Examination of Witnesses (Questions 158-180)|
SARWJIT SAMBHI, JOHN MCELROY, SARA VAUGHAN, IAN MARCHANT,
JOHN CAMPBELL, VINCENT DE RIVAZ, AND PAUL SPENCE
2 FEBRUARY 2011
Q158 Chair: Good morning.
Thank you very much for coming in. We have a big cast of characters
and a limited amount of time. I know that you, Vincent, have got
to go off, but we are allowing a substitute to come on to the
field later on. We will try to let you say what you want to say
first. Could I get you all to introduce yourselves for the benefit
of people who do not necessarily know you? Ian, we have been upgraded
as far as you are concerned.
Ian Marchant: Yes. I was delegated
upwards. I am Ian Marchant. I am the chief executive of Scottish
and Southern Energy.
Sara Vaughan: I am Sara Vaughan.
I am director of regulation and energy policy at E.ON.
Sarwjit Sambhi: I am Sarwjit Sambhi.
I head up the power generation business at Centrica.
John McElroy: John McElroy, RWE
npower, with responsibility for policy and public affairs.
John Campbell: John Campbell,
director of energy wholesale at ScottishPower.
Vincent de Rivaz: I am Vincent
de Rivaz, chief executive at EDF Energy.
Q159 Chair: Ofgem has told
us that you have whacked your margins recently. Is that true?
Ian Marchant: I wish that were
true. Our gas supply business has lost money every year for the
last five years. I am not sure that that is a sustainable business.
So, yes, we are seeking to make profits in this business. We are
generally failing. This is not a business that is awash with cash,
as people would like to think. We put out a briefing to the City
yesterdayit's in the public domainthat said our
generation, supply and profits are going to be down year on year,
despite putting prices up, despite having 300,000 extra customers
and despite investing £1.2 billion this year in that business.
I find it deeply frustrating that in this part of London I get
criticised for making too much profit and I go two miles to the
east and I get criticised for not making enough. I think we are
probably getting the balance about right. I would rather be praised
in both, but at least I am being criticised in both.
Sara Vaughan: If I could echo
that: in 2007 and 2008 we made a loss in our retail business;
in 2009 we made a small profit in our retail business; the 2010
figures are not out. Even if you look at Ofgem's own documentits
December report on marginsit talks about margins increasing
but then it talks about the fact that wholesale costs are also
increasing. So we would expect to see those margins shrinking
as a result of that change. Really what Ofgem was picking up on
was a timing point, rather than anything else. You have to be
able to make a sustainable margin in a retail business.
John Campbell: Our retail margins
have been barely over 1%. Our last published results were for
the first three quarters of 2010. The profit in our competitive
business was down by 24% and our wholesale costs have increased
by between 30% and 40% over the last year. So maintaining profitability
in the retail business is a real challenge.
John McElroy: I would agree with
many of the points that have been made along the row. As Sara
said, we made no profit in our retail business in 2009. 2010 does
not look any different in many respects. The other thing is that
we need to recognise that there are substantial cost pressures
on the business from a range of things, including increasing network
costs and a whole range of Government initiatives in terms of
feed-in tariffs, RO, and various measures to support vulnerable
customers. There is a whole host of issues that are substantially
driving costs up as well.
Vincent de Rivaz: I would like
to say two things. First, when the cold weather started to bite,
EDF Energy announced a winter price freeze. Secondly, overall
issues of how the market works are precisely about having a fair
balance between the interests of shareholders and the interests
of customers, and that is why we are talking about electricity
Q160 Chair: Several of you
have mentioned that you are not making any money in your retail
business, but since you are buying energy from yourselves, does
that mean you are making a massive amount of money in the wholesale
Ian Marchant: I talk very specifically
about my gas supply business. I have no gas upstream assets. I
may be closing on a deal today, but in the past five years I have
had no gas upstream assets. I have had to buy all that gas in
the market. There is no profit anywhere else, I can assure you.
It is more complicated in electricity because obviously I am the
generator as well, but in gas, absolutely, there is nothing anywhere
John Campbell: The dark spread,
which is what we call the profit that we make in generating from
a coal unit, is currently less than £1. The spark spread,
which is the equivalent number for gasthe profit per megawatt-houris
about £5. To replace thermal plant in the future you would
need spreads of £16 or £17. Generation spreads in the
UK at the moment are not in a very healthy place. That is why
the electricity market reform is so important to create the investment
signals, because they are not there in the current market for
thermal or renewable, or for any plant. The wholesale market is
a very weak place.
John McElroy: You were inferring
a link between the generation and the supply businesses, and I
would like to make the point that at least 90% of the generation
and supply volumes that we deal with are traded in the market
by our supply business, so everything is at arm's length. The
other thing that you need to consider is that if we look at RWE
npower's profits last year the amount that we invested in the
UK was more than three times the level of profit. That is a very
considerable factor that has to be taken into account.
Q161 Chair: We will come on
to some individual aspects of EMR in a moment. We are looking
at a prospect over the next few years, however, of rising prices
for a variety of reasons, and it looks as though a low-carbon
element will drive costs up a bit further. There is already a
suspicion among your consumersalthough you are able to
refute it, and you can say that investors are breathing down your
necks because you are not making enough returnand a lack
of trust in the price-setting process. Do you think there is a
danger that if we are going to achieve the more secure, lower-carbon
electricity that we want, which is an explicit objective for the
Government, consumers will think that actually they will resist
the price consequences of that, because of this lack of trust
that already exists?
Sara Vaughan: Can I hit that point
head-on, because it's something that we have been tackling in
our advertising? Some of you may have seen it; it heads up with
"Why on earth would an energy company want me to use less
energy?" That is exactly the point that we are trying to
hit with thatthe trust point, and the cynicism from consumers
about the approach that energy companies have. We are trying to
be very honest with consumers, and we are trying to explain to
them exactly why prices are going to go up and the underlying
reasons behind that. We are doing that through advertising; through
talking to consumers in town hall meetings; and through our internet
site, which has one of these blogs where people can come in and
join conversations that are going on. We're perfectly aware that
there is this lack of trust around energy companies.
