represent quite
a lot of small generatorswe have about 10% of the microgeneration
marketand from our point of view, the document does not
consider the impacts depending on the size of technology being
Dr Edge: From our point of view,
having a single support mechanism for all low-carbon generators
is a little bit problematic, because "one size fits all"
means that it does not fit everyone, because not everyone is the
same size. That is particularly the case with smaller onshore
wind developers, who perhaps have a small portfolio of projects,
as opposed to 1,600 MW nuclear power plants at the other end of
the scale. The system is supposed to work for the entire spectrum,
and it is very difficult to see how something could be designed
to fit everyone. The proposals about auctions are particularly
problematic at the smaller end of the scale, and we are not very
keen on those.
Dorothy Thompson: I suspect, though,
that this subject is all about the detail of implementation, because
a lot is to do with the concept of whether you are going to have
a market to which all have access openly, or a market that you
have to access through the supplier. That is the difference between
having a feed-in tariff and an obligation through the supplier.
We strongly support open market access because that is better
for new entrants and independents. On size, I know that the Government
are considering whether to differentiate between large and small
biomass stations. There is no reason in a FIT structure why you
cannot do the same. I think that this is in the detail of the
Q119 Sir Robert Smith: One
of the concerns raised about the working of the market is the
potential for new entrants and the domination by large generators.
What sort of capacity is provided by the smaller players, and
what would be the benefits of increasing the number of smaller
Dr Riley: There might be an issue
of definition around the smaller players as well. I would like
to think that International Power is a large generator. The independent
generators as a whole are about 20% of the market in the UK. It
is important that the outworkings of the energy market review
provide the right incentives and encouragement for the independent
generators to invest, because the amounts of investment are huge.
The key outcome for this, particularly for an international company,
is to get the regulatory framework right so that we are encouraged
to make investments in the United Kingdom rather than in some
of the other countries that we can choose for our capital.
Q120 Sir Robert Smith: What
sort of incentive?
Dr Riley: A good outcome for us
would be if the energy market review took a holistic view. We
have talked about low carbon. There are a lot of incentives in
the proposals to incentivise low-carbon generation, but we must
maintain a viable system going forward not only from 2030 onwards,
but between now and then, so some of the other thingscapacity
mechanisms to make sure that there is reliable security of supply
in the market and responsive plant, which will be needed when
base-load nuclear and intermittent wind resource are rewardedwill
continue to play an important part in the system going forward.
A lot needs to be taken into account in the whole review.
Dorothy Thompson: We at Drax have
been working for two years on a joint project with Siemens Project
Ventures to build three large new biomass plants. One of the
key challenges in putting together that project is finding some
way to get security of income over time against our fuel sources.
It is not possible in the current market, because the ROC is
a short market and the power market trades only two and a half
years forward, whereas the build takes three years. A structure
like a CfD, which effectively gives stability of income, is a
very good basis to go about financing and raising capital to build
Dr Edge: I think you need to be
clear about which new entrants you are trying to encourage. We
see a lot of new entrants into the generation market with renewables,
because that gives a low barrier to entry, and there are lots
of independent developers in our membership. The Government want
to encourage both that and new entrants in the form of large institutional
investors, but they are different things. You need to be clear
about who you are trying to entice into the market and what it
is you are offering them.
Juliet Davenport: The other thing
is that people already in the marketplace will try to offset their
risk, so if you increase the risks in the market, such as by increasing
buy-up prices so they are spikier, you will have investment from
incumbents. If you are looking at encouraging new investment,
you must have a look at giving certain returnsthat is really
the difference. If you are looking to get new investment in,
you need to consider what they will look at, and they will not
be trying to offset the risks of the existing incumbents.
Q121 Sir Robert Smith: Does
anyone have views on getting new entrants into the retail side?
Juliet Davenport: We are not that
new any more. We have been around for about 10 years, but we
are probably one of the smaller retailers in the electricity side
of the marketplace. Having more generators to trade with is an
important part, as are the credit terms you can establish. When
you come in as a small supplier and talk to very large generators,
they will look at you and say, "We're not that interested,"
whereas if you talk to generators of a similar size to you, they
will offer you much better credit terms. A real diversity of
generators coming in place is a really positive thing to bring
in new retail.
Darren Braham: Liquidity and,
probably, the lack of independent generation have a big bearing
on the development of retail competition. In our experience,
there were a limited number of people to talk to.
Q122 Ian Lavery: Liquidity
has been mentioned on numerous occasions from the beginning, so
it is obviously very important. It will have a huge influence
on competition. With regard to liquidity, will the electricity
market reform improve the risk-reward outlook for new entrants
in the supply and generation market?
