Select Committee on Environmental Audit Minutes of Evidence


Examination of Witnesses (Questions 120 - 139)

WEDNESDAY 6 FEBRUARY 2002

DR BRIAN COUNT, DR BRIAN SENIOR AND MR MIKE BOWDEN

  120. Are they always in-house or are you providing some services to independent generators?
  (Dr Senior) We have independent wind farms. We also put within our consolidation service the demand-side management. Clearly there are benefits in very short timescales of having demand-side management, large industrials that can shed load quickly, together with people with a very uncertain generation. So by putting those things together you can start to take the natural offsets and you can also start to manage that position as a whole. So there are a number of sites that are not Innogy sites within that consolidation service, and they are seeing the benefits, too.

  121. Is not the reality that in, say, five or 10 years' time there will be a massive shake-out of the market, and a lot of the small independent generators will have been bought up by the larger players? Is that not realistically the only kind of consolidation that is going to take place?
  (Dr Count) I think that is a very credible scenario. This is a large investment business, a heavy investment business and clearly participants have to judge the market risks. Clearly scale effects do make that the best way and will lead to lower consumer prices as a result of that. I think, as Brian says, that does not mean there is not a place for the small niche player who may have to hand their risk management to others and consequently take a lower return but at a lower risk, which is not unreasonable for the market. What should not happen is that small players are allowed to have premium prices at the expense of the consumer. There is an ultimate destiny that consolidation will happen whether through ownership or risk management. That is what is happening and clearly risk should be managed with those people who can manage it at the lowest cost.

  122. You think there might be some future for small independent generators?
  (Dr Count) There is always room for small independent generators but they cannot take the returns and pass the risks across and still expect those rates of return that a player that takes the risk would have. So it is a matter of the conditioning of the market, I think.

Chairman

  123. What sort of rates of return are you getting now?
  (Dr Count) I think the assets today are getting a very low rate of return in the market price, but I think it is reasonable to expect on a global basis generating assets to command about seven to eight per cent real, post-tax return in the market-place.

  124. That is not bad.
  (Dr Count) That is not a bad return. Leverage can, of course, give good equity return. I think the global spread is somewhere between six and eight per cent real, depending on the element of market risk. Clearly, if you hand market risk across then you are taking very much lower risk and you would expect a slightly lower post-tax return. It is still a reasonable return.

Mr Francois

  125. To reiterate one point you made earlier, when we are talking about investment and potential return, from what you were saying the greatest barrier, even looking at the seven to eight per cent potential return, beyond any other technological barrier, is political risk?
  (Dr Count) We ourselves expect to be a heavy investor in the wind projects under the renewables certificates. What will tax most of our minds in our board room will be will that scheme be withdrawn and replaced with a new scheme and hence we end up with stranded assets? We would like some sort of grandfathering rights to avoid stranded assets. If it moved to an Emissions Trading Scheme which eroded the value, then that is a big risk. In a long-term investment that requires a long-term return, that is the biggest risk.

Mr Barker

  126. Can you tell me what grandfathering rights are?
  (Dr Count) It is a quite a common process. I have experienced it particularly in other European countries. If you change the rules in five years' time because the technology may be developed, new technologies have come and let's suppose instead of threepence a unit, you think it only requires tuppence a unit, those schemes that went ahead on the basis of threepence should maintain that throughout their life and new schemes should only best stimulated with tuppence.

  127. You will look to government for that?
  (Dr Count) I think that has to be legislative. That is a government issue.

Chairman

  128. You have not had that so far?
  (Dr Count) No, that is not in the legislation.

  129. What is your experience of how political risk has been handled so far?
  (Dr Count) I think we would say on the whole quite well and there has been a smooth transfer from the Non-Fossil Fuel Obligation through to the Renewables Obligation that is going to start in April. However, there is still risk and we know, ultimately, that policies can be changed and that there is always consumer pressure. If an asset is producing power above a market rate there is always pressure to squeeze the equity holder.

Sue Doughty

  130. Moving on to the Renewables Obligation, one of the problems we have is electricity from an intermittent source. I think it is quite exciting to hear about opportunities for storage to manage that risk. In terms of this particular risk, are you able to put a value on it in terms of pence per kilowatt hour?
  (Dr Senior) The specific value of uncertain generation or the impact on value of uncertain generation really depends on the extent to which it is a stand-alone scheme. If it is completely stand-alone and there are no offsets and no consolidation with other generators, then it could be around half a pence or more per kilowatt hour. If it is consolidated then we believe that can come down by about 50 per cent.

  131. So there are some clear benefits of consolidation in order to spread the risk?
  (Dr Senior) Yes.
  (Dr Count) Correct. Just on the statistics, the irrefutable fact is that unreliable power sources in a market will be priced lower than a reliable power source because we all value switching the light on and having the light come on.

