Select Committee on Environmental Audit Minutes of Evidence


Memorandum submitted by Sustainable Energy from Innogy plc

INTRODUCTION

  1.  As one of the UK's leading integrated energy companies, Innogy supports the Government's vision of moving towards a sustainable energy future. We generate electricity and supply gas, electricity and other essential home services through our retail business, npower. We operate and manage our flexible portfolio of power stations, run our own trading business and are developing innovative energy-related technologies. Our energy portfolio is helping to meet the increasing demand for clean and sustainable energy generation and contributing to the achievement of the Government's targets for renewable energy, cogeneration and energy efficiency. Our wind power business, National Wind Power, has developed the leading position in the UK wind power market and Innogy Hydro continues to develop small-scale hydro projects across the UK. We also operate over 10 per cent of the UK's combined heat and power (CHP) plant.

  2.  We welcome the opportunity to contribute to the Environmental Audit Committee's inquiry into sustainable energy. We submitted a memorandum to Committee's original inquiry in January 2001 and much of the following is based on our submission to the PiU's Review of Energy Policy, which can be found on our website www.innogy.com/energy—review.htm.

Key Issues

  3.  In summary we believe that the following issues are key to the Government's aim to create a sustainable energy future:

    —  Market Solutions

        In our view, energy consumers recognise the benefits of reducing carbon emissions and want this achieved at the lowest cost. We believe therefore that this would be best delivered through the use of market-based economic instruments such as the New Electricity Trading Arrangements (NETA) and the Renewables Obligation (RO) to achieve both environmental and energy policy objectives. Where techniques are already commercially available, the market should be allowed to operate to determine the most appropriate technology solutions. We do not believe that Governments should attempt to second-guess the market by imposing artificial sector caps or targets. Specific measures, such as capital or R&D grants should be used to support emerging technologies, rather than segmenting or distorting the market.

    —  NETA

        In general, Innogy supports the New Electricity Trading Arrangements. NETA does, however, have a number of shortcomings that can lead to inefficiencies in the operation of the market. It is our view that any improvements in the NETA design should be targeted at improving the efficiency of the market processes rather than providing support for specific technology groups. If there is to be support for particular types of generation, such as renewables or CHP, then this should be provided outside the functioning of the electricity market.

    —  Renewables

        In principle, Innogy supports the Renewables Obligation on electricity suppliers and believes that it is generally a well-designed economic instrument. It is, of course, too early to judge the success of the Obligation, but we believe that the UK target of 10 per cent renewables by 2010, whilst achievable, is at risk of not being met in full due to the current barriers surrounding gaining planning permission.

    —  CHP

        We accept that the carbon benefits associated with the higher efficiency use of gas in CHP plant can make a significant contribution to meeting climate change targets. However, the Government's targets for the contribution of CHP look particularly ambitious. The current combination of high gas prices and low electricity prices together with structural issues of NETA, the Climate Change Levy and achieving a route to market mean that these targets are unlikely to be achieved without positive intervention.

NETA

Imbalance Charges

  4.  Since NETA requires notification of expected output ahead of time, the dual cash-out price system currently used particularly penalises those generators whose output is difficult to predict. The nature of renewables and CHP, for example, is intrinsically hard to predict.

  5.  Generally we support the principle that the costs of balancing the system should fall on those responsible for the imbalance. Irrespective of the direction of the imbalance the value ascribed to the balancing energy should be much the same.

  6.  The costs of balancing the electricity system are likely to be different if plant must be taken off the system, compared to the costs of balancing the system when generation must be added (or demand reduced). It might therefore be appropriate for the imbalance price to be calculated differently depending upon the position of the overall system. The treatment of the costs of providing a reserve of generation may separate imbalance prices in any settlement period, but generally we would support a move towards a single cash-out price, with the price calculated by reference to the overall system.

  7.  We believe, therefore, that basing imbalance charges on a single cash-out price would more accurately reflect the resource costs of imbalance, with the price calculated by reference to the overall system. This would have the effect of moving the problem from less predictable generation.

Gate Closure

  8.  At present market participants can change their contractual and physical notifications up to three and a half hours before each Settlement Period. This is known as "Gate Closure". In practice, the delay in most nomination and notification systems means that trading effectively ceases six hours ahead. At Gate Closure the System Operator takes control and a participant can do very little to correct an imbalance in his account that subsequently materialises. Generally the three and a half hours will be critical for market participants. This is the most likely time for plant to fail on run up. Demand changes, weather conditions or fluctuations in the processes of the energy intensive industry can significantly alter forecasts. For CHP plant steam production, and therefore electricity export to the system, is highly uncertain at this horizon. Wind conditions can change significantly and hydro plant cannot exploit its innate flexibility if it is precluded from self-despatch within this period.

  9.  This in turn leads to inefficiencies in the overall despatch of the system. Generally most bid/offer acceptances occur within the hour since the SO is concerned only with the overall balance of the system. An individual market participant who loses plant three hours before has no opportunity to protect against the consequences of the System Operator's actions.

  10.  At present there is little demand by generators and suppliers for insurance services that could cover this situation since operation of a generating unit after gate closure that has not been notified is not permitted. A shorter gate closure would enable flexible plant to offer less flexible generation an insurance service that could be called upon without having to suffer the consequences of the relatively expensive system action. This single change would probably do more than anything else to create significant additional liquidity in the prompt energy market.