Darren Braham: The risk with some
of the measures is that they remove liquidity further down the
curve. What might end up happening, particularly with the CfD
approach, if renewables trade out at the spot market, is that
you are left with lack of liquidity further down the curve. An
issue for us as a supply business is that we need to hedge out
18 months to two years. It is thinly traded today, so anything
that aggravates that position will be to the real detriment to
an independent retailer.
Dorothy Thompson: We are all
agreed that the principal driver of low liquidity in the UK is
the fact that roughly 80% of generation is actually owned by companies
that control 90% of the supply. Vertical integration in itself
does not necessarily mean you have low liquidity, but the fact
that there is no action, need or requirement to put larger percentages
of generation capacity or generation output through the market
causes the low liquidity.
Q123 Ian Lavery: Will Ofgem
be able to create sufficient liquidity to support new entrants?
Darren Braham: It is within its
gift to take the requisite action, but that is really a question
for Ofgem. It is something that we have made representations about
in the past three or four years since we went to the market.
Q124 Ian Lavery: Do you believe
that it will be able to?
Darren Braham: As I say, it has
the capacity to do it. One of the key solutions is a requirement
on the integrated players to offer their power on a wholesale
Q125 Ian Lavery: Has anybody
else got a view on that?
Dr Edge: If DECC wants it, DECC
will have to do it itself. Ofgem has powers to try to take this,
but this way lies perhaps a lot of litigation. I would use the
example of the transmission access review, in which there was
an industry process, with Ofgem in the lead, to try to work out
what the arrangements should be for connecting to the grid, and
it ground to a halt. Ofgem said, "Can't do it," and
handed it over to DECC, and it had to legislate to make it happen.
I suspect that this is exactly the same kind of situation. Unless
DECC grasps the nettle, it could take a very long time to do it.
Juliet Davenport: Some fundamental
changes are needed to the balancing and settlement code. I do
not think that you will achieve that through the current change
processes that we have, so I agree that it would possibly need
legislation to push it forward, because I don't think that you
can achieve it through a normal change process.
Dr Riley: There are two ways in
which you could try and improve liquidity in this market. You
could do what I think you're suggesting, which is to use the regulator
to intervene in the current market arrangements and try to put
in some measures that will improve liquidity. On the other hand,
we have a great opportunity nowthrough getting the energy
market reform right and through putting the right incentives in
place to encourage independent generators into the marketto
encourage that part of the market to grow. You would hope that
liquidity would improve on the back of that.
Q126 Ian Lavery: How much
capacity will be contracted in the proposed capacity market, and
how will that affect liquidity in the wholesale market?
Dorothy Thompson: As I understand
it, the current forecast is that you'd have about 5 GW capacity
contracted in the capacity marketI hope that my memory
is right. But it is a complicated number, because what you're
actually taking is a very big number for the demand forecast and
a big number for supply, and then looking at the difference and
trying to work out the gap. We would say that that isn't really
the capacity issue; the capacity issue is on a more regular basis.
Intermittency is the biggest issue. Do you realise that every
winter morning our demand goes up by about 50% between 5 am and
9 am? That is just today; add in more wind intermittency and more
inflexible plant and we've got another problem. The capacity market
that is being proposed is way outprobably at the end of
the decadeand for a very small element of the market for
a relatively limited amount of time. I think it will have an impact
on liquidity, because it will take out some of the demand and
some of the supply of the market, but it is actually only a small
Juliet Davenport: I think there
is a missed opportunity to talk about increasing transmission
interconnectability and looking at capacity trading between countries
as well. Significant capacity trading already exists between Italy
and some of the northern states, and obviously between France.
We have quite limited interconnectability at the moment, and I
think that that could provide us another route to providing more
security going forwards.
Dr Edge: There is also an important
confusion in the security of supply and capacity mechanism proposals.
DECC seems to want to cover the fact that we need enough capacity
to manage supply and demand overall, but also flexible capacity
to deal with a lot of variable generation like wind down the line.
There are two distinct things, but it seems to want both at the
A couple of colleagues have been talking to
EirGriD in Ireland, where it has a capacity mechanism. Its advice
was, "Don't have a capacity mechanism, but you need a lot
more ancillary service markets," so more frequency control
and voltage control. That is the kind of thing that the National
Grid already contracts for in the short-term operating reserve
market. Perhaps that is what we need to do the flexibility bit,
and the capacity bit can take care of itself. There is the important
message that DECC needs to work out exactly what it wants in this
area and then work out the right mechanism to get that, rather
than confusing the two.
Q127 Dan Byles: For some time,
I have been quite interested in, and a bit concerned about, the
potential medium to long-term impact on consumer prices. I often
get the feeling that industry, DECC and the Governmenteveryoneare
sitting around with a consensus that this is the way forward.
We are building structurally high consumer prices into the system,
but who has had that conversation with consumers? The EMR consultation
document has suggested that prices could rise from £80/MWh
to as much as £150/MWh. Do you agree with that analysis?
