To be published as HC 987-i

House of commons



Energy and Climate Change Committee

Gas Generation Strategy

Wednesday 13 February 2013

David Kennedy, Professor Samuel Fankhauser, Simon Skillings and Rachel Cary

Keith MacLean, Steve Hargreaves, David CoX and Mark Somerset

Graham Meeks, Charlotte Morton, Jeff Chapman and Professor Roger Kemp

Evidence heard in Public Questions 1 - 98



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Oral Evidence

Taken before the Energy and Climate Change Committee

on Wednesday 13 February 2013

Members present:

Sir Robert Smith (Chair)

Barry Gardiner

Ian Lavery

Dr Phillip Lee

Mr Peter Lilley

Albert Owen

John Robertson


Examination of Witnesses

Witnesses: David Kennedy, Chief Executive, Climate Change Committee, Professor Samuel Fankhauser, Co-Director, Grantham Institute on Climate Change and the Environment, LSE, Simon Skillings, Senior Associate, E3G, and Rachel Cary, Senior Policy Adviser, Green Alliance, gave evidence.

Q1 Chair: Thank you all for coming forward to give evidence on the Gas Generation Strategy. We have three panels to get through before Prime Minister’s Questions, so if you can focus your answers, and hopefully we can focus our questions, to get us through as much as possible. Before we start I must declare my entries in the Register of Members’ Interests to do with the oil and gas industry and, in particular, a shareholding of Shell that is relevant to this inquiry.

If I could open by asking, to what extent do you think the Gas Generation Strategy might have damaged our international credibility and if that matters? Who would like to?

Professor Fankhauser: I can probably start. It has not damaged our credibility just yet but it could. To illustrate that, some of you in the room were involved in a study we just did at LSE together with GLOBE, the group of Parliamentarians, where we looked at climate legislation in 33 countries including the UK. It is still true that our policy approach is up there with the best. Two caveats to that. The first one is that everybody else is catching up and it is no longer true that the learning goes one way and everybody comes here and wants to find out how we do things. That is still true, but increasingly we can go out there and start learning from other people how one does stuff, for example, Australia’s carbon legislation or even in the US, in New England the trading scheme that manages to tighten their constraints by 40%, which is something that Europe has not managed. So the learning is starting to go both ways.

The other caveat I would say is that when I tell the UK story I am increasingly telling them a different story than I used to. The story used to be, "Look, we have a plan. It can be done. Don’t be afraid. Here is a credible technological, economic path." What I now tend to say is that we have an institutional set up in the Climate Change Act that is resilient to adversity and temptation, and we are currently seeing that institutional set up being tested and so far it is passing the test. You were very far sighted when you passed the Climate Change Act. A little bit like to prophesy and the sirens knowing that there would be future weakness and you tied yourself to the mast with carbon budgets in the Climate Change Committee. At the moment the sirens are singing full blast and you are still here, so we are going through that test where we are seeing whether the Climate Change Act works. That is increasingly the story I am telling rather than telling people, "Look, we are doing it."

Q2 Chair: Is that a view the rest of the panel shares?

Simon Skillings: I would put a slightly different perspective on it. We must not underestimate how visible the UK is internationally and how much other countries still look to us. I think the important point is people look at our seriousness in restructuring our economy. No one understands outside this country the significance of 50 or 100 or 200. They would not look at that. They would look at, are we serious about changing our economy and are we taking actions to do that? Are we demonstrating we believe that restructuring of the economy is the right thing to do, in the way that perhaps Germany is doing? You know, serious action is being taken. To that extent, the gas strategy is quite totemic because it speaks of old economy rather than new economy.

David Kennedy: I will just pick up two very quick points. The first thing is anything that questions commitment to carbon budgets is unhelpful in the international context. I think it raises questions about whether we can go, for example, to Brussels and negotiate an ambitious package for 2030 when it is not clear how committed we are to our carbon budgets through the 2020s.

Then I think, separately, if you look at the international investor perspective, the signal we have given to investors is that we don’t really know where we are going with our energy system. We have some very different scenarios for future development. That is bad for the investment climate, it is bad for supply chain investment and it is bad project development. It raises a question: are we going to move to a low-carbon power system or not? If we do not move to a low-carbon power system, then further down the line internationally our framework that we have here under the Climate Change Act certainly would be open to question.

Rachel Cary: Yes, I do think that it sends very mixed signals to investors, and not just low-carbon investors, whether it be generation or supply chain. Gas generators are going to want to know how much they need to earn in the energy market and then, therefore, what they need to make up in the capacity market. If they are being told one minute that they are going to play a peaking role and the next minute that they may be playing more of a baseload, or running at high load factors role, they are not sure where they are, they do not have a credible narrative going forward. So I would argue that it damages investment in all forms of generation.

Q3 Mr Lilley: I want to ask on this, has our powerful influence that you emphasised had any effect on Germany’s decision to build 23 new coal-fired power stations?

Simon Skillings: What you will see in Germany is that those decisions were taken a long time ago. I worked for a German company 10 years ago and it was a very different view at that point, and that is when those decisions were taken to build coal-fired power stations. There has been a complete moratorium on any new build of coal-fired plant over recent years. They take a long time in the planning, the building and the construction stage, so no new projects have been started recently.

David Kennedy: Also, I think our influence has bolstered the support in Germany for investment in renewable power generation, both up to 2020 but going beyond that where there is still a very high degree of ambition.

Q4 Mr Lilley: Thank you. For the sake of interest, I will declare that I am a director of an oil and gas company, which operates entirely in Central Asia, and have been adviser to an Indian electricity generator, neither of which is relevant to the subject of this Committee. On the subject of declaring interest, could I establish that you are all professional advocates of-what I would call-global warming alarmism, of the propositions that climate temperature is very sensitive to an increase in CO2, that that potentially has very damaging impacts and that the costs of doing something about it are well below the benefits of doing something about it. None of your organisations would employ anyone who had an open mind or doubts on those propositions?

David Kennedy: What loaded comments there. Certainly my organisation employs open-minded people. We are all open-minded. We consider the evidence and we come to our conclusions. As open-minded people, we have looked at the scientific evidence and accepted that we are exposed at the moment to risks of dangerous climate change. We are open-minded, in the sense we continue to monitor the science and we will update the way we think depending on how the facts change.

Professor Fankhauser: It is very important that if you look at the vision statement of the Grantham Research Institute, at LSE where I work, what we want to achieve is that people make rational, evidence-based good decisions on climate change and the environment. Evidence base is very important and that can take us either way. It can take us in a stricter direction or a more lenient direction when it comes to carbon targets. If you look at the evidence, at the moment it tends to point towards stricter carbon targets rather than the more lenient one.

Q5 Mr Lilley: You are funded by a benevolent funder who-all credit to him-is putting his money where his mouth is. But can you imagine him employing someone who had rather different views on it, like Professor Nordhaus, Professor Richard Tol or Professor Mendelsohn who have different views on the economics of climate change to you?

Professor Fankhauser: As it happens, most of the papers I have written I have written with Richard Tol. Richard Tol is a friend. So we do collaborate with all sorts of people, if I can put it that way.

Mr Lilley: So do I.

Professor Fankhauser: As to Jeremy Grantham, he does not intervene and the LSE is quite picky about that. Our funders do not tell us how our research has to look.

Q6 Mr Lilley: Any more than Gaddafi did at the Gaddafi Research Institute, which I am sure they were all very open-minded about policies in Libya.

Professor Fankhauser: We have learned our lessons from that, so you can come and have a look and you will find that Jeremy Grantham does not intervene.

David Kennedy: We are open to discussion at the Committee on Climate Change, of which Sam is also a member, and certainly we would like to collaborate with you, for example, so that is something we should do going forward.

Simons Skillings: The point I am going to make very quickly is that you do not have to have a fixed view on the future to recognise that there are risks and uncertainties around the future. You do not have to take a 100% view that there is global warming to appreciate that there is a risk of global warming that you might want to insure society against, in the same way that you wouldn’t necessarily take the view that you were going to be burgled in the next 10 years but you would rather like some home insurance.

Q7 Chair: Can I just ask again on the gas strategy? It says, "When reviewing the fourth carbon budget in 2014, our domestic commitments place us on a different emission trajectory than the EU ETS trajectory agreed by the EU. We will, as appropriate, and consistent with the legal requirements of the Climate Change Act, revise up our budget to align it with the actual EU trajectory." Do you think this pre-empts the 2014 review?

David Kennedy: Short answer is no, and here is why. I think it reveals a position in parts of the Government that, first of all, they wished they had never set the fourth carbon budget at the level it is. Second, they think there is some kind of automatic process that will change the carbon budget when it is reviewed this year and the decision to happen next year. They think that automatic process will simply look at the EU 2020 level of ambition. It will say, "Have we moved to a 30% target at the EU level for 2020?’ and if not we will revert to a much less ambitious budget. I think that position was fuelled by the statement to Parliament made by Chris Huhne when he proposed the budget to Parliament. There he said, "We will come back to this." I don’t think he linked it strictly to the 2020 target, but he talked about reviewing it in the context of the EU 2020 target. That is a wrong position to take for the review.

The Climate Change Act is very clear that, when you review a carbon budget, you have to go back and see if the circumstances upon which the budget was set have changed. The budget was never designed to be aligned with a 30% EU target in 2020. The EU 2020 level of ambition does not really matter. What happens in the EU through the 2020s does matter, but that is different to the 2020 target. There is a whole set of considerations, whether it is the climate science, an assessment of the international context, the EU, the economics, the technologies or competitiveness. You have to go through all of those criteria again and say, "Have they changed?" If they have changed then there is a case to change the budget. It could be a more ambitious budget. It could be a less ambitious budget depending on what the change is. But it is not a case of 20 versus 30 at the EU level and some kind of automatic trigger, so there is a misconception there. The fact it is there does not pre-empt the budget review.

The budget review-just in terms of process-will be done by the Committee on Climate Change. Again, the Climate Change Act is very clear. We are working on that now. We will report back to the Government at the end of the year. Then the Government has to take a decision. I would expect them to take our advice, as they have done previously on all the things we have advised on. I would expect them to take our advice because we will make sure that our advice is analytically very robust.

Professor Fankhauser: As a member of the Climate Change Committee can I reinforce that? We would not do our statutory duty if we did a review of the budget that does not take into account all the factors that the Climate Change Act tells us we have to take into account, including the science, technology, economics, costs and the international situation. All these things matter and we would not do our job if we did not take all these things into account.

Q8 Mr Lilley: You will be pleased to know I am moving away from my previous question. I am now assuming it is all hunky-dory and that we can forecast the market failure that Lord Stern describes and cost it. Why do we not just set a carbon price and not have separate strategies for gas, nuclear, wind and everything else, and regulations and controls and quotas? Just set a carbon price or a carbon price that is going to rise over time and let the market decide.

