Examination of Witnesses (Questions 181-204)|
PETER ATHERTON, CHRIS HUNT, SHAUN MAYS AND SHAI WEISS
8 FEBRUARY 2011
Q181 Chair: Good morning,
and thank you very much for coming in. We can see your names and
we know who you are, so I will dispense with the formal introductions.
We are very glad to have you at this evidence session. This particular
inquiry is well under way, and, as you may know, we've had several
evidence sessions already. Obviously, it is an extremely topical
and important subject. We have about an hour with you, if that
suits you. We have another set of witnesses coming later.
I will kick off by asking a general question.
Each of you may answer any question, but don't feel that you have
to answer every question. Do you think the present market arrangements
make investment in low-carbon technologies too risky, or unnecessarily
risky, and therefore unnecessarily expensive?
Chris Hunt: My name is Chris Hunt.
I am from Riverstone, a private equity house that specialises
in energy investments. We cover the full spectrum of energy, but,
more so than most firms specialising in energy, we tend to invest
a fair amount in renewable energy. So I am coming in wearing the
hat of specifically talking about renewable energy.
If I am honest, the UK is investable. Under
the current arrangements, we would come in and invest more money
in the United Kingdom. In fact we have made several investments
in the United Kingdom. We own offshore wind installation ships
and a bioethanol plant, and we are investing in wind. So the UK
is investable. However, I think that the electricity market reform
will increase the amount of capital that we would be prepared
to put here, not only because we would see the UK as a better
place to invest, but in large part because I think our investors,
who give us money, would see it as a safer place to invest.
Shai Weiss: I represent the Virgin
Green Fund, which is affiliated with the Virgin Group and Sir
Richard Branson. Like Chris, we invest only in renewable energy
in Europe and the United States. That is not to say that we would
not invest right now in the United Kingdom. To emphasise what
Chris is saying, we have always said that legislation in this
market has to be three things. First it has to be clear, so that
people understand the rules of the game. The EMR should do that.
It should also give clear signals to the markets that this is
something that the UK really wants to invest in and incentivise.
Secondly, it has to be very loud. Everybody should know about
it, particularly the people who provide the capital and the people
who invest the capital. So the ecosystem should be clear.
Thirdly, the legislation should be very stable.
One of our recommendations is that we should choose a very good
system and ensure that it is very, very stable for a very long
period of time. Capital can adjust itself for risk/reward. You
asked whether the UK is a risky place. Well, it is a pretty good
place to invest in terms of risk/reward, but that risk/reward
profile has to be extremely stable over the long run. If you give
the markets these signals in a clear, concise and stable manner,
you will see greater inflow into the projects; and when you see
greater inflows into the projects, you will see that the ecosystems
of companies distributed across the UK, not just in London and
the south-east, will flourish based on that framework.
Shaun Mays: I am Shaun Mays from
Climate Change Capital. We have more than 20 renewable energy
projects in the UK. Our investor base consists of the big pensions
funds and insurance companies, who are looking for stable, inflation-linked
returns to immunise their defined-benefit pension liabilities
or to back their annuity products.
To reiterate what Shai said, we think the existing
system is fine, but it is obviously immature, so it hasn't drawn
in a lot of capital at this stage. If you are patient and hold
your nerve, the return expectations will adjust to the system
and you will see a larger volume. Our investor base is not that
entranced by the offshore wind sector at the moment, because it
sees technology risk, policy risk and construction risk. So don't
think that, just because today's policy is under review, there
aren't other factors in offshore wind financing that won't come
One of the crucial things about your review
is whether, once the assets are operational, we can get the developer
and construction cycle and the project finance money recycled
into institutional money, because that is where the big pool of
capital is, and they will want stable, predictable, probably inflation-linked
returns. They will adjust the price and the cost of capital will
come down if we can deliver that. That is the point we are trying
Peter Atherton: I am Peter Atherton
from Citigroup. For the lawyers, my usual proviso is that I speak
for myself and not for Citigroup.
It depends on the technology. The current mechanisms
and reward systems are very generous in many areas. Onshore wind
works fine, if you can get planning permission. The current systems
struggle where you have big construction risk and big technological
risk, such as with offshore wind and, even more so, with new nuclear.
In our view, new nuclear is uninvestable for private equity investors.
Under the current mechanisms there is too much construction risk
and too much power price risk. Offshore wind is in a borderline
area, but onshore wind, for example, would be fine. Carbon capture
and storage sits with new nuclear and offshore wind as being very
difficult to invest in under the current arrangements.
Q182 Chair: I should have
drawn attention to my entry in the Register of Members' Financial
Interests. I have interests in several renewable energy businesses.
Do you think that the general tone of the packagewhat
is out there for consultation nowis moving in the right
direction, or has this process introduced an unwelcome, though
perhaps only temporary, element of uncertainty?
Shaun Mays: Any change brings
an investment hiatus; we have to understand that. If we are looking
at the investment side, the one big variable is policy uncertainty.
If you go back to the UK's privatisation of traditional infrastructure,
the thing that stabilised investment in that sector and brought
large volumes was the fact that we had a regulated asset-based
system with a five-year reset. We have to think about some sort
of system like that, particularly around the carbon tax; the way
the carbon tax is in the energy market reform at the moment looks
like it is a bit too able to be adjusted at short intervals.
There is a hiatus; people are waiting, and it
is compounded by the fact that there has been policy risk in other
geographies in this same sector, so institutional investors are
sitting back and saying, "Until this is clear, I don't think
I have the ability to invest; it is just too risky and I don't
know what the returns look like or what might happen". You
just have to understand that there will be, combined with the
credit crunch, a different mindset. The credit crunch brought
a different mindset to risk, and policy change also affects it.
So we applaud the fact that you're trying to do this quickly and
we'll get rid of that regulatory uncertainty.
Chris Hunt: I would say, on balance,
that I personally welcome this package. I have been investing
in renewable energy for over 20 years and was even involved when
one of the first major reforms in the UK was introduced back in
the '80s. At that time, there was a different set of circumstances;
introducing market reform and market-based mechanisms was definitely
needed for the sector. But I think you can't necessarily fault
the system that has got us to where we are today. If you look
at the underlying statistics of how much capital has flown to
low-carbon investment, you have to acknowledge that now is probably
the time for another change. The timing and sequencing of things
are following a logical course; it is time to make a change, to
go down the route of policy signals that perhaps by some will
be considered a bit more directive, a little less market-oriented,
but aimed at achieving a goal.
