Select Committee on Trade and Industry Minutes of Evidence

Memorandum by The Department of Trade and Industry and The Department for Environment, Food and Rural Affairs


  1.1  The DTI and DEFRA welcome the Trade and Industry Committee's decision to conduct an inquiry into security of energy supply and the balance between security objectives, environmental commitments and social goals. Although forecasts of the leading international bodies do not suggest that the world faces a shortage of conventional fuels for the next 20 to 30 years, it is important that the UK is ready to respond to changing energy availability and technologies and has in place mechanisms to ensure that UK energy demands are met. This in turn has to be balanced by the need for a sustainable approach to energy that reflects the environmental, social and economic impacts of both its supply and use. Achieving these objectives will demand that all key stakeholders are engaged and that the general public understand the potentially significant role they have to play, for example in efficient energy use, The Committee's inquiry will be helpful in increasing the prominence of energy security issues and stimulating public debate.

  1.2  This memorandum provides information on the Government's policies on security of energy supplies and sustainable energy issues. Following a general introduction it moves on to address the particular issues identified by the Trade and Industry Committee, namely:

    —  Given the imminent dependence of the UK on energy imports, how can the UK maintain a secure energy supply? What mix of fuels would maximise security?

    —  Is there a conflict between achieving security of supply and environmental policy? What is the role of renewables, and Combined Heat and Power schemes?

    —  What scope is there for further energy conservation?

    —  What impact would any changes have on industrial competitiveness and on efforts to tackle fuel poverty?

    —  Is any change of Government policy necessary? How could/should Government influence commercial decisions in order to achieve a secure and diverse supply of energy?

Roles and Responsibilities

  1.3  Responsibility for energy security under the law is shared by the Secretary of State for Trade and Industry and Ofgem. The Secretary of State is responsible for setting the overall regulatory framework for the supply of gas and electricity. A key part of that framework is set out in the Electricity Act 1989 and the Gas Act 1986 as amended, for example, by the Utilities Act 2000. These provide that:

    "In carrying out their function the Secretary of State and Ofgem shall have regard to the need to secure that all reasonable demands in Great Britain for electricity and (so far as it is economical to do so) for gas are met."

  1.4  Under the legislation, on a strict legal interpretation, the duties of the Secretary of State and Ofgem relating to security of supply apply only to the extent that they exercise particular functions. The main functions relate to licensing. The Secretary of State lays down Standard Licence Conditions which apply to all classes of licensees. Power to modify these rests with Ofgems with reference to the Competition Commission if a company and Ofgem cannot agree. The Secretary of State has a power to veto agreed modifications and reference of disputed modifications to the Competition Commission. Enforcement of licence conditions is for Ofgem.

  1.5  The two chief mechanisms for influencing the activities of gas and electricity companies are by way of standards of performance (now "Energy Efficiency Commitment" from April 2002) or by schemes for incentivising behaviour. Standards of performance are often included in Standard Licence Conditions. Schemes for incentivising behaviour are generally implemented by modifying licence conditions or by amending relevant industry codes, which have to be agreed with Ofgem. Ofgem therefore exercises key powers and in practice has the main expertise.

  1.6  The Secretary of State for Trade and Industry has statutory responsibility for regulation of the exploration for, and production of, oil and gas both offshore and onshore including the authorisation of pipeline construction and settlement of disputes about access to pipelines. She also has general responsibility for gas regulation and for strategic international issues including European policy and hence for security of supply issues falling within these areas. There are also provisions under HSE's Gas Safety (Management) Regulations 1996 and under the Electricity Supply Regulations 1988 which provide for maintaining security of supply.

  1.7  Within the DTI, development of policy on security of energy supply is co-ordinated by the Energy Policy Directorate, part of the Department of Trade and Industry's Energy Group. In addressing security of supply issues and in developing policy approaches the Directorate draws on:

    —  Policy development in other parts of the DTI's Energy Group including those responsible for policy on oil and gas, coal, nuclear energy, renewable energy, social and environmental energy issues, and competition

    —  Policy development within the DTI and with FCO and Cabinet Office on European and international energy security issues

    —  close relationships with leading firms at all points in the energy industry; and

    —  advice from experts such as the DTI's Energy Advisory Panel which includes representatives from industry, academics, environmental groups, Ofgem and other Government Departments including DEFRA.

