Examination of Witnesses (Questions 130-139)
Professor Catherine Mitchell, and Mr Phil Baker,
University of Exeter; and Professor Goran Strbac, Imperial College,
London
21 APRIL 2008
Q130Chairman: Thank
you very much indeed for coming. It might help the Committee if
you were briefly to introduce yourselves, particularly your professional
and commercial experience and background.
Professor Mitchell: I am Catherine Mitchell.
I work for the University of Exeter. I have recently moved there
from the Warwick Business School, where I was for a decade before
that. In the past I was on the Energy Advisory Panel for two terms
and I was seconded into the Cabinet Office for the Energy Review
back in 2001-02 prior to the Energy White Paper of 2003. I have
just come back from working for the New Zealand government, which
has been undertaking an energy review and I am currently on the
Intergovernmental Panel on Climate Change (IPCC) working on a
special report on renewable energy which will feed into the next
assessment report of the IPCC. Phil Baker is also working at Exeter.
Mr Baker: My background is very much
the electricity supply industry. I spent many years working for
the Central Electricity Generating Board (CEGB) and more recently
National Grid. Eight years ago I retired and worked for DTI as
Technical Director, Electrical Technology. I retired from BERR,
as it is now, at the end of March and since then I have been working
for the University of Exeter.
Professor Strbac: My name is Goran Strbac
and I am a Professor of Electrical Energy Systems at Imperial
College. I am also Director of BERR Centre for Sustainable Electricity
Generation, which provides fundamental research and support of
government targets on renewables. The centre is composed of three
universities with expertise in integration, particularly of intermittent
and other renewable energy sources, including overall operation
and development of the electricity system. Our area of work is
really issues associated with the technical and regulatory framework
to support integration of renewable generation in the UK electricity
system and we are working with a range of companies in developing
standards, grid codes, and changes in the regulatory framework
to support efficient integration of these sources in the system
development.
Q131 Chairman: Thank you very much.
I wonder whether, Professor Mitchell, you would like to start.
Three members of this Committee have asked me to ask you through
the Chair to give these gifted amateurs sitting on this side of
the table a brief introduction to ROCs, to the Renewables Obligation
Certificates, and feed-in tariffs. If you could very briefly for
the record describe how they work, what is wrong with them—you
may have heard evidence given by Lord Oxburgh because you were
sitting immediately behind him—but also the applicability
of feed-in tariffs. Perhaps you would define those too for the
UK's obligations.
Professor Mitchell: Yes. Unlike Lord
Oxburgh, I think that if the UK is in any way likely to reach
this target, it has to move over to a feed-in mechanism for all
scales of renewable energy heat and power plants. It needs to
be very sensitive about an overlap with the RO for the large-scale
developments (in other words, the RO has to continue for several
years when a feed-in mechanism is implemented to ensure that those
who have invested in the RO are not adversely effected).I really
believe that is absolutely central to moving forward. The thing
about making renewable energy happen is to make it easy for people
to invest. The feed-in tariff in its purest form is made up of
three aspects. First of all, the grid operator guarantees to take
the electricity from the power plants. There is a known payment
for that electricity depending on what the technology is, and
that contract is for about ten or 20 years and there are rules
and incentives to do with connection, which also happens immediately.
There is effectively priority access for that electricity which
is just taken by the grid operator. Any extra cost of doing that
is then socialised across all other electricity consumers except
for the major users, who are exempt from it. That completely de-risks
the mechanism for investors. It means that anybody can invest.
I could invest or a medium-sized company could invest or a large-scale
company could invest. It means that it creates diversity; it can
be diversity of the type of investors come in, diversity in terms
of the geographical region—so it might be a wind farm without
very good wind energy, for example—and diversity in size
of plant. That diversity is good for security of supply and it
is also good in terms of skilling up the population. Germany now
has something like 240,000 jobs in renewable energy; we have 7,000.
