Electricity Market Reform - Energy and Climate Change Contents

Examination of Witnesses (Questions 287-338)


15 MARCH 2011

Q287   Chair: Good morning, and a warm welcome back to the Committee. It is good to see you. This is a pretty wide-ranging inquiry we are engaged on at the moment, so lots of angles. Could I start by asking: you have set out the target of getting emissions down to 50g per kilowatt hour by 2030; should that now become explicit in the EMR consultation process? Would you like to see the Government accept that as an explicit target?

Lord Turner: I think that's an interesting question and not one that we have formally considered, whether that should be made an explicit target. We certainly think that achieving a grams per kilometre of there or lower by 2030 is highly likely to be required as part of the path to the 80% reduction by 2050, and that is something that we have a high degree of confidence that we need to be around there. I think the difficulty would be saying, if somebody said, "Well, the optimal figure would be 60g or 40g", the range of precision of 50g. The calculations are not so precise as to be able to say it absolutely has to be 50g. On the other hand, a number of other targets in public life at the end of the day are created as stretching targets, even though the logic can take you to about that range, but not to precisely that figure.

We certainly believe that in the operation of the post-review structure, the Government will need to have a vision of roughly where it wants to be in 2030, because that will determine the amount of the quantity of low-carbon electricity for which it is effectively contracting through the process. So I think, as I say, we haven't thought about what the degree of formality of that target should be. I guess there would be some value in setting it as a formal target and saying, "That is the aim." Certainly, I think when we get down to the detailed operations of the EMR, DECC will have to develop an effective operational target, because otherwise how is it going to determine how much contracting it places? David, do you want to add to that?

Dr Kennedy: We're not saying, "Adopt 50g now" for the White Paper in summer, but we are saying in the letter that we sent to Chris Huhne last week, "A quantity-based approach is needed". It's not that the Government can just set the price and then see what happens in the market. The Government has to have a view of: how quickly do we want to decarbonise the sector; how much investment are we looking for in low carbon? So what we've said is that 50g of CO2 is our best estimate now. Clearly, it should be less than 100g, but is it 50g or 60g, as Adair says? Well, we don't know, and further analysis is needed and that would have to be done in the course of working out the implementing arrangements and developing the contracting strategy.

Q288   Chair: So would you say that you would like them to set something that is less than 100g anyway?

Lord Turner: Yes, definitely. I think that is clearly the range of what we think is required by 2030, yes. It's how much lower than that.

  Chair: It is how to raise the level of ambition that they currently have. They have to raise their level of ambition.

Dr Kennedy: They were working with a number of 100g, and I think they were working with that because previously we'd suggested 100g or less was appropriate. They took that as a given and they worked out: how can you get 100g and how much does it cost? Our new analysis suggests 100g is probably a bit on the high side, given the investment opportunities that we have.

Chair: Redpoint's analysis was based on 100g.

Duncan Sinclair: Correct, yes.

Q289     Chair: Have you worked out what would need to change in the DECC proposal to get it down to 50g?

  Duncan Sinclair: We have done some supplementary work and we have shown that it is possible. It depends on whether it is more nuclear or more renewables to get there. It does have quite a profound effect on the energy market itself, because at that level of decarbonisation, it's quite a big impact on market prices. So although it sounds like a relatively small shift from 100g to 50g, it is quite a profound difference. We think it reinforces the need for feed-in tariffs with CfDs, but we think it is possible. I guess the key risk is around technology, that to set a target as low as 50g, all the technologies are going to have to develop and come to fruition in a timely manner. So there is some risk around that, but at this stage, it looks like it's feasible and the cost of that isn't excessive, given where carbon prices may well go under the Government's forecasts.

Q290   Sir Robert Smith: Yes, I had better remind the Committee of my interest in the Register of Members' Interests as a shareholder in Shell and also that I am an Honorary Vice-President of Energy Action Scotland, fuel poverty.

  Just on this debate, it is quite often focused on where the new capacity is going to come from for supply. What analysis has the Committee on Climate Change done of how we can reduce demand: energy efficiency, distributed generation and demand side responses? Have you been looking at what measures could be used there?

Lord Turner: Yes, I mean, within our forecasts of total electricity demand, we have the assumption that we will continue to achieve electricity demand, use efficiency, energy efficiency improvements in electricity. A significant element of that comes through the residential appliance route, where there has been a rate achieved in the past that we have assumed can continue to be achieved in the future. It won't occur naturally. It has to occur as a result of, for instance, continued regulation. I think this is an area where regulation, in simply banning the very inefficient level of appliances and continually increasing the grading system—when you buy a washing machine, moving up from A to A+ to AA+ and then slowly making the Ds or the Cs illegal rather than simply labelled—that is very important. But whenever we have—

Q291     Sir Robert Smith: So you think the consumer, left to their own devices, is not necessarily going to follow the price signal?

  Lord Turner: I think that is right. I think the consumer, left to their own devices, the price signal for some consumers is not strong enough. I mean, the fact is that at medium or higher-income levels, the amount of electricity used on domestic appliances, although it's still significant, is not a large enough part of the family budget that there is a very strong focus, left to themselves, on the price sensitivity. People seem to be somewhat more sensitive to needing the trigger of when they buy the new appliance, information and guidance and encouragement and an element of regulation that moves them away from the low-efficient ones and more towards the high-efficient ones. When they do that, they are aware that they will get a benefit from it, but they need to be triggered and encouraged down that route. Left to itself, it's unlikely to do it.

  The net effect of all the energy efficiency though is even with significant amounts of energy efficiency, we still believe that from the 2020s onwards, we will have rising electricity demand across the system because of two major new areas of use of electricity, one of which is in surface transport through electric cars, and the other is the application of electricity to, in particular, domestic heat through ground-source and air-source heatpumps. It's those two new forms of applications of electricity that we believe will inevitably overwhelm even important and significant improvements in the efficiency in existing uses.

Q292   Sir Robert Smith: Do you think more can be done though to make the housing stock more efficient to reduce that demand for heating?

  Lord Turner: Oh, yes, we undoubtedly need to do that. I mean, at the moment, of course, the vast majority of residential housing is heated by gas, not electricity, so at the moment, the improvements in the energy efficiency, the insulation of the housing stock, which are extremely important, translate into reduced gas usage. However, once we start moving to an increasing element of electrical heat, the improvements in insulation will be helping to moderate that increase. Indeed, it's particularly important, because the efficient way to run with an air-source heatpump or a ground-source heatpump is to have low level of quite low background heat, which only works efficiently when you have a well-insulated house. They're not very efficient in terms of the way that some people heat their house at the moment, which is to have a very inefficient house and then blast on some intense heat into a particular area. That way of heating your house just doesn't tend to work well with the air-source or ground-source heatpumps.

Q293   Sir Robert Smith: Did the Redpoint analysis do much on demand side and efficiency?