  1.8  In addition, the DTI has recently established a joint DTI/Ofgem Working Group on Security of Supply. The Group's aim is to monitor security of supply issues and assess any risks to supplies in the future. Its remit is:

    —  to assess the available data relevant to security of supply, to identify the gaps in that data and develop appropriate indicators;

    —  to monitor at a strategic level, over a timescale of at least seven years ahead;

    (a)  the availability of supplies of gas;

    (b)  the availability of supplies of electricity and fuels used for electricity generation;

    (c)  the adequacy of generating capacity; and

    (d)  the adequacy of the UK's gas and electricity infrastructure;

    —  to assess whether appropriate market-based mechanisms are bringing forward timely investment to address any weaknesses in the supply chain that are anticipated;

    —  to identify relevant policy issues and consider implications; and

    —  to report twice yearly to the Secretary of State and the Gas and Electricity Market Authority.

  1.9  The Secretary of State for Environment, Food and Rural Affairs has responsibility for policy on sustainable development, climate change and environmental protection, as well as energy efficiency, including combined heat and power and fuel poverty. DTI and DEFRA work very closely together on issues relating to the environmental and social impacts of energy supply and demand, especially on energy conservation, renewable energy, CHP and fuel poverty.

  1.10  Future policy development will be informed by the findings and recommendations of the Performance and Innovation Unit (PIU)'s current review of energy policy. The review will seek to identify the longer-term strategic objectives of energy policy for the UK. It will examine all aspects of energy policy, including how the UK can meet the challenge of climate change in the longer term and how it can ensure reliable and competitive energy supplies for the next generation. The review is considering the role of coal, gas, oil, nuclear and renewables in our future energy balance as well as Combined Heat and Power and the enhancement of energy efficiency. We understand that the PIU aim to complete their work by the end of the year and that decisions on the timing and publication of a project report will be taken then. We understand that the Committee has seen the submissions to the PIU from both DTI and DEFRA. Other submissions to the review team from the Energy Advisory Panel and the DTI have included:

    —  DTI Energy Advisory Panel—Defining a Framework for Coherence in UK energy.

    —  DTI Energy Advisory Panel—Response to the Report of the Royal Commission on Environmental Pollution—"Energy: The Changing Climate".

    —  DTI Energy Advisory Panel—Security of Supply: Unresolved Issues.

    —  DTI Impact of Energy Policy on UK Power Generation Equipment Industry.

  1.11  All of these documents are available on the PIU website at: Key themes relevant to security of supply, picked up in the DTI's main submission to the review include:

    —  Fuel mix and diversity.

    —  The implications of liberalisation.

    —  Coal.

    —  Investment, market signals and the balance of generation, and

    —  Regulator and Departmental roles and responsibilities.

  The paper also examines issues around energy supply and demand and prices, the environment, social concerns and nuclear power.

  1.12  DEFRA has been contributing to the work of the Inter-Departmental Analysts Group (IAG) and hence to the work of the PIU Energy Policy Review, on the issue of the scope in the UK economy for energy intensity reductions, and the corresponding costs, under five scenarios out to 2050. Six papers were prepared which describe the results of this work, and which enhance wider understanding of why the potential contribution of energy efficiency to achieving longer terms policy goals is so significant. The papers are:

    —  Energy Efficiency: DEFRA Introduction and Projections Methodology.

    —  Energy Efficiency: DEFRA paper on Low Carbon Options for the Domestic Sector.

    —  Energy Efficiency: DEFRA paper on Scope for Demand Side Measures in Industry.

    —  Energy Efficiency: DEFRA paper on Energy Projections for the Service Sector.

    —  Energy Efficiency: DEFRA paper on Transport Energy Efficiency.

    —  Energy Efficiency: DEFRA paper on Additional Savings and Associated Costs.