Feed-in tariffs make it easy to invest and develop renewables,
which is the central thing. The Renewables Obligation, on the
other hand, is an extraordinarily complex mechanism and it does
the opposite of making it easy and it is very risky. It introduces
market risk, volume risk and price risk. You cannot obtain finance
on the Renewables Obligation contract itself. Only those who are
able to raise money via their corporate assets are able to do
that. Because it is so risky, it has been incredibly poor at bringing
in new entrants. I think 82% of our renewable generation happens
through a few large companies, the big six. So it has been incredibly
poor at bringing in new entrants, and the RO is also in the control
of those large companies. I am not a "small is beautiful"
person at all but I do believe that a mechanism that is exclusive
gives power to those who are in control, and what we have essentially
seen in the UK is that renewables develop at the rate that the
large companies wish them to develop. It is incredibly poor in
terms of deployment on the ground relative to other countries
and it is a very inflexible mechanism, which goes way beyond the
normal wishes of business to have certainty for the long term.
That is primarily because of something which is known as the recycled
or "buy-out" mechanism. There is an obligation on suppliers
to buy a certain percentage of their electricity each year. If
in the last year they supplied 1,000 MWh and if in the next year
the obligation was 3%, then the suppliers have to buy 3% of those
1,000 MWh from eligible renewable electricity sources. The suppliers
can buy that electricity directly from a generator, buy the required
number of Renewable Obligation Certificates (1 ROC = 1 MWh) or
they can "buy-out" by paying a penalty and not buying
any renewable electricity at all. The fine or penalty goes into
the recycled mechanism. That recycled mechanism fund is then returned
to the suppliers according to the percentage that they had bought
of the Renewables Obligation Certificates, which proves what they
have done. So if a supply company bought 5% of the ROCs, the Renewables
Obligation Certificates, then they would receive 5% of the recycled
mechanism. That sets up an incentive so that those companies want
to know ahead of time exactly what renewable electricity is going
to be deployed, in other words what percentage of the RO is going
to be met in any one year. Suppliers need to know that in order
to know how big the recycled fund is going to be , in order that
they know what the recycled fund coming back to them is, which
means that they then know how much the value of their renewable
energy is. I am sorry to do this to you but it is very complex.
Effectively, the incentive within the mechanism is to know exactly
how much renewable deployment is going to happen going into the
future. If there is any change at all to the rules or incentives
of the Renewables Obligation, it will affect the proportion of
the Renewables Obligation which is met, which in turn changes
the amount of recycled mechanism that comes back to the supplier,
which in turn will affect the value of their ROC. The whole of
their returns is based on knowing this, so they do not want anything
to change more than is normal in business. It is a hugely inflexible
mechanism and it is also extraordinarily risky.
Q132 Chairman: You have explained
it very clearly. I think you favour shifting the responsibility
from the energy suppliers, the big companies, who have targets
to source from renewable energy suppliers, to the renewable energy
suppliers themselves, giving them certainty, grid access, et cetera.
Professor Mitchell: Yes. I think the
target is extraordinarily challenging but, in order to have the
best go at meeting that target, a number of areas have to be dealt
with. One is the policy, so you need to move from this risky,
exclusive mechanism of the RO over to a less risky mechanism.
You need to sort out the grid and infrastructure development side
of things, and I have experts on either side of me to talk about
that. At the moment Ofgem would say that they are unable to do
the things that are necessary to be done in order to sort that
out. Ofgem either has to change its mind to start to do that or
the duties of Ofgem have to be changed. Planning has to become
more streamlined and more efficient and government has to do what
it is able to do to help in terms of the supply side.
Q133 Chairman: I am going to ask
Lord James to start in just a moment on grid access because I
know that both Professor Strbac and Mr Baker are familiar with
this and experts in the field. I think, Professor Mitchell, it
would help the Committee, when you have the time, if you could
let us have a brief note on why you feel so strongly about moving
to the feed-in tariffs as opposed to the ROCs. That would be helpful
to us.
