Electricity Market Reform - Energy and Climate Change Contents

Examination of Witnesses (Questions 224-249)


15 FEBRUARY 2011

  Q224  Chair: Good morning. Thank you very much for coming in. You know that we've been looking at electricity market reform during our last few sittings. Obviously, it's a highly topical but wide-ranging subject. We have about an hour with you. Please feel free to participate in any discussion that you want to, but don't feel obliged to answer every single question if you don't feel you have anything particular to add to what has already been said.

  I start with a general question about whether you think that the proposals in the consultation document are likely to promote investment in low-carbon power. Will the proposals reduce some of the risks that are already inherent in such investment?

  Joan MacNaughton: Alstom begins with A, so perhaps I should go first.

  We strongly support the objectives of the reform, and we strongly support the goal of decarbonisation. Because we think that all of the technologies will be required—we actually have an offer for all of the technologies—you will need a varied portfolio, which is essential to maintaining security of supply and minimising the cost to the consumer. As well as those technologies, you need to drive up efficiency of power generation, and you need to drive carbon capture and storage.

  Will the current proposals succeed? It is very difficult to tell on the information currently available. There are big design issues with the contract for difference, which are acknowledged in the consultation document itself. There is no certainty about the proposed rate of decarbonisation. We are not absolutely clear about the trajectory on either price or carbon intensity.

  There are a whole lot of questions that need to be answered. There are a lot of questions on the interaction between the different proposals, which need to be pulled through and made more visible. Until we have visibility on that, it is quite difficult to be confident that this is going to drive the real uplift in investment that is absolutely crucial.

  Christina Grumstrup Sorensen: My name is Christina Sorensen from DONG Energy. We generally welcome the energy market reform, and we believe that it is a reform of this nature, and with this ambition and will, that is needed to ensure that we achieve the challenges in front of us.

  We both talk about the aggressive capacity build-up plans that are needed; we also need to attract new investors to achieve the emission targets. We also talk about working towards security of supply and about the role of the different technologies in the electricity system. We also talk about the need for affordability, which means supporting the low-carbon and renewable technologies that are at hand right now.

  We are concerned that one of the main risks is that market liquidity is not targeted directly in this energy market reform; we believe that market liquidity is a prerequisite for many of the initiatives to be successful. We also believe that auctions as a means of delivering the feed-in tariffs will be disruptive to the build-up plans, because planning is needed. We need to bring down costs, to build a supply chain and to attract new investors, so we really need a stable investment environment.

  Lastly, we believe that the timing of the energy market reform is a challenge. It is a challenge to balance getting certainty on these big initiatives and, at the same time, working them to the right detail level to ensure that the incentives are correctly aligned to achieve the objectives.

  Adrian Haworth: I speak on behalf of GE. We are looking right now at substantial investment, certainly in the offshore wind sector, and the timing is crucial. We believe the UK has a unique circumstance where it can lead the world in offshore wind; it can develop that technology and export it in future. But right now, we need to ensure that the momentum is not lost—that investment in the offshore sector is kept in the UK and does not move to other countries that are also competing to be the supplier to this newly developing technology. We see it as being like the oil and gas sector 30 years ago. We have recently made several acquisitions in the oil and gas sector, in which we would never have been in the UK had we not moved 30 or 40 years ago. We think now is the time to move into the offshore market and make the UK a leader, because it is unique in the world to be able to do that.

  Robert Cross: Statoil would support the reform, but I think that generates a great deal of uncertainty for investors. From an offshore wind perspective, we are quite happy with the renewables obligation. We have almost completed our investment in the Scira wind project. More generally speaking, we have some concerns about the impact that these changes will have on the structure of the electricity market, and the consequences that that will have on other markets that relate to the electricity market, such as the gas market. Some of the measures may be necessary, but perhaps not all of them all at the same time, because that creates a great deal of instability.

  Q225  Chair: Given the scale of the investment needed, a variety of investors will have to participate in this, who may have slightly different objectives, looking for a return over different time periods. Is it possible to produce one set of policies that maximises the attraction to investors with different objectives?

  Christina Grumstrup Sorensen: I think the initiatives that are set out in the EMR and that are multiple, will work well hand-in-hand. So I don't see that we should need less compromise and only have one initiative for one. For the feed-in tariffs as well as the RO banding, there has been this banding that has given different support to different technologies. We see that as an example of how a mechanism can work well with different technologies.

