Examination of Witnesses (Questions 280-286)
Mr Michael Lewis, Mr Kevin McCullough and Mr Sarwjit
Sambhi
19 MAY 2008
Q280 Chairman: Correct.
Mr Sambhi: Absolutely right, and there
has been much press around the scale of the cost of investing
in offshore wind. If you are putting in 40 GW of wind, the minimum
price ticket on that is going to be £80 billion, at minimum.
Mr Lewis: I think it is worth saying
the consumer would not—the phrase you used, Chairman—have
to pay up front. By trying to create a more strategic anticipatory
framework, you are not trying to ask the consumer to pay up front;
you are trying to make sure that when the wind farms come on,
the grid is there to take them, whereas at the moment we have
larger projects waiting to come on because the grid has not been
reinforced. So it is a question of putting the timing together
rather than asking them to pay up front. Certainly they have to
pay but, as my colleague said, the key point is the grid has to
change in any case. It was designed for a different era. A lot
of investment will have to go into it to make it fit for a new
era, and certainly the consumer will ultimately have to pay for
that investment. But we are not talking about taking money up
front. We are talking about trying to co-ordinate it so that the
infrastructure is built as the projects are ready to go on to
it.
Mr McCullough: If I may come back, one
of the things that is worth pointing out is that clearly at the
moment we have the legacy system as we have it at the time that
we are trying to aggressively connect to help meet government
targets, and EU targets beyond that. One of the things that is
potentially very dangerous in this time is to forget the longer
term strategic view of what we need in the future. For instance,
when some colleagues in the sector talk about auctioning the capacity
that is surplus in the grid at the moment, my view is that it
is a very short-term, narrow view that will result in quite a
short-term spike in the cost to the consumer, because you do not
actually look at fixing the problem. You look at taking a very
black and white view: the system is this big, we have that much
capacity in it, so we will auction the spare capacity in various
blocs. That will create in particular supply and demand. There
is huge demand for that capacity, not just in renewables but in
all forms of new generation technology wanting to connect, so
any kind of capacity auction in the short term that fails to look
at the longer term strategic need is potentially very dangerous,
and unfortunately, if we go down that route of that short term-ism,
we will get to a roadblock very quickly where prices will spike,
and then we will have to repair the problem even later on, when
we have some new capacity connected.
Q281 Lord Dykes: Against that complex
background, assuming that all the planning and grid connection
issues could be resolved, and obviously that is a big assumption;
it is extremely complicated indeed, and bearing in mind what Mr
Sambhi said just recently about the German system, what would
be the impact on the deployment of renewables if one did change
from the Renewables Obligation to a feed-in tariff system?
Mr Lewis: I think the first thing, as
I said when I was answering about the target itself and the year,
is it would immediately create uncertainty. Stability is most
important in terms of marshalling the resources to deliver this
target. People want to know that they can rely on policies over
an enduring period when you are making an investment that is going
to last 25 or 30 years. So changing the feed-in tariff in itself
will generate uncertainty because it will create strategic uncertainty
for the people who have to make the investment.
Mr Sambhi: If you want to put an estimate
on it, you will have a three-year hiatus whilst investors say,
"OK, I'm backing off this market because I am not quite sure
what the regulatory regime is going to be," and in three
years we can achieve a lot in terms of construction.
Mr Lewis: I would also add that the feed-in
tariff itself is not a cure-all. You have various systems of incentive
across the world. The feed-in tariff has been very successful
in Germany but it has its drawbacks as well. The way it is structured
means it does not necessarily incentivise the best wind resources
to come on first, so you do not necessarily get the cheapest solution.
That is point number one, but point number two is Spain, which
has a very large wind penetration, more than 16,000 MW, has a
more market-based system. So it is not the incentive system that
has created the problem in the UK. As you said, it is to do with
the grid and the planning issues. I think fiddling around with
the incentive mechanism now is a recipe for creating a hiatus,
as my colleague has said. It is not a recipe for making the targets
be delivered any quicker.