Professor Mitchell: It would be my pleasure.
Q134 Lord James of Blackheath: Professor
Mitchell, I felt very much listening to you then that I had gone
back 30 years in time and I was sitting opposite the financiers
at the outset of the North Sea. I want to put it to you in fairly
direct terms that the mistake that was made then is in danger
of being made now, because the return on capital is being pitched
at the wrong point because they are not getting the right combination
of factors. If you go back 30 years, the initial exploration of
the North Sea, in which I was very heavily involved, demonstrated
that there were huge resources beyond the feasible financial level
at which you could finance at $16 a barrel at the time, and nobody
would put up the money for doing that. As things have gone on,
I want to put it to you that there is another mistake which may
be made now, because it will affect what is done with the infrastructure
that is put in here, and that if you had looked 30 years into
the future and seen $110 a barrel, everybody would have gone ahead
with that investment and would have made a fortune today but it
was because they had to pitch the investment at a level before
it could make the return. Is there not a challenge to your point
that it is not the major fuel distribution and energy source companies
that should be carrying this, and they should in fact be putting
in a huge amount of investment in infrastructure now in order
to be able to get the returns and enjoy those returns 30 years
hence, when the renewable energy has begun to challenge in terms
of the same price structure that we now have for what we left
in the ground 30 years ago?
Professor Mitchell: That was very well
explained. I was actually a journalist writing about oil and gas
at that time, so it takes me back. I will leave the grid infrastructure
stuff to these two.
Q135 Lord James of Blackheath: It
is inseparable from that issue really.
Professor Mitchell: Yes. It is absolutely
a "chicken and egg" situation at the moment that in
order for infrastructure to come forward, the renewable energy
developers have to be able to say that they definitely will use
it. They do not know that they will definitely use it because
they do not know whether or not they are going to get planning
permission, so they cannot say that you will definitely use it,
so no infrastructure gets going. That is the essential ring that
has to be broken in order that there is going to be an infrastructure
in place in time to enable the kind of technologies we want, and
it is not just any old infrastructure. One of the problems is
we do not know what technologies we do want to come forward and
we do not know where we want them to come forward, whether it
is offshore and micro or just scattered around the place. So you
need to enable these technologies to come forward in the best
way possible rather than channel them, because of the available
infrastructure, towards one technology or constrain certain technologies
or futures altogether.
Mr Baker: Transmission infrastructure
takes an awful long time to deliver. I am just thinking back to
the second Yorkshire line, which I think was the last major infrastructure
development in England. It spent about 100 months in planning
and took about 12 or 13 years to develop from start to finish.
That does not give us an awful lot of time in terms of 2020. As
well as delivering new infrastructure, in terms of renewables,
it is important to note that we should be thinking about sharing
the infrastructure we already have with renewable generation,
and to do that industry rules need to change. At the present time
National Grid applies rules which basically mean that before they
can connect new generation, the system has to be totally reinforced
and compliant with all their rules. That is fine in a world of
conventional generation which all wants to be operating at the
same time to meet the winter peak. You need to build a system
which can accommodate it all at the same time. With renewable
generation, it is basically there to replace the conventional
generation, so almost by definition it will not want to be there
at the same time as the conventional generation it is replacing
is going to be there, so there is the opportunity to share what
infrastructure we already have, and to do that things really need
to change.
Q136 Lord James of Blackheath: How
do you set out to demonstrate that cross-over in the calculation
to a potential financing source, which we failed to do 30 years
ago?
Mr Baker: It is very difficult, I think,
but National Grid are currently going through an assessment to
try and understand how much you can share infrastructure and how
much you need to build new infrastructure. The economics of that
will come out of that review.