  Adrian Haworth: Offshore wind has many risks associated with it, and they are not all financial. There is a lot of technology risk, which needs to be understood. We believe that eventually there will be economies of scale, but right now we need to get experience offshore. We need to understand that technology better; then we can develop further. Getting offshore established and started is going to be an issue. I don't think there will be one mechanism that suits a developing technology and a mature technology. That is the problem for offshore wind.

  Joan MacNaughton: I think the particular risks of the new technologies and of the large-scale technologies mean that the investors need predictability over a time scale. That doesn't mean that you need a single instrument that can fit all, but you do need confidence in the direction and pace of travel. There is quite a focus on 2020; there is a target at 2030 that we know about, although the Climate Change Committee has made a recommendation to toughen that target. But we don't have clear visibility of what the trajectory is, yet for a lot of these investments the payback period really will have go over that 20-year period at a minimum.

  I do think we need more granularity around what is said in the document about how some of these decisions are going to be taken. If you take the contract for difference, which has a lot to commend it as a proposal, we don't yet know how it is going to apply across the different technologies, and how the strike price is going to be set. Until investors have some confidence in those issues—not just the formal statement, but how that regulatory regime is going to work in practice—there will be a high value to wait-and-see. And that is actually what we don't want; we don't want the hiatus in investment.

  Q226  Chair: Given the absolutely overriding need for predictability, we heard evidence last week from someone who suggested that the potential cost to consumers of achieving quite challenging targets for renewable energy, and climate change more generally, was such that investors might be nervous that a future Government might lose their nerve in terms of what is going to happen to people's household bills and so on. If people thought that the consequences for consumers might become too much for the Government to stick to their commitments, might they be deterred from making long-term investments?

  Adrian Haworth: Yes. I don't think it's just the UK. In Europe generally, a lot of people think that once the cost of leading the world in carbon abatement is realised, they'll back off. But I think there is the political will throughout Europe, and especially here in the UK, from all parties and walks of life. People are willing to pay the little extra for a renewable future. Perhaps that needs to be better stated to people outside the UK who are the potential investors and who may not have the confidence that the people in the UK seem to have in the Government's binding contract for the future. Certainly there are sceptics outside the UK.

  Robert Cross: There does need to be a great deal more transparency about what the impact on consumers' bills will be and the effects that these policies will have on the prices that they pay. The other issue is the availability of capital to make all these investments all at the same time, which may, in itself, drive up some of those costs. I think that there are options available to policy makers that will allow other pathways to be achieved in conjunction with the investments that are being made, such as relying on natural gas generation to some extent to soften the impact of that trajectory.

  Joan MacNaughton: I understand the point about the pace. The pace could accelerate or it could slow down a bit if people did begin to lose their nerve—to use your phrase, Chair. What we've been seeing over the last several years has been, directionally, all the same, which is that people are becoming more concerned about the information on climate change and more determined to tackle it. Even in some countries where there have been two steps forward and one step back, there has eventually been another step forward. I am thinking of Australia, for example. The actions that are being taken in Asia are really quite significant. The Chinese are really moving in this area. So we are either going to grow these industries and deliver on low carbon here, or we are going to find ourselves having to deal with these issues, because of the evidence, but we're going to be buying the equipment and services from other people who have seen the advantages of giving a clear policy steer and moving forward.

  But I do think that the pace needs more detail around it than we currently have, and there needs to be an early move to give information on the issues that are not yet covered, to deliver the White Paper on time and to avoid more of a hiatus in investment than seems inevitable.

  Christina Grumstrup Sorensen: I think, in general, there is high confidence from an investor point of view. We are seeing pension funds and private equity funds entering into the offshore investments, which we have not seen before. The past 10 years have shown us that this climate, the carbon emissions targets and the need for a low-carbon world is the right direction. Investors also see that.

  We should see it as an opportunity. We are, as I said, using or deploying all the available technologies right now. We are building up a supply chain and creating new jobs, so we should think of it as not only a cost, but an opportunity.

  Adrian Haworth: Just to re-emphasise, we truly believe that the UK has the best platform in the world to launch offshore wind. It would be a great pity if we lost that initiative by just not moving quick enough.

  Q227  Albert Owen: What impact do you think the EMR proposals will have on supply-chain investment? Mr Haworth mentioned technology. Are people queuing up to be part of this?

