Select Committee on Environmental Audit Minutes of Evidence


Examination of Witnesses (Questions 20-39)

MR DAVID GREEN AND MR GRAHAM MEEKS

WEDNESDAY 30 JANUARY 2002

  20. Let us assume that we are staying within NETA, you talked about the problems of small generation and you wanted to see encouragement for certain forms of generation. Ofgem appears to be saying that the incentives to promote specific forms of generation would not be legal within the NETA framework, is that an argument you accept or not?
  (Mr Green) I have not heard Ofgem say it would not be legal, what I heard them say is it is not their job. Their position is that they are the economic regulator, their job is to construct an economically efficient market. There are debates about what is meant by economic efficiency, there job is to deliver an economically efficient market. If the Government wishes to promote particular technologies then Ofgem say it is up to the Government to put other measures in place to achieve that. The Government obviously, as you know, has two targets, one for renewables and one for CHP, and in the context of CHP I am sure that Ofgem would argue it is not a matter for them to alter the NETA arrangements to achieve the government's CHP target, they believe it is a matter for the Government to have other arrangements. That may be, but I would return to the fact when the Minister issued a guidance letter to the energy regulator to start the process going he specifically said in that letter that he wanted to see an outcome which was to encourage CHP renewables, clearly a 61 per cent drop is not an encouragement.

  21. You believe it is not the regulator's job here?
  (Mr Green) Yes. You get into a wider debate about the overall role of the regulator in relation to the environment. As you will be aware, environment is a second order duty for Ofgem, it is not a primary duty and therefore it tends to get less attention.

  22. That is not an argument just with this regulator, we have come across that with others as well. You talked in your memorandum about the effects of cash out prices and suggested that there had been some change of view within DTI. You said at one point that when you met the energy minister in July last year officials appeared to be indicating that the DTI always preferred a single cash out price but now they are endorsing Ofgem's position, that you need two cash out prices. What is your argument for a single cash out price, if that so important? What is the problem with the individual pricing?
  (Mr Green) Your summary is absolutely right, we were told in a meeting we had with Peter Hain, when we was Energy Minister, that DTI's preference had always been a single cash out price.
  (Mr Meeks) I think it is important to understand where these cash out prices lie, they are a small part of NETA but they are very central to it. We are not arguing that a number of the other elements of NETA, the bilateral markets which have been established, are a problem in any sense. We are not saying that NETA, as a whole, is a problem but there is one particular problem which lies at the heart of it, which is this system which is called the balancing mechanism, it resolves round this two part cash out price, which is a system which is used for settlement, for generators who may produce more power or sites which may have consumed less power than they wanted to, it is a settlement arrangement there. The two part cash out price was set up to encourage people to provide an incentive to make sure that they provided the energy for the system they said they would do in any space of time. What we are seeing is the fact that this arrangement, this dual cash out price, presents such a strong incentive to do it that it is actually imposing some penalties, some severe penalties, on the generators which far exceed the requirements of the system in terms of ensuring efficient balancing. The cost that a generator faces because of this arrangement exceeds the cost that it really would cost energy suppliers if they took this duty themselves to balance the system, and it exceeds the cost that was incurred in balancing the system before NETA was introduced. What we are saying is that this two part cash out price is over-penalising small generators, having an over-exaggerated effect in terms of balancing the system, it does more than it needs to do. Moving to a single cash out price has the potential to have the correct effect, an economically efficient effect and that case must be explored if we want to get to an efficient way of working the system.

  23. You are saying people are penalised at the moment, I am not quite clear how and why they are penalised.
  (Mr Meeks) In our memorandum we referred to a paper which was presented to the Cabinet Office PIU Energy Review, and it has also been presented to the DTI -convened Consolidation Working Group and what this paper demonstrates is that the costs that are now faced under NETA by a small intermittent generator far exceed the costs that they impose at a technical level upon the system. In our way of thinking that means that the settlement system as it stands today is penalising that generation for its unpredictability or its intermittency to a far greater extent than is needed to secure the system.

  24. On this question of intermittent generators, I believe there is a suggestion in an interim report from the Consolidation Working Group that suggests that we might have a bit more flexibility in the way that they are dealt with so that they can differentiate between predictable and unpredictable outputs, be able to sell them separately. Is that something that would actually work or is that going to make everything more complicated?
  (Mr Meeks) It will certainly be very complicated because for this system to work, you are introducing another party into the contractual arrangements which are needed to sell electricity. The more people you have you involved within these contracts the more people need to make a return and the less income there is available to the generator who is already hard pressed. It is ultimately a problematic system because it is just going to take money out of the system which is needed to make these CHP and renewable projects cost effective.