Returning to the point that was touched on previously
concerning supply and generation, for many yearsat least
the last 10 years, and certainly before Ofgem mandated us to do
itwe reported our generation business results and our supply
business results separately and also from our regulated distribution
business results. They were in our published accounts. Anybody
could find them on the internet. So if people wanted to look at
the relationship between those two issues, they could do so. I
would absolutely support your point, Chairman, that trust is a
key issue for this market going forward.
Ian Marchant: I agree. It actually
doesn't help that the first question that we've had on the investment
climate is about profitability and prices. Actually, your side
of the table doesn't help our side of the table either in the
way that the debate is carried on. We have to raise that element
of the debate to keep my consumers and your voters alongside the
common agenda that we have to decarbonise our society. We have
to work much more together, rather than fighting each other the
Chair: Let me absolutely assure you that
one of the things that I have been consistently saying, as some
of you will know, for the past three years is that prices are
going to go up substantially. You cannot point to a single suggestion
from me where I said that prices should not go up.
Q162 Barry Gardiner: Does
silence on the panel mean that those who are silent are doing
rather well and didn't want to participate in that debate? This
is an opportunity for Mr Sambhi to deal with such a suggestion.
Sarwjit Sambhi: Thank you for
the opportunity. In terms of the profitability and looking at
the question of how much money is made downstream versus upstream,
I will reinforce the point that the margins that British Gas has
made over the past three years have fluctuated and have been as
low as less than 2%. On average, over the past three years in
energy, that has been around 7%. Compare that to other retailerswhether
it's fixed-line telephony or mobileand it is substantially
lower than you would expect in any retail market. On the upstream,
a measure of profitability is return on capital employed, and
in terms of our return on that in investments that we've made,
particularly in power, they are currently single digit. We cannot,
therefore, be seen to be making excessive profits by a hard measure
in the upstream.
I would also point out that if you look at how
much we've invested in UK energy infrastructure, for every pound
of operating profit that we've made, we've invested £1.60
in UK energy infrastructure.
Q163 Sir Robert Smith: I had
better remind the Committee of my entry in the Register of Members'
Financial Interests, which states that I am a shareholder in Shell.
I just wondered why those businesses that are making a loss on
the retail side still do it.
Ian Marchant: Would you like to
join my board? That is exactly the question that we struggle with,
particularly with gas. We make a margin on electricity. The problem
that we've had with gas is that the wholesale price has been so
volatile. Just when we think we're going to make a profit, the
wholesale price moves against and that hasn't happened. We're
in it because it's a dual fuel market and we have to be in it,
because that's what customers want. We tend to look at a dual
fuel margin when we're looking at things, and that is a very small
positive at the moment after the price rise. Whether we should
stay in the gas retail business is a real challenge, because the
evidence suggests that we cannot make a decent margin out of that.
Sara Vaughan: Let's be clear,
we have been making a loss, but we did make a small profit in
2009, and we would want to make a profit in 2010. We're not in
the business to make a loss; we're in the business to make a profit.
John Campbell: We have a commitment
to be a UK generator and retailer. There's a lot of integrity
in that business model. As someone else just said, we're not in
it to make a loss; we're in it to make a fair return. That is
certainly what we plan to do.
Q164 Barry Gardiner: Was Ofgem
accurate when it said that the recent price rises will increase
profit margins from some £65 on a dual fuel tariff to £97?
Is that right, or is Ofgem just wrong?
Sarwjit Sambhi: Can I pick up
on the analysis? The analysis is flawed to some extent, because
Ofgem looks at current retail prices and compares that against
projected forward wholesale prices. It is mixing apples with pears.
The other thing it doesn't do is look at the additional costs
that are incurred beyond just the wholesale commodity price, such
as increase in transmission and distribution costs. So, at face
value, there is more to the numbers that needs to be explained.
I would argue that the analysis is flawed.
Q165 Barry Gardiner: I would
accept that, but none the less, that flawed analysis is still
contained in the £65 figure, just as much as it is in the
Ian Marchant: The data are right,
but if the analysis came out with a suggestion to move it from
minus £50 to plus £50, we'd be having a different debate,
wouldn't we? It is the absolute level. Ofgem overstates revenue
because it takes the highest-price customer and does not take
account of loyalty discounts and various other things that we
have. The average revenue that we earn from customers is lower.
Ofgem understates the costs for the reasons said, and it understates
the cost that we incur on risk-managing a fixed revenue stream
with a variable cost. We end up requiring it to be long or short
power and having to trade that out. Our view is that the absolute
level of those margins is significantly lower than what Ofgem
says. The change from the price increase is mathematically correct,
but the analysis is where you start from.
Sara Vaughan: Yes.
Chair: I think we will move on to the
EMR now. Thank you, Ian.
Q166 Sir Robert Smith: Some
of your earlier answers might have explained this, but one of
the concerns about the market is the concentration and the difficulty
for new entrants in both the generating and the retail sides.
Do you see any barriers that can be removed to bring in more competition,
or any benefits from more competition?
Ian Marchant: The first thing
to say is that this market is competitive compared with any in
Europe. There are eight major generators and six major suppliers
with more than 5% market share in the UK. In France, it is four
and one, and in Spain it's four and four. So we are significantly
more competitive before we start.
Secondly, I actually don't like giving evidence
with these five people. They're not my friends. I don't like them.
People do not move between these companies. We have very different
approaches to this industry, which is why when we get to the detail
of the EMR, you will hear different views. Trying to get us to
a common position is like herding catsit's basically impossible.
If I look at the liquidity of the market, I
think it is pretty good in the first year or two, for gas and
power. You can trade and hedge your position for a year or two.
The issue is longer term. The barriers to entry are, I believe,
threefold, and they are not related to anything that we do. The
first barrier is the credit requirements of banks and companies,
which have become significantly tighter since the financial crisis.
Small new entrants cannot post a collateral to trade. That's the
Secondly, in terms of the sheer size of the
investments required to set up a supply business or a generator
you're talking about hundreds of millions of pounds. Those are
not typically the sorts of businesses that private equity generates.