  These papers have been provided to the PIU to place on their website (see paragraph 1.11) but DEFRA would be happy to provide them directly to the Committee if more convenient.

Short term security issues

  1.13  The focus of this memorandum is, principally, security of energy supply in the longer term. However, the current security situation inevitably raises more immediate concerns, about the ability of the system to withstand more immediate shocks, for example caused by terrorist attacks. As the Prime Minister said in his statement to the House on 4 October, Government has ensured, insofar as is possible, that every reasonable measure of internal security is being undertaken. DTI and the companies that provide the UK's power and energy supplies are working closely with the Security Services to ensure that the risk of terrorist attack is properly assessed and that appropriate measures are in place to reduce the risk of disruption.

  1.14  The following pages deal with the specific questions raised by the Committee.


Given the imminent dependence of the UK on energy imports, how can the UK maintain a secure energy supply? What mix of fuels would maximise security?

  2.1  Energy security is best seen as a set of linked risks of interruption to supply. These include strategic risks, principally to fuel supplies, and system risk, mainly applying to the investment needed to produce/generate and transport energy to consumers. Over the past decade or so, the threat to security of supply has been perceived as relatively low, but events in the last two years—such as oil price spikes, the oil depot blockade, the California crisis, the expectation of future large-scale gas imports, and terrorism in the USA—have made security a more prominent issue again.

  2.2  The Government seeks to maintain a secure energy supply by

    —  Promoting properly functioning and competitive energy markets.

    —  Ensuring that the regulatory regime delivers appropriate investment in the domestic infrastructure.

    —  Maximising energy production from the North Sea.

    —  Encouraging renewable forms of energy.

    —  Promoting and rewarding energy efficiency.

  These issues are dealt with in turn in the rest of this section.

(i)  Properly functioning and competitive energy markets


  2.3  The Government believes that open and competitive markets are the best foundation for energy security in the long term. Actions taken by the Government with Ofgem to promote open and competitive markets in the UK include:

    —  Further liberalisation of the utilities by separating them into competitive and monopoly businesses and unbundling the monopolies to bring real competition into the market place.

    —  The introduction of New Electricity Trading Arrangements (NETA) in March 2001. The new arrangements have brought about significant changes in the operation of the electricity market in England and Wales. In developing the arrangements a key aim was to provide a strong incentive for generators to maintain some spare capacity and to make existing generating plant available if capacity is short. They also provide strong incentives for large business users to reduce their demand in these circumstances and for suppliers to forecast demand accurately. (However, the impact of NETA on smaller generators, including renewables and CHP, was and continues to be of concern. Ofgem have published a report on the impact of NETA on smaller generators and DTI intend to publish a consultation document to address their findings.)

    —  The introduction of new licensing schemes for gas and electricity companies and the separation of electricity supply from distribution, which came into effect on 1 October 2001. These will make energy markets work better and will enable Ofgem to take forward market development, providing a greater transparency and underpinning competition.

    —  A new set of electricity licence exemptions, covering generation, distribution and supply to make it easier for smaller companies to compete in the market.


  2.4  In addition the Government has been pressing for action at the European level to drive forward market liberalisation and integration within the EU. At the Lisbon Summit in March 2000, the UK pressed for and secured European Council commitment to EU gas and electricity market liberalisation. In response to the Lisbon mandate, the Commission has adopted proposals for legislation at EU level. If agreed, these proposals will lead to a substantially higher level of liberalisation by 2005. This will be important for ensuring that we have access to diverse gas supplies at competitive prices. At present, a competitive continental gas market does not exist and gas prices remain contractually linked to the price of oil. A free standing gas price would do much to send the right investment signals to gas producers. Moreover, large and restrictive long-term contracts dominate continental gas markets and new entrants have found difficulties in accessing the gas network. Although some element of long-term contracting will continue to be needed to facilitate investment, we need to eliminate anti-competitive provisions, such as restrictions on re-sale and to ensure access to the network in equal terms. The development of longer-term futures markets is also crucial for investment finance in an open market.

