Examination of Witnesses (Questions 420
- 439)
TUESDAY 8 JULY 2008
Mr Alistair Buchanan and Mr Stephen Smith
Q420 Lord Lamont of Lerwick:
Professor Bain, in a paper written to this Committee, argued that
your conclusion that the reinforcement of the Beauly-Denny transmission
line—and maybe you could just remind me about that particular
project and what its status is—would bring a lot of wind
generated electricity from Scotland to England he was not convinced
by, he was not convinced that it was economically justified, and
he also suggested that there might be a degree of political pressure
being put on you from Scotland. That is not really the important
point, the important point is the first one.
Mr Buchanan: If I could start and then
maybe Steve will want to pick up on this, for those of you who
are not familiar with the Beauly-Denny line broadly, to give you
some geography, it is a 250 kilometre standing line at the moment
at a medium voltage between Inverness and Stirling. Basically
that is going to be upgraded to super grid level. It is a highly
controversial project: there were 16,000 individual complaints
to five public inquiries when they set off down the public inquiry
route three years ago, and what Ofgem did four years ago, in 2004,
was break away from its usual approach to five-year cycles of
analysis and provisional agreement of capex. What we did in 2004
was, on the basis of our economic analysis, award primarily Scottish
Hydro-Electric and Scottish Power £332 million to build this
network. Where that system is today is nowhere; we are still waiting
for the planning process to grind its way through. It may sound
a bit pessimistic but it may not be unreasonable to think that
this line might not get built until 2015. Bear in mind that a
25-mile stretch across the North Yorkshire moors took nearly 12
years to get through planning permission and be built in the 1990s—these
planning inquiries are intense and this is a particularly controversial
issue. The controversy to which you are referring is on the economic
side. Just by way of process, we used engineering advisers SKM
to do this work for us, we used as you would expect an Impact
Assessment approach, a cost benefit approach, we also went to
public consultation. The two key elements that I would see at
the high level in terms of his concern were, firstly, that we
seemed to miss 500 megawatts of potential capacity and therefore
we did not need to make this build. When we did the analysis,
1,200 megawatts was the breakeven, there was 1,900 megawatts sitting
north of Inverness, today there are 6000. We understand what he
was saying, therefore, but we felt that the analysis that we did
suggested that there was not plentiful spare capacity so that
area we slightly disagree on. The second area which Steve can
pick up as an entrée into talking about our transmission
access reform positioning is that he did say that the system could
be run better, that we could squeeze more juice out of the current
system, and I think he had a point in that.
Q421 Lord Lamont of Lerwick:
Would your answer be affected if the nuclear in Scotland was not
replaced by nuclear?
Mr Smith: No, because the constraint
actually sits north of where the nuclear is connected so you are
actually building in a very remote area.
Q422 Lord Lamont of Lerwick:
But it would not be able to be exported to England, would it?
Mr Smith: It is not contingent on nuclear
for that very reason Alistair said, that since we did that analysis
we have now got six gigawatts of wind, of signed connection agreements
with the National Grid to come onto the system in the north of
Scotland, so actually the debate has moved on now and the debate
is not just do we need Beauly-Denny it is actually do we need
further reinforcement over and above that, and that is why National
Grid is now talking about potentially building sub-sea cables
that will come either down the east or west coast. In essence,
that was the debate we were having a few years ago but now there
is so much wind seeking to connect, that has actually signed binding
contracts with National Grid, that even Beauly-Denny may not be
enough. Just on the political interference, there are two obvious
points there: one is that we did get a judicial review from one
of the Scottish companies about our transmission charging methodology
which forces people in Scotland to pay more if they want to generate,
reflecting the distance that electricity has to travel, and we
successfully defended that so we would stand on our record there.
The second thing is when the Government took the power to cap
transmission charges that Professor Bain criticises them for,
we were very public and vocal in our criticism, saying that we
thought that that was the wrong thing to do and it was absolutely
right that people who were at the extremities of the system should
pay very high charges that reflected the economic costs of transmitting
electricity a long way from where it is produced to where it is
used, so we are comfortable that we have been as robust as we
need to be on that.
Q423 Lord Turner of Ecchinswell:
Can I just clarify, you are saying that at the moment your transmission
charges do charge more for longer distance.
Mr Buchanan: Yes.
Q424 Lord Turner of Ecchinswell:
In which case the thing put in by Professor Andrew Bain is wrong,
is it? He appears to say the opposite.
Mr Smith: His argument is a technical
one, he is basically questioning whether they are high enough.