On balance, therefore, I think the timing and
the general theme of what you're intending to do with the EMR
is very appropriate. It will open up quite a bit of capital that
to date has been sitting on the sidelines, so I am very much in
favour of this package. Most people who look at it from the perspective
of investment and yield investments and safe investments are favourably
disposed to it.
Shai Weiss: Just to add to that:
what you can see from this package which, as Chris said, is kind
of favourable for low-carbon technologies, is that there is a
penalty on high-carbon. That is the first signal it gives you,
which is a good thing, and you can debate how that is achieved.
There are support mechanisms for low-carbon; the debate can go
on in the Committee about whether, for example, a contract for
difference or a feed-in tariff is the most appropriate, but that
signal is a good one. Then there is an incentive for energy efficiency.
When you combine these three things, it seems to address appropriately
the market conditions and the change.
The only note of caution that I would sound
is that there is a lot of focus on capacity payments, so building
extra capacity, which is really taking a snapshot of today and
trying to forecast it into the future, and inherently there is
a big tensionor a small tension, depending on where you
sitbetween the existing utilities and the new entrants
into the market and the investors. That tension, through this
package, should also be addressed.
Peter Atherton: My answer is that
I have no idea; it is way too early to tell. These are very big,
complex reforms, interacting with a whole series of other, very
big and complex policies. The question is whether these reforms
achieve their goal, which is essentially about transferring risk.
Essentially, the Government have decided that what they are asking
the capital markets to do, predominantly through the utilities
sector, is too risky for the rewards on offer. They can't really
increase the rewards on offer any more, because that will have
such a profound impact on prices, and the affordability issue
is dampening their ability to do that. So they need to transfer
risk. What they are looking to do is transfer big chunks of the
power price risk from the developers to the consumer.
Now, in principle, that should be good for the
developers. However, it has a number of side effects. One is that
you are also capping out returns, so it is not just a one-way
bet: you are limiting returns as well as limiting risk. Secondly,
you may be creating brand new risks, particularly to do with the
direction of investment through the agency that is going to allocate
the CfDs. How on earth will that actually work in practice? Is
there some Government agency that will tell the industry what
to build, when and where? Will those contracts be stickable with?
What will the Government decide in future generations about the
decisions made by their agency?
There is nothing about construction risk or
technology risk either. In fact, this may be exacerbating the
construction risk, because you are basically asking people to
build on a fixed-price revenue line, which may not be that attractive.
So, yes, in principle, one of the major problemsthe power
price riskis being to some degree neutralised and to some
degree transferred to the consumer, but actually that may not
solve all the problems, and it may create other risks as well.
Chris Hunt: I agree very emphatically
that it is still too early to say. I think the overall package
that the EMR has introduced is the first of two steps. The broad
general structure of it is perfectly fine. How it is implemented,
how prices are set, what the tariffs are, it is still way too
early to tell. One thing that I have learned in watching this
sector over the last four or five years is that massive amounts
of capital will flow to the market that offers the most attractive
For example, take solar powerwhich may
not be the best example for the UK, given the lack of sun. When
Spain put forward a certain tariff level the market responded,
and billions of capital flew into that market. When Germany introduced
a feed-in tariff that was attractive, capital flew there. And
Italy. We are talking literally many billions of dollars or pounds
of capital motivated to a market in a very short span of time.
We don't yet know, under this package, exactly how tariff levels
will be set, or exactly what the ultimate profitability will be,
but the framework that you are setting up allows you to get to
that point. Whether the capital actually flows depends on how
you set the pricing.
Shaun Mays: I think the market
will adjust to risk, though. Don't let us give the impression
that our investments will not take root. What we have to do is
give them a clear sight of what risks they are taking. So I think
that the wholesale electricity market reform is also very important,
because that is a very opaque market. Some of the things that
have been proposed, like the clawback provisions and the way the
CfDs are issuedwe have to look at those and say, they could
create uncertainty around volume, price and risk, and that will
mean that the cost of capital goes up. Then investors will demand
a higher return.
One of the challenges for you is to create a
system where you bring the cost of capital down so that you get
two things: lower expense of building and operating these projects,
and secondly, bigger volume. That is the challenge, given that
estimates are up to £200 billion by 2020. That is not an
insignificant amount of money, even by the £3 trillion in
the pension fund marketit is still a lot to allocate to
this sector. The cost of a 1% or 2% change in the cost of capital
therefore makes a huge difference to the amount of money that
goes in. So we have to look at those elements and say that a lot
of thought needs to be given to the clarity of the systemthe
transparency of it, in terms of volumes and price. Some of the
things in the package at the moment suggest that those could be
adjusted at the last minute, and all that will happen is that
they will take the lowest common denominatorthe lowest
priceand any upside will go to the investors and not to
the Government. We must think about that.
Q183 Laura Sandys (South Thanet)
(Con): The enthusiasm of three of you for the reforms seems obvious,
which is very good, because we need the investment. But your enthusiasm
also creates a question for me: will the reforms that we are putting
in place be sustainable at a price that fits your investment model
and also does not have to be changed by us, or a future Government,
due to changing circumstances? The energy sector is going through
huge revolutions, not just in renewables, but in new technologies
coming through, new usages, efficiency and so on. There will be
a moment when we set fixed values to all the different indicators,
but they will change due to the circumstances. What one can't
look at is something that is fixed for the next 30 years with
a market that will, by definition, be on the move. I worry whether
the point that we need the investment is going to be sustainable
into the long term.
Chris Hunt: It's a great question;
thanks for asking it. I have a couple of thoughts. It might be
a little discombobulating but I will try to present them as best
I can. First, a lot of attention is paid toward the impact of
renewable subsidies on the overall electricity price. One broad
comment I will make is that every element of energy is a highly
subsidised business. The only difference between renewables subsidies
and subsidies in other parts of the energy business is that renewable
subsidies tend to be more transparent. They tend to be talked
about more and are more visible, but every element has them.