Professor Fankhauser: As it happens, we are partly doing that with the carbon price underpin. Most economists would tell you that this is the one most important thing that we need, but most economists would also tell you that not pricing carbon is not the only thing that is wrong in a market economy. There are other market failures. In a sense you need one policy per market failure, so you will have additional policy instruments and incentives to deal with other factors, such as the barriers to energy efficiency such as problems with low-carbon innovation and so on.

Simon Skillings: There are many, many issues associated with the efficiency of a system that is driven purely by carbon price. Indeed, one of the key rationales underpinning the current Energy Bill is the need to drive significant investment in a way that the carbon price is and is expected to fail to do. There are welfare allocation issues. It is virtually inconceivable that the carbon price, which would deliver the decarbonisation track, will not give huge and unsustainable rents to cheaper, lower carbon technologies that have delivery constraints and, therefore, cannot meet the entire decarbonisation. Europe has different economies, different asset bases that will expire at different times. It is efficient for different countries in Europe to go at different paces. They are not perfectly interconnected and therefore they will have to make use of their own domestic resources, which will be different and which will have different implied decarbonisations. So there are many, many reasons why I think a single carbon price is now not widely accepted as a tenable way forward.

David Kennedy: Although over time it may be the way to go. As we get into the 2020s and 2030s, if we have a global deal for everyone to reduce emissions, you would imagine that a carbon price that is comprehensive, both in terms of the coverage geographically, across sectors and out in time, will emerge, and that will pull through investments and change behaviour. It is not where we are at the moment.

Q9 Mr Lilley: Isn’t there a distinction between the rigorous use of the word "market failure"-things like external costs that can be defined and attempts can be made to measure them-and the simple use of the term "market failure", meaning, "The market left to its own devices won’t do what I want it to"? Professor Fankhauser seemed to be using it in the latter sense.

Professor Fankhauser: You misheard me if that is what you heard me say. If you think about market failures, you do think about deviation from what the socially beneficial outcome would be. You can look at economic studies that have been done by mainstream economists, if I can call them that, not people with a particular core interest in climate change, and they will tell you that when it comes to things like innovation there is a certain path dependency, and research departments and organisations are more comfortable and, therefore, more likely to do research on the things they understand, such as conventional technologies, rather than branching out into research into things that are altogether new to them. That is an empirical fact that you can read about in economics literature, backed up by evidence, data, and written by people who are economics professors as opposed to climate change specialists.

Q10 Mr Lilley: That is what I mean by saying that you think that, left to their own devices and responding to appropriate price signals, people won’t do what you want them to.

Rachel Cary: Or they may do it at too high a cost. One of the reasons for moving to a contract for difference is that, if you are going to make a massive upfront capital investment in an offshore wind farm, your cost profiles are very heavy at the beginning, and then you have an electricity price, which at the moment is set by gas, that varies significantly and swings up and down. So if I go out to an investment firm and say, "Can you lend me money for this offshore wind farm?" they say, "Well, we’re not sure what the revenue you’re getting is. We’ll lend you the money but we’ll lend it to you at a higher rate." Whereas, if you can stabilise that future revenue stream, it makes something that is very capital intensive-like an offshore wind farm-cheaper to finance. It is not simply about making the market do what we want it to, it is saying, "If we want to capital invest in intensive things how can we do this cheapest?"

Mr Lilley: Thank you.

Professor Fankhauser: Can I just come back to that? You seem to think that it is a personal preference of people around this table when it comes to climate change. Everybody knows that is not the case. There is a broad scientific evidence that 90% plus of people believe, and obviously some people do not, but the science derives a certain amount of economic implications for human welfare, economic welfare, socio-economic welfare, poverty alleviation and prosperity, how all these things look in a world where we are running risks with the climate.

Q11 Barry Gardiner: Given that Professor Fankhauser has mentioned GLOBE, I should declare my interest as the Chairman of GLOBE International.

What I wanted to come onto here was, really, Dr Kennedy, you talked about, or I think it was Professor Fankhauser who talked about weathering the storms that are coming at the moment on the independence of the Climate Change Committee. Dr Kennedy, could you confirm that CCC say that unabated gas should be between 15% to 20% of the energy mix by 2030? Is that correct?

David Kennedy: A bit lower.

Barry Gardiner: A bit lower than that.

David Kennedy: There is a high degree of uncertainty about the way forward for the system but not as much-

Barry Gardiner: No, I am just trying to establish what the CCC had said.

David Kennedy: Sure. Not as much uncertainty as in the gas strategy. We work with the scenario that decarbonises to the carbon intensity of 50 grams of CO2 per kWh in 2030, and the corresponding level of unabated gas-fired generation there is about 5% to 10% at that time. Then in their core scenario in the Gas Generation Strategy the Government says, "We are not as aggressive in our decarbonisation scenarios", so they have a target of 100 grams of CO2 per kWh. The unabated gas in that scenario is more like 15% to 20%, so that is the range within decarbonisation. Then you get to their other scenario that says, "Okay, we’ll invest in low-carbon technologies to 2020. Then we’ll change the fourth carbon budget and we’ll lower the ambition, and we’ll use the headroom so we can have a Dash for Gas, which will be great because of the shale gas revolution." That is the kind of story there. In that 200 grams scenario you get a much, much higher share of unabated gas in the mix, 40% plus in 2030. The corollary of that is you do not have any investment in low-carbon power generation to speak of beyond 2020. That is what they call the sensitivity, but it is the sensitivity that is there for when they, in their minds, will change the fourth carbon budget. The decarbonisation scenario is accepted, 20%, and the other scenario, the Dash for Gas scenario, is 40% plus.

Q12 Barry Gardiner: I would like to bring Simon Skillings in here, because I think I am right in saying that E3G have modelled different scenarios of gas deployment in the Gas Generation Strategy. Could you tell us what your modelling has shown about the different cost increases under a high gas pathway and under a high renewables pathway, alternately, through to 2030?

Simon Skillings: The important framing of this work is we were thinking, "How do you deliver all policy objectives?" In other words, we were trying to avoid reaching the point where you have to choose, "Prices have gone through the roof. We can’t do decarbonisation" or "We don’t have enough power plant, we have to put the lights out." We have a set of policies and we looked at the delivery of all of those policies. What we found was that if you placed big bets on a particular technology that was uncertain, such as CCS, if you were still trying to deliver all your policy objectives it could be hugely expensive, in fact impossible. You fail on the affordability front. So the important framing is we cannot say one pathway is cheaper than another. All pathways are uncertain. They have inherent uncertainties. Our job is to try and manage those uncertainties so that we can deliver all policy objectives, and that is possible. The most important conclusion is the strong strategic value of the demand side. The demand side provides a huge strategic benefit for our policy, going forward, in terms of helping us manage all our policy objectives.

Renewables are a much more predictable technology to roll out. There are a range of technologies. Therefore, there is a risk smearing there and they are not susceptible to some of the technology shocks and cost shocks. Pushing forward on CCS is extremely important because it does open up the opportunity of lower cost.

Q13 Barry Gardiner: I think we will get to that probably later in the evidence session. If I could ask you specifically about your report, the Risk managing power sector decarbonisation in the UK, the one that you produced in October 2012, and to explain to the Committee what your findings were about increased costs. I believe they varied in terms of increased cost from high gas deployment, which was up to 98%, and a renewable maximum increase by 2030, was it 8%?

Simon Skillings: That is right. We constructed two very different scenarios. There was a momentum scenario with renewables billed out beyond 2020 and gas for balancing purposes, and there was a change to high gas driven by a single carbon price scenario. We then interjected uncertainties: price shocks, technology uncertainties, billed out constraints-the sort of things that happen in real life. We found that the renewables scenario, although the base line costs were higher, had a much narrower range. They were much more constrained in terms of costs. The gas scenario, although it had a lower base line, had a much wider range. It was much more susceptible to these externalities.

Q14 Barry Gardiner: Can I try to put that into layman’s language for myself? That means that if I want certainty and predictability going forward, it is like locking into a fixed rate mortgage by going for the renewables, whereas you are on rather more than a standard variable rate in terms of fluctuation if you go for the other one.

Simon Skillings: Yes. The future is hugely uncertain and managing that uncertainty is the core of the policy challenge.

Barry Gardiner: Thank you very much.

David Kennedy: There was a similar finding in our Energy prices and bills report that we published in, I think, December last year. Basically gas is carbon intense and, as long as we are in a carbon constrained world, a gas-based system must be subject to an increasing carbon price and will be more and more expensive over time. If you invest in a portfolio of lower carbon technologies, which is expensive for a period and that period really is out to 2020, beyond which you get gradual price increases from continuing to invest and those plateau as you get to about 2030. So as I think Simon said, and as you said, there is an insurance policy that is around investing in a portfolio of low-carbon technologies, so that we are not stuck with a gas-based system that does not help us and does not fit well with our long-term challenges.

Q15 Barry Gardiner: Just to focus on that, given the present configuration of the Energy Bill-and I know it still has a good deal to run through, report stage, and going into the Lords and so on-under the Government’s gas strategy, what would be the prognosis for meeting what are currently the fourth carbon targets, for what you have predicated as the aggregate grams per kilowatt hour that would be required in 2030, and the lowest cost path trajectory for meeting our 2050 targets overall? I think the DECC modelling showed that the 50 grams per kWh decarbonisation, the new target for 2030, was the lowest cost trajectory overall. How do you see things panning out at the moment in terms of unabated gas going forward?

David Kennedy: If we look at the Gas Generation Strategy, all we could say is we do not know, because we don’t know what the Government is intending to do with the Energy Bill. Perhaps they are aiming to build a low-carbon power system and perhaps not, and that is the range of the scenarios we have-radically different-in this Gas Generation Strategy. You are right that the 50 grams CO2 per kWh in 2030 is designed to be the cost effective path to meeting the 2050 target. As long as we are in a carbon constrained world, as long as we have the Climate Change Act and the 80% target in there, then that is what we should be following, the 50 grams. As I say, they have a scenario in the Gas Generation Strategy that is radically different, and that is a problem. The problem is that this is not a document that is standalone and will have no influence. It has already had bad implications in terms of investor perceptions, but going beyond that it will form the foundation for the Electricity Market Reform Delivery Plan. As things stand, National Grid will be asked to design scenarios against including the Dash for Gas scenario in the Gas Generation Strategy. So we will have an Electricity Market Reform Delivery Plan that is trying to deliver a wide range of things that are not consistent with each other. It is hard to see how that is going to be a coherent document.

Q16 Barry Gardiner: The fact that currently the Government’s proposal is to delay even the possibility of setting a 2013 decarbonisation target until at least 2016, does that have an impact on this? In particular, does it have an impact on the final investment decisions that companies need to take in order to plan ahead?