The third thing is that it's a risky business. New entrants have
gone bust. People forget that the largest independent supply business,
Independent Energy, went bust in 2002. Large independent generators,
including Drax, effectively went bust and had to be rescued.
My fourth reason out of threethis is
like a Monty Python sketchis that an awful lot of regulations
are imposed on our sort of business that make it very difficult
for someone to set up, which is why the new entrants you see in
supply will typically use one of us to provide the services to
meet all their compliancefor us that means M&S Energy,
and I think British Gas has just done a deal with Sainsbury's.
Even companies of that size struggle to meet all the regulatory
Sara Vaughan: Can I pick up the
point about liquidity that Ian touched on? I think there is a
real misunderstanding about companies that have a generation arm
and a supply arm, and in the concept that people have of vertical
integration. They imagine that all that those generation arms
do is supply their supply arms, and vice versa. That is absolutely
not the case. If you look at a company such as E.ON, we have an
independent trading business that sits in the middle. Effectively,
we manage our generation and supply positions separately. Our
own churn in 2010 has been, on average, around five times the
marketfive times physical. So, we are buying and selling
that five times. The market throughout 2010 was around four times,
so we are trading our generation and supply more than the market
average is moving.
John McElroy: The point has been
well madewhy would you come into the retail business given
the margins at the momentbut on the generation side the
simple fact of the matter is that the market is some 30% plus
over capacity at the moment, the prices are nowhere near new entrant
levels and we don't expect to see any significant change in terms
of that overcapacity until post-2015. But if you look at other
areas of activity, such as in the renewables business, there are
around 18 players in the offshore market at the momentthere
is lots of engagement there. You have to look at which part of
the market you are dealing with and take a perspective on the
environment in which those bits of the market are operating.
Q167 Sir Robert Smith: Are
you all similarwhile being vertically integrated, you don't
necessarily trade with yourselves?
John McElroy: I have already said
from our perspective that more than 90% of our generation supply
volume is dealt with through our trading arm. It is independent,
as it were, from the rest of the business.
Ian Marchant: It varies. About
five for power, and about seven or eight for gas, which we trade
compared with our physical supply needs.
John Campbell: We have a similar
set-up. We have a trading organisation which has separate strategies
for hedging and selling gas power for generation and retail. We
typically trade up to four times the physical volume that we produce
in power. We trade several times the gas sales we have. But we
recognise that for smaller generators and suppliers it is a difficult
market, with a lot of administrative complexity and credit issues.
Ofgem has been trying to tackle the issue, and
we have made simple commitments on providing simplified master
trading agreementsthe commercial frameworkfree trade
notification services, initial lines of credit and streamlined
financial regulatory compliance. I could go on, but the point
is that there are measures we can take, and we do work with small
generators and retailers. We actively try to find ways of making
the market work for them by giving them access to the trading
services we have as an internal business. We do so on the same
basis as we trade with our own retail and generation businesses.
Q168 Sir Robert Smith: But
if you are all separated and not vertically trading in a narrow
way, why are you vertically integrated companies?
Ian Marchant: We run our business
as an integrated business, but we absolutely trade with the market.
They are not mutually exclusive. Why are we vertically integrated?
For significant risk-management benefits. Why does virtually every
power market in the world tend towards vertical integration? Because
you need the generation to hedge your customer business. That
is why it will happen.
We don't just keep all of that to ourselves,
and just trade internally. We need to be active in the market,
because at every half hour I am either long or short, and I will
need to trade with the physical players here. I also want risk-management
tools, which the banks can offer. So, for the first two years
going out in any point in time, we are very active in trading.
The point about liquidity really starts to bite in year three
onwards, when a market is significantly illiquid. That is the
problem for a small supplier or generatorthe longer termbut
we have the same problem. How do I buy my 5 billion therms of
gas in 2014? I can't, there isn't a liquid market there. So, you
need to distinguish between short term, which is very liquid and
vibrant, and long term, which is virtually non-existent.
Sara Vaughan: The UK market isn't
different from other markets from that perspective. If you look
at a number of the other markets around Europe, which we do because
we have a European trading business, then you will find most of
the trade concentrated in the nearer term and, further out towards
the third year, it will be much thinner.
On the comment of why we strive for a level of vertical integration,
I would say that one of the things that the corporation tries
to do is to smooth out earnings volatility. Clearly, being concentrated
in one part of the value chain versus the other would result in
very volatile earnings, which we would not be rewarded for by
Q169 Dan Byles: I want to
come back to an issue that we have discussed quite a lot in this
Committee, which is investment in the energy sector and this enormous
requirement that we are all aware ofErnst and Young recently
suggested that £234 billion of investment was required by
2025. Alistair Buchanan recently told the Committee that the big
energy companies are looking eastwards for investment rather than
to Europe and the UK because of the potential for higher returns
on investment. Do you agree with that?
Vincent de Rivaz: No.
Q170 Dan Byles: That is good.
The subsequent question is whether EMR will help in any way.
Vincent de Rivaz: Yes.
Sara Vaughan: That's
de Rivaz: It is important that we focus on how to make
the investment possible. I believe that we have in front of us,
from the Government for consultation, something that is coherent,
holistic as a package and fundamentally fair for moving on in
our competitive market. Let me be more explicit about what are,
in my view, the three principles that led me to answer yes to
the question. Are we poised, with our co-investor Centrica, to
make a major contributiondriving a multi-billion investment
programmein the UK? The answer is yes because in the proposals
there are three principle elements that will be instrumental in
delivering that. First, a carbon-price floor will remedy the failings
of today's trading scheme. Our view on the so-called second scenario
that the Government are proposingthe one where the price
of the carbon will be the floor price of £30 in 2020is
that it strikes the right balance. Secondly, we think capacity
payments will reward investment in firm, available generation.
It will provide the security of supply that we need as more intermittent
generation is placed on the grid.
Finally, contracts for difference will address
risk and volatility in the market, providing greater certainty
for the customers and investors and the lowest possible costs.