Generally speaking, if you look at the impact
of renewable subsidies across a wide range of economies, and you
look at how much it actually increases the end bill to consumers,
generally the number is far smaller than you would expect. It
obviously depends on the economy, but generally it increases the
end bill only in the neighbourhood of 2%, 3% or 5%. In some cases,
if you have a huge penetration of renewables and you have gone
for more expensive types, that number can be higher, but in most
economies that have gone down this road before and achieved reasonably
high penetration rates of renewable energy, you are generally
seeing the end bill to consumers going up by only 5% or less.
That is over a long-term average of what you would expect energy
prices to be. If an economy were to face an energy shockfor
example, if we were to have a sustained period of two or three
years of high oil prices in excess of $100 a barrelthat
would far overwhelm, in terms of cost to the UK, the cost of those
subsidies. When you sit down and get to the heart of costing the
numbers, it's really not that high.
My last comment on the subject is that what
you are setting up with the EMR is a framework. When you put in
place, for example, a feed-in tariff, and say to a wind generator,
"We are going to give you a feed-in tariff and you will get
that tariff for 20 years," the Government are still able
within that framework to reduce those feed-in tariffs over time.
You might offer a certain price for projects that are built today,
and then as technology matures and costs come down, you can lower
that feed-in tariff for projects that are built five years from
now, and lower it again for projects built 10 years from now.
So it is not as if you are giving up the ability to reduce the
cost over time; you are just creating a framework that allows
you to have the broad structure.
Shai Weiss: May I add to that?
Chris is saying that the UK should benefit from that cost curve
advantage. We are not saying that we are asking you to give up
the advantage over time and simply give it to the investors, and
the public do not benefit. It is fair to say that we are still
in the very early days of this entire renewable energy cycle.
Solar may not be attractive right now in the UK but could benefit
the UK in the long run, just because of the improvements and gains
in reduction of costs. Wind is improving all the time. Tidal has
not even started; there is a huge technology risk there but it
may ultimately benefit the UK, especially given its geographic
location. All those things should be allowed for in a framework.
Our enthusiasm is for a framework that is stable, that is rational
and that adjusts, and fairly benefits both the public and the
investors for gains. If that is achieved, I think you will see
a lot of capital flow into the UK.
The last point, to amplify what Chris has said,
is that the subsidies are always taken in the context of a transfer
for the feed-in tariff, so the price over and above that at which
you can buy electricity. However, when you calculate the cost
of ownership and the gains to the economy and job creation and
so forth, you will see that that should also benefit the consumers
over the long run.
Q184 Barry Gardiner: Mr Hunt,
you were saying that if the price of oil went above $100 a barrel
for a significant period of time, that would have a far greater
effect than renewables. But surely, if that were to happen and
you had a premium FIT, the cost of the renewables would be even
greater, wouldn't it?
Chris Hunt: It would in fact,
and our view is that that would be a windfall that is not necessarily
appropriate to give to a renewable energy generator.
Q185 Barry Gardiner: You would
want us to impose a windfall tax.
Chris Hunt: I actually don't believe
in a premium FIT. I believe in a FIT, for precisely the reasons
Peter Atherton: I
Owen: I am sorry, Mr Atherton; I'll give you an opportunity
in a moment. You have said that the current situation is quite
high risk. Weor the Governmentare only producing
a framework here. Mr Weiss, you have twice mentioned stability:
do you think this framework provides enough stability?
Shai Weiss: I think the elements
in here, once agreed and once they come to a rational conclusion,
should provide sufficient stability. I did point a caution on
building capacity when capacity is unnecessary, which, in my mind,
truly promotes coal and nuclear. That is a whole, to my mind,
excess capacity that the UK may not need and it is really over-emphasising
security of supply. If you handle that and build what is necessary
and promote the right things, it looks like a pretty solid framework.
It's early days
Q187Albert Owen: That is the point;
we are at the consultation process. This review will be going
on and on, it will come before Parliament, and different elements
will be discussed and debated. We are asking, is the consultation
document in itself robust enough to provide that stability?
Shai Weiss: I would say that it
is almost too robust, in many ways. What you really want is a
very simple framework, so if you just said to investors and to
pension plans, "There is a feed-in tariff and it is fixed"or
a contract for difference, but not a premium, just a fixed feed-in
tariff"and the tariff is good. It promotes the following
things, and you do it with a renewables obligation, grandfathering,
and continue it," I bet that would be almost sufficient to
improve the capital flows into the UK. Everything else is very
importantthat is the way it is done in the UK, in terms
of the depth of the analysisbut I think simplicity here
is key. The signals should be so clear that if somebody can explain
it to an investor in 30 seconds, capital flows immediately.
Q188 Albert Owen: Do you want
to comment, Mr Atherton? I cut across you earlier.
Peter Atherton: Yes, I was going
to comment on affordability. My job is to speak to institutional
investorsthe 500 largest institutional investors who own
the major utilities in Europe. I have probably met 120-ish of
them to discuss the EMR since it came out. By far their biggest
concern is affordability, because they have experienced what has
happened in Germany, Spain and the Czech Republic over the summer.
They are profoundly worriedthe mechanisms are, frankly,
The fact is that we are going to try and put
these very expensive, not very robust, very challenging technologies
on the ground very quickly. If we do that, the price of energy
will be highI am for ever shocked that anybody thinks anything
other than thatand what's more, the profits are going to
be high. What investors have to be able to imagine is a situation
where, in 2018 or 2019, the Secretary of State is standing up
to the media and Parliament and saying, "It is a really good
thing that your bills have just gone up by 15%, and will be going
up 15% next year, the year after and the year after. And it's
a really good thing that SSE and the other utilities have just
reported record profits, and will be reporting record profits
for the next 10 years." Institutional investors ask, "Do
we have confidence that, when that becomes the case, the mechanisms
will be supported and fully kept in place?" Maybe if you
have contracts for difference, the mechanisms stay in place, but
you can just tax them in another way.
To give you a feel for this, I actually ran
it through my model of Scottish and Southern Energy last nightthis
is not a profits forecast, by the way.
Laura Sandys: We are taking notes.