  Duncan Sinclair: We did, and we took DECC's views on demand going forward, taking into account the Green Deal. We also looked at an overall flattening of demand shape associated with, for example, heatpumps or with electric vehicles, assuming that there were some price signals to encourage consumers to flatten their demand. We took that into account and we also recognised the possibility that the demand side could play in providing additional capacity and helping with the security of supply issue, so that was all taken into account. I mean, the big uncertainty is smart metering, with the roll-out of smart meters. There's a lot of interest around what that could do in terms of changing consumer behaviour, and I think that is definitely a positive sign in terms of how security of supply could be managed, so there are some good opportunities there going forward. So we looked at it semi-quantitatively, but also looked at some of the qualitative issues around the technology unknowns at this stage.

Q294   Sir Robert Smith: How did you assess the Green Deal's impact?

Duncan Sinclair: We didn't assess it directly. We sort of took the assumptions from DECC in terms of what they felt the impact would be on electricity demand, so we didn't get into the details of that. That was an input into the analysis.

Q295   Sir Robert Smith: Finally, was there any analysis given to the potential role of storage and interconnection to other electricity markets in Europe?

  Duncan Sinclair: We included some additional interconnection. We took some relatively conservative views of the additional potential. There's certainly again upside in terms of security of supply and this may also reduce the cost of managing the intermittency around renewables. So that's definitely an issue, but as I said, we took some relatively conservative views on the super-grid, for example, going forward.

Q296   Dr Lee: Putting Japan to one side and their short to medium-term need and desire for gas and so on, to what extent have you factored in possible imports of shale gas, liquified natural gas, into this? We have just been to the US and they were talking about changing a terminal potentially so that it started to export gas, as opposed to just importing. Do you see that causing any problems to your calculations?

Duncan Sinclair: The gas assumptions and the price assumptions were again DECC's assumptions, and the central case has gas around where it is currently and rising gently, about 3% year on year in real terms to 2030. So that's probably at the higher end of where some analysts are expecting it to be. We also looked at a low-gas sensitivity as well, and it's clearly the case under lower gas prices the cost of some of this looks higher. But the risk is with low gas prices is we don't achieve the decarbonisation objectives that we've set out to achieve, and therefore while the analysis could show with lower gas prices lower cost for consumers, it may also show that we haven't reached the environmental objectives. So it's a difficult question, that one.

We weren't trying to evaluate the rights and wrongs of whether we should or shouldn't invest this money in achieving these targets. We were just looking at the analysis around, if we are going to try and achieve those targets, what is the most cost effective way of doing it? That was the focus of what we did.

Dr Kennedy: Just to say our analysis says we should not change the objective, to move to a low carbon power system. I think there is a myth around, which goes something like: we are going to have this low-cost gas, so we can decarbonise based on unabated gas fire generation. That's not true, because you can't decarbonise using unabated gas, because it is carbon intense, not as carbon intense as coal, but still carbon intense. Now, our analysis says, "Would you change the 50g target, for example, in a low gas price world?" and the answer is no. So the decarbonisation strategy is robust for a different set of scenarios for gas prices. Even in a low gas price world, you would still want to decarbonise the power sector. It tells you that gas CCS may be a very valuable option to have in your portfolio, and so we have stressed the need to have a gas CCS demonstration project, which then can sit in the mix going forward in the 2020s next to nuclear and to power agreements.

Q297   Dr Lee: I guess my point is that, if it wasn't for shale gas, that would be a bit easier for the renewable market, wouldn't it? The suggestion is that suddenly we found all this gas that we did not know was going to be there. If the gas had not been there, then the rest of it would then become, in the eyes of the public, more justifiable in that they would be thinking, "Well, we cannot get our power from gas, so therefore we are going to have to get it from renewable sources". I am just suggesting that this flood of gas—and it would appear that there is vast amounts of it—

Dr Kennedy: I think it makes it harder to sell the story that we need to decarbonise, because people think we can decarbonise with this cheaper source of fuel, but it's not true.

Q298   Dr Lee: Do you think it would be perhaps, if you could choose, better to have a low-carbon target instead of a renewables target?

  Lord Turner: This is something that we have to give advice on in May in our Renewables Energy Report. We clearly are attracted—as we were discussing earlier—to very strong targets expressed in grams per kilowatt hour. We also think that it is important to think about how much of the system should be zero carbon, whether nuclear or renewables, but we don't think that we should throw away the aim of a renewables target as well, because in the long term, by 2050, we have to be close to zero grams per kilowatt hour in the electricity system. I think there are good arguments—even if you believe that nuclear was the cheapest option—for not putting all of your eggs in that basket. I mean, there are things to do with waste; there are things to do with over-reliance on any one technology, which I think says that even if you believe nuclear was the cheapest option, you would want a balance of nuclear and renewables.

So I think it is highly likely that when we come back in May, we will not be suggesting that we should no longer have a renewables target as well. We think that is a useful part of the story, but it certainly needs to be combined with an approach to all three of what we see as the key sets of a low-carbon technology, which are: renewables, in the way that that term is used, nuclear, and the application of CCS, particularly the gas. I think increasingly we think the long-term future of CCS may be applied to gas, rather than, as people used to think a few years ago, exclusively to coal.

Duncan Sinclair: I think it's definitely the case that the 2020 target is pushing up the cost of the renewables, because it's a very, very rapid timeframe and the analysis suggests that a sort of slower glide path, still going to where you would be in 2030, the same renewables, same amount of nuclear, but on a slower trajectory would be a lot cheaper. You have to pull out virtually all the stops to hit the 2020 target and that's going to incur cost and cause pressure on supply chains and pressure on available sites. Then what you find if you hit the 2020 target, your rate of renewables deployment in theory could slow right down, and that's not the most cost effective way of achieving it. So there's no doubt the EU target does put additional constraints that are economically challenging, where the target for 2030 and the 50g a kilowatt hour could be achieved cheaper if that was not the case.

Q299   John Robertson: If you were to go from the 2020 target to the 2030 target, what is to say you would not go then for a 2040 target and a 2050 target? What kind of, shall we say, putting that into tablets of stone has to be there, because eventually you have to draw the line somewhere? If you take away the 2020 target, then do we have a knock-on problem?

Lord Turner: We see that by 2050, as I mentioned a moment ago, if the UK is to meet its legislative Climate Change Act 80% target, then electricity essentially has to be pretty close to zero grams per kilowatt hour or 5g per kilowatt hour, you know, a trivial amount, because the figures simply do not add up otherwise, given the difficult-to-reduce sectors, which include agriculture and bits of industry and aviation, areas where there are emissions to which we cannot see technological ways of entirely getting rid of them. Given those difficult-to-reduce sectors, we believe that electricity decarbonisation essentially has to be pretty close to total. There may be a small amount, because you may still have non-100% CCS gas plants providing the last margin of production capacity.