  2.5  Gas markets are also at the heart of current concerns about strategic energy security. There is a range of linked issues about gas imports, ranging from worries about depletion of world reserves, through political concerns about large potential suppliers such as Russia and Algeria, to market power and cartelisation concerns, and to issues of the adequacy and security of interconnectors and domestic transmission capacity. On the other hand, gas trade has grown rapidly and successfully over several years and several other European countries are already heavily import-dependent.

  2.6  Companies will look to the UK Government to facilitate trade with potential suppliers. To this end the Government works bilaterally, through the EU and through other international fora, to create a sound climate for secure long-term energy supplies. Bilaterally, the government maintains political relations and facilitates commercial contacts with producer countries through ad hoc ministerial visits and regular meetings at official level. The Government contributes to policy development at EU level through, for example, the current discussions on the Commission's Green Paper on Security of Energy Supply and through initiatives such as the EU/Russia Energy Dialogue. Internationally, the Government works with other EU partners in the Energy Charter Treaty which aims to facilitate investment, trade and transit in the energy sectors of Russia and other central and eastern European counties. It also participates in the work of the International Energy Agency which has responsibility for emergency measures to address oil supply disruptions.

(ii)  Delivering appropriate investment in the domestic infrastructure

  2.7  Security goes wider than availability of sources alone. Even with abundant supplies, supply could be interrupted due to failures in the infrastructure needed to produce/generate and transport energy to consumers.


  2.8  Generation: at the present time there is more than adequate generation capacity in Great Britain to satisfy reasonable demands for electricity. On the basis of the Seven Year Forecast made by the National Grid Company (NGC), generation capacity margins are predicted to remain in excess of 25 per cent over the period to 2007-08. This forecast takes into account closure dates for BNFL's Magnox plants over this period as well as other closures. A margin in excess of 20 per cent is usually considered to be healthy. Following the introduction of the New Electricity Trading Arrangements (NETA) there are no longer any security standards relating to generating capacity. NETA, however, provides incentives for short notice demand and supply flexibility including incentives for generators to maintain space capacity and to make this capacity available if supply is tight.

  2.9  Transmission and Distribution: at the moment planning standards provide the benchmark of network security. The standards aim to maintain the supply security of the general customer base at an agreed level. The robustness of the transmission network is reported on by the National Grid Company in its Seven-Year Statement, published as part of its licence conditions. This document details circuit capacity, forecasts power flows and loading conditions. This document details circuit capacity, forecasts power flows and loading on each part of the transmission system and fault levels for each of the transmission nodes etc. Distribution network operators (DNOs) are required as part of their licence obligations to meet network security standards. Failure to do so could ultimately lead to the rescinding of their licence. They must also issue forward-looking five year outlooks for investment in their system.

  2.10  As the DTI's response to the PIU set out, Standard Licence Conditions require distribution and transmission companies to plan and develop their infrastructure to meet certain minimum standards. There are also guaranteed standards of service for individual customers, and overall standards for all customers applicable to distribution companies which are determined by Ofgem. Ofgem will soon be consulting on new transmission access and pricing arrangements in order to ensure that the value of transmission access is effectively signalled.


  2.11  No formal security standards apply to wholesale suppliers of gas into the National Transmission System (NTS), but under Transco's Network Code they are liable to out-of-balance charges if they flow less gas into the system than the off-takes by their customers. Gas shippers source their supplies chiefly from UKCS (UK Continental Shelf) production but, if supplies are tight, will also rely on the UK-Belgium interconnector and Norway. The DTI has general responsibility for continuity of off shore supplies and specific regulatory responsibility for third party access to upstream pipelines and interconnectors. Stocks of processed gas have an important role to play in maintaining security of supply and these fall within Ofgem's responsibility.