David Kennedy: Absolutely. Let’s be clear, it does not affect all of the investment decisions. For example, there is a pipeline of projects for renewables that can go ahead as long as we get the Energy Bill through. But we need a competitive supply chain for offshore wind, for example. You have a question, "Are we going to get investment in the offshore wind supply chain, off the back of a 2020 commitment and then a high degree of uncertainty afterwards?" If we don’t have a competitive supply chain you worry about driving offshore wind costs down from £140 per MWh to £100 per MWh. You worry that we are going to have an overheated supply chain, as we have at the moment, as we have always had in offshore wind, so there is a problem there.

The second problem is we need a new pipeline of projects coming through for the period after 2020, so we have to be thinking now about nuclear projects to come on the system after 2020. Quite soon we will have to think about offshore wind projects to come on the system after 2020. It is hard to see who would put very big sums of money in to develop those projects when you don’t know that there will be contracts there. You say "at least 2016", if you work through: what if the Government sets the fifth carbon budget in summer 2016 and then says, "Well, okay, perhaps we will have a carbon intensity target", and they think about what that might be and then they consult on it, then they finalise and put it in legislation. Then they update the EMR delivery plan to reflect the carbon intensity target. You are talking about 2018 before anybody then gets any clarity about what is going to happen. The consequence of that is that you would have a hiatus in investment until the early to mid-2020s for low-carbon. That is not a sensible way forward. It is a very small price you pay to make a commitment that says, "Subject to caveats about costs coming down, we’re going to carry on on the low-carbon path beyond 2020, in order to support supply chain investment that will drive costs down, in order to support project development that will allow investment to carry on in a continuous way." It is a very small price to pay, and one that we should be willing to pay, but the Government at the moment have said it is not willing to. That is very unhelpful from an investment climate perspective.

Q17 Barry Gardiner: Thank you very much. Ms Cary, I think you wanted to come in.

Rachel Cary: Yes. I want to refer to the report that Cambridge Econometrics did for WWF and Greenpeace, which compared the impacts on GDP of offshore wind versus gas. I thought what was really interesting in that was that one of the key sensitivities was the UK content. That seemed to be more important than whether or not you looked at a high gas price scenario or a low gas price scenario. In terms of impact on GDP, the biggest difference was the proportion of the supply chain that came from the UK. It demonstrates how important it is to provide this long-term certainty so we can get that high UK content.

Q18 Barry Gardiner: Thank you. One very final brief question. Do you agree with DECC’s analysis in the strategy that we are heading towards a capacity crunch?

Simon Skillings: Picking up on David’s point, it is clearly extremely difficult for investors at the moment. If you were an investor you would be a very brave investor doing anything without a long-term contract. You are probably currently sitting on assets that are not making a huge amount of money. You might decide to close those. I am fairly sure we will be reaching the point fairly soon where decisions have to be made to ensure capacity is built. My point-again coming back-the demand side helps us enormously in this regard. It does have the potential to save consumers money. The other point is we must start thinking about the sorts of assets, the flexibility of the assets, rather than just getting anything built at any cost.

Professor Fankhauser: Just to reinforce that, I think what David said answers your question. There is a risk of a capacity crunch but it is entirely within our own control. It is a question of the strength of the signal that we send to investors. If we send a strong signal we will not have a capacity crunch. If we send a confused signal we will.

Q19 Albert Owen: If I can develop those last two arguments, Ms Cary, and yourself, Professor, on the economics of pursuing a high gas strategy? You talk about uncertainty, and I will come on to that in a second. But the economics of high risks are what? You said about supply chain. Would you like to develop that argument? What are the problems in having a high gas strategy?

Rachel Cary: The point that I was making was that when Cambridge Econometrics compared the two scenarios, they looked at the overall impact on the economy of a high investment in offshore wind versus a limited amount in offshore wind, and then a higher amount of investment in gas. They did consider different scenarios for future gas prices, and it showed that the impact of a high gas price and a low gas price made less of a difference on the relative benefits of one scenario to the other than how much content was in the supply chains. Obviously one of the biggest benefits of offshore wind is that a far greater proportion of the supply chain can come from the UK than with gas. If we want to seize the opportunity, and get the greatest benefits for going for offshore wind, we do not have to do it in a fledgling way. We have to embrace it and go for it and get the cost down to £100 per MWh. Whereas, if we dip our toe in the water, we are not going to get much progress.

Q20 Albert Owen: Does it have to be either/or-and others can come in on it? Does it have to be wind or gas? You say about the supply chain that one of the concerns now with round two is that the supply chain is not in the United Kingdom, and there are many components that are built abroad and manufactured abroad that are just going to be assembled here, and those economic benefits are not certain for wind developments.

Professor Fankhauser: I think I would make a distinction between the geography and the location of where stuff is being done on the one hand, and the speed at which costs are coming down on the other. The speed at which costs are coming down is, in the first instance, a question of the investment volumes. The more of that stuff you do the more you learn, and the more economies of scale you have the more you are willing to invest in R&D, so scale in a sense matters more than geography in that.

Obviously the first point is also a valid concern for a UK plc. We want to do things here rather than depend on imports from everywhere, but in a sense that is a different story. It is a question of industrial competitiveness as opposed to-

Q21 Albert Owen: It is economic value as well for the country.

Professor Fankhauser: Economic value but it is different from the question, "Can we drive down the costs of the renewables?"

Albert Owen: No, my question was economic benefits.

David Kennedy: Which are twofold. There are the economic benefits of having the supply chain here in terms of high value jobs and impacts on the macroeconomy, and there are economic benefits of investment in the supply chain, whether it is here or somewhere else, to cater for this market in driving costs down. Let’s be clear, first of all, you cannot just rely on the existing supply chain to deliver our 2020 renewable energy ambition both here, in France, Germany and elsewhere in Europe. You do need supply chain investment to drive costs down. You have a question: who is going to invest either here or in other countries to serve this market, given the uncertainties particularly around the UK? So, for me that story is at risk.

Q22 Albert Owen: Moving on to the uncertainties then. The strategy as it stands, what does it tell the low-carbon investors and what does it tell the gas investors of the future? You talk about uncertainty. I can understand where you are coming from. What are they saying? Of course many of these companies invest in both. They have very large portfolios. So what are they saying? Are they rubbing their hands and saying, "It’s a win-win for us"? You tell me.

David Kennedy: No, we have said it is unhelpful to all investors, including in gas, so you don’t want to develop low-carbon projects at the cost of tens-

Q23 Albert Owen: Sorry to cut across, but that is what DEC C is saying. It is giving some certainty to those who want to invest in gas.

David Kennedy: It has not given any certainty. It has created-

Albert Owen: That is what DECC said. I am only repeating what they are saying.

David Kennedy: You can say from being outside the Government, the Government have to stand behind the strategy that has radically different ways and created a lot of uncertainty for all investors in low-carbon technologies and gas-fired generation. For any investor looking at this you can say, "I just cannot say how the system is going to develop. The system development depends on the Government and the Government doesn’t have a clear view." Then you have to say, "Well, in that context of uncertainty what will I do?" I think most investors will say, "I’ll wait and see until I get some more clarity from the Government." The danger in a "wait and see" scenario is that you have a hiatus in investment and you store up problems for the future. Either then you cannot invest in low-carbon technologies, you have to invest too quickly. You get a security of supply crunch. All of those things that we could avoid if we were just on the front foot and a bit more confident in saying, "This is what we are going to do."

Simon Skillings: I think if you were an investor in gas, you would look at the strategy and say, "It is saying there is quite a bit of a chance that I will have a relatively low load factor and a bit of a chance I might get a high load factor." I don’t know an investor who would take into account that "bit of a chance" that they will get a high load factor. They would treat that as upside. They would be much more focused on the downside and they would want to make sure that that project made money even on the low load factor case, so I don’t think it adds anything.

Q24 Albert Owen: You mentioned the gas prices in the future. I would like your views on the Office for Budget Responsibility’s forecast that gas prices would fall between 2011 and 2017. DECC’s central gas price scenario shows an increase over the same period. What do you make of that discrepancy between the two?

Professor Fankhauser: I can probably have a first go at that. The first thing I would say is that forecasting gas prices is a very hard business, so the fact that we have that wide range is just a reflection of that uncertainty. It is genuinely possible that gas prices go down. It is genuinely possible that they go up. If you look at the DECC range, not just at the central DECC forecast, it actually does. The lower gas price in the DECC plan has prices going down. In that sense, you have to recognise that there is uncertainty.

If you dig a little deeper and ask, "How did the OBR come up with its number?" and compare that with the way DECC comes up with their numbers, you will see that there is a certain difference both in what they forecast and how they forecast. First of all, the OBR is a medium term forecast. I think they go up about four or five years, something like that. DECC goes out more like up to 20 years. DECC have a more detailed forecasting. They worry about supply and demand and new technologies, and in a sense it is quite sophisticated-that is probably the wrong word-detailed forecasting.

OBR make two simple assumptions. The first assumption they make is that the gas price laps the oil price by six months, and there are some structural reasons why that might be so. The second assumption they make is that, if I look at the future market in oil that tells me something about the future price of oil. When they made their forecast the oil market was in Contango so future prices were lower than current prices, and that is how the thing came about. So it is quite a parsimonious way of forecasting things.

Q25 Albert Owen: It is not very helpful for anyone, is it?

Simon Skillings: The big problem is this high scenario, low scenario. That does not happen. We have periods of high prices. We have periods of low prices. You don’t see them coming. You don’t see them going. This scenario view of the world is what drives the binary penny switching approach to strategy, which is the wrong way.

Q26 Albert Owen: I understand that, but the period I am talking about is over a six year period. It is not over 20 years. It is between 2011 and 2017, and they are diametrically opposed in their findings.

David Kennedy: It is unhelpful. We should also be clear the economics of investment in low-carbon power generation is not based on an assumption about the gas price being high in the future. It is based on assumptions about the carbon price in the future and the carbon constraint. Investing in low-carbon technology-

Q27 Albert Owen: Do you think that is more accurate?

David Kennedy: Sorry?

Albert Owen: Do you think DECC would be able to agree on that then?

David Kennedy: Do I think they would agree that the economics of low-carbon generation are about low-carbon as opposed to gas prices? I think there is a very strong evidence base around that. You also get insurance against the possibility of high gas prices in the future, but that is not why you invest in low-carbon technologies primarily.

The other thing is that IEA-which does a lot of work in this area in terms of European gas price projections-says that the optimistic forecast is of rising gas prices in the medium term, in a shale gas world. So we shouldn’t be expecting to see what has happened in the US happen here. I don’t think anybody thinks that is going to happen.

Chair: Thank you. One last short question.

Q28 Mr Lilley: You said that sustained substantial investment in wind power is necessary to bring it down to be more competitive with gas, from £140 to £100 offshore. Is that investment that has to be carried out in this country to produce a sort of learning in this country, or does it improve the technology that is then available worldwide? In other words, if the Spaniards and Germans invest in what are currently inefficient windmills, will they be developing new technologies that we can then adopt at a later stage?

Professor Fankhauser: It depends on the technology you are talking about.