So when we talk about a target of, let us say, 50g for 2030, what we described—and we described in our fourth budget report last December—is that there is further steps thereafter. Having said that, of course, most of the steps are achieved by 2030. We are now on 490g per kilowatt hour, I think it was, 2009. It will then be at about 300g per kilowatt hour by 2020, below 100g by 2030. You know, we will have achieved most of what we have to achieve then, and then beyond that, there would be further progress on, in particular, hopefully CCSing any unabated gas. So, yes, we see that as a long-term path to 2050.

Dr Kennedy: There's a practical reason to have a 2030 target, which is given the very long lead times for projects. If you look at nuclear, that's a five-year construction, two-year development. What we do over the next 10 years will determine the power system we have through the 2020s and in 2030, and so we need that target to frame our thinking and our actions over the next five and 10 years.

Q300   John Robertson: I mean, it appears to me that you put CCS as "it must happen" rather than "it may happen."

  Dr Kennedy: We need to see if it is technically feasible and economically viable, so cost competitive with renewables. It certainly will make decarbonisation easier through the 2020s and beyond. If you did not have CCS, that raises the question, could you still decarbonise at the same pace, and I think the answer is yes. It will be more challenging; it will possibly be more expensive, but we would do more of nuclear and renewables. Ideally, we'll have CCS in the mix and that will help drive this decarbonisation.

Lord Turner: Without CCS, you'd have to do more nuclear, more renewables and it would increase the importance of the super-grid interconnectivity across Europe to balance the renewables, because you'd have a system that you couldn't simply easily balance through the gas-fired.

Q301   John Robertson: Is there a plan B?

  Lord Turner: There is a plan B. Most of the modelling says that if you knock out the possibility of gas CCS, it is still doable at a not absurd economic cost. It is a higher economic cost, but it doesn't dramatically increase, but it is simply more difficult. The best way forward is with all these three sets of technologies to be part of the mix.

Q302   Sir Robert Smith: Lord Turner, you mentioned sort of in passing the future of the gas CCS being almost a swing generator, but apparently the first generation of CCS is going to be very much baseload, because it is not the kind of thing that likes to be switched off and on.

  Lord Turner: Yes, well, you're quite right, that initially, because CCS in itself is quite capital intensive, you can't just use it at the swing.

  Sir Robert Smith: Also the process itself.

  Lord Turner: Yes, the process. No, I agree with that. Indeed, it has to be, and provided it gets efficient enough, it can be a part of the permanent baseload as well. I mean, the crucial thing here, which is one of the things that has to be focused on in CCS for the long term, is how efficient it is. Does it take out 80% of the carbon or 90% of the carbon? We sometimes talk of this as being sort of CCS or non-CCS. One of the crucial things that we are going to have to get down to is what percentage is achieved. If it can achieve very high percentages, then it can be part of the long-term baseload as well as the rest.

Dr Kennedy: We should stress though that the baseload that we have at the moment, which is kind of 30 to 35GW on the system, we envisage will increase very significantly over the next 20 years because of the demand for overnight charging of batteries for electric vehicles and because of storage heat that is electric. Now, the scenarios we have actually add the capacity to run as baseload, whether it is gas CCS or nuclear.

Q303   Chair: Given the importance that CCS is likely to have in relation to achieving these targets, does it worry you at all that with the prize of £1 billion of public money available for competition, that competition only attracted one entrant?

Dr Kennedy: Well, I think the key is that we have four potential demonstration plants. We are very interested in the second competition, which is for the second, third and fourth demonstration plants. My understanding is that, in terms of expressions of interest, there are a lot of expressions of interest. Within that, there are some very serious project proposals that DECC is considering at the moment. So I think the test of this will be the second phase. I think it's important to go on with the Longannet project and get that into construction, so to get the contract signed and to move forward, but also to move forward with the second competition and get those other three projects, of which one we stress should be gas CCS. So that's the key for us, the second phase.

Q304   Christopher Pincher: Without naming names, are those expressions serious expressions of interest from members of the Big Six, because I spoke to two of them this week and last week and those two certainly were not interested, so that leaves you with four, of which one is already in there. What about the other three?

Dr Kennedy: As far as I know, not having looked at the details of this, there are some big players within the Big Six who are interested in doing demonstration projects; not all of them, but some of them. As I say, I think there are enough serious proposals that are there for consideration to make us feel reasonably confident about this. I think the bigger issue actually is confirming and securing the funding for this second set of demonstration projects. That is something that the Government, I understand, is going to comment on over the next several months.

Q305   Chair: Just reverting to the question of the technology mix, the challenging 2050 target and the possibility that we may flooded with cheap gas and therefore a lot of gas capacity is built in the next 10 years, do you think that a 35% contribution from renewables in 2030 takes us far enough to get to the near total decarbonisation in 2050?

Lord Turner: Well, this is precisely what we will be setting out in the renewables review. We're looking carefully at precisely these figures; we were debating them just on Friday. Obviously, it crucially depends on how much nuclear you think should be in the system and the prospects for CCS. It is as simple as that. That's the balance that you have to strike there. So that's whether you need to put it higher, and then whether you can take it higher at a reasonable cost depends crucially on what we think is going to happen to the cost of offshore wind. Now, there are reasonable cases from forward-looking engineers that over time, this thing will come down in cost, in particular with, for instance, movements to very, very large turbines, for instance, even 20MW turbines and so on, and just the relentless process of engineering cost improvement that typically happens with a technology. If those are achieved, there will become a point, I think, by 2030 or so where offshore wind will not have the cost premium over nuclear—or maybe even over onshore—that it has at the moment. At that stage, you could then expand the renewables element of the total mix without facing a cost penalty.

As Duncan has said, there is, however, undoubtedly some cost penalty in the pace at which we are going to 2020, because over that period of time, you just do not have enough time for the cost improvements to work, and also there are some bottlenecks in the supply that drive up the cost. So we are looking at the issues. As Duncan has also said, at the moment, there is a danger that we have a ramp-up of offshore investment to 2020, then a drop and then a lower level in the 2020s, which certainly does not make sense in terms of a consistent supply industry slowly driving down cost. It is, therefore, possible that the optimal path might eventually, if these costs reductions are indeed achieved, have a slight moderation of the targets to 2020, but an increase in the long-term target.

But what that illustrates, I think, is that while you need a broad direction of change, and while we'd certainly say that there needs to be a minimal renewables target that should form the contracting within the new market review, you do not need to be precise. You need to know that, as part of your strategy, you want it to be at least 30g or 35g by 2030, but you do not need to decide whether the balance in 2050 is 35g, 35g, 35g between renewables, nuclear and CCS or 40g, 30g, 30g. You do not need that. Indeed, there is a loss of flexibility by setting things too far in advance, even if you set certain minima to drive the development of the technologies.

Duncan Sinclair: I would agree with that. I think that at this stage, it's just too early to say. We are on a path of learning on multiple technologies here, and by the 2020s, presumably we will not be in the situation we are now. I would expect that two of the three technologies will be demonstrated to be a low-cost option and we will start gravitating more towards those options. So at this stage, we are talking about a balanced portfolio in CCS, nuclear and renewables. It may well be by the time we get further on—10 years', 15 years' time—the winner is a bit more obvious and we're starting to sort of consolidate on the lowest cost option. So I agree with Lord Turner. I think to say explicitly, "You have to have this target for X, Y, Z" is probably wrong at this stage. We need to have some flexibility there as well.