Peter Atherton: Scottish and Southern
Energy last year did 105p of post-tax earnings, so I thought I'd
run through my model how much profit they would be making by the
end of the decade if they were to do their proportional amount
of this investmentaround £4 billion a year. In 2015,
their profits would have risen to 155p, but by 2020 they would
be at 225p. Therefore, their profits are going up 15% or 20% a
year at the end of the decade, just as bills are rising.
We represent different types of investors here.
My colleagues' here are predominantly people who can get their
money out very quickly, whereas my clients are the investors who
are there for a 10, 15 or 20-year payback periodthey are
the equity guys who will be sitting there into the long term.
The question for those institutional investors is whether they
have the confidence. They don't really have the confidence that
this kit will work, for a startso they don't have the technical
confidence. They don't have the confidence of being able to bring
them online in time and on budget, and they don't have the confidence
that the policy mechanisms, whatever they are, will be sustainable.
The Green Deal will perhaps offset that a touch, but don't forget
that people have to pay for the loans. The Green Deal is not a
grant; it's a loan. You are paying for the loan. Your overall
energy bill may fall, but when you add the loan price back in,
the cost doesn't actually fall for the consumer.
Q189 Albert Owen: So the people
you're talking to will be feeding into this consultation and saying,
"Do what?" and "Change what?"
Peter Atherton: I speak to hundreds
of people, so it's very hard to paraphrase them, because they
have different views. Actually, their advice will be to change
the targets. That is what is driving it all. The targets are too
much, too fast, and that scares my side of the investment community
profoundly. I don't think that changing the mechanisms will necessarily
release their flow of capital, because they just do not think
that it's going to be affordable for the consumer, and therefore
they do not believe whatever mechanism will be put in place.
Maybe that can change. Maybe as you go through
time, particularly as they become more comfortable with the construction
risk and the technology risk, that will alter, but as we speak
today, I think that would be a reasonable summary of what they
Q190 Chair: On what you've
just outlined, are there alternative areas of the world or alternative
countries where the concerns that you have just expressed do not
applyin America, for example, where BP might think there
is an element of political risk nowadays, or some of the Asian
economies where there is perhaps a less regulated environment
and a better expectation of economic growth?
Shaun Mays: Well, they will still
have feed-in tariffs. To go on from what Peter was saying, we
will have technological change that will improve the returns from
these investments over the next five, 10 or 15 years, and you
have to be able to adjust for that. We don't want a Spanish situation
or one like we had in our carbon fund with HFC-23, where the switch
is on or off. We understand that volumes will increase, GDP rates
change, wholesale electricity prices change and that technology
changes. But it's like driving a car. You don't put your foot
on the brake and then on the accelerator; as you're going along
the road, you adjust to take account of traffic lights and other
things. You need to build a system that has a clear framework,
but is adjustablejust as we did with CPI-x for the
utilities system before. Everybody knew that, after five years
or whatever, it changed, and we reset it and went to a better
system. That is what we're asking for here.
We all represent investors who want to be in
this sector for the long term. They can see both sides. They can
see how they risk-manage their existing portfolio out of dirty
technologies and dirty power production and how they can have
an opportunity to invest in the future and clean and renewable
energy. They want to do it, but we have to give them a stable
Chris Hunt: Let me take a stab
at the answer to your question in a slightly backward way. You
have the benefit now of being able to look at the mistakes of
other economies and their not necessarily better systems, and
we can talk about what Spain and Germany did wrong. I agree with
Peter in some respects. If you were to actually take a snapshot
of Spain and Germany and ask whether it has worked, the answer
is, in some respects, yes. They have both, as economies, motivated
a tremendous amount of capital to go in and build low-carbon energy
generation. However, they erred in a couple of areas. The main
area in which they erred was that they tried to do too much, too
fast. They went in at an early stage when costs of certain generating
kit were very high.
To put that in perspective, we own a solar company,
which is installing solar generating kit today at less than half
of what it was two years ago. If we draw the clock forward another
two years, it will be less than half that. Over a four-year period,
we're at a quarter of the cost curve. Germany and Spain, unfortunately,
did not really cap or control the rate at which that investment
went in, so whether they like it or not, they now have 20-year
obligations at relatively high cost levels.
If, however, the UK is sitting here right now
and wants to set up a framework that says, "Hey! We want
to do this stuff, but, by the way, we're going to manage this.
We're going to feed in acceptable amounts each year, and we'll
give you a 20-year tariff when we feed that in, but we're going
to actively manage that cost curve down," then you're introducing
this in a very rational and sane way, and the impact on the consumer
will not be so bad.
Peter Atherton: But that's not
going to get you 20,000 MW of offshore wind by 2020 and 16 GW
of new nuclear by 2024. I haven't verified this figure, but I
was told by one of the major German utilities that in the current
year they expect solar to produce 1.2% of power in Germany and
to account for 8% of the bill to the consumer.
Chair: That's very encouraging, given
the ridiculous tariffs we have for solar in this country.
Q191 Barry Gardiner: May I
pick up on two things? The focus of my questions here is on the
carbon price support mechanism, and I would invite you to put
on the record your thoughts in relation to that. The Government
obviously think that this will give good signals for investment
into the market, but as a tax it's precisely going to be easy
for future Administrations to vary it, to change it and to become
dependent on it. I just wanted your quick views about how much
stability and confidence that gives you if you go down that route.
Shaun Mays: We've got a fairly
large carbon fund, which trades in the ETS. In your report you
hinted at the fact that you think that's underpriced carbon and
had it as an unstable environment. When I look through, you can't
really tell what the carbon tax price is when you look at the
existing mechanism. The two guidances that I would give you from
our point of view would be to set it for a reasonable period and
properly inflation-link it, and then reset it again. That would
be preferable to doing what you do, which is to tell us what the
carbon price is after the event each year. That is the way it
looks in your document.
We are not talking about for 25 years; it can
be a relatively short period, but when we model our investments
at least that period will be predictable. We will take the risk
for the rest, and once there have been two or three resets we
will start to understand how the resets are working. I think if
you're saying that it's backward-looking and every year, that
will not be an easy system to work with.