Mr Lilley: Which one were you talking about?

Professor Fankhauser: The generic answer is, yes, there are spillovers and we learn from one another. You then asked: what are the technologies where the UK in a sense has a comparative advantage, where we can help to bring down the costs perhaps better than the Spanish and others? In the Committee on Climate Change, we came to the conclusion that wind is one of those areas alongside things like marine, whereas perhaps solar is not one of those areas.

Q29 Mr Lilley: Could you give us a note explaining the technologies that Britain has a unique advantage in, and why we are so much better than the Spaniards and the Germans?

David Kennedy: We can provide the innovation report that we did where we went through each of the technologies. Take two examples. Solar is not something where we are a big player. We don’t have a comparative advantage and, in our view, we can allow other people to spend money developing that and possibly buy it in in the future, so a free ride on their innovation spending. Whereas in offshore wind, we are a major player. We have a comparative advantage. It is potentially a very useful technology to us and to others in the future, but the focus is on developing the technology that will help us meet our longer-term goals. That is why we should invest in offshore wind technology. I think if we were not to invest in it we won’t get the same innovation story happening in total.

Q30 Mr Lilley: We won’t in the world, if we don’t?

David Kennedy: No.

Mr Lilley: So the world is dependent on us investing in lots of wind?

David Kennedy: I think it is fair to say, we will have a material impact on the development of offshore wind technology because we are a major player in the market. We are the biggest player in the market, followed by France and Germany.

Q31 Chair: Is that because we have a major resource in terms of offshore wind?

David Kennedy: We have a major resource, yes. We have the major ambition. We have very ambitious targets at the moment to 2020-not beyond. As a consequence, if we are successful at making those investments, and getting a supply chain around that to deliver the cost reductions, we would have a very good innovation story. Whether we do-you have a question, actually, given the uncertainty created by this Gas Generation Strategy.

Chair: Thank you very much for that. If there is anything you feel that you did not get across, if you could put something in writing to us that would be most welcome. Thanks again for that helpful evidence.

Examination of Witnesses

Witnesses: Keith MacLean, Policy and Research Director, SSE, Steve Hargreaves, Corporate Strategy Director, EDF Energy, David Cox, Managing Director, The Gas Forum and Mark Somerset, European General Manager and Vice President, InterGen, gave evidence.

Q32 Chair: Thank you for agreeing to give evidence to us on the Gas Generation Strategy. Time is tight, so we will just kick off with the first question.

As we have heard, DECC’s strategy was to reduce uncertainty around gas generation for investors. As investors what do you think the signal does? Does the strategy send a signal to low-carbon investors and to the gas investor community? Who would like to start?

Mark Somerset: I will pick up on that one if I may. I think as far as encouraging gas investment signals to the gas-fired community, such as InterGen, it is still too early to say. I believe it is very much a question of this current stage, once the primary legislation has been completed. We are now into the consultation stage where we try to nail down some very important detail. It is very important that that detail is coherent and sends the proper message to investment. I think it is still a little premature to say that the Gas Generation Strategy is incentivising or encouraging gas investment. I would give it another couple of months, quite crucial months coming up now, where we should nail down this detail.

Keith MacLean: I would certainly agree that the strategy, as a standalone document, does not take us that much further forward. It outlines scenarios. I think there is a useful conclusion in it, which is that we need to build gas. We are going to need it for capacity, whatever happens. There is more of a question still about how much it is going to run. But the strategy itself, as a document, is just outlining a number of potential scenarios that do not improve clarity for the investor at all. The real progress, which Mark alluded to there, could be made with the introduction of the Capacity Mechanism in the Energy Bill. It is essential that we get clarity about that. It is also important to say that it needs to operate probably much more quickly than is currently outlined in the Government’s intention in order to have the right impact, because we need to recognise that the Capacity Mechanism and the gas strategy need to deal with existing plant and make sure that that stays open as long as is sensible, rather than just focusing on new build, which may come at some time in the future. If we don’t deal with the issue of existing gas, and making sure that that can continue to operate, then the capacity crunch would be much more significant.

Steve Hargreaves: I think we would agree with all of that. What is clear from the gas strategy is that the gas strategy is required to make up the difference between whatever low-carbon is built and closing plant and making up the difference for peak demand. The way to minimise that difference is to maximise the amount of low-carbon that is built. So the key thing is to progress the Energy Bill, progress EMR, progress the CfDs. The capacity market is absolutely important. I completely echo what Keith says, that it is very important and that there is a level playing field between older plant and new plant.

David Cox: I would agree with most of that. We, in the Gas Forum, obviously have members that are investors in renewables and in gas and other fuels as well. When we look at the Gas Generation Strategy we welcome the intent. We welcome the warm words, in terms of talking about a place for gas in the transition phase and perhaps beyond if gas-fired generation with CCS can be made to work economically.

At the moment the detail is lacking. The Capacity Mechanism is vital in bringing forward that detail. To some extent, until we see the outcome of how that Capacity Mechanism works, the prices realised in those auctions, it is still going to be difficult to see how we get the wave of new investment as well as encouraging existing plant to stay on the system. Until we see some of the prices from that auction, we are not going to be clear about how much gas-fired generation is going to be built.

Q33 Chair: What does that do for the low-carbon investor?

Keith MacLean: The recent debate that there has been, pitching gas versus renewables, has been very unhelpful, because it has discouraged investment in both rather than allowing either to go forward. Just to echo the comments of the first panel, it is essential we get longer-term clarity about the likely volumes that are going to be required in order to allow investors to make the appropriate decisions. These are all long-term investments and without long-term clarity it is very difficult to make that investment case.

Steve Hargreaves: Agreed. Honestly, we need all technology. We need the diverse mix. We need a mix of gas. We need a mix with nuclear and renewables. We shouldn’t say it is either/or. The Energy Bill delivers policy to deliver all and we should focus on that and get on with it.

Q34 Chair: In your evidence, Mr Hargreaves, you said we should not go beyond the minimum required to transition to a low-carbon economy. What sort of minimum did you have in mind?

Steve Hargreaves: The simple answer is that we need enough gas to make up the difference between whatever is built in low-carbon and older plants retiring. You can minimise that by maximising the life of old plants and maximising the amount of low-carbon that you build. DECC has a core scenario with a diversified mix scenario that says 26 GW of new gas plants, I think 3 GW of that is already coming. That is a credible scenario. Some gas is definitely going to be needed when we get into the next decade and that is a credible scenario.

Q35 John Robertson: What is the value of investing in new gas plant?

Mark Somerset: I will take that one. We have talked about the uncertainty, for example. If I can give you a specific example on a design detail in the Capacity Mechanism, DECC is currently talking of a quite hefty penalty for non-availability, which reflects what they call proper scarcity value or value of loss load. They have been talking about £3,000 per MWh for that penalty. The concept of penalties is a fine. If you look at that high level of penalty, then a 700 MW station that is not available for four hours, that is a £8.5 million bill. That would wipe out the annual profit for one of my power stations last year. I acknowledge that this is still not baked in to DECC policy and this is still the consultation stage. These ideas are still very current in DECC and I feel that that is just going to send: one, new investors scurrying away; and two, the existing gas-fired fleet much of which is on life support, that is going to switch it off. That is the uncertainty I am talking about.

Keith MacLean: At the moment, the economics of gas generation are unattractive. The current economics don’t justify investment. If we look at how we see the economics of gas generation developing going forward, in all likelihood we see gas plant running less often than it did previously, and potentially in a market where the effect of a low marginal cost plant, like renewables, is further depressing the price it is going to get. If the economics are unattractive at the moment, if we are looking to run less at a lower price in the future, that is not an attractive scenario. That is why it is so important that we look at the Capacity Mechanism as a different way of remunerating the investment that better reflects the role that gas will play in providing backup capacity as its core function, rather than necessarily running base load and earning its money from that role.

Steve Hargreaves: To add, I agree that the economics for new gas generation at the moment are not good. The main driver to that is the large overcapacity that is on the system. We had the recession that has taken some demand, and reduced demand, but there is also a large amount of new gas generation that was planned before the recession. The fact that there is overcapacity means there is not a need, so there is not a market signal. Over time that will return a little bit. But I absolutely agree with the point that Keith makes, which justifies why the Capacity Mechanism is needed.

Chair: We are going to come on to the Capacity Mechanism.

Q36 John Robertson: Does the strategy help or does it hinder?

Keith MacLean: It doesn’t say exactly what is going to happen. It says there could be lots of renewables running, in which case gas will not run very much. If we don’t invest much in renewables it will run more. We could work that out ourselves.

Q37 John Robertson: So the strategy has been basically a waste of time then?

Mark Somerset: No, it is definitely not a waste of time. I am not being over negative. There are certain things there that are very welcome. For example, there is a commitment to look at improving liquidity, which I think is across the board, not just the independents such as my company but also my cousins on the far end of the table there that we all support. So there are some very important pieces of that, which we support and we encourage the Government to work with us and listen to us and let’s get this thing moving.

Q38 John Robertson: I have always found with companies if there is profit involved it is good. If it is anything else it is bad. Mr Cox, you are swaying a wee bit there.

David Cox: No, I think the Gas Generation Strategy is an essential first step in clarifying the role of gas in the generation mix going forward in the medium to longer term. The detail is lacking yet but we in the Gas Forum welcome the first steps. Much more detail and clarity is needed as we go through the EMR reform, and that detail needs to be added quite quickly if we are going to see the investment that we need. I think we need it quite quickly otherwise we will face a capacity crunch and the lights will start to flicker.

Q39 John Robertson: Last question. Long-term clarity was what you said is required, yet the difference in gas price forecasts from DECC and others is the opposite. Where is the clarity going to come from?

Steve Hargreaves: I think that is absolutely why you need a diverse mix because trying to forward forecast, we are talking decades of investment here. We are not talking about the next few years. We are talking about decades of investment. So trying to forecast where those prices will come from so you hedge your bets, I guess.

David Cox: In a previous life I made a very good living forecasting gas prices and selling my reports to these companies here. It is a very difficult process. When one looks forward 10, 20, 30 years, and tries to estimate what gas prices will be, it is just as likely they will be lower as higher. When I look at the world, and I look at the global supply and demand position at the moment, we are awash with gas globally. We have 200 to 300 years of gas reserves at our current level of consumption, so we are not short of gas globally. That tells me as a forecaster, as an expert, it is just as likely that gas prices will weaken rather than increase, which is one of the scenarios. You have to model both a high and a low gas price future, but it is not a science.

Q40 Albert Owen: How much then is dependent on the price of gas for investment as opposed to any strategy that, picking up, is not useless but would have less impact than the gas price?

David Cox: I think my colleagues here are better placed to answer that.

Albert Owen: Sure, all of you.