Q282 Lord Dykes: You have maintained
a high degree of agreement on this issue. Do you agree with that,
Mr McCullough?
Mr McCullough: I absolutely fundamentally
agree with that. I think if the comments I made about the 70%
or so being achievable are predicated on what we know today, one
of the absolute cornerstones of stability for the investment community
is the RO in the UK. If you look historically, and my colleague
from Centrica has pointed out already the feed-in tariff in Germany,
for example, where you have near saturation of onshore wind farm
capacity, something like 20,000 MW, yes, has been a very successful
instrument. However, if you look at the UK pre-2002-2003, when
we had a whole series of effectively feed-in tariffs, non-fossil
fired obligation, where there was a tariff mechanism established
to encourage the onset of the cheapest renewable form of energy
on to the grid first, that had a near flat growth for the ten
years preceding that, with only a very small amount of generation
coming on in the UK. When the RO was introduced in 2002 we had
a period of about a year or 18 months where the investment community
educated themselves by involvement with all the stakeholders about
how long-term this would be, how stable it would be, what kind
of cross-party support it would have, all of those very essential
ingredients to give us confidence that, rather than go to country
X, Y or Z, we can invest very large scale here in the UK, and
without a shadow of a doubt the RO, if you look at the growth
since that 2003 period, it is now nearly exponential. As I said
in answer to one of the first questions, we have 2.4 GW of installed
capacity today and 1.8 to 2 GW of that have been brought on since
the onset of the RO. We have a further 6.5 GW in planning awaiting
determination on the back of the strength of the RO, and we have
a further 9 to 10 GW all in various stages of development, again,
on the strength of the belief that the RO is the mechanism that
has given true confidence to investors. We are now seeing secondary
investment in some of the schemes. We are seeing people like the
traditional investment fund community, from the pension funds,
et cetera, globally wanting to actually take a piece of what is
considered very stable, very predictable, despite the fact it
is driven by market and therefore is more price reflective than
many of the feed-in tariffs that are artificially based at some
point or figure and do not reflect the true cost of generation.
Q283 Lord Dykes: Mr Sambhi, did you
want to add anything?
Mr Sambhi: The only thing I would add
is feed-in tariffs may have a place in promoting other forms of
generation such as micro-generation or even distributed heat.
So, as a mechanism, it can be applied to stimulating technologies
where there is an absence of deployment.
Q284 Chairman: We are almost running
out of time but before I ask colleagues whether they have any
more questions, we have spent all our time on wind. Can you give
us any evidence or comment on other sources of renewable energy,
for example, solar or water?
Mr Lewis: I will give a quick view on
what E.ON is doing. As I said in my introductory statement, we
are 90% wind, we are 9% biomass/biogas and 1% everything else.
We are currently looking at how we position ourselves in relation
to those other technologies. I think it is fair to say that outside
of wind, biomass and biogas will be the two technologies which
make up most of the additional growth. Biomass has certain challenges.
It is different fundamentally from some of the other renewables
in that it has a significant variable cost component, so it is
not just in the up-front investment; you have to manage the long-term
fuel procurement. Nevertheless, we do see that as a cost-effective
way of meeting at least part of the targets. I think of the other
technologies, there are still a number of technologies where there
is a long way to go in terms of reducing costs. If you look at
solar PV, it is extremely expensive per megawatt hour of energy
produced, particularly in northern Europe. E.ON is looking to
drive down the cost of that. We have a joint venture with Schüco,
the manufacturer of photovoltaics, to use thin film technologies,
and we would look to do a joint project with them to try and drive
the costs down and ensure that that technology can be deployed
more widely. There are other projects we are looking at—wave
and tidal power in the UK. Again, it is more of a test and learn
phase rather than a deployment phase, but we do expect the costs
of that to come down over the next decade or so. In a nutshell,
apart from biomass, most of the other technologies are extremely
expensive at the moment but we do expect to see the costs fall
over the next decade, and it may be that certain technologies
start to emerge as ones that can be rolled out in a large-scale
deployment like tidal stream or concentrated solar power.