I think today that our shared challenge is to ensure that both
the mechanics of this reform, which are complex and holistic,
are right, and that the reform itself is delivered in a timetable
that drives key investment decisions in new generation in good
time. That is why my conviction is that, for this consultation,
we need to reach the point where we can deliver reform in a very
In my company, we are contemplating a multi-billion-pound
investment programme. At the beginning of 2012, we will have to
make some big financial investment decisions. The decisions we
make will be very important for this country's growth agenda,
investment agenda and jobs agenda as well as delivering what we
have been looking for for yearsmarket reform delivering
secure, clean and affordable energy. That is a very important
point. The reformswe are discussing them in the Thatcher
Room todayare the most important reforms proposed since
the privatisation of the market. Some have said it is a seismic
change; it is a holistic change. My priority is to make it happen.
John Campbell: Just to answer
your question, like other participants here, we're part of an
international companyin our case, Iberdrola. The investment
will go where the confidence and the returns are for that investment.
The electricity market reform has the potential to improve the
UK's attractiveness in that respect. It's trying to deliver two
key things to drive low-carbon investment. The renewables obligation
scheme is working. We need to be confident that what is coming
along to replace it will not reduce the momentum and that there'll
be no hiatus. There's another perspective on energy market reformthat
it is to maintain security and affordability, as well. I'm sure
we'll get into the detail of some these, but we have to make sure
that capacity payments and carbon-price floors do not put at risk
security of supply in the transition to the lower-carbon generation
portfolio in the future. There's a lot of detail to be worked
through, but we believe that EMR has the potential, if we get
it right, to increase investor confidence in the UK. But there's
a lot of detail to go through before we get there.
John McElroy: RWE is one of the
biggest investors in the UK at the moment, so we're not walking
away from the UK. But, in response to your question, we need to
recognise the scale of the challenge and the need to bring in
new money, new sources of capital and new investors. Therefore,
it is criticalthe electricity market reform gives us the
opportunity to do this, as others have saidto make certain
that we have a regime that generates stable, predictable returns
on investment that are commensurate with the risks of large low-carbon
projects. Whatever else we do, the outcome of EMR needs to satisfy
the criteria of investors to maintain the attractiveness of the
UK going forward.
Q171 Dan Byles: Do you think,
from what you've seen, that it will do that?
John McElroy: We would say that
we're far from the end of the road, as it were, but what's on
the table at the moment is certainly a good start, and we need
to work together to make certain that we get the right outcome.
Sara Vaughan: E.ON was one of
the companies that Alistair spent quite a lot of time talking
about in his evidence
Dan Byles: I gather you're selling half
of your assets and running away.
Sara Vaughan: I think he was suggesting
that we were looking east rather than looking at the UK. When
we announced our strategy in November last year, we made it clear
that we were seeking to get 25% of our profits from other markets
outside Europe by 2015. This reflects the opportunities for growth
in those other markets, but it also means that we are looking
to get 75% of our profitsvery much the greater part, thereforefrom
Europe. The UK is a key market for E.ON. We are already investing
in the UK. Over the last three years, we have invested more every
year than we have taken out in profit. Since E.ON bought us in
2002, it's invested more than £7 billion in the UK, which
is quite significant. We see no reason for that to change. We're
just commissioning our combined heat and power plant on the Isle
of Grain. We're investing in London Array, which, when built,
will be one of the world's largest offshore wind farms. We have
an option for a gas-fired power station at Drakelow. With RWE,
we're a partner in Horizon Nuclear Power, which is looking to
build 6 GW of nuclear power in the UK. None of that suggests a
company that is anything other than committed to the UK.
Ian Marchant: We are looking east,
but probably not quite in the way you envisage. We are looking
at the North sea, which is technically east. We are a UK companywe
and Centrica are the only two UK-domiciled companies hereand
100% of our investment is in the UK and Ireland. So this market
is absolutely crucial to the future of my company in a way that
it is not as crucial to the four Europeans. They have choices
for where they invest. I want this market to work. I am not as
comfortable with the EMR package as some of my colleagues. There
are two key points.
First, it is only part of the problemwe
have problems with planning; we have problems with the grid, both
on access and on charging; we have problems with the supply chain;
and we have problems with construction risk, which EMR does not
tackle. Those are the biggest constraints on investment today.
Secondly, the CfD principle will fundamentally
undermine the importance and the nature of the market. The UK
will live to regret that. The liberalised market has been a major
driver of innovation and investment in this market and the EMR
package significantly undermines that. We will look back and end
up changing it. We will put the market back in the driving seat,
rather than the state, as the CfD is doing in deciding what is
built, by whom, where and when.
Vincent de Rivaz: I understand
that Ian thinks he can comment on the intentions of his competitors,
but it is preferable that I speak on behalf of EDF Energy rather
than him. We are a UK company. We are committed to this market.
It is the second largest domestic market of the EDF group, which
is an international group with a UK business.
We should not isolate the contract for difference,
which is part of the package, from the carbon price floor or the
capacity payments. It is part of the better market for which we
are all looking. It is not about a lesser market; it is about
a market that works. The contract for difference will address
the volatility and uncertainty, which has been a problem for many
years. It should not exist in isolation, which is why I am also
promoting the idea of the carbon price floor and the capacity
payments. Those payments will be made to all plants that are available
at times of peak demand, and not only to the peaking plants, which
has the potential to distort wholesale market prices.
Contracts for difference are about contracts,
which are compatible with markets. The market is made of contracts
every day, so I do not see why the simple idea of a contract is
contrary to the idea of a market. It is a contract for difference,
and it will be settled against the reference price in the wholesale
marketwhich, yes, places a high premium on ensuring that
market arrangements deliver a credible price. That is why it has
to be part of a package.
I really believe that the right combination
of the contract for difference and the carbon price floor will
ensure that consumers do not have to pay any more than necessary.
The feed-in tariff, and a premium on the feed-in tariff, is the
I understand those who have been lobbying hard
and successfully to have ROC banding. Two ROCs for an offshore
wind farm is very favourable for such a premium on price, but
it is more costly. If you take what the analysis is saying, the
cost of capital, as it is today without the market reform, is
13.2%. With the feed-in tariff it will be 12.2%, and with the
contract for difference it will be 11.2%.