David Cox: In my experience gas price risk is something that these companies are used to dealing with in the past, but we are moving into a reform of the whole electricity market where the Government is making choices about what that mix will look like and there are additional-

Q41 Albert Owen: Just to add to that then for your colleagues to answer. The price of coal production of electricity now is pretty cheap. That is going to come offline. Is gas going to be more attractive there, and are those factors, and external factors, like the price of gas, more important than the Government strategy?

Keith MacLean: Certainly the coal plant coming off will make a difference. But to be fair to the strategy document, what it does make clear is that the role of gas plant going forward will be to provide capacity. If it is providing capacity and if it is remunerated for providing capacity, it is then far less needy of the earnings from energy production in order to remunerate the investment. Therefore, if we can focus on that role of gas for capacity, if we can remunerate it on that basis, then there is no real pressure to run it a lot in order to produce energy.

Again, echoing the first panel, if you have energy production with a fuel that costs you nothing you should be maximising your energy production from that route. Both of those in combination mean that you are de-risking the energy supply, and the prices that consumers will pay for that in the UK, by investing in two sensible measures both of which would be remunerated with fixed and much more predictable costs than if we continue to burn fuels with very, very volatile prices.

Steve Hargreaves: Recent history in the UK would show that gas prices largely pass through to the electricity price, so the profitability of a gas station is very much driven by the capacity element rather than the energy element. That is one of the reasons we have seen significant increases in customer bills, it is just the gas price simply passing through.

Q42 Albert Owen: A question I put to the other panel was with regard to the discrepancy between figures supplied by the Office for Budget Responsibility and DECC themselves, as to the gas price between 2011 and 2017. Do you have any comments on that?

Mark Somerset: No, I can’t particularly expand on the answers that were given before.

Albert Owen: I was not sure that you were listening.

Mark Somerset: We all listened.

Q43 Albert Owen: We do have different panels to try to get different views as well. So no comments on that. The reason I ask the question in the way that I do is because you have the OBR that is predominantly advising the Treasury. The hand of the Treasury is all over this gas strategy, and DECC are saying one thing and they are saying another. That surely causes uncertainty.

Keith MacLean: The general point you are making is absolutely true. I don’t think it is specifically with regard to the price of fossil fuels because we would all agree that they are highly volatile, and-apart from David, who made money out of predicting-

Albert Owen: He has gone quiet.

Keith MacLean: -none of the rest of us would perhaps wish to risk our reputations on getting that right.

But the point that you make is absolutely clear, if we are getting confused and conflicting messages from different parts of Government, that is not something that is helpful to investors, whether based in the UK or even more so if they are based outside the UK.

Steve Hargreaves: The Energy Bill is a hugely important thing. In the second reading in the House there was awful lot of support for the general thrust of the Energy Bill, and that is an important signal in itself. Following through on that, following through on the EMR, getting CfDs agreed, and getting projects going is far more important.

Q44 Dr Lee: I just want to clarify. The Government will try to set a strike price for, say, wind, which relies upon gas backup, and set a strike price that then removes the signal to you to build gas power stations. We will get to a point where we have these wind farms that don’t blow when it is cold, but we won’t have the gas power backup because you guys have not received the price signal, because the Government has over-subsidised.

Keith MacLean: I repeat the previous point, that the important thing for gas generation going forward will be to ensure that, to a large degree, the fixed costs of investment are covered by the capacity payment rather than needing to be recovered through-

Chair: We are going to come on to capacity payment.

Q45 Dr Lee: I know, but building on what you said, what you are saying is we need another Government intervention in order to try to deal with a Government intervention?

Keith MacLean: You could describe it in that way. The important thing to recognise is that we need to value energy and capacity separately. If we wish to have markets investing in energy production and capacity provision, we need to make sure that they are valued appropriately. Under the current circumstances, even more so looking forward to the reformed market, we don’t have a clear signal for capacity, and that needs to be developed. We are not alone in that in the UK. If you look across most European countries moving to a low-carbon future, they recognise that there is a need to have that separate remuneration. It does not mean additional it just means separate and focused.

Mark Somerset: Also to add to your question, we have high levels of Government intervention, potentially in nuclear and renewables. I think to expect gas to provide the service that it will be doing, with no intervention at all, is an unreasonable ask. Therefore, there has to be some attention paid by Government to supporting what has hitherto been a neglected sector and therefore merits a requisite and appropriate level of Government intervention.

Q46 Mr Lilley: A question that may provide a bridge between this and the Capacity Mechanism. What capacity of gas generating power would need to be installed if, on average, we were supplying about a third of our electricity in kilowatt hours from wind and other variable sources? What sort of backup would we need, and could you relate it to the actual generating capacity of the wind? In other words, is it one for one or-

Mark Somerset: A cold winter’s day at the moment is probably about 55 GW in the UK. If we look at a third nuclear, a third renewables, a third gas, which is one of the broad balances being discussed, then you are looking, therefore, at approximately 20 GW to 30 GW of gas. Of course wind blows-

Q47 Mr Lilley: No, I am talking about the backup for when the wind is not blowing.

Steve Hargreaves: Trying not to state the obvious but the most it can ever be is one for one. After that it is a question of the correlation of wind across the country. For example, in our analysis we say the wind capacity might be worth 10%.

Q48 Dr Lee: Can I just follow on from that? What you are saying is that the Government has to intervene and subsidise gas production because it has intervened and subsidised wind production. The more wind production we have, the greater the subsidy for gas that is required, because you are not getting the price incentive. My point being that when people say if it is £150 strike price for wind, it isn’t, is it? It is more than that because if you have to also subsidise you chaps to build the gas as backup for the intermittent nature of it, it is significantly more. That then plays in to the need to subsidise nuclear, which I would suggest, yes, you do need state intervention in nuclear, but everyone keeps telling me it is really expensive. But it sounds like wind, from a variety of sources, is much more expensive.

Steve Hargreaves: The first bits of wind that you add to the system is not that expensive at all, but as you ramp up it gets more and more expensive, it becomes the more dominant part of the system.

Q49 Dr Lee: There is a divergence, is what I am suggesting. The more you have it is almost the greater. It is not one for one. It does this, doesn’t it, because of the intermittent nature?

Keith MacLean: If you see that in isolation you can take it to that extreme. It is important that we look at the system overall. We have not yet fully explored the potential for storage to act as a bridge and, as others mentioned before, the demand side is also important in understanding how much of a balancing act you have to perform.

I repeat the point of earlier on. Gas is relatively inexpensive in terms of investment. The main costs of gas in terms of the overall price is burning the fuel, so if you are going to choose a technology for backup you choose the one with very low capital costs. If you are choosing a technology for energy production you choose the one with zero production costs. It is quite a good choice to go for low-carbon that has a zero production cost once you have invested in it and to have the backup from something that is low. The point I also made earlier on is the fact that you use a Capacity Mechanism does not necessarily mean that you are providing a subsidy to gas, only that you are remunerating it more through a fixed payment rather than through-

Chair: Can we move on?

Q50 Dr Lee: What you are saying is it is better to do contracts for difference for gas because of the production cost, because you are getting a fixed price over a period of time, instead of giving the contracts for difference in nuclear, which has pretty little cost of production.

Keith MacLean: I don’t think that is necessarily incorrect, but I would make the analogy of your own electricity bill. You have a component that is a fixed or standing charge that reflects the fixed or standing costs of the system, and you have a variable charge for the energy. What we are saying is, in the future, gas should have more of a standing charge or a fixed charge to remunerate it rather than having to get it-

Chair: That brings us on to Barry’s question on capacity.

Q51 Barry Gardiner: It is very funny because I wanted to talk about the capacity market but we have quite heavily discussed that already. Let me broaden the question out a bit more, at least at the beginning. You have talked about the uncertainties, and I think each of you has mentioned the problem of a lack of clarity and real uncertainty in this area. There is one uncertainty that I don’t think you have touched on, perhaps because of your delicate sensibilities, and that is political risk. I wonder if one of the other things that is-among all those that you have mentioned-holding back investors from a final decision at the moment is this sense that we know that the Government has kicked certain things into touch until 2016, in terms of decarbonisation targets for 2030. We are not quite sure what might happen after the cliff of investment in renewables that comes at 2020, but more than that we are uncertain about the political situation. We are a bit worried that a future Government, perhaps of a different colour, may come in and not simply do what this Government has done and set up already. In that respect one of the things I wanted to ask you is, would it be helpful if the Opposition, at this stage, were to try and give the industry clarity about what it would do after a general election if it were to come back into government? In that sense you might say, "Well, you know what, I would prefer a scenario that allows me to go on emitting at 450, right the way through 2045. But if I am not going to get it, I would sooner know now what I am going to get. Then I can base my investment decisions on the disparity between those two positions", rather than have the Opposition hold all its cards to the chest until after the next election and then you find out, perhaps in 2015, perhaps 2016 or 2017, what they have decided they are going to do.

Mark Somerset: Perhaps I can kick off as somebody not representing one particular company. I think political risk is something that is there always and it is not just political risk in the UK. It broadens to Europe and globally with the climate change because this is dealing with a global problem. One particular country cannot work in isolation from that global solution. To have an Opposition party and a ruling party, even in coalition, come out in perfect harmony I do not think deals with that political risk. That would be a personal view.

Steve Hargreaves: The stable policy environment that the UK generally has is a valuable thing and cross party support is important. We have a situation where the Climate Change Act was brought through by the last Government and this Government, Liberals and Conservatives together are bringing through the Energy Bill, so we are seeing that consistency. I am sure-

Q52 Barry Gardiner: Sorry to interrupt, and I want you to continue, but you will have heard the Deputy Prime Minister say to the Liaison Committee last week that he personally was in favour of decarbonisation targets for 2030 on the face of the Bill but we live in a coalition. Given that the Opposition is highly in favour of decarbonisation targets for 2030 it is not inconceivable that the political position might change, either because of a Labour Government or indeed because of a coalition of a different consistency later on. What I am trying to get at is how much would early sight of what might happen under a different political flavour overcome some of the uncertainties that you are facing?

Steve Hargreaves: For me, I think it would help. But what matters is what is agreed in Parliament through the Energy Bill, through the EMR, through the contracts and then on to projects.

Keith MacLean: To pick up the specific example that you gave there of the EPS and widening that example out, I think that what-

Barry Gardiner: I gave the decarbonisation targets not the EPS. But I wholly agree because I have talked about EPS in the past.

Keith MacLean: The 450 grams, sorry, I thought was referring to the EPS. But for investors the worst political risk is the sort that you see in Spain at the moment with retrospective changes. For investors the grandfathering principle is probably the key one. Even if the Opposition were to plan to change something going forward it would be useful to see that in advance, plus the party support is good. I think having that overall commitment to the principle of grandfathering is by far the most important one to maintain, because if you lose that then you will find it difficult to get any investor making long-term commitment.

Mark Somerset: Just echoing that sentiment expressed by Keith about the importance of grandfathering. I think an example of political hiatus-a very encouraging example-is Australia where they have implemented a carbon tax, which is fiercely opposed by an opposition that is likely to be elected. Although it has come in, no one is taking too much notice of it, in terms of long-term hedges for example, because they realise it could easily be overturned once the new Government comes in.