  Adrian Haworth: I am not sure that we all fully understand it yet. We believe EMR is going in the right direction. We are trying to understand how fast this market is going to move. Therefore, we could ramp up our investments in the supply side—it is not just primary supply side but also secondary and tertiary supply sides. Obviously we believe that the UK is the place to be because it seems to have the biggest opportunity for offshore wind. But there are other places that are developing. There were recently announcements from France; there have been lots of announcements from Germany and so on. We think that if there are delays in the UK, that could compromise the potential for investment in the UK because we will be almost forced to take opportunities elsewhere, which will often necessitate having sourcing locally there. Secondary and tertiary sourcing will be lost from the UK. That is why it is necessary to forge ahead right now and ensure that no hiatus is caused by the EMR. We think the EMR is the right direction, but if it causes a hiatus, that will be very negative for the industry.

  Q228  Albert Owen: That is a very neutral answer, if I may say so. Do you think that prior to the EMR, there was confidence for the supply chain, and that it is now more difficult, from what you have seen thus far, for the secondary ones to commit themselves?

  Adrian Haworth: I think we are going in the right direction. There are people looking—some people are here, but we have not all committed yet.

  Q229  Albert Owen: We have had road shows and various things.

  Adrian Haworth: We have. We need to understand right now that there are several other things taking place[1], along with the EMR, which need to happen to give everyone the confidence to take the big leap—and it is a very big leap—into this marketplace. That is our position. Yes, we are going in the right direction, but speed and time are of the essence here.

  Robert Cross: To echo that, timing is critical. We are not operating in a vacuum because other countries are implementing their own policies, and industries other than offshore renewables are also entering into these investment programmes. Equally as part of the EMR, the potential for pressure on this budget is quite significant if there isn't clarity about how all this is going to work.

  Q230  Laura Sandys (South Thanet) (Con): One of the things that we have heard from many of the people giving evidence is the importance of breaking the monopoly of the six big generators. Do you feel that the EMR allows greater openness for the market? What are the barriers that the EMR still does not address? What exact levels of investment do you feel that your companies can be making in the next 10 years? Have we got the framework to, in some ways, break the market open for companies like yourselves?

  Christina Grumstrup Sorensen: As I started by saying, the market liquidity issue is not addressed as directly as we would have hoped for in the energy market reform. If we go for a feed-in tariff, it is difficult to see exactly how this index price would be framed. At best, you would have an intransparent price that you would then need to top up to make the feed-in tariff level. In the worst case, there could be room for price speculation. So we are very worried about the contract for difference, especially with an illiquid electricity market.

  Robert Cross: It is not clear from the EMR consultation what the structure of the market will be in 2020 or 2030. You could have a situation where a significant proportion of the market is on some kind of contract for difference or on some capacity payment for balance and generation. I think they all in themselves will have an impact on the incentives for the generators and how they operate on a day to day basis, and I don't think that is very clearly thought out in the consultation and how it will affect those of us that are looking to be in the market as part of our investment programme.

  Joan MacNaughton: I agree with that. I would add that transparency is really important here. In principle, with the kind of market we have at the moment with six big players, that shouldn't be uncompetitive. In principle, that is capable of being competitive and there are various studies that suggest it is pretty competitive, but more transparency would help, and it would help with liquidity. That comes back to the point that we've got to have coherence between these proposals and the liquidity review from Ofgem and the carbon price support mechanism review from the Treasury. There are all these different moving parts and they seem to be being handled somewhat separately but need to be brought together. We need to have visibility of how they are going to be brought together pretty quickly.

  Q231  Chair: On the question of implementation, a timetable problem is already emerging. Given that the time scale for any project is so long, and the 2020 targets are so demanding, how late do you think we can agree the outcome of this consultation and still hope to attract the necessary investment in time to achieve our targets?

  Joan MacNaughton: The later you leave it, the longer the hiatus in investment, and some of that investment will then occur elsewhere. We are in competition for that investment with other countries, because the investment goes wherever there is a good project with a good risk/reward profile. So I would put it the other way and ask, how soon can we do it?—can we deal with this as a time-driven project in order to ensure that we do hit the decarbonisation targets that we all think are important?