Is that the sort of impact on consumer prices that we will see?
Juliet Davenport: When trying
to make long-term forecasts for the impact on consumer prices,
you have to look at a range. It is very hard to get precisely
the right number, because there will unexpected consequences as
a result of some of the market coming in. The document in the
EMR talks very much about gas setting the marginal price. Obviously,
as you bring in significant amounts of renewable energy, you begin
to see that it will not always be setting the marginal price.
You might have the marginal price being set by wind at some point
in time, which I know sounds rather odd to some people.
We are seeing that, potentially, you could see
certain reductions in cost, depending on the impact of external
world market prices. That really is not taken into account within
the considerations that we have seen so far. I think that you
have to look at the risk around future prices, as well as what
the actual future price might be. The investment ideas behind
EMR are about trying to reduce those risks going forward. Although
we could see some initial price increases, the long-term risk
might actually be reduced.
Dr Edge: The issue is that prices
will rise and we will need to have investment. We have been behind
for a long time and we need to put a lot of investment in, but
the prices as they are now are below the level that you would
need to support the investment, so prices are going to rise.
A high level of low-carbon generation should
be a lower risk. It might be a higher price, but the chances
of that moving around are a lot lower, because you have high capital
costs and low running costsyou know essentially what the
up-front costs are from day one. If you go down a high-fuel route
with a lot of gas and coal, however, you are exposed to a lot
of price volatility, so it is important to put that into the equation.
Dorothy Thompson: We have set
ourselves, as a nation, some very clear climate change objectives,
and we need to recognise that, at least through the electricity
market, there is going to be a price for that. On the other hand,
the nation believes there is a benefit from that as well, so it
is a price we have to face.
As for the specific proposals, in terms of the
FIT, the market is designed to be more competitive than the current
renewables support we have, so that should deliver a better price
to the customer. In terms of the carbon floor, I find that a little
more challenging, because you already have the FIT to support
low-carbon generationI don't quite understand why you have
the two. I think the general commentary is that there is less
confidence in the carbon floor as an indicator for investment,
so it is less clear that it will drive through the value through
the investment. What is clear is that if you do have a carbon
floor and that is introduced now, it will provide a windfall to
existing renewables, to existing nuclear and, to an extentuntil
coal has shifted in the systemto existing gas. That windfall
will be paid for by the consumer, so I think it's a bit mixed.
Q128 Christopher Pincher:
I agree that we certainly need to focus the challenge, but if
you are asking certain constituents of mine in Tamworth to face
that challenge and pay that price, they might balk at the prospect,
so we need to demonstrate that we have consumer interests, as
well as our climate change objectives, at heart. Do you feel that
the green deal and its pay-as-you-save proposals are an opportunity
to offset some of that risk that we are shifting away from the
providers of energy to the consumers?
Dorothy Thompson: There is no
question but that the more we can improve energy efficiency, the
better we are at delivering a reduced total bill to the customer.
The challenge is how to get consumers to change their behaviour;
people seem to like more and more flat-screen televisions, or
whatever it might be. I believe in the green deal, but I think
it is a big challenge.
Juliet Davenport: May I add to
that? I think that one of the areas where EMR could go a little
further than it has is in looking at what demand-side response
individual consumers could start to bring to this marketplace.
What is interesting in the microgeneration area, particularly
with solar PVwe are working with a lot of social housing
in which solar PV has been installedis that behavioural
change is driven by having generation in situ. The green deal
is great, but it doesn't address some of the other sides where
you could get significant behavioural change by incentivising
people to use power at different times of the day.
Dr Edge: If I can widen that a
little bit, there is a wider economic bonus if we get it right.
We may be paying more through our bills, but we may get more economic
development. I am thinking particularly of the manufacturing opportunities
in offshore wind, but there are also other employment opportunities
in the renewable energy industry more broadly. If we can get that
benefit for the price we are paying, that is an equation that
would allow people to see that it is a price worth paying, but
we have to ensure that we capture that. It is very disappointing
that in the market reform consultation, there was no recognition
of that as an opportunity for the UK economyit was purely
focused on the electricity sector and its market, which I think
was an opportunity missed.
Q129 Sir Robert Smith: I appreciate
the importance of energy use and the potential for renewables,
especially in my constituency, but when it comes to Government
electricity policy, shouldn't it be about the lights being on
in a low-carbon way that is as affordable as possible for the
Dr Edge: There needs to be a wider
cost-benefit analysis that says, "We could go down this route,
which might cost us a certain amount, but the wider economic benefit
is very limited; or we could down another route, which might cost
a little bit more, but you get a lot more from it." That
kind of judgment is absent from this, and there does at least
need to be recognition that one of the reasons we are doing this
is that we think there is a wider benefit to the UK economy.