Q306   Chair: Your analysis showed a roughly—what was it?—a similar level of renewables, whatever the scenario. Was that because we do not know enough or because you simply built in a 35% assumption for renewables?

Duncan Sinclair: That was just because that was an assumption given to us by DECC, so we kept that constant across the cases, because I think if we hadn't done that, then the different costs in renewables would have then kind of drowned out the messages with respect to the effectiveness of the different policy options. So we deliberately kept that fixed.

Q307   Albert Owen: Yes, can I just try and consolidate what you have been saying about unabated gas? You have commented on a number of occasions indeed, Mr Sinclair, today that too much unabated gas from power stations might jeopardise the UK's long-term targets, and can I bring you back to our inquiry on EMR and the EPS within that? Do you think that the EPS will allow unabated gas plants to be built as in the consultation documents?

Duncan Sinclair: Certainly at the levels set out in the consultation documents, yes. Obviously, there's a concern from investors that once the legislation is in place, that could be tightened up, so that does create some risk for them. But it's one of those things that I think, given security of supply is another key issue here, it seems to me very unlikely that the EPS is going to be assessed at a level that jeopardises security of supply. Therefore, if we need new unabated gas for security of supply, I think the assumption should be that that should be allowed, or else we are going to have a security of supply problem. So I think the EPS in some ways is an added backstop. That's not entirely necessary, given the other measures, but it is there as a backstop.

Q308   Albert Owen: Phillip Lee mentioned that we had been the States on the shale gas thing on another inquiry that we are doing. Do you think there is a possibility of another dash for gas in this country? What analysis have you done of that and how that will impact on the targets?

Duncan Sinclair: I do not think there's a risk of that currently, because I think everyone is nervous around—

  Albert Owen: It depends what we are talking about "currently". You say in 2020, 2030, 2050. I mean, if the dash for gas was to come onstream relatively quickly, then it is going to impact on your targets.

Duncan Sinclair: It would do, but again, it depends on what happens with the feed-in tariffs. If the feed-in tariffs are being offered and plenty of low-carbon technology is coming forward through that mechanism, then the room for gas is going to be squeezed and that's going to put pressure on price and that will deter investors. So by definition, the CfD policy is failing if we end up with a dash for gas. I think that's the case.

Dr Kennedy: It comes down to the credibility of the new arrangements. If that carrot that says, "If you invest in low carbon, we will pay you for it", if that works, then we won't have a dash for gas. If nobody buys that story and wants to sign these contracts and bring on the low carbon, I think there's a risk that you get some portfolio investment instead with some nuclear, some renewables, but also some unabated gas. That's why you might want to consider, "Well, what can we do in terms of stick, which says, 'We don't want unabated gas on the system behind a certain time'?"

Q309   Albert Owen: Sure, I mean, some of the experience that we picked up in the States was basically that, although they had invested heavily in renewables, wind, now the dash for gas was pushing that back and there are less ambitious targets. This is the danger. Do you see that?

Lord Turner: I think the answer is: it entirely depends upon the tightness of the overall policy framework. I think given the possibility—not certainty, but possibility—of the scale of the supply of shale gas in particular, it's certainly possible, indeed, I think likely, that if we didn't have a Climate Change Act, an Electricity Market Review and a set of constraints, we would, as it were, see a new dash for gas or an intensification of the dash for gas. I mean, gas is the safe option in terms of the balance between marginal cost and capital intensity. So the issue is simply what are the constraints that constrain that through the renewables objective, through the details of a target for grams per kilometre, through the scale of the contracting, the contracting for differences for effectively the feed-in tariffs for low carbon? Those are all mechanisms that essentially constrain it. In an unconstrained world, yes, the supply of shale gas might well mean that people would build less renewables and less nuclear, because if the forecasts of large supply are there, then that is quite a new, pertinent fact.

Q310   Dr Whitehead: Mr Sinclair, you mentioned the role of an EPS as a backstop. What is your view on the relationship of the levels that are being consulted on in the context of the idea of a backstop? It appears certainly that the high level would permit only very marginally greater coal, perhaps even by the addition of some biomass, and the lower level would permit pretty widespread unabated gas. Therefore, it might appear that this is not a backstop but a non-stop. Would that accord with your analysis or do you think there is a role for EPS at those sorts of level?

Duncan Sinclair: To be honest, I think it potentially is redundant, because with the Carbon Price Support and with the support for low carbon through CfDs, naturally the higher emission plants should be pushed off the system through the basic economics, because they get pushed out of the merit order. If they are not, that implies that we need them anyway for security of supply, and so if anything, the EPS is an unnecessary complication that could threaten security of supply. That is my own personal view. You know, EPS as a mechanism, as a stick, is a possible option, but you might want to pursue that if you were not going down a Carbon Price Support or a CfD route. It does seem a little bit like overkill to have both in place, in my own personal view.

Dr Kennedy: We have had a slightly different perspective. The wording in our letter to Chris Huhne last week says, "At the level proposed, it will not have a material impact on investment decisions". We have suggested a tighter level. For example, the alternative proposal in the consultation, which I think was about 450g rather than 600g, that would tell you, if you're thinking of investing in unabated coal, you better be planning to retrofit it, which is an important issue. Then a tighter performance standard still would tell you: do not invest in unabated gas beyond a certain time. So there is a potential usefulness in those backstops.

We have not suggested you necessarily would introduce them straight away, for example, in the case of CCS, to prevent investment in unabated gas. It may be that the market arrangements pull through low-carbon investments and you don't need it, but what we have said is that certainly you shouldn't rule those things out at the moment.

Q311   Chair: In that letter, you suggested an alternative, which would be a forward contract for low-carbon capacity, alternative to an EPS. Would you like to enlarge on how that would work?

Lord Turner: Well, we certainly think that the quantity-based instrument is absolutely fundamental here. Essentially, what we are proposing—but also the Government is heading towards this in its response—is a mechanism whereby an investor in low-carbon plant has the certainty of a future quantity times the future price. That can be done. You can do that by directly setting it up as a feed-in tariff, or you can essentially do it by having a contract for difference from a fluctuating price.

We see that as the absolute core of the way forward. We think all of the debates about the EPS are whether or not there is a useful ancillary set of policies, but the core policy we believe is these effective feed-in tariffs. We are arguing that they need to have a quantity element to them, that people are assured of the ability to deliver a certain quantity at a particular price, rather than simply a price but no assurance of quantity.

We also believe that this is preferable to premium feed-in tariffs. Premium feed-in tariffs essentially give you a little bit extra above the fluctuating price, but can be quite expensive ways of buying low carbon. You can end up paying more through that mechanism than you would if you simply did a straight feed-in tariff or contracts for difference.

