Examination of Witnesses (Questions 101
WEDNESDAY 6 FEBRUARY 2002
101. Welcome to all three of you. Thank you
for coming along this afternoon. Thank you also for your memorandum.
I know we asked you for an update and it was even more substantial
than we envisaged. Thank you very much for that; we are very grateful
to you. Can I just clear up one point. I am not exactly sure how
big Innogy is in the UK market. Secondly, is there anything you
would like to add, however briefly, to your memorandum, as we
would like to hear it first of all and then go on to the questions.
(Dr Count) I will deal with that point,
Chairman. I assume the memorandum is broadly read. I will just
introduce the team. I am Brian Count, Chief Executive of Innogy.
Brian Senior to my right is Director of Trading and Asset Management
so he deals with the need for interface, and Mike Bowden on my
left is the Company Secretary. Just to put Innogy into perspective;
we are the largest supplier at the retail end of electricity and
have a leading presence in both the domestic sector, small businesses
and the large business users. We are the second largest gas supplier
at the retail end, obviously some way behind Centrica/British
Gas. We produce around ten per cent of the country's electricity
from our power stations. That means we are a very substantial
player in the electricity market. We also are market leaders in
renewable energy production. We have approximately a 30 per cent
share of the wind energy market in the United Kingdom. We operate
15 wind farms here in the United Kingdom with a capacity of just
under 160 megawatts. We also have eight hydro-electricity stations.
Two per cent of our generating power already comes from renewables.
Also on the renewables side we have secured a site for our first
offshore wind farm off the coast of North Wales and we are proceeding
with consent on that. We operate over ten per cent of the country's
combined heat and power plant, so we are very strong in both the
retail and the production of electricity and the production from
renewable sources. I think at that, Chairman, I will leave it
open for questions.
Chairman: Thank you very much. Those are very
diverse interests. Mr Gerrard?
102. You are a very diverse company and perhaps
more diverse than quite a lot of people in the field. If the market
had just been left to itself, if everything had been driven by
market forces, without for instance the Renewables Obligation
or the Emissions Trading Scheme, would we have seen that diversity
or would we have seen generators holding nothing but combined
cycle gas turbine stations?
(Dr Count) If the market had been left to itself without
any support for renewable schemes, then renewables schemes would
not have been built. Wind power previously was built under the
Non-Fossil Fuel Obligation which did give premium prices against
the market. Co-generation was built without too much support,
but now the market conditions even demand that that needs some
support. No, without any support, renewables would not be built.
103. If we look at some other European countriesDenmark,
Germany, Austriathey seem to have got on considerably better
than we have in developing renewables. They are all countries
where there is a rather less liberal, less open market than the
UK. Why do you think they have been more successful?
(Dr Count) I would disagree that they have been more
successful. They have developed more renewables but that just
needs a decisive framework put in place in order to stimulate
it. I believe very, very firmly in a market-based solution with
an overlay. If our objective is to reduce carbon and we price
carbon appropriately, then I believe the renewables will be developed,
and carbon free technology will be developed at the research end,
the development end and the investment end. If you look at places
across Europe such as Holland and Italy, they are now doing exactly
as we are doing and putting in obligations to supply so much of
their output from renewable sources, but clearly in all of those
countries they have had to pay a premium price for that development.
104. How is that premium paid? Is it in the
price that consumers have paid or has it been through support
that has been given to develop the renewables?
(Dr Count) I am not an expert on those European markets.
Clearly my understanding is that ultimately the consumer has paid.
105. You are not just a renewables generator.
Very obviously you have got considerable coal and gas generation
capacity which is still there. Do you think that there are significant
costs associated with coal generation, and perhaps to some extent
gas, in terms of pollution that have not been adequately accounted
for in the past?
(Dr Count) I think it is undoubtedly the case that
there must be an environmental cost. However, I think it is right
and proper that we would say that the Government and the regulatory
framework determines what cost that is, puts that cost into the
equation in some form or another, and then allows the industry
to decide which technologies to develop and pursue taking that
cost fully into account. One could argue that the renewables scheme
that is being proposed, where renewable sources such as wind power
will command a three pence per kilowatt hour premium, is an attempt
at costing that effect and saying that carbon reduction technologies
do merit a premium price. We do not have a difficulty with that
and would support that overlay in the mechanism. I agree there
is a cost. It is not for us to judge what that cost should be.
106. Do you think that cost has been adequately
accounted for in the past or not?
(Dr Count) Clearly there has not been carbon costing
in the market-place so I do not think it has been fully reflected.
There is a lot of science that needs to go behind that. Our view
is that there should be a carbon cost overlaid from the natural
market and you can have those two market structures and that will
stimulate reduction in carbon production.
107. I wondered if Mr Gerrard had asked you
about government in the sense of the market particularly with
the Renewables Obligation and now Emissions Trading, whether you
can tell us if you felt any pressure at all from the point of
view of any government policies regarding energy efficiency? Do
you feel that affects the market at all?