I know you have various academics presenting to you and this is
something that the various academic cognoscenti disagree on. There
is a review going on at the moment as part of our transmission
access review and the thing that we have always been clear on,
which has attracted a lot of political opposition in Scotland
as to the principle, but it is clear and any electrical engineer
will tell you the costs of transmission increase with the distance
you travel, and really the debate we are having which is Professor
Bain's point is whether National Grid's methodology captures that
appropriately.
Q425 Lord Turner of Ecchinswell:
May I also, My Lord Chairman, seek a clarification in relation
to the questions from Lord Lawson. We had some figures in relation
to the cost of renewable energy per megawatt hour and we had some
total system costs which were in billions. I wonder whether you
could just clarify if my mathematics is correct in terms of how
you translate from one to the other? I believe that our total
demand across the system is of the order of magnitude of 350 or
so terawatt hours or 350 billion kilowatt hours; if those were
costs put forward from the National Grid which would support renewables
moving to, say, 30 per cent, then there are costs to support a
move to something like 100 terawatt hours of renewables in which
case £1 billion is 1p per kilowatt hour or £10 per megawatt
hour.
Mr Smith: Indeed.
Q426 Lord Turner of Ecchinswell:
That would be correct; that might help the Committee to place
the context of a billion within the context of the previous figures
that you quoted of £40 to £75 for onshore wind versus
£70 to £80 for coal. £1 billion could make £10
difference but it does not make £50 difference.
Mr Buchanan: Yes, you are absolutely
right and, in fact, to be fair to the National Grid, they used
a figure of £12.
Q427 Lord MacGregor of Pulham Market:
Do present electricity trading and transmission arrangements—and
coming to the access review we have just talked about—provide
a suitable framework for an industry with a high proportion of
renewable electricity generation? You have just referred of course
to the fact that you and BERR have just published your report
on the Transmission Access Review; can you tell us what the key
outcomes of this review are and how quickly do you expect the
industry to implement them?
Mr Buchanan: Broadly the trading arrangements
are robust and do work but in this area there has been as it were
an element of a black hole for some time, and we have tried to
sort this out—if you get a chance to read our submission—aggressively
a number of times before and it is not unreasonable to say, because
it is a phrase that Steve uses, that we are slightly in the last
chance saloon in trying to sort out transmission access. The way
I approach it is that it is almost a story of three no's that
we have got within the system at the moment: there is no prioritisation
in terms of access, it has been first come, first served and you
become very lazy, you do not try and work out who really can get
onto the system; there has been no incentive for any of the parties
to basically trade their access rights—we have had some
shambolic scenes in the last few years for example with British
Energy, when nuclears have been shut down, actually wanting to
trade its access rights—and there has be no speed to the
process. These three no's have needed to be resolved and what
we have announced broadly is a package of both short term and
medium term measures. In the short term this is tapping into something
we talked about a few minutes ago: what we are looking at is improving
and making more relevant the system standards and squeezing the
system basically where we think we can identify another one megawatt
of potential that can tap into renewables. In the medium term,
which is far more important, what we are trying to do here is
provide proper incentives for the companies, but this is not a
one-way ticket, we have to be responsible to consumers, so we
want to put in proper incentives that will properly reward them
but by the same token we want to put in penalties for those who
do not actually meet their commitment to connect. So there is
an element of carrot and stick that we want to bring into the
process and we want the concept of incentives to be built into
this process. I am really quite encouraged in that National Grid—and
as you can imagine at times we have a degree of critical tension
with National Grid—have stepped forward very well in this
area. You may want to ask yourself why they have not stepped forward
before but they are doing it now and I am encouraged by that.
Mr Smith: The only things I would add
are on timescale. We hope to introduce the new access arrangements
by 2010; the only cloud on that horizon is the threat of litigation
because in essence you have a number of the big existing conventional
generators who view themselves as having evergreen rights to use
the system and who have been litigious in the past at protecting
those. Our view has always been that they have never had those
rights, there are not any contracts they can point to and when
times were bad in the earlier part of this decade they mothballed
the system, stopped paying and happily went and spent a few years
off. We have always said to them we do not think you have existing
rights, we need a mechanism that basically allocates rights to
whoever is willing to pay the most. That is something that, as
I have said, they may choose to challenge us on, either through
existing appeal mechanisms or through the courts, so that is the
only danger to the 2010 timetable, if we find ourselves in litigation.
Q428 Lord Griffiths of Fforestfach:
What other measures are you taking, if any, to promote the connection
of renewable generators?