  25. Essentially you are saying help the intermittent generator by the cash out price mechanism.
  (Mr Meeks) I think, as Mr Green said, the whole way that NETA has been structured is to deal with some problems that are historic. It has not been designed to look forward to an electricity system, which is what the Government has envisaged with its 2010 targets for CHP and its renewables. It is very difficult to see how the system could be tweaked through facilities such as consolidation, to turn it round from the very damaging situation we have now to one where we are moving towards those targets, which is why he said earlier it would make sense to take these generators out of the system. If that were not possible then the single cash out price may provide an alternative solution. If we want to be sure of going in the direction that we want to do then a simpler approach may be to exclude the smaller generators and sustainable generators as a whole.

  26. Has any consolidation actually happened?
  (Mr Meeks) I do not know the details of any individual transactions but to the best of our knowledge at the present time there is only one company which has come forward to offer specific consolidation services. There may be a number of companies listed on Ofgem's website but there is only one company actively trying to promote and make money out of this particular activity. We are far from having a mature market in consolidation services.

  27. We are expecting the report from this Consolidation Working Group fairly soon, what sort of recommendations would you like to see it make or are you again saying you do not really think that consolidation provides a very effective way forward?
  (Mr Green) We have seen the draft, we have not seen the final one, that is hopefully arriving today or early tomorrow, before it goes into the DTI. The sort of things they are suggesting is changes to the technical arrangements for consolidation that make it easier to consolidate. There is still a debate going on about the extent to which the report would recommend a single cash out price and there are various other issues. They will make consolidation, in some situations, probably slightly more attractive. The issue is whether the transaction costs involved in consolidation will fundamentally still make it possible to operate, that is the difficulty. What the DTI have reminded me is that in the response they gave to Ofgem consolidation was by no means the only thing they were looking at. There were other changes they indicated in their consultation paper they wanted to consider, everything has come to be focussed on consolidation because there is a specific Working Party at the moment. When the Government responds in total to the range of measures that might be needed to resolve issues under NETA we hope it will not be only on consolidation, we hope it will be on other changes that can be done as well to make the NETA system more equitable. There is a process for change but it is by no means clear that Ofgem are willing to enable those changes to happen because legally they have the right of veto over any changes any party can propose. It needs a signal from Ofgem they are prepared to consider fundamental changes.

  28. Or a signal from government to Ofgem.
  (Mr Green) Yes. Although we are always reminded by Ofgem they are an independent regulator and they take a view on any matters. We are yet to have the environmental and social guidelines to Ofgem, it may be those could provide a mechanism to give that steer.

Ian Lucas

  29. In your memorandum to us you said one thing that interested me, "The DTI has apparently inadvertently included CHP in the renewables obligation base". Why did you say "apparently inadvertently"?
  (Mr Green) That is what they told me. Legislation, as I am sure you know much better than I, often has unintended consequences. The way in which the renewables obligation operates is the obligation is placed on licensed suppliers, a lot of CHP schemes because they supply have to be licensed suppliers, and it has come to a head with one major CHP scheme that is under debate at the moment, you either have to pay the buy out price or commission our colleagues and members of the BWEA to develop some wind turbines. The irony is that you are in a situation where a light green technology, CHP, is subsidising a deep green technology. This came to a head a little while ago. My understanding is that the interpretation that the Treasury solicitor took, and it went to the Treasury solicitor to resolve the matter between the legal bits of DEFRA and DTI, was they could not exempt CHP from the renewable obligations base without a change in primary legislation. We have raised with Ministers that if Parliament was to decide to have any modest energy legislation in the next session it would be an opportunity to amend that. This is actually directly analogous with something that happened with the last government, when John Gummer was Secretary of State, supported by the then opposition environment spokesman Frank Dobson, who was extremely helpful in finding a relevant bit of legislation that could, four years after the passage of the 1989 Electricity Act, amend another similar inadvertent consequence from the 1989 Electricity Act. It is something we are used to, it is just very frustrating, Chairman.