(Dr Count) We have not felt pressured per se because
we are one player in the market, but if you take the broader issue,
do I believe we should have some uniform structure that relates
the end use to the production, I agree with that entirely. I think
I come back to the view that the purest way of doing it is probably
an emissions trading market. I think that would be a sensible
pressure to take place, both from the retail end and the production
end. We have probably got a lot of concentration on the production
end and probably less attention on the end users.
108. Have you identified any gaps at that retail
end in a sense which you would suggest might be something we could
be looking at as a Committee when we look at the European experience
later on in the investigation that at the moment is missing from
what the Government is trying to do in terms of energy efficiency
and fuel poverty as well, another key strategy, and how this may
affect the way you relate to some sort of carbon trading system?
(Dr Count) Already there are energy saving measures
and obligations on us that clearly we are happy to enact. I think
what I would only say is that we seem to have mechanisms at the
demand end and a different mechanism at the production end, and
obviously from an investment point of view at the broader end,
if I look at the consumer I would say that sits at the centre
of this issue of sustainability. I believe the consumer is very
keen on seeing carbon reduction. I think the consumer would like
to see it at minimum cost.
109. Government as well.
(Dr Count) Government as well. I think it is right
for the nation. I think when you look at these (and we have got
these initiatives at both ends) we need to ask how can we marry
them up into making sure that the allocation of the resources
gets directed where the best return is and the best value for
the consumer. I would only argue that it is not self-evident that
that is necessarily the case on the current structures.
110. Can I finally ask you one specific question.
There is currently going through this Parliament a Home Energy
Conservation Bill. Have you looked at that as a company as to
if that were to go through and be passed how that would affect
(Dr Count) I would expect my retail division to have
but I could not answer questions in detail on that myself. I know
that my retail division will look at all of those issues. If you
want any view we can come back to you on that issue.
111. There are an increasing number of policy
instruments in the energy area. As a company is that a problem
for you? Do you think there is a need to rationalise the number
of policy instruments? If there is, have you any thoughts about
(Dr Count) The answer is yes and I will let Mike have
some air time now.
(Mr Bowden) Our view is that a broad framework set
by the relevant agencies gives the overall rules within which
companies can operate and optimise as they see fit. I will give
you an example where we feel that perhaps over-complexity of regulation
is working against the overall objective of the agency concerned.
We are clearly interested in sulphur regulation insofar as it
impacts on our generation fleet, our power station fleet. I was
learning yesterday that if one looks at the issue of sulphur regulation,
there are for non-FGD power plants ten quite separate levels of
control rising to 14 for a company with FGD as part of their coal-powered
112. FGD is?
(Mr Bowden) Flue Gas Desulphurisation. It is a process
at the back end of the power station that cleans up emissions.
One can make a case for each and every one of those in the abstract
and we will do our level best to comply with each and every one
of them but we feel that overall it would be better for there
to be a choice made as to what would be the key measures that
would make the difference, and we suggest that that would lead
to a more efficient market in which the players could operate.
That is just but one example. There are others where we understand
and support the general thrust of regulation but feel perhaps
there are rather too many measures, sometimes overlapping and
conflicting, that we have to weave our way in and out of, and
that can be difficult.
(Dr Count) If I could add just a short point to that.
The over-burdensome nature of the processes and conditions here
make it unduly complicated to make things happen. If it is overly
complicated it will not happen and the cost of weaving
113. When you say "it will not happen",
what do you mean by that?
(Dr Count) If there are too many complicated processes
and initiatives to go to energy efficiency then it acts as a barrier
because it is so complicated to find one's way through it and,
ultimately, it will not get as good an investment pattern as it
114. So it would deter investment?
(Dr Count) It would deter investment. Clearly the
other point I would make on investment is if we are going to make
sustainability work we need something in this country of the order
of £5 to £10 billion of investment over the next decade.
If an investor such as us believes that there is going to be changes
of rules, because there is a plethora of rules, then we risk stranding
the assets. We think very much that political risk is the biggest
barrier to long-term investment in the industry.
115. You have given us one specific example
there which I think is helpful. Could I ask you to address specifically
the new electricity trading arrangement for a moment. Last week
the CHPA pointed out to us that the Government in the letter commissioning
the NETA process stated that the outcome was to provide encouragement
for renewables and CHP. That was a fundamental aim of the concept.
Do you accept that it has not done that and NETA is working directly
against the intent of the Renewables Obligation because of the
way it has been designed?
(Dr Count) I will let Brian Senior take that one.