I don’t see that situation here based on my experience of travelling around these long corridors. Certainly we are also meeting with the Opposition as part of our normal day job, and we are not getting that impression that there is a massive disconnect between where we are now. But, yes, it would be helpful to continue that dialogue and for them to raise any early concerns.

Q53 Barry Gardiner: Indeed, Mr Somerset. The sense of my remarks was not intended to undermine grandfathering. It was more around the issues of decarbonisation target and EPS, which, if it were to be reduced substantially from 450 down to about 200, might make a considerable difference to gas, obviously.

Mr Hargreaves, you have said that from the consumers’ perspective closure of low-cost existing assets to be replaced by expensive new gas generation, which becomes stranded, would be a poor outcome. Could you talk us through the way that the Capacity Mechanism and the Industrial Emissions Directive need to be co-ordinated to ensure that that poor outcome does not happen?

Steve Hargreaves: Yes. The Capacity Mechanism is going to be an auction, and that auction ought to reveal the cheapest way of meeting the capacity. What is important in that is that, first, it incentivises just the right amount of plant; there is a level playing field between new and old so they can compete on a similar basis; and also the right incentive between peaking plant and combined cycle gas turbine. Because if you are getting to-in the Government’s numbers-27% load factors in 2013, that is going to be a combination of peaking plants and combined cycle gas turbine. The interaction with the IED comes as a timing point, so we are expecting an awful lot more detail from DECC in May this year on the Capacity Mechanism and the way that will work. At least we will be able to model what we think will happen in the Capacity Mechanism and what will happen in the auction, as we make decisions for the coal plants in relation to the IED at the end of this year. We will then get an awful lot more information. The plan is to run a capacity auction in 2014 for the 2018-19 winter, and again we will get a lot more information that will help decision-making on coal stations at that point.

Q54 Barry Gardiner: One final question perhaps to all of you, perhaps with the exception of Mr Cox. Do you sometimes wish that you were more like water, and that you had a regulated asset base and you had your regulatory return and you did not have all this to worry about?

Keith MacLean: About half of our businesses are regulated assets and we are very happy with that. We would like to have half of our assets in a market-based environment. Our greatest plea at the moment is to decide whether the generation and supply part is going to be regulated or whether it is going to stay in the market. We will make do either way, but preferably we believe there should be a continuing role for the market in that.

Chair: Albert, you had a quick question on gas storage.

Q55 Albert Owen: Yes. We have not talked about gas storage at all and I think it is very important. Mr Cox might comment or might not. I can remember many years ago, when I was at deep sea, there used to be very large crude carriers and ultra-large crude carriers just lying at sea waiting for prices to change. We are going to need a proper gas storage strategy, aren’t we, otherwise if these cold days are more frequent we could be in real trouble in this country? Do you think that should be given a greater priority in the Government’s proposals?

Keith MacLean: Gas supply, particularly in a world where gas will be running very differently to how it is running at the moment, will be very important. Again, whether it is an electricity capacity mechanism or a gas storage mechanism, it needs to take into account existing as well as new investment. There is a risk, in looking at what is needed in storage, that we do something for new that puts at risk what we already have. But you are absolutely right, we need to look at gas supply and storage as part of the strategy rather than just what we are doing once we have it.

Q56 Albert Owen: Mr Lee and Mr Lilley talked about the backup capacity. Where I live in my constituency there is a nuclear power station and there are windmills right alongside it. One doesn’t blow in a cold period, and we rely very much on nuclear. But in the summer, of course, when the wind doesn’t blow and it is very warm, there is the nuclear power station, yet people are saying, "Do we need to take them offline?" Whereas if we had gas, which I think is more flexible, rather than shutting them down, we could have storage when it is very cold and perhaps burn a little bit more when it is warmer as well. What is the problem? Why do you think successive Governments-this is not a party political issue-have not invested in gas storage or encouraged investment in gas storage?

Mark Somerset: Part of it may be due to the fact that even in the last five years gas has become far more of a globally sourced commodity for the UK; 10, 15, 20 years back it was North Sea and a bit of piped from the Continent. Now it is globally sourced and that may have taken the eye of Government off the ball in terms of indigenous storage sources. I would argue that, because it is becoming more global, it is ever more important to have your local indigenous storage sources here in the UK. For example, an LNG ship coming here could be diverted because Japan is offering twice the price. These things happen in the market all the time and I do think more attention should be paid to indigenous gas storage.

David Cox: The market signals have disappeared, winter-summer differentials of gas prices, so that has removed some of the market mechanisms to bring forward a new seasonal storage. In this new world of lots of wind, we are going to need more fast cycle storage to back up the wind as it comes on and off from one day to another. There is also a debate about our probably needing more seasonal storage as well. I think we will have to look at that very carefully, and the Government will need to monitor it as it is looking at further intervention measures in security of supply and I think it has its eye on the ball there.

Q57 Albert Owen: Is there a planning issue for gas storage as well? My understanding is when the previous Energy Minister was in opposition he was very much pushing for it; when he got into Government he got very frustrated-I am sure he’d admit to this-and there are planning issues.

Mark Somerset: Yes, there are always planning issues for anything to do with energy infrastructure.

Q58 Dr Lee: Moving on to the capacity crunch, which I suppose is neatly following on from Albert’s questions, do you agree with DECC’s analysis that we are about to reach a capacity crunch? If so, do you have a time window, a period in which you think it is going to be acute and customers are going to start taking a greater interest in it?

Keith MacLean: We would agree with Ofgem’s analysis, which had an earlier potential drop in the capacity margins. That is why we believe it is so essential that we not only run the first capacity auctions next year but that they take effect as soon as possible, particularly for existing plant, to make sure that no more plant closes than is already planned. Looking at some of the statistics from December, on what was a fairly normal day, we have seen a series of circumstances, which meant that if you took out the plant-that will probably be closed by this year-from the Large Combustion Plant Directive, opted out, that plant was the plant that was keeping the lights on. If that is no longer there at the end of the year it is then a question of how we deal with that.

The LCPD sees the plant closing at the end of 2015 but, because it has been very attractive to run coal at the moment, nearly all of the plant that is opted out has run out of hours or is running out of hours. We saw Kingsnorth closing several months ahead of what was already brought forward. So if the Government is saying the problem is not until 2018, we hope they have got it right. But we think it would be sensible to take an insurance policy out on that, and make sure that we do everything that we can to keep existing plant on that does not have to close, and take plant that has been mothballed out of mothballing in order to make sure that we do have enough capacity over the coming years.

Steve Hargreaves: You have to be quite careful with the Ofgem analysis because that analysis was performed on a D-rated basis. The way that they do it is they take an allowance for the probability that each power station will be available to meet supply. If you turn that back into old money, a non-D-rated basis, the equivalent of Ofgem’s 4% is over 20%. That is even accounting for D-rating wind. That 20% is roughly where we have been since the early 1980s. It was a little bit higher before that. What matters after that is that the plant that can stay on under the IED can stay on and bridge the gap. If we can get the capacity mechanism right and get it working, then hopefully there will be enough power stations.

Q59 Dr Lee: Would you agree that the admirable attempt to increase economic growth will bring forward the date of a capacity crunch?

Mark Somerset: Demand is really significant for our industry, particularly industrial demand, and basically that is what has fallen off the perch since 2008. That will exacerbate the problems that Keith has just described.

Q60 Dr Lee: One quick question. Do you see the role of gas post-2030 as base-load, peak demand? How do you see it? How are you modelling it at the moment?

David Cox: First of all, you have to remember that post-2030 gas will still be vital in the heat sector for our central heating and our use in the home, as well as in industrial and commercial processes where it is more difficult to replace. So gas has a role post-2030 in the heat sector that I think is acknowledged by everyone, even the renewable lobby. In terms of gas in gas generation, The Gas Forum would like to see a role for gas as a destination fuel. We would like to see-I think the next panel is going to talk about it-gas-fired generation with carbon capture and storage and if that could be made to work economically. The numbers look good. Already in the DECC numbers it looks cheaper than offshore wind on the estimates.

Q61 Dr Lee: That is not difficult really, is it?

David Cox: You say that, but if that can be delivered on a large scale. The Gas Forum are worried about the delays that go on and on with getting the CCS demonstration projects up and running, but we see gas as a destination fuel because the technology for all the different parts of it should work. It is just a question of tying it all together now.

Keith MacLean: We need to open up a tremendously higher degree of flexibility and diversity, if we are able to decarbonise and abate the carbon emissions from gas. It quite transforms what we will be able to do through the 2020s and certainly beyond 2030. I would absolutely echo David’s point, we very quickly need to get to a point where we are not talking theoretically about whether CCS works, technically and economically, but that we are getting on and demonstrating it. It is quite frustrating how long that is taking.

Q62 Ian Lavery: The amount of gas plant required by 2030 is obviously a very debatable point and different people on the panel probably have different views. The gas strategy has revised the Government’s estimates upwards, citing things such as the electrification of transport and population increase as the main reasons. Do you agree with that analysis?

Steve Hargreaves: As a quick summary, we are in a general trend of energy efficiency first, then to decarbonise the electricity grid, then to electrify transport and heat. There is an awful lot less rationale for doing those last two steps if you have not decarbonised electricity.

Mark Somerset: I would agree that, assuming that decarbonisation takes place and heat and transport are electrified, then that will boost electricity demand tremendously.

Q63 Ian Lavery: There are economic risks in pursing either a high or a low gas scenario. What are the economic risks?

Steve Hargreaves: If you pursue a scenario with lots of gas you have the risks of price volatility, the risks of energy security and the risks that you can’t meet your decarbonisation targets. If you pursue a risk of a low gas strategy you run the risk that you cannot meet peak demand at times of system stress.

Keith MacLean: One final thing from the strategy is that there are some quite interesting graphs in it that show that, in terms of the capacity, there is not an awful lot of variance between the high and low scenarios. The big differences are with regard to how much the plant runs and the energy that is produced from them. As with so many things, there is a low regrets level of gas that it would seem sensible to have as our baseline now. Rather than debating whether it is zero to 100, let’s say it is somewhere between 30 and 40.

Q64 Ian Lavery: In your view, there is not much risk between a high and a low gas scenario. Is that what you are saying, Mr MacLean?

Keith MacLean: No. Mr Hargreaves outlined the risks that by going down a high gas route we would be exposing ourselves to the volatility of the gas price, which is what has driven most of the price rises over recent years, and the security of fuel supply risks that would be attendant in that as well. So I would agree with those points.

David Cox: Absolutely, and also our comparative competitive position with other countries is important. If we set a regime that gives us very high electricity prices, because we are on the straight path to a low carbon future but other countries deviate, of course our competitive position will be destroyed.

Q65 Ian Lavery: Which scenario would carry the least risk?