Mr Buchanan: Apart from the work we are
doing with regard to creating an opportune regime and, as we have
just discussed, the access review/reform, there are two that I
would particularly pick out and they probably, to be honest, came
from criticisms of Ofgem and of our remit. The first takes you
back to 2004 where we were given a sustainability duty and within
the price controls that we have put through since then we have
been very minded about sustainability and, in particular, to try
and promote research. There was this sense that whilst RPI minus
X—the price formula that we used very successfully for the
last 20 years—effectively was just a case of squeezing the
opex so hard that in fact the organisation will not spend any
money, either on opex or in fact on capex and R&D, what we
put in in 2004 was a line, we broke away from RPI minus X to a
certain extent and put a line into the regulatory equation for
research and development. What is quite encouraging there is that
for example in Orkney Scottish Hydro-Electric have taken that
forward and have now developed a system within Orkney that needed
a degree of research and development funding to get it off the
ground. They have now got an integrated system and that I am very
pleased with; it is a good signal of the kind of thing we have
done and we know there are other projects going on, particularly
in rural locations like Mid Wales, and Lincolnshire. The other
area which I am pleased about—and we are going to make quite
a song and dance about it in September/October time—is that
there was a concern that we were becoming very five-year focused
as an organisation and, therefore, we announced about 18 months
ago that we were going to commit to what we call our LENS programme
which is a Long term Electricity Network Scenarios analysis. The
work has started and I will let Steve talk a little bit about
that. We have worked with Strathclyde University and we have taken
2050 as our timescale so that we do not tell the market what we
think is going to happen in terms of will it be nuclear or will
it be local generation, but there are massive implications for
the network and for the network spend; therefore we are going
to put out a report—it is effectively already done—with
a range of scenarios. Steve, I do not know how much more we should
say today.
Mr Smith: As Alistair said, the big issue
is if you look out to those time horizons some views of the world
tell you that you do not need much of a transmission system, it
will all be distribution and things will be done locally, other
people tell you that you can have huge amounts of offshore wind
and you can have big nuclear stations and therefore you need to
spend billions on transmission. What we are trying to do is we
have got some leading academics working with us to look at what
the different scenarios are, what the cost implications of them
are and what we could or should not do in terms of the way we
regulate to either avoid spending billions of pounds that we find
becoming redundant in 10 to 15 years or not do simple things that
we could do in terms of network design that would keep options
open. As Alistair said, we will be publishing that in September
and we have been doing a lot of work with the industry, with the
network companies, with the University of Strathclyde and with
Imperial College on that.
Q429 Chairman:
Given the timescales we are talking about here and the targets,
it all seems rather fluid, or am I misinterpreting it?
Mr Buchanan: In terms of our promotion
of spend?
Q430 Chairman:
In terms of preparedness to take on the amount of renewable generation
that is expected over the time that is expected to be taken.
Mr Buchanan: It is a good question and
if I gave the impression that we were comfortable with being very
laissez faire here, that would be an incorrect presentation.
If you look at what we have done at Ofgem in the last five years
there are a number of indicators with regard to networks and as
long as the spend is efficient and economic, meets our criteria
and meets open challenge then we will support it. In 2004 we authorised
a 50 per cent increase in capital expenditure at the local electricity
network level; in 2006 we put through 100 per cent increase in
the super grid spend. Part of that is because the network needs
to be upgraded but it is also a feature of us providing the money
to the organisations to make sure that the systems can be built
out and they are fully funded. Most particularly, consumers have
a very low pain threshold when it comes to blackouts and we have
one of the best systems. When the Department of Energy published
its White Paper only the Netherlands had a better system than
we do and that is something that we feel is incumbent upon Ofgem,
to make sure that we support the funding. We supported the early
funding as I mentioned before for Beauly-Denny and a number of
other schemes—that was £560 million that we authorised
in 2004—currently we have told the companies, and they are
coming back to us in September or October, certainly within the
next three to four months, that if the companies can make the
case to build what are effectively two motorways down either the
west coast or the east coast of the country, there is effectively
£2 billion worth of spend there. I do not believe, therefore,
that we are being tardy here at all, but we must be able to turn
around to consumers and say we have checked the numbers vigorously
and there is value for money. Equally, an important issue here
for Ofgem with the broader pressures that are coming on us, comes
back to political pressure. What we are seeing in America at the
moment are some very interesting things. If I use the Illinois
regulators, recently because of the very high pressure on the
wholesale prices that we are having to endure as well the transmission
and distribution of electricity, Commonwealth Edison went to the
Illinois regulators and said "We need £300 million for
capital expenditure, just to keep the system as it is." The
regulators chose to give them just £6 million because they
wanted to keep the overall price, because of the wholesale charge,
down. That to me is starting to break down why you have an independent
regulator if those kinds of decisions are made—and of course
they are not independent arguably in America because they are
politically appointed in many states but you start to get that
kind of pressure. When we put through the 100 per cent increase
in capital expenditure for National Grid in 2006 it was an increase
in consumers' prices at a time when prices had gone up very sharply
in 2006 because we were extremely worried about the security of
gas supply, you may remember, and what had happened to the price
in 2006 was that prices had broadly gone from 40p per therm up
to 70p per therm. It was important however to make sure that the
network was funded for the future and therefore we did not look
at the overall price and say I think we should pull it back. You
would be right to call us in if you felt we were doing that and
enquire of us why we felt we needed to do that.