  30. In short it is a cock up.
  (Mr Green) Chairman, what is that phrase you can say that I could not?

  31. You are clearly arguing for a CHP obligation, you would like a CHP obligation. How would that specifically effect the companies that are having such difficulties at the present time who were involved in CHP before March 2001, when NETA came in? What would be the effect on those companies?
  (Mr Green) It would provide some degree of surety of income, most CHP schemes are long-term investment, you are not talking about schemes that are going to pay back tomorrow, you are talking about schemes that pay back over two, three, four, ten years sometimes, they are long-term commitments between the customer and the host site. One of the benefits of having arrangements for CHP akin to those for renewables or some other mechanism is that it would provide some surety. We have never argued that it should be at the same level as renewables, because CHPs are a more mature technology, we argued that it could be at a lower level, providing surety in a fairly volatile market. This will give companies the willingness to invest. Whether or not that happens remains to be seen. The Government did take the powers in the 2000 Utilities Act to introduce these arrangements. Michael Meacher confirmed it several times on the floor of the House that powers did exist. We hope when the Government CHP strategy comes out it might give an indication as to whether or not they are prepared to move in that direction. The thing we have pointed out is if you think about it, a renewables obligation is going to come in on 1 April this year, the work on that started in about 1997, the intellectual work, so these things do not happen quickly. Okay, there is some legislation but it will probably take two or three years to physically put it all in place. It is a matter of committing now and doing something that might have a benefit in the slightly longer term as a way of actually achieving the government CHPs target by 2010.

  32. We are all rapidly discovering this is an incredibly complex area, particularly when we get to exemptions of various sorts, and you have already mentioned the time delay that would be involved in introducing CHP obligation because of the lead-in time that the renewables obligation took. Is it, therefore, a realistic expectation that the companies that are in trouble at the present time could actually respond to an immediate announcement by government at this time?
  (Mr Green) The thing that the companies are looking for, Chairman, is an immediate announcement, a strong commitment from the Chancellor in the Budget Statement because that is pretty soon, that is April. Even if that was subject to state aid approval it would give people confidence that the government is committed to doing something. It would cause some companies to cease to close down their CHP operations and begin to see a turnaround coming. If they then see through the CHP strategy it would begin to reawaken market confidence. There are people in all of these companies, from chief executives downwards, who would love to be developing CHP, they are professional engineers, they take a real pride in their work, they appreciate efficiency benefits, they want to do it. They are not sitting there saying, we do not like it, we are not going to do it. They need to have confidence the market is going to be there for them.

  33. Do you see it as essential to the future of CHP in this country there is a CHP obligation?
  (Mr Green) Yes.

  34. You mentioned earlier exemption from the Climate Change Levy as well, another complicated area, is that a matter of similar status in your mind?
  (Mr Green) It is a matter of very great immediacy in the industry because everyone understands to do an obligation would take a bit of time, hence the importance of full exemption for the Climate Change Levy because, yes, it would need changes through the Finance Act but those are a fairly steady process. The Treasury went quite some way on this in the Pre Budget Report. What we hope is that Treasury sees enough of a need for change to go the full stage, subject to state aid Commission in the April Budget, hence our meeting with Paul Boateng and our meeting with other ministers to ensure they are aware of our concerns, which they certainly are.

  35. That would be the short-term finish and the CHP obligation is the long-term desire which you have. It is clear from the papers that we have that DEFRA's CHP strategy has been severely and repeatedly delayed, have you any perception yourself as to why that is happening?
  (Mr Green) I am sure the Committee see this as another area where DEFRA are very thin on the ground, their ability to devote staff in depth to some issues is quite limited. An awful lot of the areas that CHP deals with are quite complicated in a market driven area and it is not an area that traditionally DEFRA will be that actively engaged in. They have difficulty sometimes in fully taking it forward fully. They have given a lot of focus in the last three years on a quality assurance scheme for CHP and that has taken up, I know, a considerable amount of intellectual and staff time in the department and that has lead to some of the difficulties and delay in the CHP strategy. They have been very focussed on a minutiae, which is important, but you also need to make sure you have your underpinning legislation and strategic framework in place. A lot of CHP is driven by energy legislation, that comes out of the DTI, and you get into the whole debate about the relationship between the departments, it is not insignificant. When we had the problem last time it was sorted out on the back of environment legislation, it would not surprise me again if it happened this time. We are used to being the afterthought.

  36. On a slightly different tack, a lot of the focus at the moment on renewables is about very large-scale production through offshore wind power and all of the rest of it feeding into a large scale grid. As far as the infrastructure of the industry is concerned small-scale CHP and, indeed, other forms of small-scale energy obviously have different needs within such a grid. How easy is it to create a grid which accommodates both, is that problematic at all?
  (Mr Green) I am not a grid engineer. We have a system now which has grown up of remote power stations bringing power to our buildings. The way technology is moving, you see it with computers as well, it is getting smaller and closer, you have it on your desk and you can carry it around. Technology is getting smaller. There are technical developments both in the CHP field and in renewable energy areas which makes the technology a lot smaller and there is a lot of excitement in the market place about the development scale CHP in your own home. It is already quite small but not as small as right down into your own home. Assuming that happens in the next three, four or five years and an effective roll out is achieved it would have the effect of fundamentally changing the characteristics of a system, just as more local wind turbines or more local solar rhoto voltaics will, because it is about generating closer to the point of use. Over time that will change the nature of the system. What is very interesting now is since the Utilities Act with the separation of distribution and supply there is now a whole range of people in the electricity industry who do not want to sit there looking after wires, they want to do it more creatively, the debate is whether you get active management from the distribution system, so you begin, over a period of time, to see things like smart metering, domestic CHP, et cetera, that will change the nature of the way in which the grid system operates. You will still have large power stations, you will maybe have fewer of them and more local generation.