Q130 Christopher Pincher:
We were talking earlier about liquidity being a key element. Do
you not think that increased liquidity in the marketplace is another
element that could drive down price for the consumer? Surely we
don't want to give the impression to the consumer that this has
to fall solely on their back. Their behavioural change is the
only way that prices can be reduced for them.
Dorothy Thompson: We would connect
increased liquidity with increased efficiency, a better relationship
between generator and supplier, and more open opportunities for
suppliers. We believe, therefore, that it would have a positive
impact on prices.
Juliet Davenport: As a result
you may have a lower cost of credit, too. That is one of the key
issues for suppliers. One of the barriers to growth for suppliers
is how much they have to spend on having credit lines in place
to be able to deal with generators.
Q131 Barry Gardiner: Whichever
way we look at the figures, there will inevitably be a huge amount
of investment over the next 10 years. How much of that investment
do you think can come from the independent sector, if I may call
you that? What investment plans do you have? How much are you
going to bring to this party?
Dr Riley: I guess the answer to
that largely depends on the outcome of this energy market review,
because at the moment I don't think any of us would have serious
plans to invest very much. The market signals just aren't there.
If you look at the often quoted £200 billion that is needed
over the next decade or so, perhaps £100 billion
is in low-carbon technology. The independent generators represent
some 20% of the market, so if the framework is right, there is
no reason why they couldn't invest their fair share.
Dorothy Thompson: We're actively
looking at two sorts of investment. I shall first tell you a little
about Drax. Drax is the largest coal plant in the UK. It produces
7% of UK power, but we burn a lot of biomass. We have made a major
investment over the past two years, and we can now burn an eighth
of our capacity in biomass. That was a large investment, and last
year we were, plant-wise, the largest renewable generator in the
UK. With the right policies, there is an opportunity to change
our coal station into a renewable station. To do that, we would
need the right support from our equity investors as well as debt
As I mentioned earlier, we have also been looking
at new-build plants, which we have found challenging. What we
have not found challenging is finding access to capital when we
can put the right structure in place; we have found it challenging
to find the right structure to make it financeable.
Juliet Davenport: We deal
with about 1,700 renewable generators in the UK. In terms of recent
policy changes, it has been really interesting to see the difference
in attraction of external capital. There is significant debate
around the current feed-in tariff, but it has very successfully
pricked up the ears of various equity investors to make them come
into this marketplace; it has done that very successfully. From
our point of view, it has also been interesting to talk to investors
and find that many are still very interested in renewables post-planning,
but not pre-planning. So it depends what you are talking about;
there are things other than electricity market reform that still
affect incoming equity.
Q132 Barry Gardiner: What
effect will the instruments that have been proposed in the consultation
have on the different types of risk that you are facing?
Dr Edge: If I may jump in, from
the figures that I have seen, of that £200 billion only about
£45 billion is possible, via the Big Six's balance sheets.
Other forms of finance, such as conventional project finance,
are only going to take that up to, perhaps, £105 billion,
so a large chunk£95 billionmust come from somewhere
else. Obviously, the big ones that everyone points at are the
institutional investorsthe pensions fund and insurance
companiesbut to get them in, you need more simplicity and
ease of understanding. People say that the renewables obligation
that they are being offered is complex, difficult to understand
and unique to the UK, so we are not sure how that will appeal
to those new institutional investors.
Dorothy Thompson: We are owned
by institutional investors, and we have had some dialogue with
them. The message that comes out to me is concern that the EMR
document itself does not think hard enough about investors. The
situation is ultimately value versus risk versus return, and any
institutional investor will say that there are many different
places in which they can put their investment; they will only
invest in this sector if it is attractive, relative to the opportunities.
That is about return as much as risk.
Certainly, the investors that we have been talking
to recognise the attraction of the stability, and contract nature,
of a contract for differences, as opposed to the current regime,
in which there isI don't like to say this in the UKan
element of political risk. I strongly agree with Gordon that the
real key is to keep it simple. The more you do that, the more
investors can understand and money can be attracted.
Q133 Barry Gardiner: So how
will what is proposed in the EMR affect the cost of capital for
Dorothy Thompson: There is no
question but that our analysis shows that if there is a contract
for difference with the right level of return in it, there will
be a lower cost of capital for us to create an investment, when
compared with the RO, where we had risk on both the electricity
price and the final ROC value.
Juliet Davenport: At the smaller
end of the market, however, a CfD instrument may have the opposite
effect. It may drive investment upwards into much larger projects
and away from some of the smaller ones because of the transactional
costs that are related to the proposed instruments.
Dr Edge: It has been well proven
in a number of markets that when there is a lot of wind on the
market, the price goes down. With the CfD, because variable generators
such as wind are price takers, there is a risk that you will not
get the index against which the CfD would be judged. You will
not, therefore, get the strike priceit will be at some
level below that, which you may not be able to predict with much
accuracy, so although it promises price stability, it may not
deliver that fully, which is a key risk for us.