  I do have concerns about the "taking one issue and then taking another issue" kind of approach. That has been very evident in relation to the CCS projects, which are taking far too long to bring through to award of contracts. Yet, they could make—they will have to make—an important contribution by the time we get to 2030, but if they are going to do it in 2030, you have to be rolling them out in 2020. That means you really ought to be thinking of starting the demos as soon as possible. That is one example of where you are not taking it as a critical-path-driven project but you are doing your consultation, your award process and everything else in sequence, so you are doing everything in sequence rather than driving it down a critical path.

  Christina Grumstrup Sorensen: I think from an offshore wind perspective, in the system we have right now, we give evidence 3 years in advance of the current system running out in April 2014, so in April 2011 there should come out a new level for the ROC in 2014, so that time frame is okay—3 to 5 years. That is also why we don't see an issue in having a staged approach, in having not to fix all 5 initiatives at once. It's good that we know that all 5 initiatives will be in place, but we could move ahead with the market liquidity first, and some of the other areas, and then move further with the feed-in tariff once we have comfort in the market liquidity area.

  Adrian Haworth: Some of the initiatives—for instance, the capacity mechanism—will be required as a consequence of other policies being successful; if the other policies are not successful, you will not need a capacity remuneration. Therefore, there obviously needs to be a concentration on the matters at hand that are important right now, and resources should not be deployed on policy that is not required right now. We don't believe that the capacity mechanism is required right now and we don't know whether that should be more focused on the supply side or the demand side. We don't know how fast the demand side will be taken up, and we don't understand exactly how much wind will be deployed or what the profile will look like that will need support from capacity mechanisms. Clearly, sorting out the FIT system is the most important for us right now, from a supplier's point of view, to make our investment plans.

  Joan MacNaughton: I largely agree with what both colleagues have just said. I think the worry would be that if you have a potential capacity mechanism—you know it will happen, but you don't know when or how it will work—that in itself may stall some investment. You could argue that the capacity mechanism and the emissions performance standard do not add much to the package at the moment, but if they are always about to happen—on the shelf, about to be pulled off—and you don't know what shape they will be or when they will be brought off the shelf, it will have a dampening effect on investors' decisions. Having said that, I absolutely agree that one of the constraints here is the policy resource to get all the rather complex and difficult issues to the point where they need to be as quickly as they need, to be delivered.

  Q232  Chair: Given the risk to which you referred of investment simply going elsewhere, which is perhaps compounded by a less regulatory regime in some parts of the world, higher growth economies and so on, I feel that there is a touch of complacency in much of the discussion here. I know we've got to get all this sorted out and it's very important to get it right, so would it be helpful to have an early indication from the Government on some of these points, even before the consultation is complete, so that some of the uncertainties could be removed?

  Robert Cross: I think that while it may be useful, it is also important to ensure that a sufficient impact assessment is undertaken of the changes being made, because the changes create quite a different structure in the electricity market, and those consequences ripple out to other markets as well. I don't think that any early indications or commitments channelling the direction of policy should be at the expense of thoroughly understanding the wider implications of the market as it is changing. There are obviously markets that supply the electricity market, which will be impacted by the structure going forward, particularly the gas market.

  Q233  Chair: There is particular sensitivity about the transfer from ROCs to FITs, where there appear to be particular concerns. Do you want to say more about that? I know that DONG particularly expressed views on that.

  Joan MacNaughton: I just want to pick up on your question, if I may? Because this policy has so many risks and requires so much information that needs to be managed, maybe one needs a highly iterative process. Some visibility of some decisions on the consultation ahead of the White Paper could be quite good for testing some of the conclusions before the White Paper stage of what has been quite a traditional consultation document.

  Christina Grumstrup Sorensen: On the transition from the ROCs to the FITs, we have no problem working with the FIT system; we work with it in other markets and are quite comfortable with it. The prerequisite is that market liquidity is working well. The energy market reform document sets out that ROCs will be extended until 2017. As I said before, we need clarity three to five years in advance, so that there is time to work through all the devilish detail to ensure that all the incentives put in place are working effectively and coherently, and supporting the objectives and aims that I set out.

  Q234  Dr Whitehead: May I return to capacity mechanisms? You have mentioned that there is a potential problem of, as it were, a looming capacity mechanism not being there, but perhaps being there somewhere in the future. Because we can't determine exactly what the future will look like, a looming capacity mechanism may be the best we will get. On the other hand, in terms of the various directives and so on, we know that a lot of plant is closing. Therefore, we can't replicate in an automatic capacity mechanism the way that the market has previously pushed certain plants aside, and they then provide the back-up capacity.