Peter Atherton: It's hard to see
what the carbon price floor achieves if you have the CfD in there
as well except as a tax-raising measure for the Treasury, which
may or may not be a good thing. I am not sure what it achieves
in the context of the reform package.
Barry Gardiner: That was going to be
my next question, only I would have asked it as a question rather
than making it as a statement.
Chris Hunt: They are certainly
Shaun Mays: But aren't you using
it as a signal that you want to make the transition to the low-carbon
economy? That's the way I viewed that particular element.
Shai Weiss: It's slightly confusing
politics with incentives. A political statement does not have
to come through the form of taxes. It could come through the feed-in
tariff, which is much clearer, much more precise and achieves
probably the same outcome without the whole debate on it.
Q192 Barry Gardiner: Well,
it will raise the wholesale power price, but it is nullified by
Shai Weiss: That's right.
Q193 Dr Whitehead: The whole
question of carbon floor price, both as a signal and indeed as
an actual incentive for low-carbon investment, seems to be very
much bound around by several factors: by the duplicative process
of measures in the EMR; by its relationship with ETS; and by factors
such as the extent to which you could put a carbon floor price
in and have an interconnector policy at the same time, where other
countries perhaps don't have the same carbon floor price policy
that you have. Taking those factors into account, do you think
there is a serious possibility that a carbon floor price really
could drive investment in this country in the way that some people
suggest it might? Peter Atherton, you speculated that the carbon
floor price as far as nuclear investment was concerned would need
to be much, much higher than is predicted at the moment, and they
would then, presumably, potentially run into those problems that
I have already outlined.
Peter Atherton: Sure. To make
nuclear workable, they need a high electricity price. You might
decide to get there through a CfD, for example.
I gave some figures to the Committee before
Christmas; after the EMR was published EDF held a UK investor
seminar and gave us two pieces of information. First, their latest
cost estimate for a twin EPR is £9 billion overnight price
in today's money. Secondly, their cost of capital, taking into
account the EMR, will be 10% post-tax nominal. Running that through
our models, they would need a £78 per MWh electricity price
to make that workthat's in today's money. If you roll in
interest during construction (IDC) and inflation, they need about
£105 per MWh to make it work. So those are the sort of numbers
they would probably be looking to strike their CfDs at. Clearly
if you get to those sort of numbers via a carbon price floor then
the carbon price would have to be huge, though presumably you
wouldn'tthe carbon price floor would be set fairly low,
and it would be the CfD that gets you up to those sort of minimum
Chris Hunt: The carbon floor price
is a somewhat blunt instrument. My personal hesitation is that
if you set a carbon floor price for a means of justifying a nuclear
plant, I agree totally with Peter, it has to be very high to induce
the investment you want. Personally, I'm not sure it is the best
instrument to usethere are probably more efficient ways
to get at what they're trying to get at. If it's truly the desire
to build a nuclear plant, you can get there much better and much
quicker in other ways.
Peter Atherton: But your general
point is, if you can import power produced on continental Europe
where there is a much lower carbon price, then clearly people
will, if they can.
Shai Weiss: Which I think is an
important point altogether, because we are now thinking about
this only as an isolated market, but over the future there will
be an interconnect, and the interconnect will import energy from
lowest-cost provider to highest-cost provider. That is why, for
me, you can do the carbon price but not unilaterally, because
you can see future Governments saying this is a transfer of wealth
from one country to another via a tax on the residents of one
country. That will clearly be a political problem that will bring
us full circle to the point where Governments will want to change
it. If you're going on the carbon price, you are then in the realm
of policy and politicsfor example, between countries. I
think there are other mechanisms to ensure that we are not doing
things in isolation from the continent, where they will have,
for instance, very efficient nuclear.
Peter Atherton: But it's not just
the carbon price itself, it's the whole set of policies and targets.
At the end of the day, if they are successfuland we have
offshore wind, onshore wind, solar, nuclear, in 10 to 15 years'
timethe UK will have a very, very high fixed cost, very,
very high operational cost, low variable cost power system. If
that differs from our trading partners across the interconnectors,
and fossil fuel prices happen to fairly modest at the time, then
of course we will import a lot of power, and we should, because
it will be an awful lot cheaper to do so than to produce it from
our own very high operating cost system.
Shaun Mays: I think you have to
be a bit careful about time frames here because I will be very
surprised, in my working life, that there is an interconnected
power system. The way I viewed the carbon tax was quite simple.
First, I though it was a political mechanism, obviously, a political
signal that we are doing something about a transition to a low-carbon
economy. I think that is an incredibly important signal. Secondly,
it's a financial mechanism for taking money away from dirty coal
power producers and allowing that transfer to the clean energy
producers. So I think it is an important and necessary signal.
In 20 years' time, when we are connected to the rest of Europe
in a supergrid and power gets sucked into that system with no
energy losses, and energy efficiency and smart group technology
is phenomenal, there might be a change required. But at the moment
it is an important signal, and I would think that we are a long
way from importing power from Germany or France, although I could
Peter Atherton: Sure. We have
a reasonable amount in interconnection already: the 2 GW for France,
BritNed is now on, and Norway is almost certainly going to go
ahead; 3 GW or 4 GW already is quite a reasonable amount.
Q194 Chair: Just pursuing
the logic of what you were saying there, would it be better for
us, instead of tying up a lot of money in some low-carbon technologies
that are sometimes slightly unproven but undoubtedly very expensive,
just to have another a dash for gas so we don't mind being exposed
to imports? That will get us through the next 10 yearsto
where we need to beand then maybe the other stuff will
have got a bit cheaper and we can put the investment in then.
Chris Hunt: Do you want to go
Peter Atherton: Well, we are straying
slightly into the political arena rather than just the
Chair: Come on, stray.
Peter Atherton: My lawyers are
Laura Sandys: From an investment perspective?
Peter Atherton: From an investment
perspective, yes absolutely because it's a proven technology,
it's very simple. I think if the market was left to itself they
would gradually and incrementally develop wind and offshore wind
and things, and they would build a reasonable amount of gas. Does
that leave the UK vulnerable? Potentially, of course it does.
However, I would question this whole point of vulnerability. At
the end of the day, you want to be like your trading partners.