Juliet Davenport: Which I think
is a big dilemma full stop, because we need to have that pricing
signal right at the end, at the dispatch. Otherwise, we will not
have cost-effective dispatch, which will not be cost-effective
for consumers. The only way to have efficient dispatch is to have
the market price in it, and then you are left with the problem
of how generators deal with that. At the moment, under the ROC
regime, there is no protection, and the only way to get it is
to go to a large supplier who will buy the risk. Under a CfD,
you will be in exactly the same positionthe only way to
get protection for that last-minute dispatch risk is to go to
a large supplier.
Q134 Sir Robert
Smith: We have already touched on carbon price support in
one review of those proposals. How do the rest of you see carbon
price affecting your business?
Dr Riley: I think the important
point is that if there's a feed-in tariff of some sort that's
going to be used to incentivise investment in low-carbon generation,
there is a question mark around why the carbon floor price would
be needed at all, because you've effectively then got two different
mechanisms incentivising. If you've got a capacity mechanism as
well, you've got a third, maybe, so there's a question as to whether
it's needed at all.
Q135 Sir Robert Smith: I was
thinking you've got the EU ETS.
Dr Riley: Yes, okay, so you've
got a carbon price alreadypotentially a carbon floor price;
it depends on the level at which that's set. But if it's already
incentivised by a feed-in tariff, then why is it necessary? To
the extent that it's decided that it is necessary, again we would
make the same comments that were made earlier: it should only
come into force when the generation that it's trying to incentivise
is actually on the bars and generating, and not earlierand
at a sensible level that doesn't put too much of a burden on the
Darren Braham: Our concern would
be a straight pass through to the consumer's electricity bill.
Some of the numbers that are being talked about would imply a
25% or 30% increase in electricity retail costs.
Dr Edge: In general terms, we
think that having more certainty in the carbon price would be
a good thing. Our preference would be for some kind of EU-wide
mechanism to do thatperhaps a reserve price on EUA auctionsbut
at the moment we're a little bit agnostic around this one. As
Steve said, if there is a CfD it's a bit irrelevant, in terms
of what our members actually see as their income at the end of
Juliet Davenport: Can I come
in on that? I must admit that I came at this a slightly different
way round, and maybe my thinking was just slightly back to front,
but I felt that the reason for the CfD was the carbon price.
Given the fact that you were putting a long-term price indicator
into the market on carbon, the CfD mechanism was there precisely
to make sure that you didn't overcompensate some of the technologies.
If you don't have a carbon price, I'm not entirely sure why we're
having the CfD, but maybe that's just me misreading it. I felt
that a long-term price indicator that gently ramped up and gave
long-term indication in the market would be a good thing, finally,
and some kind of translation mechanism between the existing mechanisms
we've got and a carbon price in the future would be the way that
we should go eventually.
Q136 Sir Robert Smith: Do
you think the UK can go it alone with its own carbon price floor
when it's got a trading mechanism for emissions and is also about
to, possibly, have more interconnectors with other countries?
Juliet Davenport: No, I think
it has to be negotiated at a European level, and I think it has
to be brought into a European type. There are already forms of
carbon taxation across structures, across Europe, and I think
considering how those interact would be an important part of it.
Q137 Sir Robert Smith: Just
one thinga slight red herring: Professor Dieter Helm put
it to us that the gas supply was becoming almost infinite and
that a way of going quickly to a low-carbon situation would be
to close all the coal-fired power stations and build lots of gas-fired
stations, and then mothball the gas-fired power stations when
future technologies become available. Does his analysis strike
Dr Edge: I can't see how anyone
would want to invest in a gas-fired power plant on that kind of
basisthat at some time in the 2020s they would forcibly
shut it. It does seem like a very odd way of going on.
Q138 Dan Byles: I think his
logic was that investing £100 billion in offshore wind in
nine years is so staggeringly expensive that even turning a gas-fired
power station off in 10 years would be cheaper.
Dr Edge: But then you would get
no benefit, in terms of all the things I was talking aboutin
terms of the industrial sideand you would be wide open
to the gas market. Okay, there may be some kind of global glut
at the minute, but there's no guarantee of that. It may be that
shale gas turns out to be so environmentally horrific that you
just can't rely on it and we're back again at square one with
dependence on Gazprom.
Darren Braham: Yes, I think
you are moving the risk somewhere else, and in the absence of
creating more storage, I think it's a very risky way forward.
Q139 Chair: Going back to
FITs, do you support the Government's view that FITs with a CfD
is the right way to do it?
Dr Edge: We think that's a slightly
higher-risk strategy than the premium FIT, which is their back-up.