So essentially, we are saying we need to get as close as possible to—and essentially, all the way to—a mechanism where for a certain proportion of their output, a low-carbon investor knows in advance, or has reasonable certainty in advance of the ability to deliver a certain quantity of electricity at a certain price, and to us, that is the core of what needs to be achieved in the Electricity Market Reform.

Q312   Christopher Pincher: Can we talk a little bit more about CPS? You mentioned, Mr Sinclair, the play-off against using EPS against Carbon Price Support. Lord Turner, with your previous hat on in the City, EU ETS is a mechanism for setting a carbon price, but the view is that that is too low to change behaviours demonstrably; therefore, further CPS is required. I just question whether applying that price unilaterally will have a deleterious effect on industry, on the economy, and if it does have that effect, will investors not be less likely to want to invest in it?

Lord Turner: Well, a couple of points. First of all, I think the difficulty with the EU ETS is that it is at the moment far too weak an external constraint. I think there were always some concerns as to whether the total quantities set in the ETS, and in particular the ability to meet them through clean development mechanism purchases, was too soft. But the impact of the post-crisis recession, which therefore decreased total production and demand, has led to a situation where the prices within the EU ETS are simply too low to do the pull-through of a low-carbon economy. That is point one.

The second point is that I think if you go back to Nick Stern's work on the economics of climate change and whether you best incentivise low-carbon technology through a fixed-price instrument, where you—the Government, as it were—sets the fixed price of carbon, or a quantity instrument, which constrains the quantity and allows a fluctuating price, you'll see there and in a lot of the economics literature, a suggestion that the optimal way forward is always probably a hybrid. It's to have some quantity limit with a fluctuating price, but with some carbon underpin within it.

So to us, the ideal way forward here would be if we could get our colleagues across Europe to agree to a tightening of the European EU ETS, with moving to a 30% target, combined with an underpin price within the EU ETS. That should still be our objective.

In the absence of being able to get that, we believe there is a strong case for a carbon price underpin in the UK. You are absolutely right that you then have to think what about the effect is on the competitiveness of potentially mobile industries. In relation to electricity, broadly speaking, it is not a highly potentially mobile industry, which is why, for instance, across Europe we've been able to move towards auctioning within EU ETS the permits, and people have argued very strongly against that in the non-electricity sectors. So a carbon price underpin, as it relates to the electricity sector, can work well.

Obviously, there are then difficulties of how to apply that and at what level to the non-electricity sectors. And if you get it wrong, and if you get it too high, then yes, you could start inducing a movement of steel production from one part of Europe to another, which would be neither beneficial to the economy, nor of any benefit in terms of the carbon emissions. So I think there is a crucial distinction there between electricity and non-electricity sectors.

Dr Kennedy: People have said, "Well, if you have these long-term contracts, why do you need a carbon price underpin done, because it's the long-term contracts that will drive the low-carbon investment". We have highlighted four benefits of a carbon price underpin in the context of the long-term contracts. They are: first, it gives you the signal not to invest in unabated coal generation, you have to think about retrofitting it, which we have suggested is a key issue; secondly, I think it will strengthen incentives for energy efficiency improvement; thirdly, it will help investors make choices within these new arrangements about investment in coal CCS and gas CCS, where you need to know what the carbon price will be in the future; fourthly, I think it is consistent with the Government's objective, which we think is a sensible objective, to increase the share of green taxes within the overall tax take. It will provide a revenue source to finance low-carbon innovation, and particularly CCS demonstration.

Duncan Sinclair: I think, overall, the cost of decarbonisation is going to be fairly high upfront, and hopefully the savings will come later. So that is the thing that's potentially going to have an impact on competitiveness and consumer bills. So that is kind of a given. The Carbon Price Support is an element of that. The problem with it, or potential problem, is it created unintended consequences, because we have an interconnected electricity market and we are going to have the possibility that we have more imports into the country from emitting plant from elsewhere in Europe.

Q313   Christopher Pincher: It does not have any Carbon Price Support and, therefore, benefits from our high prices, but is not any cleaner.

  Duncan Sinclair: Yes, I think that is a problem with it. The other potential problem with it is that, while it is generating additional receipts for Treasury and that is fine, we are estimating at about 25% of the cost of the CPS is going to inflate profits for existing renewables and nuclear generations, so that is increasing the rents for those players. So there are some downsides with it. As David has mentioned, there are some potential advantages, but those have to be considered quite carefully in the context of the additional cost to consumers in the near term.

Q314   Christopher Pincher: You mentioned downsides. What do you think is the biggest downside?

Duncan Sinclair: I think the biggest downside is we distort the economics of the electricity markets across GB, Europe, and also in Ireland as well. That is an unintended consequence and that's not achieving any additional carbon reduction. It is not probably achieving any additional low-carbon investment, because we have the CfDs. Therefore, it is increasing cost to consumers. It may be we can shift taxation in other areas to compensate, but we have an interconnected market. It is going to get more interconnected. By far the preferable solution, as Lord Turner suggests, is that we have a European-wide mechanism and a European-wide underpin and then I think it's a viable option, but to do it unilaterally, it does incur significant risks.

Q315   Christopher Pincher: Do you think we are doing enough to prepare the public for the potential, or indeed, the likely higher prices, given that there is much more likelihood of that than getting a European agreement?

Duncan Sinclair: No, I do not think we are. The question is an intergenerational question here, which is the extent that consumers over the next 10 years are paying more for their electricity to save consumers in the following decades for the cost of their electricity. That's quite a significant shift. I think that needs to be probably understood and the public need to be aware of what those costs and trade-offs are.

Lord Turner: Though that is a slightly different issue or a wider issue than the specific one of a UK unilateral carbon price underpin, because that cost would still arise from a European carbon price underpin, or indeed from a contracts for difference or anything that involves a carbon price and a commitment to low-carbon technology, to the extent that that is higher cost. I mean there are non-trivial increases in electricity bills that are going to occur. I think we believe those are small in the context of the total economy, but they are non-trivial and they will be noticed. I think it is important for us to be honest with people that that is part of the cost of achieving progress towards a low-carbon economy.

Q316   Chair: Given that even in Phase III the EU ETS is unlikely to drive very significantly a high enough carbon price and to tighten the limits in Phase III requires unanimity, and we are not going to get all 27 countries signing up, do you think we may have a problem here? If for perfectly normal reasons we introduce a carbon price, which critics will say is much higher than the EU ETS price and, therefore, we are simply penalising British consumers and making us less independent, is that going to be a political challenge, do you think?

Lord Turner: I think the crucial thing there is to explain that this is also producing a revenue flow for the Treasury, without which there would presumably be higher income taxes or higher taxes elsewhere. This has always been the challenge with green taxes to explain to people that, within a fixed total amount of revenue that the Treasury needs, more tax from this is presumably at the benefit to something else that is lower elsewhere. That is the overall case that I still think needs to be made more effectively for a shift towards green taxation, of which, however, we are strongly supportive.