There is very little advantage in being very different.If we have
a tremendous renewables-based system and in 20 years' time there
is an oil price shock, then the transfer mechanism into the UK
economy is through trade. We will have a recession like everybody
else. Our recession might be slightly different from everybody
else's but it probably won't be very different. France's ability
to sustain the oil shocks of the '70s, because of their large
nuclear fleet, was tiny. They did not benefit greatly from it.
Where you run the real risk is, you build all this stuff, you
lumber yourself with incredibly high fixed costs and a not very
robust high-operating-cost system, andyou know what?fossil
fuel prices are modest. Nobody else has built it or nobody outside
Europe has built it. That is your real danger. You want to look
like everybody else; being in the middle of the pack is where
you want to be on this.
Q195 Chair: That sounds like
a fund manager wanting to keep his job.
Chris Hunt: I'll take a slightly
different perspective on the issue. First, I'll comment as a firm
that owns just as many megawatts of gas-fired generation as of
renewable generation. We are, frankly, agnostic between the two.
There is tremendous vulnerability to the economy of being too
reliant on a single generating source. If you look the world over
at rates of penetration of gas versus coal versus nuclear, for
example, the UK, if it had another dash for gas, would be on the
extreme of having an over-dependence on a single fuel source.
We are talking about renewables as if they don't work and they
are unproven. The truth of the matter is that we have had wind
turbines up for 15 to 20 years, we know what they can produce
and they are not unproven. Biomass plants are the equivalent of
boiling water. We know how they work and it is not like it is
new-fangled technology and something that doesn't work. Solar,
admittedly, is on the newer side and is on a cost curve, so perhaps
on solar there is some benefit in waiting. Certainly on tidal
there is some benefit in waiting. But we do have options here
to diversify and at an expense that is not extraordinarily higher
than another dash for gas. So, on balance, while there is always
some benefit in waiting, it would be a dangerous move to sit back
and just allow another dash for gas.
Shai Weiss: If you look at our
counterparts, China last year investedsorry, "invested"
is a strong word here. They gave subsidies of about $37 billion
to their solar companies by way of cheap loans. You don't have
to wait much longer for the Chinese to promote solar, which they
are doing; likewise on wind and many other technologies. There
are great benefits from these alternative resources such as security
of supply, which everybody knows. We should not forget, whether
one believes or notsome people do believe that there is
global warming, and we haven't talked about this at all. But if
you do believe, then there are benefits from reducing your reliance
on fossil fuel-based economies. Natural gas clearly right now
is in vogue. It is very cheap and very available and very productive.
We always think that it is good to have multiple sources of energy
to avoid those shocks, and to be able to achieve other aims than
just the lowest costs at a specific point in time.
Shaun Mays: Decentralisation of
the system is an important factor here. You have to look at the
UK's competitive advantage. We will never be a big producer of
solar power; Spain has a natural advantage over us. I think there
are some elements where you just have to say the UK has an advantage;
doing offshore wind and being able to get there first has been
a big advantage. The financing challenge is not insignificant.
I think the estimates for Hornsea alone are about £13 billion.
It is almost the same as all our onshore wind put together. We
need to create a system that can recycle capital. I agree that
there is an opportunity for the UK to be at the leading edge of
the competitiveness curve. We have to be realistic about time
frames and the amount of money it takes to do that. There are
some GDP reasons why you would do these things as well.
Peter Atherton: I struggle to
see where these benefits are. These jobs are costing a fortune.
The ROC scheme has cost £1 billion a year already. That is
money out of consumers' pockets that would create jobs if the
consumers were left to spend it themselves. Where is the cost-benefit
analysis that this creates more jobs than it destroys? It is a
tax on consumptiona tax on energy. Having reliable and
affordable energy is a really, really good thing. We are in danger
here of forgetting that and letting other priorities completely
dominate. We would all agree about some diversity and some development
of these technologies. But the targets are driving the rate of
change and that rate of change is creating the challenges and
the risk; and now we are trying, mid-implementation of the targets,
to reallocate that risk while trying to maintain affordability.
That is an extraordinarily difficult balancing act to do mid-stream,
when you have already set the actual targets.
Chris Hunt: I think the data will
prove outthey have proved out across economies that have
taken this step. The impact, while it sounds like a big number,
is not as big as we think and if you take price shocks into accountthere
are plenty of data; I could quote someit comes out surprisingly
Shai Weiss: And when you look
at the cost curves of these alternative energies, they are coming
down and competing on par with the basket of goods coming from
traditional energydefinitely at the prices we are seeing
today, and with further benefits yet to accrue.
Q196 Laura Sandys: On feed-in
tariffs specifically, some people have voiced concerns about the
move away from the renewables obligation to feed-in tariffs and
say that that will undermine investment in renewable electricity
across the board. I add one other aspect of this. We have lots
of different mechanisms and obviously, the feed-in tariff is an
important, core one. Are all these different mechanisms relating,
creating different and conflicting behaviours? In many ways, you
will be looking at it from different investment perspectives and
all these mechanisms will create different investment outcomes.
How important is the feed-in tariff, how important is the renewables
obligation and how do you see the move from one to the other impacting?
Chris Hunt: Obviously, if the
Government were to change the policy every five years, it would
make things very difficult for investors. As long as there are
relatively few regulatory approaches on the system at any given
time, that is useful. When we invest in a project, we invest in
the expectation that we're going to hold the project for 20 yearsthat
is the useful life of most of these projects. When we invest,
we make that investment decision based on the assumption that,
whatever regulatory environment we invest in will be there for
the duration of our investment period. The concern of people with
the RO is that they invest in one scheme and if the system changes,
they are worried that the fundamental basis under which they made
their investment will be gone. That is a perfectly justifiable
As the data have shown, and as you look at the
price curve for renewables obligation certificates, they all tend
to be gravitating towards a certain common price, so in general
terms, most of the people who have RO-based projects today probably
have a reasonable degree of certainty that they will be coming
out okay if you make a move over to feed-in tariff systems. It
is a fair concernthey invested in one thing and want to
make sure that they see a pay-out on their investment over an
extended period; but generally, most people are satisfied that
they're going to be okay. The FIT system still needs to be defined
as to exactly what it's going to be, but as long as we go in with
a system and stay with it for an extended period of time, it's
a structure that's simple and people will get their arms around
it and will put the development dollars and capital behind it.