We see there are a lot of details that need to be got in there
with the CfD for it to be a fully workable system. At the moment,
we are trying to work through those details and see if we, internally,
in our industry, can come up with a system, within the parameters
that are set out, that we think is fully workable. We have not,
however, got to the end of that process. At the moment, we are
not saying yea or nay to that option. The premium FIT is lower
risk for us. The transition to that would be less disruptive.
Juliet Davenport: The CfD is interesting.
The examples that are given within the document relate to a one-sided
CfD, as far as we can see, and particularly to ensuring that there
is no downside to the investment, rather than to trying to pay
back some of the upside. They particularly look at large-scale
technology such as offshore wind. I come back to the point that
CfD is not workable for smaller-scale generation. My feeling is
that we have two types of FIT already, fixed and premium. Perhaps
you could go with three types of FIT: a fixed, a premium for the
mid-sized generators and a CfD for the very large ones. That would
allow the trading teams that you require to manage a CfD. The
overhead of that would match the larger-scale sites. You could
have the review on a CfD-type basis for the premium side.
Q140 Chair: The CfD FIT gives
predictability on income, doesn't it?
Juliet Davenport: It is not about
the predictability; it is about the transaction costs of managing
that predictability, and about being able to get the strike price,
as was mentioned earlier, for the smaller generators in a marketplace
at the rate that is perceived by the market index.
Q141 Chair: When you say "transaction
costs", what do you mean?
Juliet Davenport: I am referring
to the fact that under the considerationadmittedly, there
is not much detail here yetyou would need to be trading
on a regular basis, whereas generally, a smaller generator tends
to put a 10-year PPA in place, does one trade and allows somebody
else to take that over. The CfD proposal is expecting a much more
active trading position. Therefore, if you are asking for that,
you will have to carry another overhead or pay somebody else to
be able to do that.
Dr Riley: From International Power's
perspective, the preference would be for a premium FIT. While
a straightforward, full FIT would give absolute certainty for
that investment, we would not support that because it does not
take account of the impact that would have on the market as a
whole, once you are looking at the amount of renewables likely
to be on the system. We have a preference for the premium FIT
over the CfD because it is simpler.
Q142 Chair: Even though it
takes away the certainty?
Dr Riley: We would argue that
investors in the energy market should be prepared to have some
degree of energy market risk that they are willing to manage.
I do not want to confuse looking for a risk-free investment with
looking for a lower-risk investment that should be managed. It
is important to maintain a liquid wholesale market and, therefore,
a transparent wholesale price. The premium FIT would be more likely
to do that.
Q143 Chair: But almost every
prospective generator of low-carbon energy says to me, "The
reason we are not investing is that there is no certainty about
the price." You're saying that you want the choice that doesn't
give you that certainty.
Dr Edge: I think it is fair to
say that people are investing against the RO, which supposedly
does not have that certainty of price, but it has the familiarity
of the mechanism, which allows people to make a judgment on whether
it is an investment worth making. People have been investing,
particularly in wind power, in this country.
Q144 Chair: But nothing like
Dr Edge: That's not the fault
of the RO. It's because we have not been able to get enough through
the planning and grid connection systems. The fact that 20,000
MW of onshore wind has entered the planning system since the start
of the RO in 2002 says to me that the mechanism works.
Q145 Chair: This is not about
onshore wind. I see that there is a planning problem with onshore
wind, but onshore wind is virtually a marketable technology anyway.
We are looking at the other ones that are not marketable without
some help. You are all saying that the one system that you want
to choose is the one that takes away the thing that everyone else
says they want, which is predictability on the price.
Dorothy Thompson: Excuse me, but
I am not saying that. We support the CfD FIT. The premium FIT
also works, but the problem is the cost to the consumer. To encourage
investment, the investors will have to assume a certain power
price. They will have to look for a safe enough power price, relative
to the volatile power prices, to be confident of their income.
Please excuse me if I'm getting too complicated. If you think
the power market will be at one level, you will have to assume
it to be at a lower level to make your investment, which means
more support will be needed. We think it is a consumer issue,
but from an investor point of view, it's all about the level of
support. In terms of the small dispatch, it is definitely the
case that it will be difficult for the small generators to manage.
It's exactly like the RO today; under the RO today, the small
generators have to go to a supplier and say, "Give us a contract."
Under the CfD, we'll be in the same position; if they don't want
to face the transaction cost, they will have to go to a supplier
and say, "Give us a contract."
Juliet Davenport: I agree that
the CfD, in principle, is a good mechanism for the larger generators,
but I see it as a transactional cost for the smaller generators.