  Do you think that what the Government are putting forward about capacity mechanism is perhaps as good as it needs to be, in terms of indicating that there will be a need for capacity mechanism to keep the total amount of capacity available, and that that, therefore, should be put centrally into the system for the future?

  Robert Cross: If I may answer first, with the capacity mechanism, we think it's good to recognise that you need to have that balancing power available to the market when you are going to have, potentially, a great deal of intermittency on the grid. What we see as one of the concerns is that although that gives you the generating unit sitting there ready, the question remains as to where the fuel for that generating unit comes from. If you have the significant amount of balancing capacity required to suddenly switch on and then support intermittent load, that is likely to be gas-fired generation, which is the flexible supply source. You then have to find that gas in the system to suddenly meet that generation capacity. What the capacity mechanism doesn't do is send that additional signal further upstream to where those supplies need to come from at short notice—either storage, or imports, or LNG, or whatever.

  Adrian Haworth: It doesn't seem to be clear exactly what the capacity mechanism is yet. The market is already handling the situation quite well, and given some adaptation, there could be a mix between new potential peaking capacity, if it's required, or investment in the existing plant to make it fit for purpose as it changes its back-up role for renewables to demand-side measures that may be just as strong as supply-side measures. It is not clear yet what is required, and I'm not sure that anything in the document specifies what, in fact, the Government wish to drive forward. I am not sure that we know what is going to be necessary or what will be the best solution moving forward. Certainly, demand side is not very clear, but it is potentially very strong. The major concern for an investor would be the potential to subsidise peaking capacity and new peak capacity in the future that would threaten existing assets. I think that is what the lady from Alstom was alluding to.

  Joan MacNaughton: Could I add to the comment that Robert made? There is one particular risk that hasn't clearly surfaced, although it is there if you read carefully; a lot of coal is going to retire, and there is a clear intention that there should be no new investment in unabated coal, which is perfectly understandable. But coal plays an important role at the moment, and the question is whether you are going to have coal with CCS, and gas with CCS in due course, as part of your overall mix. Coal plays a particularly important role in the winter, when gas prices are high, which is when you see it providing quite a lot of our generation. That is when it becomes a very important hedge against gas price volatility. It is an important hedge for the country, rather than necessarily for an individual generator, because generators will hedge on their gas contracts.

  I think some thought needs to be given as to whether there are enough incentives to invest in coal plant, when there is a clear signal that we are going to drive forward with CCS and allow coal with CCS to play a role in the system, as well as the very large proportion of renewables which we are legally required to do, the nuclear projects to which we aspire, and a lot of flexible gas. That would be a truly diversified portfolio, but as currently constructed I think the combination of these measures risks driving coal out of the system, or at least driving it to quite a small level and making us much more vulnerable in the winter. It takes away that intrinsic hedge against gas price volatility.

  Q235  Dr Whitehead: What do you make of the so-called "slippery slope scenario", whereby if you have a capacity mechanism which is plant based, more or less, then the logic may look as though you do not invest in new plant outside that capacity mechanism, so that as the capacity mechanism unfolds, it comes to encompass all investment over a period of time, and therefore rather overthrows its own purpose. Do you think that is a realistic possible scenario for a capacity mechanism, or are there ways to avoid that? Are there other examples that may have occurred elsewhere?   Robert Cross: It depends on the detailed design of the capacity mechanism, which is not apparent as yet. But it is a possibility that you have, as I said at the beginning, a significant proportion of your generation on some form of support, be it the contractual difference or the capacity payment. I think that what that does is leave you in a situation where the market for providing generation is very much altered, and it is difficult to see how you would fit unsupported generation in that mixture. I think it is certainly a potential, but it is difficult to say exactly without having more detail about the capacity payment mechanism.

  Q236  Dr Whitehead: Is that view held by everybody?

  Joan MacNaughton: I agree. I do not think that we have seen examples of where capacity mechanisms are confined to very specific circumstances. I agree with what Rob has said.