Shaun Mays: And I think you've
got a pretty clear signal when you see that grandfathering is
an important thing. If you invest on one basis and it changes
halfway through, like Spanish solar has, it makes a big difference.
I can see two risks with the ROC system. We've got quite a few
projects now with ROCs. When the whole question mark over ROC
grandfathering for biomass came up, we had two projects where
we couldn't get finance: finance evaporated. That meant that other
projects didn't go aheadhave gone completely, we will never
do them now. So there has got to be a careful look. We try to
entice finance into these areas, whether it be project finance
or long-term pension fund money, and they do take these blips
as a problem. The second thing I can see is, there could be gaming
at the end between a ROC and a FIT, and you've got to find a way
to prevent those of us who've got these projects from doing that
little tweak at the end to get that little bit of extra return
because there's more margin in the FIT than in the ROC. Again,
I'd caution you to think through that.
Q197 Dr Whitehead: The suggestion
that has been made to us on capacity payments as one of the pillars
of the EMR is that in other countries where they have been introduced
they have often been changed significantly, after they were put
in as part of the scene. First, do you think that the regulatory
risk and the investment uncertainty may well be substantial, should
there be a period of potential change in capacity payments? Secondly,
on that basis, do you think there is perhaps urgency in nailing
that downparticularly since we know that the increased
intermittency, for example, of a substantial element of offshore
wind in the system will mean quite a lot of additional stand-by
capacity, the exact composition of which remains at present rather
uncertain? Do you, for example, try to extend existing plants
or effectively commission plants that are really never, or hardly
ever, going to be run? Do you go for other forms of, say, interconnector
storage which can actually provide that underpinning? Do we need
to make some clear lines at an early stage for what I think is
probably going to be a strange investment challenge in terms of
underpinning that future capacity?
Chris Hunt: I'll take the first
shot at that question. Speaking with my gas-fired generation,
rather than my renewable-fired, hat on, the capacity markets here
could stand an overhaul. The system as it is now is uncertain;
you're taking a fair amount of risk in just going forward and
building peaking capacity in this country. But that said, the
UK is not alone. I could point to virtually any open market in
electricityparticularly in the USwhere the capacity
markets are very uncertain and hard to build into. So it is an
endemic problem in the electricity industry or in the open electricity
industries about how to get capacity payments right.
Speaking more from the perspective of the US,
the US divides itself into multiple different regions, so there
are about 12 different electricity regions; five or six of them
are what you would call open systems like the ones you have in
the UK, and the other five or six are traditional state-controlled
electricity systems. In the five or six open systems, we have
been trying to get capacity markets right for 15 years and we
have not got it right. You could look at the rules on capacity
payments, and they would probably be four times the thickness
of this bundle of papers. It is inordinately complex, and prone
to regulatory review and change almost every other year. Fortunately
for the US, it is in a slightly different circumstance because,
in that country, if you don't get the capacity payment rule right,
you can always rely on a neighbouring state to bail you out. There
is much more interconnection capability there, just by virtue
of lines connecting across states, than there will ever be here
in the United Kingdom.
I think this is an inordinately important part
of this whole equation and you do need to do it, and you need
to do it relatively quickly. Right now, there are a lot of different
themes going on: you have National Grid out there, trying to arrange
its own capacity through short-term operating reserve contracts;
you have the overall system trying to set up its capacity payments,
and you have yet another system now coming in through the EMR.
It is ripe for rationalisation. You need to do it soon, because
it takes a while for us to respond to it. If you make the rules
now, we're not going to be in a position to be able to build for
another five or six years. So I think your point about getting
on with it is pretty important.
Peter Atherton: I would agree
with that. The only thing I find slightly odd about the proposals
is that they don't allow existing fossil stations to benefit from
the capacity payments, as I understand it. I find that very odd.
Keep the oil fired stations and there is your capacity back-up
there and then. They may only run 2% a year, but keep them. Don't
shut them downyou don't need to do anything else. Just
keep the oil plant.
Q198 Dr Whitehead: What, the
six oil plants that are going up?
Peter Atherton: You might need
a bit more eventually, but yes
Dr Whitehead: Mineral oil?
Peter Atherton: Yes, but they
won't operate much; they will only operate for short periods during
the year. They serve that function now; they are the super-peakers
on the system now. Just keep 'em.
Chris Hunt: There are people out
there now building under contract to National Grid, who are going
to be building 1 MW and 2 MW power plants specifically for that
purpose. They are no different from a farm tractor engine, there
to operate, maybe as you say, one or two hours a year. That is
not the most efficient way to solve the problem.
Q199 Barry Gardiner: Turning
to emissions performance standards, it seems there are two problems.
One is that they are toothless. Secondly, if they are not toothless
and you ramp them up to do more than just get rid of unabated
coal, they may fluctuate and be subject to change. How much, from
an investment point of view, would you be taking notice of them
now? At what level might they kick in so that you do begin taking
notice of them? How much would the grandfathering of themif
that were introducedchange your investment appetite?
Peter Atherton: For the existing
utility companies that are already operating under LCDP and the
IED and emissions performance standards on top of that, it causes
tremendous problems for them and their investor base. We are for
ever shortening the life of their existing assets. Anything that
significantly threatens their gas fleet in our modelling in terms
of the valuation would be profoundly unhelpful to the share prices
of those companies. Forget about security of supply issues. The
share prices will all go down if we start assuming that all the
gas plants have to have a major refit or closure in the early
2020s, which we certainly don't at the moment. We assume that
they will carry on merrily through to the 2030s and beyond, with
some re-planting of the turbines.
If you start raising doubts in the minds of
the shareholders of the major utility companies that the existing
assets will operate, it is already very, very complicated. That
is one of the reasons why the share prices have been performing
so poorly. It is profoundly complicated already for investors
to take a view on the life of assets that are on the ground at
the moment. How are they going to operate over the next 10 to
15 years in terms of load factors and what their cost bases are
going to be and so on?