Q317   Christopher Pincher: Lord Turner, you mentioned that prices are going to go up and you said that the impact will be non-trivial.

Lord Turner: Yes.

Christopher Pincher: Granted that it is your opinion and that, if you increase the tax take, there are ways in which you can then offset the increased costs, what would your view of a non-trivial uplift in prices be?

Lord Turner: Can you remember the actual figures? David is probably closer.

Dr Kennedy: Order of magnitude over the next 10 years, we would expect the carbon price impact within electricity prices to be less than a 5% increase. I think the impact from financing offshore wind under the renewables obligation, again, about 5% there.

Lord Turner: So it could be a 10% increase.

Dr Kennedy: That is electricity bills. I think you need to bear in mind electricity bills are a small percentage of energy bills. If you translate that into energy bill impacts, I think you are looking at 3% or 4% through the combination of the carbon price and the renewables obligation.

Lord Turner: The problems get most acute of course with a subset of the housing stock that has electrical heating in it, often correlated with relatively low-income people. That is where these figures become much more important and significant. For many people who heat their house at the moment with gas central heating and are middle-income people, that 10% on their electricity bills is not trivial but it is not a major threat to their household budgets, but there is undoubtedly a subset where there is. That is why we need to continue to have policies and an element of targeting within the Energy Efficiency Policy, which tries to make sure that we are improving the insulation and the electricity of those houses in particular.

Dr Kennedy: There is enough energy efficiency potential to largely offset those price increases. The question is: can we unlock that potential through the Green Deal? I think that is an open question.

Duncan Sinclair: To reiterate, it is a timing issue that the bills will seem to increase in the near term, but the analysis we did for DECC suggested that from the mid-2020s onwards the prices would be less, under the CfD in particular, because consumers are protected from the increase in fossil fuel prices and carbon prices going on from there. So it is that trade-off between paying now potentially for gains later, but of course that critically depends on what you are seeing gas and carbon prices will do in the future.

Q318   Dr Whitehead: Could I take the question of CPS and interconnection a little further? At present, interconnection counts for something like 3% of our electricity supply in any one year. With the proposed introduction of new interconnectors, and possibly even the emergence of a European super-grid, have you done analysis on the point at which the supply, as a proportion of UK electricity, undermines the potential of a Carbon Price Support to the extent that it becomes a brake on that interconnection; that is, is there a point at which you either go for interconnection or you continue with Carbon Price Support, assuming it is UK as opposed to European CPS?

Duncan Sinclair: Yes, if the Carbon Price Support level is consistently higher than the EUA price that potentially will stimulate further interconnection. Most of the interconnection investment at the moment is looking at the opportunities of arbitraging between two markets, because the generation mix of some of our near continental neighbours—France excepted—is quite similar, so the concept is very much around balancing around wind, and so on. If there is a systematic bias that gas or coal-fired generation in GB is a higher cost than elsewhere, then that will naturally lead to greater flows into the country rather than out of the country. So I am not sure whether that answers your question, but it potentially could have an impact going forward.

Clearly, interconnection is a good thing, to the extent that it helps security of supply and it is a more efficient and cost effective way of balancing interconnected markets. It is not an economic solution if it is being built to address distortions created by unilateral policies in one market or another.

Q319   Dr Whitehead: I think the thrust of my question is that eventually, if you wish to pursue a unilateral CPS arrangement, at what point would you have to discourage interconnection in order to maintain that policy.

Duncan Sinclair: Oh, I see what you are saying, yes.

Sir Robert Smith: Where is the tipping point?

Duncan Sinclair: Yes, good question.

Lord Turner: It is a perfectly valid point. When I described electricity earlier as primarily a non-internationally competitive market, that is—you are absolutely right—based upon the fact that the interconnector is a relatively small part of it. If you had a significantly different carbon price in the UK than elsewhere, over a period of time in which people could respond to that by building gas plants somewhere else, and building the interconnectors to do it, yes, you could have a problem. You are absolutely right. I do not think we have calculated at what level of price, or at what level of interconnection, that would occur but you are logically right to spot that as a problem.

Dr Kennedy: We do want significantly increased interconnection over the next two decades to balance intermittency. This could become more of an issue. We have not looked at that particular cut off. I think it takes you towards saying we should not do this in a vacuum, and we should be looking for a set of arrangements at the European level that make us confident that Europe is decarbonising its power system, partly through a tightening ETS cap, but possibly through the kind of arrangements that we are looking to introduce here, which is the low-carbon contracts. We know that there is a lot of interest in Brussels in this issue and the kind of reforms we are looking at here, with a view to making those a model for Europe.

Duncan Sinclair: There is another related issue, which is perhaps even more significant in the long run, which is: if we are supporting our low-carbon investment here and we are driving down our own electricity prices, we could be exporting power to continental markets. That could be at the cost of UK consumers who are paying the additional support prices. So I think the general message is that we cannot really afford to be too far out of whack with what our interconnected neighbours are doing or else we are going to have economic distortions, which perhaps are not sustainable. So I think the UK taking a lead is kind of where we are at. It is going to be a good thing if everyone follows suit. If they do not, it is going to become harder and harder to sustain a unilateral policy.

Q320   Sir Robert Smith: Would you say that the priority is probably the super-grid or a highly interconnected market? It is probably a better long-term solution for the problems we are facing.

Lord Turner: A highly interconnected market, with a tighter EU ETS and a carbon price underpin across Europe, is policy nirvana.

Q321   Sir Robert Smith: If you cannot get the tighter market, do we then have to become unilateral and not become part of a super-grid and go it alone? That is the process.

Lord Turner: I think we have to find a way to be part of a super-grid because eventually, at the whole European level, I think there are some significant, potential efficiency improvements from greater interconnectivity, particularly the higher you push the renewables percentage. It is the renewables in particular, with their intermittency, where you need the interconnectivity to reduce the cost at the margin.

Dr Kennedy: As well, are we going to be out of whack with Europe? If we look at the 2050 Pathways work, which was published I think last week, it says that they are aiming to decarbonise at the European level. In the view of the Commission, that is what they should be aiming to do, possibly at a slightly slower pace than we are here because of the differences in capital stock in the UK and on the continent, but as you get into the late 2020s and into the 2030s, we would broadly be in the same place.

Sir Robert Smith: In earnings, but maybe not in mechanisms, I suppose is the problem.

Dr Kennedy: I think the next stage for Europe—and certainly DG Energy has to come up with its 2050 analysis by the end of the year—will be to start to consider the kind of things we are thinking about here in the UK and respond to that.

Q322   Dr Lee: My policy nirvana would be—and I would be interested to know your comments—why do we not disconnect continental mainland Europe; connect with the Norwegians; double our nuclear build; reduce our energy need by 20% through efficiency programmes? In view of the fact the Norwegians have not maximised their hydroelectricity output at all, they have a vast amount of gas, which is the cleanest extracted gas on the gas market.