  Q237  Ian Lavery: You mentioned the coal and carbon capture and storage and the need to look at the energy mix in the future. How critical in your view is coal and carbon capture and storage in the future energy mix of the country?   Joan MacNaughton: I think it is critical. If you look at the Government's 2015 road maps, it is envisaged that there is going to be a lot of fossil fuel generation—gas and coal—and that you therefore need to develop CCS. The International Energy Agency says that if you attempt globally to get to 2050 without applying CCS to power generation, then it will cost you 70% more than with CCS. That is not specifically a coal point. But if CCS works I cannot see why you should not be applying it to coal equally as to gas. In fact, given that coal reserves are highly abundant—they are well diversified across stable countries as well as in some less stable parts of the world—I do not see why you would deny yourself use of that resource. Indeed we know that there are a lot of countries that are not going to deny themselves access to that resource. This is going to happen globally, and I cannot see why the UK would choose not to take advantage of that particular technology and fuel mix if that is really what is going to happen globally.   Robert Cross: One of the issues I would see with coal particularly is that whereas there is an issue with the transition aspect of it, from the older plant to the new abated volumes, the difference with gas is that you can still make a lot of your contribution towards meeting your carbon reduction targets by unabated gas to which you can then apply CCS. Whether there is enough in terms of developing both of those together after 2030 depends on what happens in between.

  Q238  Dr Whitehead: On capacity mechanisms and plants, the assumption that a number of people have been making is that any capacity mechanism, looming or otherwise, would be plant-based. That is effectively underpinning new plants, for example to replace standby oil plants as they have gone out of commission. There have been a number of suggestions that a substantial element of the capacity mechanism might consist of non-plant-based measures such as storage and substantially increased use of interconnectors—assuming there is something on the other end of the interconnector when you are connecting. Indeed, suggestions have been made that new players might be able to come into the market to aggregate demand-side measures, which then effectively operate as capacity mechanisms and could actually come into the capacity mechanism itself. Have you thought about those particular suggestions in your companies and organisations? Do you think that they could play a role in what may turn out to be how the capacity mechanism works?

  Christina Grumstrup Sorensen: We certainly believe that all of these levers must be applied in the future electricity system, as they are also in other markets. Some of the means are not yet fully developed on the demand-side management and we should really embrace this opportunity to develop these things. We will not be able to know exactly what will be available 10 years from now, so solving it on a 10, 20 or 30-year horizon with all of these mechanisms not at hand right now could be dangerous.

  Adrian Haworth: I would absolutely echo that. Some of you have visited GE's Smart Grid Centre in Bracknell, which we are very proud of. I think we see a really strong future for demand side. We don't really know; it is an evolution, but the UK is one of the world's leaders in this evolution. We think there is very big potential on the demand side but we can't quantify it yet, so it would be very difficult now to try to define where we will be in 20 or 30 years when we are really stepping out into the unknown at the moment. Definitely there is supply-side opportunity. There is so much interest in storage mechanisms right now that that would also be very interesting. On interconnectors, and on supply side and various ways of making that supply side responsive to what the needs will be in the future—which again is somewhat unclear—we think setting a rule now for what the capacity mechanism will be is premature.

  Joan MacNaughton: May I add two points? First, more connectivity definitely reduces risk and helps with cost, but one needs to be a little bit careful that we don't interconnect to take a lot of high-carbon generation from other places. That's slightly self-defeating in terms of the goals of the policy.

  The second point is on efficiency: how effectively you manage your dispatch, your management of your power generation assets, efficiency at the supply side, the whole transmission piece and demand-side response driven by smart meters, among other things. All of those are important. We have begun to move down the road on smart meters, but I think we need a coherent approach to the whole smart power piece, involving the storage, the dispatch, managing the intermittency, managing the likelihood of intermittency with different weather patterns very close to time and managing the transmission losses. Those technologies are beginning to emerge, and what we need to do is think about just how we incentivise getting them all in place. That's another important interaction with the current proposals and one that Ofgem has under its purview in the RIIO proposals, which I think in principle are quite promising.

  Q239  Dr Whitehead: That suggests that you might take the view that in terms of existing EMR consultation and what we know the pillars will look like, demand-side measures are perhaps not as present as they might be—or at least the co-ordination of demand-side measures to balance the overall market mechanisms. Is that your view or do you think that what is in the EMR at the moment, and the development of the various measures on grid-smartening and smart meters and so on, will do the job?

  Joan MacNaughton: I come back to my initial answer. It is quite difficult to tell. It depends on how you design some of these individual instruments. They contain the potential for getting hold of some of the demand-side response, for allowing some of the new models of how you manage these issues to emerge, but it is not exactly clear how and at what pace that will happen.