When we this model this stuffinvestors
do the same modellingyou can get wildly different outcomes
in terms of valuation of plant. At the end of the day, these utilities
are the sum of the parts of how much we think their power stations
and their networks are worth. If we add that up it comes to a
sum-of-parts valuation and that gives our share price target.
If we start shortening the life of assets or assuming those assets
are going to produce far less power than currently assumed, those
valuations will fall, which means that the companies can invest
less. There is a feedback loop through share prices.
Q200 Barry Gardiner: Just
to come back to grandfathering, for new assets grandfathering
on an EPS would be something that you would see as de rigueur.
Peter Atherton: Yes.
Shai Weiss: But when you grandfather
you really need to make sure that the incentives from that mechanism
actually end in further investments, prioritising what we are
trying to achieve. Grandfathering becomes an extension; then an
extension becomes a new investment.
Q201 Barry Gardiner: At the
moment, how much incentive do you think there is for building
new renewables from the existing EPS?
Shai Weiss: I would say, not much.
All you have to do is look outside; there is not a lot of it.
If there is not a lot of it, I presume there are not enough incentives.
Clearly, we do not represent the utilities, but the utilities
are inherentlyand we have no cloaked share in public securitiesobjecting
to change. They like stability, so do their shareholders, and
they are incentivised by capital investment in their existing
assets and new assets of the same type. That mechanism can go
on for another 20 to 50 years unchanged. We are talking about
introducing change and uncertainty into this market. Clearly,
that is going to have some kind of adjustment in terms of share
prices. If done well, it should not hurtif grandfathering
is permittedif they are incentivised to promote newer technologies
within their basket of goods.
Shaun Mays: I have had a lot of
conversations recently with equity portfolio managers of the big
pension fundsthe same side that Peter deals withand
I would say that they understand the equation of having a lot
of capital tied-up in old technology and having a vested interest
of ensuring that that gets a return for a very long time. It's
a capital-intensive business, and you have to acknowledge that.
You invest for the very long term. Institutional investors are
looking for a pure play into, for example, mature onshore wind
assets, where they can invest in new technologies, which will
offset the investment in a bundled-up old and new technology company.
We have to look at it that way. We can't switch offnor
should we switch offall the existing technologies, so we
have to preserve and manage that. I realise that it's a delicate
issue, but we need to move. We're only in the clean side, so it's
easier for me to say, "Switch all the coal technology off,
and let's get cracking on offshore wind." I can see that
it's a delicate situation to manage.
Chris Hunt: Grandfathering is
important. If we see a circumstance where, after a plant is built,
the rules change, it raises the cost of capital for all of us.
On a technical point about the emissions standards, at what point
do you declare an old plant a new plant? That is a mistake that
the US got caught up in, which was very important, and it has
been a mistake that we made that we haven't actually been able
to reverse. In some cases in the United States, for example, you
had a coal plant, and the US came in and said, "We're now
going to impose higher standards on new coal plant builds."
So what happened is that people who had old coal plants were reticent
and hesitant about making any improvement to their plants. They
didn't want to install scrubbers or desulphurisation or any of
that, because if they made those improvements, they would be designated
as new coal plants and would therefore be subject to a different
regulatory regime and different emissions standards. As a result,
that gave people the perverse incentive of doing nothing with
their plant, which resulted in the worst coal plant possible.
Where is that relevant in the UK? It is relevant
around coal plant improvements generallysome of that is
covered by the large combustion plant directivebut it is
also relevant for biomass. If you wanted to take your existing
coal kit and then convert that to be able to burn biomass, either
in whole or in partmaybe 10% or 15% of your feedstock being
biomasswe have to ensure that that does not make that coal
plant be deemed to be a new plant and then be deemed to have to
adhere to a higher standard. It's a technical point, but it's
actually a very important one.
Q202 Barry Gardiner: Thank
you. That's very interesting.
May I get a final question in here, Chair? I
know that you want to press on. This is looking at different kinds
of risk. Mr Atherton, if may just quote yourself back to you,
you said, "I warn you that it is not a question of making
the rewards more and more, because the more you make the rewards,
the less trust investors will have that those rewards are going
to be sustainable." If one looked at the alternative of a
sort of regulated asset base and guaranteeing a regulated return
where you could transfer the off-take risk, the electricity price
risk and construction risks away from the generator, is that a
more attractive way of doing this?
Peter Atherton: Well, it's a different
set of attractions, and it would all depend on the terms of the
regulation. If it was very similar to the regulation of onshore
networksNational Grid, for examplethose assets are
well supported by investors. The step up in investment that we're
seeing in networks is generally well supported. The Ofgem regimes
are generally considered to be okay. We have a new regime appearing
in a couple of years' time with the RIIO system and things, so
there will be some issues around that. Generally speaking, however,
regulated networks are an attractive proposition. Companies can,
are and have rounded up substantial amounts of new capex into
them. Obviously, from the policy perspective of making offshore
wind a completely regulated activity, you are transferring an
awful lot of risk and you are capping out return. There will be
issues around that in exactly how you deal with construction and
things like that. It is, however, clearly an option. The Government
looked at it, as far as the EMR, and they said that they would
rather not go down that way, because they don't want to remove
all the disciplines of individual companies making individual
decisions and things like that. That is a reasonable decision,
but would you get more built faster? Probablyat least in
the short term.
Shai Weiss: This is now going
into macro-economics. If you look at regulated markets, they tend
to be efficient in the short term and inefficient in the long
run. There are no incentives to improve, and there are no incentives
to pass on cost reductions or efficiency improvements. We see
that as having a significant damping effect on the competitiveness
of the market and, because of that, on the effectiveness of the
companies supporting it. So it becomes less attractive in the
Q203 Barry Gardiner: Even
though your first remarks to the Committee today were about the
importance of stability?
Shai Weiss: Yes. Stability in
the framework is key. All we are asking is that you tell us the
rules of the game, so that we understand them. If the rules are
half fair, we will play in the game; and if they are not, we will
find other places to put our capital to work.
Barry Gardiner: Thank you very much.
Chair: Unfortunately, we have run out
of time. It has been a very useful and interesting discussion
from our point of view. Renewed thanks for coming in and giving
your time to us this morning.