So that will make a big difference, because
at the end of the day the lower the cost is, the lower the price
for the customer will be. We have to accept that we are facing
new challenges, which are not the same as 20 years ago, when we
had over-capacity and oil and gas in the North sea. Nobody then
was talking about climate change and CO2 and, thanks
to privatisation, everybody was expecting downward trends for
bills for ever.
We are facing new challenges in the next two
decades. One is security of supply; we no longer have any oil
and gas reserves in the North sea and there are important geopolitical
issues. Security of supply is important to keep the lights on.
We have to tackle climate change. This country has made a binding
commitment to reduce carbon emissions by 80% by 2050. We have
to abide by that and at the end of the day we have to have the
least-cost solution for the customers. These challenges are not
the same as challenges in the past.
Every day as companies we adapt our way of working
to the changing environment; we are praised for that flexibility,
adaptability and ability to react. It will be bizarre if we are
not able to make the same changes to the electricity market. The
package that the Government are proposing is credible, comprehensive
and holistic. My feeling is that there is a momentum to get this
investment under way. There is a large consensus, despite differences
that we hear here and there, and my priority is to make it happen,
to enter this consultation and then, with the working relationship
we will have with the officials, to enter a process where the
details will be fixed so that we can move from a period of debate
to a period of action.
John Campbell: May I follow the
theme? ScottishPower is a local British company that is part of
a global group. It has spent £3 billion in the last three
years and will spend another £4 billion in the four years
to come. So we are also very interested in the outcome of this
market reform. For us, looking at the feed-in tariff issue, we
think it is down to the detail. We are not prepared to say that
the premium is right or that CfD is right.
There is more detail to be explored on indexing
and on returns. That will come out. These mechanisms can both
potentially deliver a viable replacement to renewable obligation.
Absolutely key is that the returns on investments already made
under ROC are protected and that that ROC scheme is available
right through 2017 until we are very clear about the alternative.
I would differ a bit, as you might expect, in
terms of the carbon price floor. We think that will be a very
expensive tool for UK industry and UK consumers. If the feed-in
tariff scheme is right, it will have a limited role to play, if
any, in supporting low-carbon generation and it has the potential
to push some of the plant off the bars, which will be required
to keep the lights on in this country over the next 10 to 15 years.
So our view on that is, go low and go relatively slow on any carbon
We are a big supporter of capacity payments
because the market needs to reward firm capacityespecially
a market which may have more intermittency in future. We are not
particularly happy about the initial proposals or discussion topics
from DECC on that. Experience from all round the world says reward
all firm capacity. If you try to target for peak periods, what
tends to happen is you displace investment and end up with the
scheme migrating towards all firm capacity being rewarded. We
think we should make sure that we get that right from the beginning.
It could be inefficient to see existing plant taken off the bars
to be replaced by new build. Getting that capacity mechanism
right and making sure that any emissions performance standard
isn't biting too deep too soon is critical to maintaining security
while we drive.
One final point: the current scheme of transmission
charging in the UK does not follow the objectives of UK energy
policy on carbon reduction. Renewable plant and carbon capture
and storage cannot follow that transmission price signal, and
that issue needs to be addressed if the UK is going to hit its
renewable targets. We have seen evidence from people like Oxera
that we will get a lower-cost deployment of renewable generation,
and the potential for carbon capture and storage demonstration,
if we can sort out transmission charging.
Vincent de Rivaz: Mr Chairman,
I have to apologise because I must leave. The reason is not that
I do not attach great importance to your Committeejust
the opposite: I made a choice to come here despite this diary
clash. But I have also to talk to my shareholders about electricity
market reform, because the multi-billion investment will come
from them. So Paul Spence will deputise for me.
On the carbon price floor, one word: it is part
of a package, not to be isolated from the rest. Carbon price
floor support is not a new policy. It merely restores the carbon
price signal that was expected from the EU ETS. The problem is
that we all know that the EU ETS as it is today doesn't work and
we have no certainty that it will work, so it's logical that there
is a carbon price floor, which is going to reinforce both the
principle that the polluter pays for what it pollutes and the
intention of the people who designed the EU ETS, in delivering
a credible signal to the market for the investors to invest in
low-carbon technology. So for me the carbon price floor will
not be contradictory to the market, as I have already said.
I am very supportive of the second scenario
of the Government proposals: a kind of gradual increase starting
with a low leveljust the carbon price as it is today, more
or less; then in 2020, £30, and in 2030, £70. I have
heard some comments saying if I am in favour of that, it will
just come from benefits in the short term for the existing nuclear
power plant. That is not true at all. My good friend Dorothy
from Drax is defending a position against carbon price floor setting;
it's detrimental for 4,000 MW of coal power. But I have exactly
the same quantity of coal-fired power plants, so it's not something
that will distort the competition between us.
I will ask Paul Spence to step in. Many thanks.
Chair: Thank you.
Sarwjit Sambhi: I will just answer
Dan's questions. So on the first one, clearly at Centrica we have
nearly 90% of our business in the UK, so there is no question
about itlike Ian, we are committed to investing in the
UK market, and we plan to spend £15 billion over the next
10 years. There is no question about our commitment to this market.
On the EMR reforms, I think we ought to step
back a little bit and say "What's the problem that we're
trying to solve?" It's a difficult conundrum that DECC has
been posed. We want security of supply, low-carbon generation
and renewable generation. The current market, as is, won't deliver
all that, so something different has to be put in place.
Do the EMR reforms, as proposed, deliver that?
I think they do. Take each one quickly in turn. On carbon price
support, we'd advocate that introducing the floor creates emissions
reductions early and it's cheaper than other forms of carbon emission
reductions. So we'd actually advocate that the sooner it comes
in, the better. On the CfD or PFIT, we think that either could
work. CfD has practical implications, especially in terms of how
it interacts with the wholesale market. PFIT can work, and one
could see that that's a natural extension of the current renewable
obligation, albeit simplified.
Capacity payments incentivise having security
of supply in advance of having new nuclear or sufficient wind
capacity on the system. In the long run, they are also good for
ensuring that we have back-up to take up the slack when the wind
isn't blowing. As a package, I think that the measures, as proposed,
address the multiple objectives that we're trying to achieve.