Lord Turner: The answer is that does heavily depend on your attitude to nuclear. At the moment with the figures we are looking at, it would look that nuclear might be the lowest cost low-carbon electricity right now. There are some figures that suggest that that is not necessarily the case in 20 years' time, once other things have gone down a price reduction path, and I think the attitude of the committee is that there are some disadvantages in a strategy, which is, as it were, the French strategy of going for 80% of your electricity from a nuclear basis. You can clearly. It is clearly technically feasible.

Dr Lee: I am not advocating that.

Lord Turner: All right, well, then it becomes a matter of balance because, if you are not advocating that and you are still limiting nuclear, and you are still committed to achieving the 80% overall reduction Climate Change Act by 2050, which requires the decarbonisation, then you still need a very significant element of renewables. Then there is a value in that being able to balance, not simply against Norway, but against other bits of Europe as well.

Q323   Dr Lee: If you have gas CCS, hydroelectricity and nuclear, you are not using carbon.

Dr Kennedy: It depends on what potential there is in Norway to export hydro—

Dr Lee: You are not using carbon, are you?

Lord Turner: Of course, that crucially depends on the gas CCS.

Dr Lee: Yes but, with respect, everything does.

Lord Turner: No, no, absolutely.

Dr Lee: We are all fingers crossed, aren't we, with CCS?

Lord Turner: I return to the point we made earlier: given the uncertainties, we think this is absolutely an environment where sensible policy does not limit itself to two of the three main categories of options. As between nuclear, renewables and gas CCS, all of which are different ways to a low-carbon future, we believe that a rational policy has a significant element of each of these in the mix, with the precise amount of it not something that you can or should fix at this time. So that is our approach.

Q324   Dr Lee: My point is this renewables target, which is Europe dictated, seems to be pushing us down a path of increased subsidy, something that maybe we should not be doing. Maybe if we extracted ourselves from the European mainland and its approach, and physically disconnected because the reality is we are relying upon all of our European partners behaving themselves with regards to how they generate electricity. By doing that, are we not more likely to get to a situation where we do meet all our carbon targets and, at the same time, retain some stability with a secure neighbour, such as Norway?

Duncan Sinclair: Norway is connected to other European markets—

Dr Lee: Of course, it is.

Duncan Sinclair: So it would not want preferential treatment.

Dr Lee: Yes.

Duncan Sinclair: Historically, why do we not have more interconnection than other European countries? It is a geography thing—all the other European markets are interconnected and flows over the interconnectors between those markets are very large. So it is an historic thing and history has proven that is a cost-effective way of managing and balancing an electricity system. To separate ourselves because of some policy differences flies in the face of what rational economics would say in terms of a least cost solution, so that would be very extreme.

Q325   Dr Lee: You think what we are getting at the moment is based upon rational economics?

Duncan Sinclair: No, it is not. It is based on an objective to try and decarbonise. There are different views on how to do it, but here we are today and things are going to change over the next few years so it is hard to say.

Dr Kennedy: There is a possible role for imports in decarbonising. So if you can have additional investment in Norway, or if it is in North Africa for concentrated solar power, that could make a contribution. I think we should open up these electricity market reforms to consider: could you give a contract for difference for something that is imported into the UK? I think you would not rule that out at the moment, whether it is Norwegian or North African or anything else imported.

Q326   Dr Whitehead: Turning to feed-in tariffs, do you think the introduction of feed-in tariffs, in whatever form, would encourage or, as some suggest, rather discourage and marginalise CCS energy and electricity storage?

Lord Turner: We believe that, although CCS is important, we cannot rely entirely on it and a sensible mix requires elements of nuclear and elements of renewables as well. Therefore, we believe that the feed-in tariffs achieved, either directly or via contracts for difference, is a key way forward there. Obviously, the more that you are effectively buying through those feed-in tariffs and contracts for difference, you have somewhat reduced the amount of the market that is gas CCS, but that is just how much you buy. If we did the electricity market reform and then the Government chose, we would not advise it at all to say, "We are now going to have contracts for difference and feed-in tariffs for the entire amount of our demand". Then there would be, by definition, no space for gas but that just becomes how you sensibly allocate the quantities you are buying on this.

On the issue of storage, David, do you want to comment on the storage point because I was not quite sure what you were getting at there?

Dr Kennedy: Storage is a crucial part of the story and so in our fourth budget advice, which we published in December, we highlighted the role of, for example, the importance of having car batteries as a store on the system. Now, it does not have to be car batteries; you can simply have storage on the system that you can then put back to balance intermittent generation. Is it the feed-in tariffs that will drive investment in storage? I think it is a separate instrument—

Dr Whitehead: I think that is precisely the point, isn't it?

Dr Kennedy: It needs complementary policies.

Q327   Dr Whitehead: Essentially, storage relates to what might be determined as surplus electricity. Surplus electricity, by its definition, would not come within a contract for difference very easily and therefore would have to be perhaps issued by separate mechanisms such as capacity payments.

Lord Turner: Yes, I understand now, you are basically saying if you over did the feed-in tariff approach you could remove the incentives that we want people to have to drive storage, which enables them to sell at the high price arena. With a contract for difference, they are still able to shift it during the day, aren't they?

Dr Kennedy: There are two things that will drive the storage story and they are—

Dr Whitehead: It only becomes equipment when it is no longer surplus and is put back into the system after it has been stored.

Dr Kennedy: Yes, smart meters are key, and the roll-out of smart meters in a way that will support storage and putting stuff back into the system is very important. The second thing, as you said, is the balancing market and possible capacity mechanisms and allowing those to bring in demand-side flexibility, as opposed to unabated gas-fired balancing.

Q328   Dr Whitehead: If the Government did indeed choose to go down the contract for difference path, how would the Government set the prices for that contract for difference? Indeed, Mr Sinclair, I think you may have done some analysis, for example, on the extent to which non-competitive baseline suppliers, under a contract for difference, could essentially receive large amounts of free money, as the arrangements progressed without effectively bidding into a contract for difference market. Did you do that analysis and did it appear in your final document that was published by DECC?

Duncan Sinclair: We didn't quantify it. We highlighted it as a significant risk. The problem with this is—

Q329   Dr Whitehead: Did that highlighting appear in the final document or did it disappear?

Duncan Sinclair: What we said was that, to the extent to which the prices were set above the level they needed to be, that could have an impact on consumers. I think we estimated for every £5 a megawatt hour the price was higher than what was needed, that would cost consumers on average about £5 a year additional cost. So that is not insignificant. So there is that risk.

That risk exists today with the renewables obligation because we are assessing ROC bands based on imperfect information. It is going to be the same challenge with nuclear and CCS. Inevitably, although auctions are a long-term objective and potentially are a good solution, in the near term that is not realistic. Given the number of potential players, that has to be bilateral negotiation and that is going to be difficult, but over time moving to auctions is possible. It may well be that the Government will have enough information to be able to set the CfD strikes based on technologies that are more established, for example, onshore wind and maybe by then offshore wind. They can set the price as effectively as they are doing today.