  Adrian Haworth: Right now I think the system works with the STOR (Short Term Operating Reserve) arrangements and other arrangements with the grid. We are not clear why an extension of that right now would not leave a level-playing field for these technologies to compete and sort themselves out. I am not sure that they need interference right now. I think people were looking to 20 years hence and a very spiky supply curve and thinking that we need to do something. But we are not there yet and we don't understand what it will look like in the future. So right now I think that enhancements to the grid's operating mechanism will suffice.

  Q240  Chair: You mention the need to avoid interconnecting to sources that are high-carbon, but in practice there is no way of controlling that, is there? Okay, if we interconnect to France at the moment all that is nuclear, but if we interconnect somewhere else and they decide to have a lot of high-carbon generating capacity, we are stuck with that, aren't we?

  Joan MacNaughton: Yes; you can't label the electrons. But if you are going to factor in a certain proportion of interconnection you can be very conscious of what you are doing to your mix by implication. So, I come back to transparency and being very clear about what it is you are trying to achieve and what the impacts of your measures will be.

  Q241  Chair: I can see that interconnection might be beneficial in terms of security and price, but it couldn't be a sure-fire way of guaranteeing progress towards low carbon.

  Robert Cross: One of the things that becomes apparent with the carbon price support is that you can cover generation of carbon within the UK but when you have interconnection, you can't apply the same rules to the electricity that is brought in. That is one the problems that we see with that.

  Q242  Laura Sandys: I am just trying to turn it around a bit. Is there any way in which one could incentivise the capacity issue to penalise companies in distribution if they have to access additional capacity? In many ways one is putting the emphasis on the demand side and pushing companies and generators to look at better management and to incentivise them to ensure that consumers are managing energy more effectively. Instead of paying extra for this capacity, could we penalise for the need for extra capacity?

  Adrian Haworth: I think the market does that now. To a certain extent the pricing in the market already addresses that issue. Peak-time electricity is more expensive than non-peak-time, and it is in the interests—

  Q243  Laura Sandys: But the consumer ends up paying for it.

  Adrian Haworth: Yes, but—

  Q244  Laura Sandys: Whether one relays it on to the generator or not.

  Adrian Haworth: This is all part of the smart grid evolution. Part of the idea of the smart grid is to solve the problem that you are addressing. If you are paying real-time prices for electricity, you will modify behaviour. That is the theory. I am not sure that that is the whole goal here. It may not be the householder himself, but maybe a co-operative of householders, or however it evolves, will manage the demand side based upon pricing. That is the ultimate goal.

  Q245  Laura Sandys: Let me continue on the different subject of international comparators and international investment models. Are there markets out there that are more attractive for investment? What elements of the market regulation do you find particularly appealing, or offer you longer-term opportunities in different areas that we could learn from?

  Adrian Haworth: From a supplier's standpoint, we are obviously driven by customers. We don't self-develop generally—we are not a utility, we supply equipment to utilities and other independents. We are where the markets are moving the quickest, so clearly a market that has defined the way it wants to go and is attracting investment is where suppliers will focus their attention.

  In the UK, we see that offshore has everything we need for a supplier base—it has the skill set, it has the training, it has the ports, it has the continental shelf, it has the wind—it has everything you need to lead, but if there was activity elsewhere that was going to happen sooner, it would be attractive to us to play in that market first. We all want to get experience and we all want to be early in the market, which is why time is so important. The UK has all the ingredients, but if other markets are moving for other reasons—whether that is due to feed-in tariffs or other mechanisms—and are more attractive to the people buying our equipment, then we will follow them. That is just the way that our shareholders drive us.

  Joan MacNaughton: I agree with that; I would just mention the importance of consistency and predictability. Traditionally we have had a very clear regime—very market-oriented although it has always been regulated—and people have had confidence in the stability of the regulatory framework. We have had some very large investments in infrastructure over recent years, and in plant we don't have a problem with reserve margin at the moment. If investors feel that they have a predictable and stable regime and there is a consistency of principle then they will be drawn to invest. You have a problem if you are chopping and changing every few years—trying this, you don't think it works, trying that, you don't think it works—so it is important that we understand the principles and criteria that will underlie some of these mechanisms, and important to know that they will persist.