Mark Somerset: Do you mean from a macro point of view or from a gas generation strategy point of view?

Ian Lavery: Both.

Mark Somerset: From a macro point of view, the more balanced the mix is to me that is then a hedge for the nation. That is the optimal thing. So you have sensible proportions of nuclear, sensible proportions of renewables and a sensible proportion of gas and essentially you have an internal hedge there.

Chair: Thank you very much for that evidence. It has been most useful. If there is anything you think did not come across you can write to us afterwards. Thank you again.

Examination of Witnesses

Witnesses: Graham Meeks, Director, Combined Heat & Power Association, Charlotte Morton, Chief Executive, Anaerobic Digestion and Biogas Association, Jeff Chapman, Chief Executive, Carbon Capture & Storage Association, and Professor Roger Kemp, IET Energy Policy Panel, Institution of Engineering and Technology, gave evidence.

Q66 Chair: Thank you very much for coming to give evidence on the Gas Generation Strategy. As we finished on the last one, carbon capture and storage is seen as an extremely important part of our energy future. Mr Chapman, you have expressed concern that there are a number of aspects within the strategy that run contrary to the development of CCS. Could you explain what those are?

Jeff Chapman: We are very concerned that there are a large number of gas-fired power stations built unabated in places, where later on it will be either too expensive or completely impractical to retrofit CCS. We realise, of course, that there is a capacity crunch coming up and that we will need to built unabated gas-fired power stations in the interim to satisfy demand, but we would like to see more planning in the system to enable power stations to be built in appropriate places where the CO2 can be captured and transported away to storage. It is not too difficult because the storage resources that we have in the UK are in the southern North Sea and the central North Sea and in the east Irish Sea, so it is fairly obvious that putting new gas-fired power plant in locations near to the shoreline in those cases will, in effect, have a no-regrets situation for the future. We are particularly concerned about planning and this development in new unabated gas should not happen in a haphazard manner.

Q67 Chair: What has it done for the prospects of CCS?

Jeff Chapman: I don’t think it alters the prospects for CCS. There is obviously about half the amount of CO2 to be captured from a gas-fired power station of the equivalent output to a coal-fired station, which is a good thing because it reduces on the costs of the infrastructure of pipe work and storage that is needed to dispose of the CO2. CCS is cost effective. I think someone mentioned earlier how cost effective CCS looks set to be. In another role I chair the CCS Cost Reduction Task Force and we conclude that CCS is cost effective, whether that is from gas or from coal.

Q68 Mr Lilley: I have always been told by technical experts that CCS, capturing carbon, is a comparatively old technology and it should be quite simple, so I am perplexed as to why it is taking so long to get anywhere with it while we are having to devote £1 billion just to experiment to see whether it can be made to work. What is the problem? Is it in the extraction or is it in the transport or is it in the storage?

Jeff Chapman: I am just as perplexed. It is not to do with engineering anyway. It is proven.

Q69 Mr Lilley: Why do we need a competition if it is already proven?

Jeff Chapman: We need to kick-start the industry. The first projects will be high in capital costs and that will, of course, feed through into the levelised cost of electricity. The reason for that is that they are laying down infrastructure that will be used by subsequent projects. So there is a hurdle to overcome before you can begin to see the cost coming down. The first projects we are looking at, although they are coal commercial in size-they are of 300 MW in size, which is quite a lot-it is not the size of the power stations that we are accustomed to building. We are more accustomed to building 1,000 MW or 2,000 MW of power stations at a time. So they are not getting the economies of scale that we will eventually get out of CCS-equipped power stations built new later on.

Q70 Mr Lilley: A lot of the problem is the transport and storage, which has to be done for one power station but could actually serve several?

Jeff Chapman: If there is any single biggest risk in the CCS chain it is probably concerned with the storage. The storage needs to be explored and developed. That is quite an upfront cost in itself. But once you start pumping CO2 down a pipeline, injecting it into a store, and you are building up a model of how the store behaves, then the confidence level will improve enormously. That has been shown in previous projects elsewhere in the world.

Q71 Mr Lilley: Technically, is there much difference in CCS for gas and CCS for coal?

Jeff Chapman: Technically, no. It depends whether you are talking about pre-combustion or post-combustion. Post-combustion is very similar. It is where you capture the CO2 as an end-of-pipe solution on the back end of a power station. Pre-combustion on gas means shifting methane to produce CO2 and hydrogen, and split out those two streams. It is very common in oil refineries. This is practised an awful lot in oil refineries. The difference between that and pre-combustion on coal is that you start by gasifying the coal and you make a synthetic gas, which you then chemically separate. One of the inherent criticisms of the gas strategy we have is that it is just for gas. It is not for fossil fuels; it is just for gas. We have four coal-fired power stations under development at the moment and one gas-fired power station with CCS. Three of those are pre-combustion and they lie quite nicely alongside gas, because the fact that in pre-combustion you generate hydrogen means that it is a kind of substitute for gas. We talked about gas storage earlier. At a coal-fired power station, the storage is a big pile of coal and there is no better energy store than a big pile of coal. I am not here to promote coal, but this kind of diversity is beneficial and fits quite nicely alongside a gas strategy.

Q72 Ian Lavery: I want to ask a question with regard to the gas-fired project in the competition. There is only one gas-fired project in the competition of four and, given the emphasis in the strategy on the importance of CCS for gas-fired generation, do you think it is likely that the gas-fired project will receive a fair share of the money, a fair share of the cake?

Jeff Chapman: Who am I to say? Of course it is likely because it is a good project within the bounds of the competition, but I am afraid I don’t know what is going on behind the closed doors in the corridors of Whitehall.

Q73 Ian Lavery: Do you think that the Government is taking CCS as seriously as it should be at this moment in time, and do you think that DECC is taking CCS as seriously as I believe it should be at this point in time?

Jeff Chapman: In sentiment, yes, but in deed not really. We need to see more action more quickly from Government. It is taking a very long time. As you know, we spent five years on an abortive process on competition number one. The process of selecting these projects is taking longer than expected. We have to be able to see our way to move into the general EMR, where CCS projects will be able to apply for CfDs under EMR for support alongside the other technologies, which is the commitment. The clarity that we are getting on CCS in the EMR process is nothing like as good as I think the clarity that is perceived for the other technologies.

Q74 Ian Lavery: Has it been kicked into the long grass?

Jeff Chapman: I don’t think so.

Q75 Barry Gardiner: Professor Kemp, following up on what Mr Chapman was saying, how important do you think the development of CCS technology in this country is, not simply for our energy system but actually for our economic system? For our manufacturing economy to be able to export that technology, what is going to be the hunger for that technology elsewhere in the world if we were to be able to develop a market lead in it?

Professor Kemp: I think it depends very much on where the price of carbon goes in the future and where international agreement goes in the future. The previous panel was talking earlier about political risk, and it is not what happens in Britain so much as what happens overseas. If we are all aiming for an 80% reduction in CO2 then CCS is clearly going to be an absolutely vital component of that, because there is no other way of getting down to those sort of levels without either totally unrealistic amounts of renewables or unrealistic amounts of nuclear.

Q76 Barry Gardiner: You have read the Chinese 12th five-year plan, I am sure.

Professor Kemp: Yes.

Barry Gardiner: You will know exactly what they are proposing. In the light of the number of coal-fired power stations they are building, perhaps you could direct your answer to my question.

Professor Kemp: Within the DECC policy statement about CCS it does say that we have a UK lead in research in this area. Perhaps I am being uncharitable but I can’t frankly see it. Yes, we have done some small-scale research but we are not really going to demonstrate things until we have a full-scale demonstrator. Certainly the view of my colleagues at the IET is that we are most unlikely to get a full-scale demonstrator until we have a guaranteed carbon price that makes CCS competitive with other sources of supply. At the moment, while we have the gas strategy that is offering grandfathering rights up to 2045, and a maximum limit of 450 grams per kWh, the financial justification for going to CCS seems, shall we say, not totally proven.

Q77 Barry Gardiner: I heartily agree with you. Let’s look then at the impact of trying to get those indicators into the market here in the UK. We heard earlier about the difficulties of a carbon price, toute simple, in terms of a global economy, but by putting in place as early as possible a decarbonisation target for 2030, for example, by talking about reducing the EPS from 450 grams per kWh right the way through to 2045 but an earlier and lower level of EPS, both of those indicators then presumably, given what you have said, would be at least helpful in setting the signals into the market to develop CCS technology in the UK.

Professor Kemp: I think one thing we are missing in the UK is what you might call a global view of energy. Most gas goes into central heating systems, domestic and commercial. The amount going into power stations is not particularly great by that context. At the moment there is no real carbon taxation at all on domestic gas-fired central heating boilers. If you look at the Government’s heat strategy, it is talking about converting gas boilers into air source heat pumps fed by low-carbon electricity, but that does not seem to be reflected in the numbers that we are seeing in the capacity requirements in the Energy Bill. So there seems to be a mismatch between the heat strategy and the gas strategy. There seems to be a mismatch in costs between where you put the charges for carbon and there is also a vast amount of uncertainty. You have seen the gas document that talks about 100 grams as a target but it might go up to 200, it might go down to 50.

Q78 Barry Gardiner: Professor Kemp, you would be a wonderful politician because what you have done is you have jiu-jitsued me and you have taken what I gave you and, instead of answering my question, you have told me what you wanted to tell me, which I agree with and it is fascinating. But if I can just peg you back to the question of whether the market signals that I spoke about would help to incentivise the sort of progress in CCS technology within the UK, and whether you think those market signals that would lead to a higher carbon price would actually do that?

Professor Kemp: Yes, I agree. If you were to reduce the-

Barry Gardiner: That is all I really wanted. Go on.

Professor Kemp: If you were to reduce the maximum allowable CO2 per kWh, clearly that will incentivise a lot of low carbon technologies, including CCS. If you change some of the other indicators, the targets, again that is going to incentivise CCS. It is not very obvious to me that at the moment there is an incentive for CCS.

Q79 Barry Gardiner: I entirely agree. One of the things that I wanted to ask about more generally-and maybe Mr Chapman is the most appropriate to answer this, I don’t know-is looking at the Treasury infrastructure pipeline figures. Mr Chapman, I suspect you have looked very carefully at these and you will have seen that in 2012-13 there was £172.74 million. Currently there is £201.53 million, in 2014-15 £86.37 million and nothing beyond that. Given that originally we were told this was going to be £1 billion, and then we were told in the Treasury figures that it was amounting to, I think it was, £565 million, but now it is down to about £200 million in the current spending round. I don’t know if you are familiar with Harry Potter. Do you remember the Triwizard Cup? Harry Potter is instructive in many ways, but in the Triwizard Cup the guy who actually gets it ends up dead. It isn’t really great: you win the competition, but you end up duelling with Voldemort. The point I am trying to make here is-

Mr Lilley: Obscure.