  2.12  The Standard Licence Conditions for Gas Transporters require licensees to plan and develop their pipeline infrastructure systems to meet certain minimum standards. The introduction of the New Gas Trading Arrangements in October 1999 provides for the auctioning of short-term entry capacity into the NTS and financial incentives on Transco to maximise available capacity and minimise the costs of managing entry capacity constraints. Ofgem has been developing proposals for long-term signals and incentives for Transco to invest and provide an efficient level of transmission capacity on the NTS. The framework proposed by Ofgem provides for the use of longer term auctions of entry capacity rights and provides Transco with incentives to respond to the price signals emerging from these auctions and from the secondary trading of capacity in determining an efficient level of investment. This framework is outlined in more detail in the next two paragraphs.

  2.13  Ofgem attaches considerable importance to ensuring that the regulatory regime produces the right signals to secure investment to maintain and develop the UK's domestic infrastructure into the future. In this respect Ofgem has recently published final proposals for Transco's price control for 2002-07 that include new quality of service targets and output measures.

    —  Under the price control, Transco receives funding to cover efficient operating and capital expenditure to provide an agreed level of capacity (the baseline outputs). Output measures will be set for NTS entry capacity, system storage (linepack) and exit capacity. In addition, working alongside the Transco price control, Ofgem has also recently proposed a new package of short and longer-term incentives for Transco in its role as NTS system operator.

    —  Under Ofgem's long-term investment incentive scheme. Transco, as system operator, will be required to offer for sale at least the baseline entry capacity output measures via an auction of tradable entry capacity rights. Prices emerging from these auctions will improve the signals to Transco for the need for new capacity and hence additional investment.

    —  Transco will be provided with financial incentives to undertake incremental investment to the level of market demand, and to diverge from the output measures where it is efficient to do so. If Transco chooses not to invest physically to meet the entry capacity output measures, it will retain the associated price control funding but, potentially, be exposed to higher costs through the increased need to buy-back capacity rights.

    —  Further the signals emerging from the primary auction and the secondary market will enable Transco to invest above the level of the output measures, when it is efficient to do so. Under its incentives Transco will be able to earn additional revenue through its sales of incremental capacity.

    —  Transco will also be provided with incentives to manage the day to day costs of buying back capacity rights from market participants that it has initially sold but is unable to physically deliver on the day (eg as a result of system maintenance, demand conditions, or a lack of physical capacity).

    —  In terms of NTS exit capacity, Transco will be provided with incentives to trade off the relative costs of investment in pipeline (and compression), interruption and local storage in deciding how best to manage capacity constraints at exit.

  2.14  Ofgem has also proposed a package of incentive schemes that address both system balancing (eg the use of operating margins) and residual gas balancing. Ofgem believes that its proposals will deliver enhanced security of supply, lower system operator costs which are passed through to customers and, potentially, improved competition.

(iii)  Maximising energy production from the North Sea

  2.15  Clearly, the more the UK can exploit its own resources, the less it will depend on others. PILOT is the forum for co-operation between the Government and the oil and gas industry and is pursuing a programme of work aimed at securing improvements in the international competitiveness of the UK industry and continued exploration and development activity on the UKCS.

  2.16  Work is currently focused on three initiatives:

    —  Progressing Partnership Workgroup (PPWG).

    —  Exploration Workgroup.

    —  Brownfields Workgroup.

  2.17  In March 2001, PILOT established PPWG to address commercial and behavioural barriers to UK Continental Shelf (UKCS) development. Two groups, Contractors and Operators, working in parallel, aim to make progress towards changing behaviours in terms of commercial practices and relationships between operators and contractors throughout the supply chain. They key issues to be addressed are:

    —  Improving commercial effectiveness through a new Code of Practice on Supply Chain Partnership.

    —  Increasing the take-up of new technology by operators.

    —  Promoting the UK as a regional hub for supply chain activities.

    —  A more active exchange of licences.

    —  Easier access for new entrants and smaller companies.

    —  Transfer of decommissioning liabilities.

    —  Standardisation of Agreements.

  2.18  The Exploration Workgroup's main objective is ensuring timely and efficient exploration. The main areas to be considered are:

    —  Potentail of the UKCS as an exploration province.

    —  Recent and potential activity levels.

    —  Efficiency of current processes and areas for improvement.

    —  Effectiveness of recent changes to licensing and regulatory regime.