The devil is in the detail, however, and the key thingreturning
to Vincent's pointis how it is all going to work. Implementation
is now key.
Sara Vaughan: Just on that one
point about whether the carbon price floor reduces emissions earlier.
In the UK, a carbon price floor is likely to cause a shift from
coal to gas, but looked at across Europe as a whole it will not
reduce emissions at all. All it will do is shift it out of the
UK into somewhere else in Europe. Will it have a positive environmental
benefit, looked at in larger terms? No, it won't have.
Sarwjit Sambhi: I am sorry, but
I have to come back, because that's true if the same number of
allowances are allowed to be in the system. The UK could make
a choice to reduce the number of allowances that are auctioned.
John McElroy: You can't do that
with phase 3.
Sara Vaughan: That's not proposed
at the moment.
John McElroy: I've struggled with
some of the arguments on a carbon price floor from Vincent and
from National Grid. As a company, we have always believed in the
EU ETS; ultimately, we believe that is the right instrument for
putting a price on carbon, but it comes back to some of the points
made about the impact of a carbon price floor on security of supply.
Equally, if we go down a CfD track it's hard to see the relevance
of a carbon price floor.
Also, I would take issue with ScottishPower
on its perspective on the need for broad-based capacity mechanisms.
We do not believe that the case for a capacity mechanism has been
made as yetcertainly not in the EMR consultation as we
have seen it. We also agree with the view recently expressed by
Centrica that it is premature to prejudge exactly what the balancing
situation will be in the market in the 2020s. We don't know what
the energy mix will be and we don't know the extent of interconnectedness,
and there's a whole issue of how the demand side plays into this
and how it responds.
In our view, things could be done to strengthen
the existing regime, particularly in terms of cash out prices,
to make certain that we encourage players in the market to minimise
the extent of imbalance. We believe that we have to work hard
on delivering demand-side measures through smart metering. We
agree that we really need to come up with a robust mechanism to
monitor the capacity margin situation, but we would say it's premature
to take action.
Ian Marchant: I fully agree with
Vincent on capacity. We need a capacity market in the UK, and
it should be for all capacity. Any targeted mechanism anywhere
in the world ends up being changed into all or nothing. We think
that there should be a market for capacity, particularly when
intermittency is increasing. The sooner we start, the better,
although it could be at a low level.
The carbon price should be absolutely central
to our policy for decarbonising the economy from 2020 onwards.
The sooner we can stop all other support mechanisms and focus
on the carbon price, the better. I would start some form of carbon
price support or floor early, at a nominal level, to start proving
to ourselves that it works. At the same time, we should continue
to seek to reform the ETS to make that bankable, because if that
works it is still our best hope.
As I said earlier on CfDs, I think that is the
wrong way to go, because we need a vibrant, liquid energy market
and CfDs go to the heart of that. A premium feed-in tariff is
easier to doit is less intrusive on the market and easier
to remove when the technology of CCS, nuclear and offshore wind
can compete against a carbon energy and capacity price. In a sense,
as you're hearing, there are six different views. On each topic,
some of us agree, but every one of the six positions is different.
We thought that we would make your job difficult for you.
Q172 Chair: On the timing,
we need huge investment in nuclear and offshore wind, both of
which are going to be pretty slow to bring to production. It is
likely that some of the decisions about those investments will
have to wait until the EMR process has been concluded. In your
minds, is there a last possible date by which the Government need
to decidethey are consulting, but they have to make a decisionto
ensure that we get somewhere near achieving the 2020 targets?
Ian Marchant: I have always felt
that this year is crucial. I am not saying that December is a
hard deadline, but if we have not got clarity by the end of this
year, the risk is that the momentum that is clearly building up
in all three technologiesCCS, on which projects are being
developed; offshore wind, on which we have formed alliances and
are attracting in new manufacturers; and nuclear, which three
active consortia are developingwill start to reduce. So
this year is crucial.
Sara Vaughan: I absolutely agree
with that. There is already a concern that we may be seeing slippage
in the time scales. We were hoping that we would have legislation
in this session and would get Royal Assent in 2012. More recently,
it appears that that will not come into the current Session, and
therefore, at the earliest, we are looking at its being introduced
in May 2012. Therefore, we are probably looking at 2013 for Royal
If that has already slipped, does that mean
that you will have knock-on slippage when the date for the White
Paper is no longer late May 2011, but suddenly turns into summer
2011? All those things are being watched not only in boardrooms
in the UK, but in boardrooms in Germany and, I am sure, in Paris.
I would agree with Ian on this pointthe need to keep up
the momentum and impetus is absolutely crucial.
John McElroy: I would add that,
in one sense, we need to understand the framework and as much
of the detail as possible. On delivering the detail, that absolutely
has to be done by the beginning of 2013, which is particularly
important in the renewables world, as it has a lead time of four
to five years on new renewables projects.
With the RO terminating in 2017, investors in
the renewables community will clearly need to know what the rules
look like by the beginning of 2013. We want to see as much as
we can this year, and when it gets down to the granularity, we
have to have that level of detail by the end of 2012.
John Campbell: We are in a very
similar position. We have major investment decisions to make over
the next 12 monthsinvestment decisions on offshore wind,
coal-life extension, carbon capture and storage, and potentially
in new gas plant. Like other companies, I do not think that the
UK can wait for three or four years to see where this all ends
up. We need clarity over the next 12 months, and some of the fine
detail, legal application and implementation can come later.
On timing, in regard to the renewables obligation,
we need to be absolutely clear that the current scheme will continue
to reward. The changes through electricity market reform may impact
on the current market, and hence impact on the rewards through
renewables. We need to be absolutely firm and clear that our investment
in low-carbon generation will be protected, and that we will ultimately
have choices to make about when we transfer over to the new scheme,
once we are absolutely confident. If we do not get that right,
we risk having a hiatus in renewables deployment, which would
be a terrible shame.