Dr Riley: May I have one more
go? If this was a single-issue review, and you just wanted to
incentivise low-carbon generation to a particular level, a straightforward
feed-in tariff would do that; that would give absolute certainty
for those investments. What it wouldn't do is take account of
the market as a whole. We had a conversation earlier about the
importance of liquidity in the markets and thinking about a viable
system going forward. That's why we'd like to thinkto answer
your question about why we don't go for something that gives absolute
certainty for a particular investmentthat the system will
consider the market as a whole.
Q146 Barry Gardiner: Is either
of the two proposals for emissions performance standards worth
the paper it is written on? Dr Riley, you had something to say
on this in your submission.
Dr Riley: I think we're already
on record as saying that we think the emissions performance standard
is an unnecessary regulation. Certainly, existing coal plant has
enough constraints on it through the large combustion plant directive,
the industrial emissions directive and the emissions trading scheme
to ensure that there's a fairly low level of generation unabated
going forward. Given the level at which the emissions performance
standard is set in this document, it's very much a back-stop and
probably an unnecessary piece of legislation.
Dorothy Thompson: We would completely
Q147 Barry Gardiner: Would
Juliet Davenport: I don't know
enough about it, but in principle, I would agree as well.
Q148 Barry Gardiner: Let's
imagine a scenario where the level was brought down from 600 or
450 grams per kWh to something that might seem to have a bit more
teeth and that might actually bite into gas as well. What would
the effect be? Might it be worth having that?
Dr Edge: Philosophically, our
view would be that you'd want something in the short to medium
term that incentivises the low-carbon, while in the longer term
you have something like the EPS to squeeze out the rest of the
carbon in the system. I'd have thought, as part of an overall
mix, an EPS that does indeed bite down into unabated gas eventually
is what you'd want. Certainly, from our point of view, for the
low-carbon, we're much more focused on the carrot bit of this
than on the stick of the EPS, which may be necessary in the longer
Q149 Barry Gardiner: In a
sense, the carrot and the stick are just the obverse of each other,
aren't they? If the EPS is biting down, it is increasing the attractiveness
of the investment proposition for your sector.
Dr Edge: That would be, to mix
metaphors, a bit of a blunt carrot; it would be an incentive,
but it would be rather indirect.
Q150 Dan Byles: I just want
to come on to capacity mechanisms. A number of respondents to
the Committee have suggested some uncertainty about exactly what
the capacity mechanism is supposed to achieve. Is it supposed
to achieve a certain amount of capacity of any type, a certain
amount of capacity of particular types or something else? I would
welcome your views on that.
Dr Riley: If the capacity mechanism
is there to ensure security of supply, that means you need a wide
range of technologies in the system. It should, therefore, be
a broad mechanism that ensures you keep the capacity in the system
for reliability and security of supply.
Q151 Dan Byles: A technology-blind
Dr Riley: Correct.
Dorothy Thompson: And also supply
and demand blind.
Juliet Davenport: Yes.
Dr Riley: I'm sorry, but I have
one more point on this. We have seen this effect in some of the
other markets in which we operate. Clearly, demand-side participation
would be an important part of the market going forward, as well,
but that also needs to be real. In some of the other capacity
markets in which we operate, demand-side bidding is there and
participates at the auction stage. However, it isn't necessarily
there when it's intended to be, and the penalties for non-performance
aren't that great. There is a lot of devil in the detail around
thinking through capacity mechanisms where demand-side participation
is used as well.
Q152 Dan Byles: Do you think
it's possible to design a system that will reward both generation
and demand-side measures?
Dr Riley: Yes, there are systems
around the world. There's the PJM
in the US, where there is a functioning capacity market, and I
thought the all-island market
was quite a good capacity market as well, in contrast to the comments
made earlier. The markets exist, and it is possible to learn lessons
from some of the detail of those markets as they've operated.
Juliet Davenport: Bringing in
the demand side is very important. Part of that needs to look
at how the settlement system brings in the demand side and what
the opportunities are for aggregating the smaller-scale demand,
not only the larger scale. It is also about looking at the technology
links into that. We talk about smart metering and smart grid,
but we are not really talking about connecting it to a smart settlement
yet. I think you need all of those aligned, and a bit more creativity
and imagination could go a long way towards bringing in other
Q153 Dan Byles: Do you have
a view on the level of capacity mechanism that we would require?
Pöyry Energy Consulting did some modelling that threw up
the idea that we might need up to 40 GW of back-up or demand-side
measures. Do you have a view on what level might be required?
Dr Edge: It rather depends on
the rest of the mix. It also depends on how much you can bring
in on the demand side and how much interconnection capacity you
can build with the rest of Europe. I am afraid such estimates
are a little like asking, how long is a piece of string?
Q154 Dan Byles: Do we not
need an idea, or at least a working ballpark figure, if we're
going to design a system that will generate the capacity required?