Q431 Lord Best:
In terms of these costs what is your estimate of the total amount
that is going to be needed on transmission and distribution networks
by 2020 if we are to achieve the 15 per cent target for the UK?
What is your role also in getting value for money out of that
spend and how do you implement that role?
Mr Smith: In terms of the numbers, National
Grid are talking about something of the order of £6 to £9
billion on the onshore transmission network. The figures for offshore
vary between £2.5 billion and, for eight gigawatts of offshore
wind, up to about £10 billion. If you move to 25 gigawatts
of offshore wind—and many people will tell you that to meet
the 2020 target you are going to need at least 25 gigawatts offshore
because of the difficulties and the limits to how much onshore
wind you can get—we have actually asked the three transmission
companies within the next six months to come forward with a technical
study which sets out clearly what the options are for investing
both onshore and offshore and cost that.
Q432 Lord Best:
It sounds at the moment as though it is about £20 billion.
Mr Smith: Give or take, yes. On the distribution
side we are actually at the beginning of our five year price control
review so we are waiting for the companies' business plans, which
will come later in the summer, of how much they want to invest
over the next five years and beyond. We would be happy to give
you written evidence but I would not like to take a stab at that
at this stage. In terms of incentives—I know this has been
a big issue for the Committee—what we are trying to do is
strike the right balance because obviously whenever we are signing
off on these investment programmes it is costing customers money,
so one of the things we have proposed to the transmission companies
for this investment is that shareholders begin to share some of
the risk so that the amount of money the companies actually earn
when they invest will be linked to how much generation actually
connects after it is built. For example, if they build a big wire
down the east coast the rate of return they earn will be linked
to how much offshore wind actually connects on completion, and
that is so that we can be more certain because otherwise under
the existing process they just come forward to us and say "Approve
£10 billion of spend" and then once we have approved
it they have a guaranteed rate of return. We just do not think
that is a good deal for customers; what customers need is some
assurance that because shareholders' money is also on the table
if these things are being built they are actually going to be
used. Two of the transmission companies have so far indicated
that they are happy to move to that sort of set of arrangements
and, similarly on the distribution side, most of our work to connect
wind has been about incentives, where we say to the companies
you can earn greater rewards but you have to take more risk, so
if the wind generation does not turn up you do not and if it does
turn up you earn a bit more.
Chairman: I am going to have to ask you
to be slightly more succinct in your answers because time is marching
on. Lord Layard.
Q433 Lord Layard:
That relates to this question in that there is a time difference
between the construction time of the transmission line and the
renewables power station. Does it mean that if the renewable generator
is to be sure of having the transmission capacity, the transmission
company has to start before it knows what the extra capacity will
actually turn out to be, and who is going to carry the risk associated
with that?
Mr Smith: That is broadly right and to
go back to the previous answer that is why we are pushing for
this new incentive scheme, because we cannot have customers bearing
all of that risk. The transmission companies tell you that the
nature of network investment is that you do not need to know precisely
where or how much and that they are confident enough in the broad
order of magnitude that they would be willing to make some of
these investments. We are obviously much more comfortable if there
is some real shareholders' money on the table and if they get
these calculations wrong it is going to cost their shareholders.