Paul Spence: This is one area
where there is heated agreement across the whole industry. As
Vincent said before he left, we have a very major investment decision
to take at the start of 2012. We need to be able to lay out for
our investors and shareholders the basis on which they will take
that decision. That means that we absolutely need to get on with
the market reform. If the longer-term reform will take longer,
we need to know what happens for people to take decisions in the
meantime, so that we do not lose momentum.
a rapid resolution of all this would be made easier if there was
agreement between you on other aspects as well.
Q173 Sir Robert Smith: Quickly
returning to the carbon price, you've already dealt with the interaction
with EU emission trading and the different views there, but if
National Grid is right about the growing want of interconnectors,
how can a British go-it-alone carbon price work with an interconnected
Ian Marchant: We think that if
you get a difference of more than about £10 on a tonne of
carbon between the UK and Europe, you will effectively get investment
in Europe. It makes more sense to build a CCGT in France, the
Netherlands or at the end of an interconnector. The frictional
costs of the interconnector mean that you can have a small difference,
but about £10 is unsustainable in a single market. We think
that the interconnectors are going to be quite significant.
In the earlier session, you were talking about
the need for back-up capacity. I think interconnection can make
quite a significant contribution to that. That's why we announced
a study yesterday on linking the UK to Norway, because it partly
depends on where the interconnection is with. Linking the UK and
Ireland will not really change the dynamic, because its energy
system is very similar to ours. If you go to different energy
systemsNorway has hydro and different wind and weather
patternswe think that interconnection will make a difference.
It means that getting the ETS right is absolutely the crucial
thing, because there is a limit to how much the UK can or should
go it alone on carbon price.
Q174 Sir Robert Smith: Is
the dilemma that the carbon price is really needed to get the
nuclear investment, even if it means going it alone and damaging
the other markets?
Sara Vaughan: No. I come back
to the point that was made quite strongly in the previous session.
If you have a mechanism like a contract for difference in place,
that effectively means that the role of any carbon-price floor
is much lower, and some would say that it is not really having
an impact at all. Looking at the Government's own documentthe
Redpoint documentthat they published at the same time as
the consultation, Redpoint said that adding a carbon price support,
and the figure that they chose was £30 a tonne by 2020, to
a fixed payment or a CfD makes little difference in terms of the
amount of low-carbon investment that is produced by the market.
So you then start asking, "Why are you adding that extra
cost?" I can see some argument for having it there to make
the reference price of the CfD more closely reflect the level
under the CfD. Most investors, however, would be largely indifferent
to the level of the carbon price if they had the CfD or premium
FIT in place anyway.
Ian Marchant: I think part of
the issue with EMR is that, although we talk about high-level
objectives of security of supply in energy, it has actually been
designed to get nuclear built. If you design any energy system
around nuclearanywhere in the world apart from in Franceit
is a recipe for disaster, because nuclear is such a different
technology. Don't get me wrong: I am not saying that nuclear should
not be built, but if you design your market structures with that
objective in mind, you get an awful lot of unintended consequences
on capacity, other investment and prices. We should be much more
honest. If subsidies are needed to get the first few nuclear plants
built, let's be clear and let's make that happenlike we're
doing with renewables and carbon capturerather than designing
a created market just to get something to happen.
John McElroy: Can I respond to
that? I take slight exception to it.
Ian Marchant: I'm sure you do.
John McElroy: The point I would
make is that, because of the way that the market is structured
in the UK at the moment, only renewables will be built as a low-carbon
technology. We want a market that can bring forward a range of
low-carbon technologies, because we need those to get anywhere
near the targets. We need diversity in the energy mix. There are
a whole host of reasons for doing it, and it isn't just because
of nuclear in particular. We have to look at the whole range of
technologies and bring them forward.
Q175 Chair: I'm sure that
you understand that the world of politics is not quite as rational
as that of business. Therefore, there have to be devices to help
coalition partners, in particular, get through the nuclear problem.
We call it a feed-in tariff for the contract for difference. The
average Liberal Democrat voter does not understand that that is
actually a subsidy.
Returning to Ian Marchant's point, what are
the malign consequences of the systems that have been designed
around nuclear? What has gone wrong in the rest of the energy
Ian Marchant: My belief is that
it will downgrade the role of the energy market to a simple half-hourly
balancing, and that is no mechanism on which you can build gas
plant. Again, I suspect that we would all agree that the UK needs
to build some new combined cycle gas turbine plant in the next
10 to 15 years, to act as the flexible generation and provide
the megawatt hours that we need.
My concern is that we solve the nuclear problem
and we ensure, in the way that we do it, that we solve the renewables
problem, and actually we create a problem that nobody will build
fossil plant, particularly with the way that the capacity price
mechanism has been designed. So nobody will go and build a CCGT
plant until they get the capacity support. So that is my first
concernthat we have undermined the liberalised generation
My second concern is about putting the state
in as the buyer. Vincent is talking about contracts with markets.
Let us be clearthe CfD is a contract with the state, or
the state will create an energy agency. Goodness knows where from.
I do not see any existing body that can do it. You have effectively
put the state in the driving seat as to what happens. That is
a fundamental shift from where we have been during the last 20
years. That will have unintended consequencesactually in
a way that I cannot predict. I think that it will change the nature
of supply as well, because at the moment supply is a combination
of retail and risk management. Those are the two services that
we provide. It becomes a pure retail business, because the state
has taken on the risk management business, because the state is
deciding the nature of the generation mix.
I do not have confidence that the state will
get that right. The state does not tend to. It has not got a good
track record of making large, long-term procurement decisions
and getting those judgments right. We still get it wrong, but
on average we get it less wrong than the state does, because effectively
you get the wisdom of crowds and you get individual diverse decision
Q176 Sir Robert Smith: If
you are going to have nuclear, the state is going to have make
a decision. No one else is going to make it.
Ian Marchant: But if your objective
is to secure security supply and low carbon, if you price capacity
and you price carbon, the market will decide what the right technology
is. If that is nuclear, the market will deliver it.
Sara Vaughan: It is still the
investors who are bringing forward the projects. So, as an investor,
we may be bringing forward an offshore wind project; we may be
bringing forward a biomass project; or we may be bringing forward
a nuclear project; and they will all be looking at the same market
regime. So the state is not making that decision. The investor
is making that decision, on the basis of their view of the market.