  Q246  Laura Sandys: What other markets would you say are at the top of your list for investment due to their regulatory framework and management of the electricity market? What could we learn from them?

  Joan MacNaughton: Again, we are a supplier and it's down to customers, so I agree with Adrian. Actually, I think the UK has traditionally been a very strong market from that perspective.

  Christina Grumstrup Sorensen: From a generator's point of view, we have invested heavily in the UK in the past two years—offshore wind farms in Gunfleet Sands, Walney and London Array, where we are majority owners. We have done that because we have confidence in the UK regulatory framework. I very much agree that rocking the boat should be done with great care and implemented in a good way. I think the industry now needs stability, predictability and a long-term planning horizon. That is why we argue so heavily against the auctioning process, because that will be a major step back in the long-term planning of offshore and will not serve the aim of bringing down costs, bringing in new investors who have not been in the offshore industry before, or developing a supply chain.

  Robert Cross: To echo those points, Statoil have chosen the UK as a market to invest in already, and I think that is reflective of the support mechanisms that are currently in place being sufficient for those projects. I think it is important that future support mechanisms retain some of that auctionality for investors to be able to manage their needs in exposure to the market. The current renewables obligation gives you a bit of certainty and a bit of market exposure, whereas some of the other mechanisms that are proposed in the EMR might not give you that same flexibility.

  Q247  Albert Owen: Sticking with the point that was raised by the Chair about integration with Europe and the interconnectors, how much interconnection do you think the UK will have from neighbouring Europe? Do you think that brings associated risks with it? What is the balance? At the moment, it is very low; we just have the nuclear coming in and the Irish connection. How do you see the market developing? Does that pose risks for the United Kingdom?

  Joan MacNaughton: I would just repeat that I think, in principle, more interconnection will reduce risk rather than increase it, because you have more choices about how to manage your supply and demand balance. Peak demand is at different times. You will have intermittency factors operating in different ways at different times. If you add together the large nuclear component that is France and even the storage from hydro that you get from the Nordic countries, you have, in principle, a very diverse mix. At the moment I cannot, therefore, see reasons why it would necessarily add to the risk—assuming that it is built to all the right standards, which we do.

  Adrian Haworth: Clearly, more interconnection would help the renewables build out, but I think there is a limit to how much you can get in any case. So I don't see that we're going to be wheeling power in from China to the UK. Once you get to a certain point, you start merging peaks, so there's really not much point in having an interconnection. It is limited, and I don't think it's a threat to the UK. It can only be an enhancement to the UK situation.

  Robert Cross: I think it will improve security. The other thing that you have to look at is that there is a European framework within which the UK electricity market operates, which is meant to be driving us towards a single European market. The structure of that market will be important in determining power prices in the UK.

  Q248  Albert Owen: So if we get that harmonisation, will some of the issues that we have been discussing as a Committee, such as emissions performance standards and raising the cost of British electricity, provide some sort of risk that people will be buying cheaper and maybe dirtier electricity from Europe?

  Robert Cross: I think that is why the policies have to be aligned with those of other countries and why there has to be an effort, on a European level, to make sure that countries are trying to move towards the same goals and objectives in the same way.

  Q249  Albert Owen: What would be your advice to the Government on EPS?

  Robert Cross: From Statoil's perspective, we replied to your emissions performance standards consultation and said that we didn't think it was a necessary tool at present and that it may, in fact, draw resources away from investment in things such as CCS, because it basically stops you from investing. It may be something that you want to introduce at a later date, but it is almost as bad to have it hanging over the industry than not having it there at all. We would probably not see it as the best option.

  Joan MacNaughton: Just on that specific point, I can see a case for certain forms of EPS or for an EPS that is, as your report on emissions performance standards set out, surrounded by an appropriate package of measures to incentivise CCS. I don't think that the current proposal actually does that, and I don't think that it is going to drive CCS. In fact, it will drive a lot of unabated gas—grandfathered under the current detail of the proposals—which means that you're going to have higher emissions in the late 2020s than you would without it. So I don't think that the current EPS proposal is either right in itself or necessarily surrounded by the right package of measures. I think it is quite a risky proposal.

  Adrian Haworth: We don't have any comments. We don't think that it's a major piece of the current legislative effort, and it is not necessary at the moment.

  Chair: Thank you for your help. I am sure we will be in touch again.

1   Note from the witness: "such as the ROC Banding Review, grid connection and planning Back

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