Mr Francois

  37. I was interested in some of your comments on the need to integrate CHP with the planning framework when you look at the development of new power stations. Can you give the Committee any examples of missed opportunities where there has been a significant failure to exploit CHP and conversely can you give us examples of best practice?
  (Mr Green) There are two examples that spring to mind, one is where there are urban estates near a power station which you can use the heat from. I suppose, although I hesitate to mention it at the moment, bearing in mind the news headlines about Enron, but there was a very large power station developed in the North East of England which produces 3,000 megawatts of heat, at the moment that heat keeps the birds above Teeside very warm, none of it is used in the local community. It would be very difficult, to be fair, to use 3,000 megawatts of heat in Middlesbrough, much as the homes are very cold, and it is my own region, so I know the severity of winter sometimes. What we are talking about is trying to have a market where people are producing more optimally sized power plants where you can use the heat. The one I would give as the best example is not physically built yet, it is a very interesting process, is it subject to a planning inquiry at the moment, that is down near Southampton, where the local authority in Southampton have always been a strong champion of CHP, they use CHP, they take the power from a geothermal plant used in the city centre. When they were approached first of all by the power station the developer they encouraged them to think about CHP, they then made a bid, the local authority, to DETR, as it was, one of the urban regeneration programmes to put in the heating infrastructure, they were successful with that and it will mean when the new power station comes on stream the power will be used locally. There are local residents concerned about the development of the power station, so it is currently the subject of a planning enquiry which will be going to the Secretary of State when the inspector will be reporting to him. That is an example of getting some joined-up thinking and we can make the two happen. In terms of an existing power plant where it has happened, historically both Nottingham and Sheffield, when plant has been developed and they are connected into the local community and the heating is used locally and has contributed towards bringing down heating bills in that community.

  38. That is interesting. The Government has a review of planning policy at the moment. From your perspective, what specific changes would you like to see come out of that review?
  (Mr Green) The ones that we begun to make representations on, not so much in the sort of major infrastructure projects area it is more in the structural and urban planning process, is, for example, a developer is wanting to develop a new building in an area then one of the issues that is raised with them is, have you thought about how you can either use CHP in that building or if you are in a city, like the City of London, where there is an existing CHP plant, have you thought about how can you connect to that CHP plant. I know from colleagues at TXU they are very frustrated that they are finding it very difficult to engage in discussion with the new property developers in the City about connecting their system which increases heating, cooling and electricity. The conventional person who develops an office block wants to do it quickly, the conventional way of doing it is a boiler, air conditioning on the roof and plug into the electricity mains. It may well be that it could increase the value by not having a boiler in the building because you have more letable space. If you could have an outside interjection that did not say you must do it but caused people to think about it that is what we would like to see with the planning regime. That is what we have, to a certain extent, got to with the planning guidelines that the DTI issue for Section 36, where the developer of a power station is supposed to indicate they have given consideration to CHP in that process. If you look at it from the power station's side, the planning authorities are DTI not DTLR and the local authority.
  (Mr Meeks) It is worth saying that the Section 36 guidelines have not really been tested since they came in last year because there have been so few applications to build any new power stations that it is difficult to understand where people rank the identification of a heat mode, yes they can see where the gas is supplied from, yes they can see where there is a connection to the grid and those are, perhaps, two primary considerations when one looks at a power plant. It is difficult to understand whether in practice and in the application of those guidelines the identification of a local heat load or a load where one can actively use the heat has enjoyed equal status, if you like, with those other two planning considerations. We would certainly advocate moving towards that arrangement, where it enjoys that priority in a way that we can maximise efficiency.

  39. How about the Government's community energy programme, can you report any progress in that area?
  (Mr Green) John Prescott announced it last year, it goes live on 1 April this year, so it is not physically available yet. Last week Michael Meacher announced in a parliamentary answer that the application forms are available. If I may, I would encourage any of you who have constituents thinking of applying to go into the Energy Saving or Carbon Trusts website and download the application forms. We are determined to ensure that the £50 million that has been allocated over two years is put fully to use. All I can say is the application forms are now available and we hope from the Pathfinder phase we will get some good application in quickly and they will then be appraised by the Carbon Trust and the Energy Saving Trust for DEFRA and the final decisions will be taken by who is going to benefit by Ministers at DEFRA.


 
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