Barry Gardiner: It is obscure, but to a whole generation of people it will be very clear indeed. The point I am trying to make here is that this competition may not have a prize at the end of it if the money is not there in the Treasury.

Jeff Chapman: Can I start with your last question first?

Barry Gardiner: Absolutely, yes.

Jeff Chapman: We do have a carbon price in the carbon price floor. That is quite strong, and I don’t think there is very much more we can do for that because it is already heading us out of kilter with the rest of Europe. So I am perfectly happy that we have a surrogate for carbon price in payments for clean electricity. That is fine. We still have some issues to resolve and-following on from what Mr Lavery said earlier-one of our issues, for example, is we want to know that our CfDs can be linked to fuel price. We don’t have the clarity that we need about that.

With the £1 billion, which is £200 million in the current spending round, it is understandable that the Treasury budgets for £200 million in the current spending round and the rest comes later. We have to take that on trust because the next spending round has not been decided yet, but what will be decided are contracts. The Government has to make contracts with the projects that are selected in the competition and once those contracts are made then the £1 billion will be committed. That is the point of the proof of the pudding and that is what we want to see.

Q80 Mr Lilley: Could I come in very quickly? Part of the argument given for this is it is worth subsidising it all because we will build up an industry where we will be able to take on the world. The four groups that are shortlisted for carbon capture and storage I think all have a foreign component. I am not a great enthusiast for industrial strategies, but I can think of no worse industrial strategy than British taxpayers supporting the growth of technology in Siemens or French or other foreign industrial champions. Can you see any British companies that are going to be subsidised to produce, acquiring a technological advance that will enable them subsequently to capture markets overseas?

Jeff Chapman: Yes, there are British companies in there. There are British companies developing technology at the moment, and the Government-

Q81 Mr Lilley: In these consortia?

Jeff Chapman: Within those consortia. I have to say that, in common with all other technologies, the world tends to be dominated by multinationals, most of which are not domiciled in the UK.

Q82 Mr Lilley: Siemens could be called a multinational but I think of it as German. I don’t mind whether the multinational is multinational if it is British, but I can’t see that there are obvious candidates that are going to take on the world.

Jeff Chapman: I think the thing especially about CCS is that there are three parts of this. One is at the capture end there is a lot of process engineering. If we get the process engineering expertise created in the UK, no matter who owns the company that houses that expertise, that is our expertise and the UK owns it. The next bit is pipeline engineering and-

Q83 Mr Lilley: The UK owns it? Could you elaborate on that concept a little? Siemens develop some technology; the UK owns it?

Jeff Chapman: The engineers that are expert in process engineering are resident in the UK. The same thing applies to pipelines. We have a tremendous expertise in process engineering, we have a tremendous expertise in pipeline engineering and also, in Aberdeen and elsewhere, we have an enormous expertise in reservoir engineering. So CCS is something that really fits the UK staff resource. It is a perfect fit.

Q84 Mr Lilley: We need to find a wholly British consortium to-

Jeff Chapman: I am not going to pick names but there are British listed companies and British unlisted companies in the competition too, remember.

Q85 Barry Gardiner: Mr Meeks, briefly what are the benefits of using CHP technology?

Graham Meeks: When we look at what the gas strategy set out to do, one of the key things that it sought to achieve was making best use of our natural resources. When we again look at the strategy, and perhaps where it is lacking, what it fails to do is to address the fundamental waste that exists in our electricity system today. If you look at the amount of energy that our electricity system consumes, only 40% of that is delivered as usable energy to the final consumer. If you look at combined heat and power then you are looking at a figure that cuts that waste by half, so you are looking at something over 70% of the energy that is consumed being used by the end consumer. In eliminating over half the waste in the energy system, CHP delivers a number of benefits, of which affordability is one, security is another. We are reducing gas imports by 5% today on the existing CHP fleet and, of course, we could make further inroads into our carbon abatement goals if we were able to exploit that efficiency.

Q86 Barry Gardiner: Thank you very much. In your expression of interest it says, "There is a technical feasibility for a total 24 GW of combined heat and power by 2020 but DECC expects capacity to grow by less than 3 GW by then." Why are those figures so different? Have you failed to convince them of the benefits that you have just outlined? Why do they seem so ill disposed to CHP in that way?

Graham Meeks: I think Professor Kemp hinted at part of the problem, in pointing out that when we look at our energy system we should recognise that 49% of primary energy is consumed in the heating sector, and across the heating sector gas is by far and away the dominant fuel in every single subsector. When you take a step back from that, you will see that gas consumption in the heat sector is twice what it is in the power sector today. If you are a commercial business doing a bit of market analysis and you came up with a strategy that ignored the fact that your primary raw material, in effect, was being consumed in twice the volume in a market right next door to you, you would probably send the report back. I think what we are seeing in Government is an institutional failure to address energy in the round, and to recognise that heat is a massive part of our energy economy, as is power generation. If it was able to address the two elements in parallel then the efficiency benefits of addressing those in parallel would become obvious, but what we have seen again perpetuated in the Gas Generation Strategy is a silo-centric approach to the problem. That is not a strategy. That is a set of wishes in respect of gas generation, and I am afraid it falls short. I think that is the answer to your question.

Q87 Barry Gardiner: Indeed, I think so too. What are the market barriers frustrating the rollout of CHP? You have talked about the silo mentality in DECC but-

Graham Meeks: As you say, there are institutional barriers and there are market barriers and sometimes the two get blurred. If one looked at CHP and you looked at the genesis of the electricity industry, most of the original power generation in the liberalised market that we had then was combined heat and power. That is where it started because the efficiency benefits were obvious. As we have become increasingly centralised, those have tended to fall away. If we look at the CHP market today, it is healthy. It is viable in those situations where people are trying to avoid the electricity market. So where people are sizing a CHP plant to supply only the onsite power and the onsite heat, then it is a viable proposition. As soon as one starts to interface with the wider electricity market it becomes a lot more difficult. The market is very hostile and there are certainly many issues around liquidity, and particularly of costs of transaction, that make it difficult. I think we also have to look at who is investing in CHP. A lot of the companies who are the sponsors of an industrial CHP project are looking at a hurdle rate for investment of perhaps 30% or higher, whereas a utility is prepared to take a more relaxed view.

Q88 Barry Gardiner: Why do you think the Government is ending the Climate Change Levy Exemption Certificates?

Graham Meeks: I think in reality CHP was an unintended victim of a bit of housekeeping that was going on between Treasury and HMRC. I find it hard to believe that one would intentionally go out to undermine what is one of the most cost effective carbon abatement measures. The effective subsidy that CHP was receiving was saving carbon at around £20 per tonne of CO2, compared to £70 for onshore wind and £140 for offshore wind. It is a very cost effective means of doing that and it has been rather left in limbo. The next consideration is: what has Government done in the two years since it has known that there has been a problem? We have been reassured that virtually any Government Department that one asks believes that CHP is a very good idea. We can go to BIS and they are very strongly supportive; DECC are very strongly supportive; it says so in the Gas Generation Strategy; it says so in the heat strategy. Treasury think that CHP is a good idea, but they have pushed the problem back into DECC’s parish, and it is still sitting there as a hot potato in DECC and unresolved. You can argue about whether the Levy Control Framework is the sole issue there, but I would argue that if CHP is there as a means of abating carbon cost effectively then it has every right to a place within the Levy Control Framework considerations, as indeed other measures do.

Q89 Chair: Ms Morton, what proportion of the UK’s gas requirements do you think could be provided by green gas?

Charlotte Morton: Our estimates, which are backed up by estimates produced by the Committee on Climate Change, suggest that we can produce over 10% of the UK’s domestic gas supply.

Q90 Chair: That would be for all gas usage, heat as well as generation?

Charlotte Morton: I assume so. I am not sure if some are different.

Q91 Chair: Do you think the lack of mention of green gas in the strategy means the Government does not share that assessment?

Charlotte Morton: No, I don’t think so, but it is an extraordinary omission. The Government has made clear its support for biogas. In the Coalition Agreement it committed to exporting a huge increase in energy from waste through anaerobic digestion, but the support could be much greater. Given that we have a gas generation strategy that is looking at sources of gas, it is rather a bizarre omission that we don’t have the best low carbon source of gas that is domestically produced included in that strategy.

Q92 Chair: How do you think it should have been included?

Charlotte Morton: Including it in the first place would clearly be the first job. There are a range of sources of gas. This form of gas is ultra low carbon. We have talked about today what level of carbon is acceptable. Biogas is produced at around 11 grams of CO2, so well below even the best target that the Committee on Climate Change is aiming for. As I have said, it is also domestically produced. It is produced here, so that helps get round some of the security of supply issues from sourcing gas from perhaps more volatile regions overseas. We are also one of the UK leaders in this technology so the possibility of developing significant export markets is huge. There are a range of reasons why it should be included, and the potential to increase the rate of growth would be immensely helped by the Office for Unconventional Oil and Gas including biogas within its remit.

Q93 Chair: That is a specific suggestion, but do you have any other suggestions as to how biogas could be incentivised and developed? Is there any Government action that is missing at the moment?

Charlotte Morton: The rate of increase in biogas supply is dependent on a range of co-ordinated policies across a number of different Departments. For example about 60% of our potential comes from household and commercial food waste, so waste policy clearly has a very big influence on our ability to deliver. Equally farming policies and transport policies have a big impact on top of the financial incentives regime, which is again why having the Office for Unconventional Oil and Gas co-ordinating those policies across Departments would make a significant difference in the rate of increase in domestic gas, at the same time helping to address the capacity crunch that we have talked about a lot today. This is a source of gas that is generating today that has the capability of scaling up fast and cheaply, which could help address some of that capacity crunch.

Q94 Chair: Professor Kemp, do you have any views on that?

Professor Kemp: Yes, I think there are two points that are probably worth making. The first is that biogas does have the great benefit that you can store it, just like any other gas. That means if you are then looking at decarbonising the overall heating sector that you do not have to have the same peak in electricity generating capacity that you do if you are using, for example, heat pumps or direct electric heating. So, the role of biogas as a way of producing a storable energy vector seems quite useful. There is a second point, which is that, as far as I can see, the present subsidy regime favours burning biofuels in a relatively inefficient power station to make electricity rather than converting them into biomethane to inject into the gas system. These seem to be a couple of policies that are perhaps not co-ordinated as well as they might be between the gas policies and the electricity generation policies.

Q95 Chair: If you put it into a combined heat and power plant I suppose that would be preferable?

Professor Kemp: A combined heat and power plant? Yes, of course, that is probably preferable from a number of points of view, but you still have the storage issue. Storing heat is quite difficult; storing electricity is exceptionally difficult; storing gas is relatively easy.

Chair: Thank you very much for your evidence. It has been most helpful. As I said to the other panels, if there is anything you think with hindsight you should have said and did not have time to, if you could write to us that will be taken into account as well. Thank you again.

Prepared 20th February 2013