(Dr Senior) Basically we see the changes that NETA
has brought about as fundamentally beneficial. In other words,
NETA is performing much more as a commodities market, liquidity
has gone up, people are able to manage their risk much better
in the market generally. Where we see some distortions which we
believe disadvantage CHP specifically, and also wind, is in the
way that the market values uncertain generation and, on the other
side, uncertain uptake arrangements as well. There are two specific
examples which we might mention. One is that we currently operate
in the very short time scales of the balancing market, the three
and a half hours to real time part of the market, what is in effect
a penal system designed to drive people to balance the amount
of generation that they contract on the one side and the amount
of uptake on the other side. If you are out of balance then you
pay one of two prices. The difference between those two prices
is typically about two pence per kilowatt hour. It is a large
number. That particularly hits the CHP and wind because they,
by their very nature, have uncertain generation, wind, because
the wind is blowing or not blowing, and CHP because your first
duty is to your on-site customer (whether it be steam or electricity
arrangements) and what you are effectively doing is selling surplus
into the market. That £20 per megawatt hour difference then
gets put into a pot and redistributed pro rata with the amount
of megawatt hours that people generate so the people who tend
to benefit from that dual cash out arrangement are the people
who are baseload generators in the wholesale market, not CHP and
wind renewables. That is one specific area. The second one that
is probably one worth mentioning is the fact that the market operates
as competitive market-place where people can buy and sell freely
in an open market until three and a half hours before real time.
There is no reason, in our view, why that cannot be shortened
to around an hour and possibly shorter than that, which allows
people who have uncertain generation to get much closer before
they are into this balancing mechanism and it allows the market
to find consolidation and other arrangements which work much more
effectively close to real time. Those are the two things that
we particularly see as disadvantaging CHP renewables in NETA.
Generally NETA is working as a market but in the specifics of
the balancing market there are things that we think could be improved.
116. In your submission one of the improvements
that you highlighted was a single cash-out price. How do you respond
to the argument that the DTI would make that this would fundamentally
undermine the commerical initiatives within the system in the
(Dr Senior) I think we would suggest that the principle
we are aiming to work to is that the market reflects actual costs.
So the way that the dual cash-out currently works introduces,
effectively, a penalty and a surplus of funds because the system
is not out of balance in one way or the other way, it is not simultaneously
out of balance in both ways. So individual participants are bearing
costs that the system is not bearing. That is what creates a surplus.
To our minds, if it were an efficient market that surplus would
not exist. The costs are not being incurred by the system. They
are being taken off individual participants and reallocated post
the event to participants according to megawatt hours generated
or supplied. That does not indicate to us an efficient market.
That indicates some kind of subsidy in some form or a dislocation
of the market.
117. One of the problems you have is lack of
technological advance in electricity storage, but in your submission
to the PIU you do highlight this and, reading between the lines,
you seemed to indicate that where there was not a clear time line
that in years to come there would be far more work done on electricity
storage to the benefit of those who supply electricity, and that
is of particular interest to renewables. Can I have your thoughts
on where that technology is going and when it is going to start
to impact the market, given that in your PIU document you are
talking about a 20-year timescale?
(Dr Count) In the last decade we have developed a
storage technology known as Regenesys. That storage technology
is being put into full-scale application at the moment. We are
building a 15 megawatt plant that will service people 30,000 people
at Little Barford near St Neots. That is next to one of our gas
plants. That project is expected to commission in the second half
of this year. First of all, this is a chemical based storage system
that is here and now and we have made a commercial sale to Tennessee
Valley Authority and that project is running some nine months
behind. Clearly, over the coming years we intend to develop it.
It will take some time to make a major impact but it will increasingly
make an impact in our view over this decade. We also know that
at the smaller scale end the Japanese are developing similar technology
with slightly different base chemicals.
118. You have got 30,000 people in St Neots.
Where do you think you will be in ten years' time? 30,000 today
is a drop in the ocean.
(Dr Count) I think we will be making significant inroads
into the market. I am not trying to hedge the question but you
are asking me for a profit forecast. Ultimately, could it make
substantial progress towards helping renewables? Yes, in that
timescale and, indeed, it is known that we are talking to the
Danes on assisting them with storage. They are interested in the
development in order to support their wind power programme and
it will make a material difference to how you can take unreliable
power, which is of low value, and make it much more reliable and
more highly valued. Assuming that our technology goes to plan,
and we have every evidence that it is going to plan, in the next
decade it will make a material impact on how you can turn unreliable
power sources into a reliable power system.
119. You have got another subsidiary, Concert
Energy, that is dealing in the field of consolidation. Do you
see any real signs that consolidation in a technical sense will
ever become a practical option?
(Dr Senior) We have within Concert consolidation services
around 60 sites now, so we have invested heavily in consolidation
services to people. Consolidation is the process of putting into
the balancing market a number of uncertain generators and then
taking the benefits of the randomness of their generation. We
believe that is an important risk management service that we can
offer and others can offer into the market. Will it increase?
Yes. The only concerns we have, apart from the issues I mentioned
before about the fact we cannot do any consolidation post three
and a half hours out, are about the potential for real changes
and things that mean the investment we have made in consolidation
services are effectively rendered useless. We currently have a
major consolidation programme underway over 60 sites. Generally
it is working well. We are seeing the costs of balancing reducing
for our customers by about 50 per cent from our consolidation
services. That is the scale of the benefits that we and others