Q137 Lord James of Blackheath: Picking
up a point the Chairman made earlier, if you could win that argument
about the future value of what you were going to get with what
you were spending now, what would you most wish to give as a priority
for development for another renewable source beyond the wind we
talked of earlier? Where would the concentration of that investment
go with your direction?
Professor Strbac: I am not sure I understand
the question.
Q138 Lord James of Blackheath: I
am saying that 30 years ago we did not take everything out of
the ground we could have done because we could not finance it
at that time. We now would like to have what we knew was there
then and have it at that cost. If you were able to make the extra
investment now, not just in wind or whatever else is available
now at this time and get the 10% target, but could actually get
to the 25% target, what would you actually look to develop and
where would you look to try to enhance the financing ability of
this by bringing in new financing sources to generate new sources
of renewable energy which are not currently on the slate, or which
are known but not considered economically viable at the moment?
Professor Mitchell: There are two things
here. The problem is that in the short-term economic analysis
you are not including all the disbenefits of climate change. The
problem is that that calculation is not able to be done. I think
Lord James is saying if you were going to spend your money now,
where would you spend your money where you think in the future
would have the best returns back for developing renewables most
quickly and most effectively, if you had the chance to do that
now?
Professor Strbac: I am probably not understanding
your point. We have got the commitment to market-based operation.
We are not trying to second-guess what is going to happen in 20
years' time and we are trying to make sure that a framework is
put in place to ensure that a cost-effective solution to whatever
we want to solve will emerge. That is how I understand the emphasis.
Maybe I do not quite understand where you are leading to but I
would not be able to tell you what I think we should be doing
in terms of investing in this technology rather than that technology.
I simply do not have a full enough appreciation of that to be
able to answer that question in that way. The work which we are
doing is providing quantitative evidence of the fundamental economic
change of the system which we are going to merge into if we connect
such a significant proportion of new forms of generation. What
we are showing is that the present technical commercial regulatory
framework, which is being optimised for an incumbent system with
conventional generation, is not providing a level playing field
for facilitating cost-effective integration of any renewables
which we potentially want to connect. There is a significant commitment
in that context to market operation, and the focus of the development
we are working to is to make sure that the regulatory framework
is such that we have this level playing field rather than trying
to pick out winners ahead of all information being available.
Q139 Lord James of Blackheath: 30
years ago I was a humble boat driver driving round the North Sea
looking for oil, and in those terms it seemed to me at the time
that I was deeply frustrated by the fact that the banks we were
dealing with would not give me the extra contract to go another
month to go five miles north, where all the geological evidence
was that there was a huge amount because they said, even if you
found it, we could not get it out at $16 a barrel and make a profit.
Now we know that we could have done. I am saying what is it that
is there at the moment that you could get to which would be for
the future the same answer to that same issue that we would not
have lost if the financing sources would put the money up to enable
you to go five miles north, as I was not allowed to do? I developed
the Argyll field.
Professor Mitchell: You are talking about
renewable sources, energy that we could get if we spent money
now.
Lord James of Blackheath: I am talking
about it strictly in terms of renewable. I am not talking about
finding another field of the same stuff that we have not had or
not used. I am talking about where you are going to get the investment
to make worthwhile what you could do, and know about, but which
is not happening now.
Lord Mitchell: Can I just ask Lord James, if you
were posing that question 30 years ago, you would also have to
say your expectation of what the price for oil would be 30 years
in the future, because that is what was not known then but we
know now.
Lord James of Blackheath: We were talking with the
big banks and we knew at that time that if we got a $10 hike on
the $16 a barrel that they got the return that they wanted, but
they did not believe oil would ever go that high. I thought that
was ridiculous.
Lord Mitchell: But we live in a different world today
and I think it might help if we perhaps plugged into the equation
a price in the future, $150 or something like that, and how that
would change things.
Lord James of Blackheath: 150 and counting, yes.
Chairman: Here a political commitment is being made
by European Union ministers about renewable energy. Unless you
want to add anything, I want to turn to some other colleagues.
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