It is a big challenge. There is no doubt about it. There is a risk of making mistakes, and mistakes will inevitably be made and consumers will pay more because of it, but the flip side is not going down that route and not achieving the decarbonisation. So that is the price that we may have to pay.

Q330   Dr Whitehead: You mentioned, Lord Turner, in your recent letter to the Secretary of State—and you have touched on this issue—that since different low-carbon technologies are at different levels of maturity, you would need some form of differentiated technology support, which is not easy to see how that might be incorporated into at least certain forms of FIT or contract for difference. What is your view on that and what did you mean by the different levels of technology support that we need?

Lord Turner: Of course, we have different levels of technology support at the moment, by the ROC banding mechanism.

If you simply said the Government wishes to make sure that there is a certain amount of low carbon, either capacity or delivered power, and organised an auction for a contract for difference for that quantity, that would not assure a particular support for particular technologies, because one technology might be able to bid the lowest price in terms of the contract for difference. So the way that this would essentially work is that you would have to say, "In total, we are going to want to purchase this amount of low-carbon capacity or generation and we are going to ring-fence an element of this".

There are then two ways to proceed: there is either ring-fenced auctions, right, where you are essentially saying, "The only people who can enter this auction are people who are willing to do offshore wind, but nuclear cannot enter this bit of the auction", or some process of quasi-administrated mechanism where you are trying to work out what a fair price is.

As Duncan has said, the long-term vision, the ideal, would be it is all in one pool and it is all done through an auction, but I think realistically we are going to have something where there is a willingness to have some subsets of quantities for particular technologies and, to a degree, some administrative processes of setting the price, rather than a pure auction technique. Having said that, that is not really a level of complication beyond what we have at the moment, where we have to set the ROC bands. The ROC bands are themselves an expression of different support for different technologies.

Q331   Dr Whitehead: Except, of course, as you have observed, we presently have ROC bands. There will be no ROCs under FITs.

Dr Kennedy: There has to be some kind of banding mechanism, effectively.

Dr Whitehead: So is this FITs with a bit of ROC added to it?

Lord Turner: No, they would be FITs that would vary by technology. You would need—

Dr Whitehead: Variable FITs, banded FITs.

Dr Kennedy: There would have to be a price in the contract for difference depending on the technology, so if it is nuclear it will be £70 a megawatt hour. For offshore wind it might be £100 or £110 a megawatt hour.

Q332   Dr Whitehead: Would it not be determined by market trading, but nevertheless it would still be banded, I assume?

Lord Turner: You essentially will end up with some sort of banded FITs. I think that is a reasonable definition of what you will end up working with. You will end up with a variant of banded FITs, rather than banded ROCs, but there still could be a price discovery auction process, within a particular technology for what that price is.

Q333   Dr Whitehead: So might the bands then be determined to some extent by auction discovery?

Lord Turner: Yes, but within a particular technology.

Q334   Dr Whitehead: So how far away is that actually from the ROC trading system?

Lord Turner: It is still significantly different from the ROC trading system, yes.

Dr Kennedy: The ROC trading system is effectively a premium feed-in tariff, which we have been very clear is a bad thing because it is unnecessarily expensive for the consumer. So it should be very distinct from that.

Lord Turner: The ROC is essentially on a banded basis determining how much extra you get as a price above whatever the future price of electricity is; a contract for difference based feed-in tariff is essentially determining what price you will get in future, independent of what the rest of the wholesale price is.

Q335   Dr Whitehead: It is mediated by auction discovery.

Lord Turner: Yes, but that price can be to a degree informed by auction discovery. That is the ideal, and I think one simply has to pragmatically work out how much of that one can do while still supporting reasonable technology. For instance—let us be clear—the difficulty, in relation to the nuclear bit of that upfront, is going to be how real an auction you can have when you have only a small number of players. Therefore, these things may have to have an element of judgment and negotiation as to what is the appropriate, effective feed-in tariff, rather than believing that it can all be determined by a perfect auction.

Q336   Dr Whitehead: Is that not where the free money argument comes in at that point?

Lord Turner: That is absolutely right, that if you get it wrong you can be handing over free money, but I think we have to realise that all these policy instruments have the danger of free money, both carbon prices and ROCs; almost any other instrument has a danger of free money. One of the things we are trying to do is minimise it. That is the challenge here.

Q337   Chair: I am afraid we are running out of time. Could I conclude with a question about how we measure the success of all this, EMR, and how it is going to pan out. Do you see a role for your committee, monitoring and reporting on the costs and impact of the various alternative interventions?

Lord Turner: As a committee, every year we have to produce our monitoring report to Parliament against the Budget. We have in the past and would propose in the future to comment, not just upon the emissions last year, but the development of the policy frameworks and whether the policy frameworks, in principle, look like ones that would be delivering future developments.

I am sure, as part of that monitoring, within any particular regime, we would be looking carefully to what occurred. So, for instance, if there was a contract for difference scheme put in place we would then be very carefully looking, in 2013 and 2014, at what volumes of contracts had been contracted, because that would give us powerful forward indicators of what was likely to happen in 10 or 15 years' time. One of the things that we are very focused on within our monitoring reports is how do we get things that are forward indicators of what is going to happen in the future, rather than indicators now.

So, to a degree, there is an element to which we naturally do that. It would be up to the Government whether it wishes, in addition to those regular reports, which are written into the Climate Change Act, to ask us to do a more detailed investigation of the particular impact of the regime.

Q338   Chair: What are the metrics you think the Government should use to assess whether it is achieving its objectives as set out in the EMR?

Lord Turner: We certainly think that grams per kilowatt hour is a very important one, but I think one also has to look at degrees of certainty as to what the future grams per kilowatt hour will be. You do that by tracking, as we try to, how many offshore wind platforms have gone into planning; how many have gone into construction, because that tells us how many will be in place in two or three years' time.

I think one of the values of the contract for difference techniques is that that will give us a very concrete form of forward indicator, because once you have contracted that someone is going to have that contract for difference applicable in some future year then that significantly increases that certainty. So I would say the three categories of things are: the grams per kilowatt hour, now and prospective; the physical indicators of what people are investing in and what that tells us about the future; and the balance of the contracts that have been struck and what that tells us about the future.

Dr Kennedy: We probably want to look at costs and price impacts as well. It is obviously important.

Duncan Sinclair: Yes, I think tracking consumer bills against the European average would be an interesting metric and of course security of supply is going to be key to track that as well, both in terms of where we are today but also projections going forward.

Coming back to the investment question, clearly there is a lot of nervousness in the City right now about the impact of this change and I think in near term the thing to measure is going to be the level of activity over the next one to two years to see if we do have a hiatus in investment while people try to absorb what is going on with these changing rules. So I think there are some quite near-term things that have to be tracked quite carefully.

Chair: Thank you very much indeed. We could have gone on for another couple of hours, I am sure, but we much look forward to your report on renewables. Thank you for coming in.

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