Mr McCullough: I would agree certainly
in terms of biomass being perhaps the second greatest contributor
in terms of volume. The one thing I would say, however, is if
you look at the UK in relation to natural resources available,
wind is an obvious resource: 40% of Europe's wind is actually
here, fortunately, in and around the UK, and we do not exploit
it enough. The same applies however for the tides and the marine
environment. Clearly, we are all aware, for instance, that the
Severn estuary scheme is raised again as a potential, and it is
very true that that technology is actually quite simplistic. It
is not that complex. It is very costly because of the large civil
engineering construction there, but I am only talking about the
direct cost. In a similar way that biofuels has quite often, unless
it is truly indigenous and local, more global implications for
sustainability that have to be considered, likewise do very large
tidal and marine schemes. They all have their consequence of deployment.
The energy capture is available. There is no doubt about that.
I think all of us without exception are beginning to invest in
the very small-scale—not pilot scheme but small-scale commercial
scheme, which is no different to where the wind sector in the
UK was ten or 15 years ago. It is a cycle that has moved on, so
whilst wind is maturing, marine is not quite embryonic any more;
it is beginning to see its commercial reality. On top of that,
the other thing that we clearly have to consider is that we are
a European utility and we do not just look at the UK market. We
look at a selection of markets, so solar thermal in Iberia, geothermal
in some parts of Europe has great potential, and we are looking
at all of those, but for the time being in the foreseeable future,
by far the largest contributor to targets will be wind.
Mr Sambhi: We have got some interesting
developments at the distributed generation and heat level which
have the advantage that you save on the 7% of transmission loss
that you get down the power lines or the 1 to 2% cent through
gas transmission. For example, we have pilot programmes for air
source heat pumps and also a ground source heat pump as well.
We have made an investment in a company called Ceres Power, which
has quite a unique fuel cell technology which takes natural gas
and air to produce both heat and power in the home. All of those
are emerging technologies. To start getting them up the growth
curve, potentially not for the next decade but the decade after,
we need to see demonstration of deployment mechanisms like feed-in
tariffs to support them.
Q285 Lord Powell of Bayswater: There
is a very large advertisement in today's Wall Street Journal
placed by Japanese sources for heat pumps, which you have just
mentioned. I have not the faintest idea what they are. Could you
give us a 30-second tutorial?
Mr Sambhi: Basically, a reverse refrigerator.
An air source heat pump basically, through a refrigerant, takes
heat out of the air and pumps it into your home. The ground source
heat pump does the same but it is using heat from the ground.
That, in a nutshell, simplistically, is what they do. The technology
is in its early days but the main issue is cost, bringing the
unit cost of the infrastructure down.
Q286 Lord Powell of Bayswater: The
Japanese present it as the answer to all climate change problems.
Mr Sambhi: The reality is if we go beyond
2020 and start to think about the 60 or even 80% reduction in
greenhouse gases by 2050, we have to start seeing accelerated
development of these types of technology over the next 10 years,
otherwise that longer term goal is shot.
Chairman: Let us hope all members of the Committee
will still be sitting here to discuss 2050! I just have one request
to make before we close the public session. It would be very helpful
to the Committee if you could submit in writing some brief thoughts
on how the remit of Ofgem might be changed to meet the point which
all of you have made about investment by the Grid in anticipating
additional supply to meet additional renewables demand. I think
that would help us because we are coming to take evidence from
the Minister and we are going to Brussels. Unless anyone has any
other questions or there are any final statements, if I might
say so, it has been a very helpful session. You have been extremely
clear, and also everyone seems to agree with each other, which
is quite remarkable. The formal session of taking evidence is
closed. Thank you.
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