Equally, we may be bringing forward a CCGT plant, depending on
how attractive the market looks like for that technology at the
Q177 Barry Gardiner: It does
not affect your decisions at certain points[Interruption.]
To say the state is not taking that decision is a very bland way
of describing what is going on.
Sara Vaughan: Is that not the
way that it is at the moment?
Barry Gardiner: Yes.
Sara Vaughan: So it is a continuation
of the wayI can see that the state will have a larger role,
but it is a continuation of the way it is at the moment.
Q178 Barry Gardiner: Yes,
but let us not paint two extremes here. The state is involved
in this; it should be involved in this; and the incentives and
market regulations that it sets inevitably structure the market
in one way or another.
Sara Vaughan: I would vehemently
agree with you.
Barry Gardiner: Good.
Sarwjit Sambhi: On Ian's point
about letting the market decide, I think that, with the current
market, if we let the market decide, it goes to the lowest cost
of generation, because we have a system that is based on marginal
pricing. Where you have generation that has high fixed costs and
therefore high average costs, like nuclear and wind, they will
not get built if you just rely on BETTA to deliver it. In terms
of the CfD and unintended consequences, it still has to function
against a wholesale market, because the contract is set against
a market index. So I understand Ian's concern, but some of it
can be alleviated through how well you design the market index
in the CfD.
Also, when you project out and look at the amount
of volume that will be covered by the CfD, it only becomes significant
when you get into the back-end of the next decade. So are CfDs
the right investment tool to get the things built to meet the
objectives that we set out earliersecurity of supply and
lower-carbon renewables? I think they can, if designed correctly.
Q179 Chair: Just to be clear
about the way that the CfD prices are going to be certain, are
you favouring auctions, as the Government seem to be?
Sara Vaughan: No. When the EMR
was launched, the Secretary of State said in terms that, if he
was going to try to run an auction tomorrow, he would have a very
small or indeed empty room in which to hold his auction. There
are a number of problems with auctions, particularly when you're
looking at these sorts of high capital technologies, because to
even get a project to the point where you might enter it into
an auction, you are talking about investing several hundreds of
millions of pounds. Are people really going to do that against
the possibility that their project will not be successful in an
auction? The alternative is that you do an auction at a very early
stage, and then you end up with a project that never gets consent
and there isn't a viable project there, so they don't continue.
We have had pretty poor experience in this country in the past
of auctioning with the non-fossil fuel obligation auction system
in the early 1990s, which brought forward loads of projects, but
very few got built.
Ian Marchant: The build rate was
25%. CfD without an auction is effectively a negotiated-behind-closed-doors
process. You've got to convince the other party to sign the contract.
You spend all your development money and if for whatever reason
the other party doesn't want to sign the contract, you haven't
got a project. As a developer, CfD means you've lost control of
deciding whether to do that project or not. Today, I develop a
wind farm. In other words, I decide to do itit happens.
Under a CfD, I do all that and then the energy agency is in purdah
for an election period and can't sign a contract for six months,
or it's changed its mind. It doesn't want to do a 300 MW contract.
It wants to do a 600 MW contract and I have developed for a 300
MW project. The risk is that I've got a bureaucratic counterpart,
and it will take me many years to learn how to predict how it
will behave. Therefore, we will get a hiatus in development in
the next few years. The organisation that doesn't exist today
gets established, manned up and builds a track record. Of course,
it slants to what comes forward, because if you ask for 300 MW
of low-carbon energy, nuclear can't compete. If you ask for base
load energy, wind won't compete. So how you go out procuring your
CfD effectively decides what gets built.
Sarwjit Sambhi: Economists would
say that, theoretically, an auction is the perfect option. It
works where the product is homogeneous, there are many sellers
and the start-up costs are very low. In nuclear, and arguably
in offshore wind, that is not the case. The start-up costs are
quite high. You have to invest quite a lot of money before you've
actually got a project. The sites are being developed at different
rates. While theoretically plausible, in practice we find it very
difficult to find a workable auction option. The possible exception
might be on tendering for capacity.
John Campbell: Take a nuclear
site where the site has already been allocated to an organisation.
Take offshore wind tranches as well. It is impossible to envisage
how you can have price discovery through an auction process in
Paul Spence: We echo that;
in the real world, this is about negotiation, certainly at the
early stage. I would just like to pick up some of the issues
that Ian raises, and say that our view is that, yes, they are
questions. The approach should be how we find a way to solve them
to make sure that we have a credible process through that negotiation
that allows investors to move ahead with the confidence that there
is a body capable of doing that negotiation. That should be the
next phase of the consultation. We should get on with making
John McElroy: I agree. There is
overwhelming agreement on auctions, and I endorse the point that
the devil is in the detail, so we need to get on with trying to
sort it out and making it work.
Chair: We are running out of time. Do
any of my colleagues have any other questions?
Dan Byles: Ian was absolutely right when
he said that we would not get a single model answer.
Q180 Sir Robert Smith: One
very quick thing and on another matter that has a tight deadline:
are we on track for the smart metering to actually be achieved?
Ian Marchant: Our mantra is start
well and finish early. It is right to get the central communications
agents called the DCC, to use the technical jargon. That should
be up and running as quick as possible. Once it is, our businesses
are very good at mass deployment quickly. What we are less good
at is fits and starts, so it is taking a little longer to get
going, but we don't think that that is necessarily bad. We still
think that we can finish by 2018.
John Campbell: I agree that getting
the DCC up and running and established, so we understand the protocol
and don't have any issues of assets being stranded and also making
sure that data security and information protection is a key part
of the protocol are the key things to make it happen.
Paul Spence: I absolutely agree
with those points. While that is going on, the other thing is
that we are all gearing up, getting ready and trying out different
technologies. I know that we certainly are, and I watch what my
Sarwjit Sambhi: Getting the smart
metering roll-out is key, but other things are important as well
in terms of timing, such as green deal, and making sure that there
are the right financial incentives to the technologies that we
plan to put in homes.
Chair: Thank you all very much.