Mr Buchanan: Can I just make two additional
observations there? The first is on new nuclear and certainly
it is going to be a challenge to think about building the wires
to connect, for example, a new French design EPR at Sizewell or
at Dungeness because certainly from all the analysis I have seen
you are going to need 70 to 80 kilometres across the North and
South Downs if you are at Dungeness, or across Suffolk and Norfolk
if you are at Sizewell, and there is no point in building your
new nuclear station and having the wires coming in late, so we
are going to have to think very, very carefully about how we do
that. The second issue which in preparing for this session certainly
caught my eye was about the turbine development. The Secretary
of State was talking about 7000 turbines in order to hit the targets
for 2020; there is immense pressure globally at the moment on
all parts of the power generation chain and also on the transmission
network chain. Just to put that in context, the American Wind
Association thinks that they will have demand for 75,000 turbines
by 2030. There is enormous pressure on the turbines, so when you
look at the turbines you say how quickly will they arrive, but
with offshore turbines we are into new territory because for offshore
turbines the broad characterisation is that you are using onshore
turbines and slinging them offshore. The Germans are leading the
way here in trying to develop them and for the five megawatt turbine
the latest from their pilot is we will not know whether it is
going to work properly until 2011. So there is enormous pressure
building up here from the technology side and also from the global
demand side, and I think those to me are very interesting events
to debate, in terms of how we are going to get to our targets.
Q434 Lord Turner of Ecchinswell:
Can I first of all just ask for some clarification of what you
said and then there is one particular question that I want to
ask about offshore wind. The £2 billion big motorways down
the side of the country, those are undersea intentions.
Mr Buchanan: Yes.
Q435 Lord Turner of Ecchinswell:
Am I right that those would almost certainly be DC rather than
AC, therefore they would have significantly lower transmission
losses and therefore the extent to which the transmission charge
should go up with distance would decrease if one built those,
is that correct?
Mr Smith: The first part is right, they
would be high voltage DC cables, so lower losses; unfortunately
the economics of onshore versus offshore means they will still
be more expensive because it is more expensive to lay sub-sea
than it is to do it on land.
Q436 Lord Turner of Ecchinswell:
Would they be instead of Beauly-Denny or do you still need Beauly-Denny
as well?
Mr Smith: We are waiting for the technical
studies from the transmission companies but our early views have
been that if you are looking at the 2020 targets and talking about
potentially 30 or 40 per cent renewables you need both and actually
your choice is do you do Beauly-Denny and then put even more onshore
or do you do Beauly-Denny and then go offshore because, as I said,
in north Scotland at the moment we have already got more people
wanting to connect to Beauly-Denny when completed than it will
be able to accommodate.
Q437 Chairman:
Can I do a follow-up on that? If the 2020 target were to lapse
by a few years would that change the economics?
Mr Smith: Yes, I think it would because
the basic trade-off is that offshore is more expensive but it
is quicker and time is really what you are trading off. Onshore
is cheaper but there is a very real issue about the extent to
which you begin to hit hard constraints about how much capacity
you can get from Scotland into England because if you look at
where the interconnectors are they are in areas of outstanding
natural beauty, and you have to question whether you would ever
be able to double up on the towers and wires. There is a view
that says there is a technical limit because you are never going
to be allowed, whatever planning reforms are made, to run a second
set of towers and wires. You may therefore still come to the conclusion
that you have to go offshore however much time you have got.
Q438 Lord Moonie:
How much more expensive is offshore. You have implied it is more
expensive but you do not have to build any towers for a start
and you do not have to pay for any planning inquiries.
Mr Smith: As an order of magnitude I
think you are looking at three to four times as expensive and
it is purely to do with the costs. At the moment there is a huge
pressure because the ships that lay cables offshore are the same
ships that lay telecoms cables and are involved in oil and gas,
so there is this huge cost inflation there. It is also to do with
the fact that you have to be very careful when you are laying
offshore that you do not lay across gas pipes and telecoms wires.
We have seen studies from around the world; we have seen the costs
of laying similar offshore wires in Australia and it is pretty
robust information but I would have to ask you to ask an engineer
to give you a thorough breakdown on why.
Mr Buchanan: Perhaps another angle is
that whilst it is more expensive than the traditional overhead,
bearing in mind that the figures you have had given to this Committee
for undergrounding, you are looking at £6,600 for the first
kilometre against overhead at £600. If it is underground
from Beauly-Denny or going by sea then the economics change.
Q439 Lord Turner of Ecchinswell:
My final point of clarification and then one question is when
you were using the figures earlier in response to Lord Best on
the total figures of the transmission and distribution spend,
those were for the capital expenditure and to get those onto an
annual basis—leaving aside the complexity of whether you
might make it risk-related—essentially we multiply by 5.5
per cent, do we not, so £20 billion becomes about £1
billion—is that how the National Grid essentially gets to
the charge? You agree a capital expenditure and they are allowed
a rate of return which is of the order of magnitude of five per
cent.
Mr Smith: Absolutely. You then need to
add to that a depreciation charge, so about a twentieth of that
number. As a rule of thumb operating expenditure is roughly about
a tenth of the capital cost.
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