  132. That was a useful answer because we have seen varying figures and you have explained for us why there is that variation in the values there. On the ROCs the benefit tends to come, we believe, to the suppliers rather than directly to the people generating. We touched on this problem before, but in terms of this particular context, looking at the position of the small renewable generators, if the suppliers can avoid passing back the full value of what they are getting to the generator, does that place the generator at further risk?
  (Dr Count) We would not agree that the suppliers take the benefit. We think that is a fair share. I would make a number of points. The first thing is the suppliers will have obligations to buy this premium-priced power. In my judgment I do not believe all of that will be passed through to the consumer because I think a vast majority of that will be competed away in supply competition. So, in our view, we will not see price increases at the domestic end; we will see price competition continuing to develop, and that is an extra cost. The second issue is that if you do not give that back to the suppliers, what incentive has the supplier got to take the renewables certificates? They will just buy out. There is no real incentive and we want to see things happen. If you go to the production end, the producer does have the renewables certificates and that certificate could be worth more than three pence in a tradeable market if there is a shortage of production because the suppliers will be incentivised not to buy out because they get this "green smear" back, so ultimately I think the producer is getting a fair return threepence per kilowatt hour over and above market price and the supplier is incentivised to take that. The benefit they get through the smear is only partially offsetting, in my view, the cost they will have to absorb, and supply competition will keep prices down. So I believe the balance is right.

  133. Looking at investment in the Obligation and financial institutions and the sort of returns they are looking to see, obviously we all want to see more investment in renewables and we need the financial institutions to really play a strong part in this. How confident are you about the financial institutions seeing this as a sound investment, and something they want to get into? What is your view about that?
  (Dr Count) I think it comes down to a fair return for the risks taken by the investor. Clearly markets are global. One could argue even sitting in a pan-European market or a United Kingdom market that we are certainly in the financial world in a global market and ultimately companies and investors and financiers have the option of investing either in the United Kingdom or in another country. Ultimately if the returns are better elsewhere, capital and equity will flow that way. If returns here are below what is sensible on the world stage, then the capital will flow elsewhere.

  134. Which is worrying because looking at your analysis you are very much involved with wind energy but also a lot of the other low carbon energies and high capital risks and so on. How do we go forward with some of those other technologies then? Obviously we do not want to be totally reliant on wind, we want to bring on other technologies too.
  (Dr Count) I suppose my response there is that there is a time for technologies to come into the market. If at today's level there is a range of technologies that can provide the consumer with the best solution, then we should use those technologies and develop them. If over time we want to increase the value of carbon reduction or the technologies themselves get developed by the developers to bring them into the market, then their time will come. There is an argument why do you have to bring all technologies to the market in one go? I think I come back to the storage. We have not asked the market to produce any incentives to invest some tens of millions in our storage technology. The global plant suppliers in gas turbines have brought their technologies to market and ultimately there is a place for that. I would simply question do we have to have every technology competing at one time if some of those technologies are further away from development? I think there is an old saying that a technology brought to market too early costs people a lot of people.

Mr Barker

  135. Do you feel you are getting the right amount of support from universities and academic research in this area? I am struck by the huge amount of money that is pouring into this area in North America, sucking in international PhDs, etcetera, across a whole spectrum of renewable sources. It seems to be here that we are not putting that investment in. Is that correct?
  (Dr Count) You are on one of my second loves. I think we under-utilise our research institutions. On the Regenesys technology we do have a lot of relationships with the universities, but I think there is a whole difference of culture between the United States and the MIT model being the classic model, and the United Kingdom model. I think that is a very wide issue. We would like to see much more working together. We are almost saying that it is more important to get a commercial technology to market rather than some learned academic paper that is giving the intellectual capital away to somebody else. On the wider point, no; on the specific point of Regenesys we have initiated a lot of university contact.

  136. On the wider point, do you feel that the relationship between power producers and universities is satisfactory?
  (Dr Count) No, I think it could improve considerably. I do not think it is power producers, I think it is just industry at large.

  137. Is that a cultural thing or a financial?
  (Dr Count) I think it is a cultural thing. There are many issues but I think culture is an important thing. We have got to take away the culture that doing a learned research exercise is more valuable at that level than working for business or working with business, where there is still the belief that independence is somehow lost, and I think that is a culture we have got to get over. I would only make the point that half our research position on Regenesys now is in the United States because that is a better environment for top-level electro-chemical research.

Sue Doughty

  138. That is quite an interesting point because I was quite concerned that while you are involving in some technologies fairly heavily, to a certain extent government is almost picking winners. From what you are saying you are looking for a product which is reasonably mature in its development. If there is research still to be done I am getting the feeling that you would like to know it is a bit further on before you start making investment in it.
  (Dr Count) We have taken a technology through but that is a heritage. I would counsel against government picking winners. Create the market incentives and R&D expenditure will go in and technologies will be brought to market because it makes real sense.

  139. With the Renewables Obligation, is it not actually more or less saying here is the winner because it really favours wind above any of the other renewables?
  (Dr Count) I think I would argue that it does favour wind more heavily. I think one could argue from our perspective—and we are neutral in this but I find it very interesting—if the issue is to save carbon then we are incentivising offshore wind and that is almost, in our judgment, round about five to six times more expensive to save a tonne of carbon dioxide than co- generation which is not receiving any real incentive package. What has happened is that nobody is investing in co-generation and people are investing in wind. I do not mind what the objective is but we would much prefer to see a value of carbon put into the market to stimulate research and technology, and to allow the most competitive technology to come through. If biomass is not competitive then we should not worry about that if another technology is more competitive. Ultimately biomass may become more competitive in a few years' time when people have invested in it.


 
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