  11.  Reducing gate closure to one hour (or less) would enable producers to better manage their risk exposure in the market. This would also allow the emergence of effective insurance products that would be of use to smaller producers.

Ex-Post Trading

  12.  In addition to a reduction in gate closure, ex-Post notification of contracts would enable both producers and suppliers to modify their contractual position and thus enable the supplier's imbalance risks to be better managed. Both changes would promote liquidity in the prompt market and reduce costs overall. It would particularly aid embedded generators, such as renewables, whose imbalance contributes to the risks of the supplier.

Consolidation

  13.  Our commentary above demonstrates that as presently formulated dual cash-out prices, the length of time between gate closure and when plant is despatched, and the requirement to notify contracts at gate closure creates risks that are difficult to manage. As a consequence prospective consolidators have found it difficult to offer terms that are acceptable to many smaller generators. Despite this we believe that the availability of competitive consolidation services is the route by which the smaller player, and especially renewable generation, can participate in NETA.

  14.  Basing imbalance charges on a single cash-out price, reducing gate closure to one hour (or less) and permitting ex-Post notification of contracts would encourage the more effective operation of consolidation services, and thus the emergence of competition between prospective providers.

RENEWABLES

NFFO Portability

  15.  We welcome the DTI's introduction of an instrument permitting NFFO contracts to be moved. These fixed price contracts are very attractive to independent developers seeking project finance since they are not exposed to market price volatility. It is expected that it will take finance houses some time to become comfortable with the risk profile associated with the Renewables Obligation. Portability of NFFO Power Purchase Agreements (PPAs) should enable developers to achieve funding during this RO "settling down" period.

  16.  Later NFFO 4 and 5 power purchase prices are substantially below prices expected to be achieved under the Renewables Obligation. Developers are unlikely to develop these sites if alternative, non-NFFO sites will yield greater returns. NFFO 4/5 sites are thus likely to be sterilised in terms of future development.

  17.  There should be a mechanism for rescinding unwanted NFFO contracts where developers are unlikely to develop them.

Planning Consents for Renewable Projects

  18.  The Renewables Obligation will provide an economic framework which offers the potential for rapid development of renewables in the UK. We believe that wind power has a major role to play in contributing to the achievement of the Government's renewables target for 2010 as it is the least cost, highest volume energy source. The only substantial barrier to development and investment remains difficulty with planning consents. Although there is a general perception that public opinion opposes wind farms, this is not borne out by the facts. Independent surveys persistently indicate that opposition is restricted to a small minority of the population. A recent survey by the RSPB reported that just 3 per cent of the public are opposed to building onshore wind farms; indeed only 14 per cent do not want wind farms within 3 miles of their home.

  19.  The Government is strongly in favour of renewable energy. We have consistently obtained positive planning decisions from local communities for well-designed wind farms. The problems currently seem to be in regional and county authorities, who have consistently "called in" planning applications. The solution rests with a combination of:

    —  urgently revised planning guidance (PPG 22), which should allow planning authorities and inspectors to correctly weigh the national need for renewable energy against the local impacts, which is the current emphasis;

    —  England and Wales taking a lead from recent Scottish guidance and practice which has recognised the national benefits of renewables development; and

    —  agreed Regional Targets for renewable energy which should be built into Structure Plans.

Ensuring a fully competitive market for renewables in Great Britain

  20.  It is clear that the Government's intention is to establish a fully competitive market in renewable electricity. Renewable Obligation Certificates (ROCs) will be tradeable throughout Great Britain and the level of the Obligation is the same for suppliers in England and Wales (E&W) and Scotland. While the Scottish Renewables Obligation Order is substantially equivalent to its E&W counterpart, the fact that buy-out receipts obtained in Scotland are proposed to be recycled to Scottish suppliers, and those obtained in E&W recycled to E&W's suppliers, effectively decouples the E&W and Scottish markets.

  21.  This separation of the E&W and Scottish markets in terms of recycling of buyout receipts is clearly contrary to the principle of a fully competitive market for ROCs in Great Britain.

  22.  Recently announced delays in the introduction of British Electricity Trading and Transmission Arrangements (BETTA) will also impact on the competitive entry of renewables developers into the Scottish electricity market both in terms of access to distribution systems and the regional monopoly of the existing supply companies.

  23.  The opening up of the Scottish electricity market to full competition at the earliest opportunity will facilitate the delivery of a fully competitive market for renewables in Great Britain.

COMBINED HEAT AND POWER

  24.  The Government's target of 10GW of CHP plant by 2010 is ambitious under current market conditions. The combination of high gas prices and low electricity prices together with the structural issues of NETA, the Climate Change Levy and the difficulties of achieving a route to market mean that these targets are unlikely to be achieved without positive intervention.

  25.  The measures discussed above in relation to NETA would also benefit CHP plant. At present exports from CHP plant are only CCL exempt where supply is direct to the end user. CHP operators should be allowed to use the customer support infrastructure of other licensed suppliers in order to minimise the burden of having to become a licensed supplier themselves.

  26.  To encourage investment in good quality CHP the shortcomings of NETA should be addressed and arrangements that will facilitate a route to market implemented. Investment in new plant is only likely to occur when electricity prices reflect market fundamentals, so that the additional efficiencies of CHP give rise to added value.

February 2002


 
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