Dr Edge: I certainly think that
we need to focus much more on post-2020 scenarios. Our industry
has been very focused on 2020 because we have a very hard target
to meet, but beyond that is a really important debate that we
are only just starting to have, which those questions would come
out of. DECC has been trying to do it through its 2050 pathways
work; we can argue about the usefulness of that, but we need to
have the conversation and we're not really down that path.
Q155 Dan Byles: Do you think
it's too early for DECC to be looking at trying to create a capacity
Dr Edge: No, but knowing how much
it wants to deliver is another debate that may have started but
certainly has not finished.
Dorothy Thompson: There are two
different time frames here. I strongly agree on 2050, but the
thing to remember is that our new nuclear plant will probably
be load following. The profile of what our plant can do will change,
and that will be a big advantage if we achieve what we want to
achieve in nuclear by 2050. There is a risk in the transition.
We read recently that it is estimated that by 2020 the hourly
swing will go from 5 GW in 2009 to 17 GW in 2020that is
if we achieve what we expect to achieve on wind and so on. It
is an enormous figure; 17 GW is like every household in the UK
going from no power to almost full power within an hour. It is
a major swing.
I think we have to worry quite a lot about what
the transition will be. There is no question but that by 2020
most of our coal plant will come off the system. Our coal plant
is providing an awful lot of that flexibility. We are a very strategic
asset, so I see it day by day. We spend a lot of time providing
frequency response and balancing support services, and on special
contracts to National Grid just for that support. The coal will
go, or a large part of it. That is simply a feature of the industrial
emissions directive. You will also find that some of the older
plant will go, which is also providing some of the flexibility,
and we will have much less fossil fuel plant to balance the system.
I don't know what the answer is, but I believe it is something
we should worry about. As you said, people should be trying to
estimate exactly what the problem is so we can work out how to
Juliet Davenport: Just to add
to that, one small thing is that we're quite mute about electric
vehicles at the moment and consideration of what that load may
do to the system. I am concerned that there is no consideration
at the moment for restricting electrical vehicles, and when they
can charge and how they can chargewe are talking about
speed charging. Those types of loads could make much bigger swings
than we are talking about in this context. So, I think that needs
to be considered to make sure that we don't add to the problem
that may be coming towards us.
We touched on interconnections earliersome of us were at
National Grid yesterday, as it happens, and they are very keen
on seeing more investment in interconnectors. Do you think that
there is a limit as to how much we should regard interconnection
as part of the answer? I know that it is a two-way process; obviously,
we are supplying them sometimes as well. However, do you have
a view about the theoretical maximum?
Dr Riley: I am sure that
there is a limit, but I wouldn't have a number. Again, I would
have thought that there is evidence from some of the interconnected
markets in continental Europe, where the peak in demand is actually
coincident, and therefore, the effectiveness of an interconnector
may be more limited than its nameplate capacity. As long as that
sort of effect is taken into account, interconnection has an important
role to play.
Juliet Davenport: I think renewable
resource interconnection is quite interesting. If you look at
the disperse of weather systems across Europe, when you are generating,
you look at your generating capacity. When we buy power in the
UK we try not to buy it in one region; we buy it across the UK.
So, our 1,700 generators are spread, because that spreads our
weather risk. Essentially, if we are going to move to a much windier
portfolio, which we will, having larger interconnection means
thatalthough I agree with the point about demandin
terms of wind, you will get spread.
Dr Edge: You might estimate some
kind of limit, but by the time we get towards that, technology
will have advanced, so the limit will have extended further. So,
in some ways, you might regard it as essentially infinite, although
I cannot predict the future. It is always difficult.
Q157 Chair: The other point
that was raised right at the start was about coherence of the
package. There are several elements in it, but do they all fit
together? Are they all necessary? Do you need a carbon price mechanism
if you have a feed-in tariff, and so on? Do you think that those
elements are not really consistent?
Dorothy Thompson: I echo what
Steve said. If you are supporting your low-carbon generation through
a feed-in tariff, I would question the role of the carbon floor.
Dr Riley: Again, the devil is
in the detail. It would be quite easy, with some of these measures,
to not think about the impact that a single measure has on some
other important attributes of the market. At the same time, however,
with enough considered thought, it is possible to bring this package
together so that it is coherent and protects the good elements
of the market that we have so far, as well as improving it and
encouraging the right investment.
Dr Edge: I would have concerns
about the reliability and security of supply measures, and the
low-carbon support measures. It is possible that, through the
capacity mechanism, you could really affect the wholesale price
of power and that would impact on your low-carbon support mechanism.
So, those bits need to fit together.
Chair: Okay. We have reached the end
of our allotted time. Thank you for coming in, and I am sure we
shall see you again individually or collectively on other matters
1 Note from the witness:
"actually about £130 billion" Back
Note from the witness: "Pennsylvania, Jersey, Maryland" Back
Note from the witness: "all-island (Irish) market" Back