    —  Ways of making the UKCS a more attractive province for exploration.

    —  Changes effected in other mature areas to stimulate exploration.

  2.19  The Brownfields Workgroup's objective is to identify and delivery the action needed to deliver the estimated additional recoverable 3.5 billion barrels of oil equivalent within Brownfields (ie fields which have reached a plateau but which are still in production). Three workshops will focus on the different levers necessary to improve the industry's overall performance in accessing the Brownfields.

(iv)  Encouraging renewable forms of energy

  2.20  The Government has been supporting development of renewable sources of energy since the mid 1970s. Renewables were included in the Non Fossil Fuel Obligation (NNFO) in 1990. Under NFFO, electricity from renewables was provided with a guaranteed market at premium prices, subsidised by a levy on electricity consumers. A supporting programme ran alongside the NFFO to stimulate the development of renewable technologies including wind, solar and hydro.

  2.21  Renewable sources and electricity from waste currently contribute 2.8 per cent of our energy requirements. The Government has now set a target of securing 10 per cent of UK electricity supplies from renewable sources, excluding non-biodegradeable waste, by 2010, provided that the costs to consumers are acceptable. Measures to support this target are discussed in more detail in section 3.

(v)  Promoting and rewarding energy efficiency

  2.22  In general, price mechanisms have the potential to deliver very significant enhancements to the flexibility and security of the energy supply system through their impact on demand. Prices which are higher at times of peak demand, for example, very cold periods, could encourage industrial customers to change their patterns of energy use.

  2.23  The Government sees an important and increasing role for demand side management through energy efficiency measures and embedded generation. Energy efficiency has increased substantially in recent years. Since 1970, the UK economy has grown by more than 90 per cent but energy consumption by only 10 per cent. To some extent this has reflected decline in the energy intensive industries such as steel but it also reflects real gains in the efficiency with which we use energy. There is however, substantial scope to make further cost effective improvements in energy efficiency across the UK economy.

  2.24  The Government has announced a range of policies to promote energy efficiency and reduce emissions, in the domestic, public and business sectors:

    —  DEFRA has consulted on the Energy Efficiency Commitment (EEC) for 2002 to 2005. It will place an obligation on gas and electricity suppliers to make energy efficiency improvements, through measures provided to domestic consumers. It is currently expected to save 0.4 mega tonnes of carbon (MTC) per year by 2005.

    —  The new Home Energy Efficiency Scheme (HEES), a radical reshaping of the former scheme, is designed to tackle fuel poverty among those most vulnerable to cold-related ill health. The scheme provides grants for comprehensive packages of insulation and heating improvements, including central heating systems. Access to the scheme is through receipt of a qualifying income or disability related benefit. By 2004, HEES is expected to have assisted some 800,000 householders.

    —  The Market Transformation Programme produces, reviews and helps to deliver integrated, strategic action plans to ensure products, systems and services use less energy, water and other resources. MTP supports cost-effective UK and EU policy measures including energy labelling, minimum energy efficiency performance standards and procurement. Whilst the programme can demonstrate substantial improvements in energy efficiency, actual savings may be offset by the projected strong growth in consumer demand for new services, for example, air conditioning and digital television services.

    —  DEFRA's £50 million Community Energy programme will, from April 2002, promote community heating through capital grants to install new community heating schemes and refurbish obsolete infrastructure and equipment. It is expected to reduce CO2 emissions by half million tonnes per annum by 2010 and reduce energy costs for around 100,000 households, taking the majority out of fuel poverty.

    —  The Climate Change Levy came into force in April 2001 and is payable on energy use in the business and public sectors. The levy is expected to reduce carbon emissions by 2MTC per annum by 2010. In addition, 43 sectoral Climate Change Agreements with energy intensive sectors that are required to meet individual challenging efficiency targets in return for an 80 per cent discount from the levy is expected to reduce emissions by a further 2.5 MTC per annum by 2010.

    —  Emissions trading could play a key role in the longer-term solution to reduce greenhouse gas emissions. A national Emissions Trading Scheme is to commence from April 2002.

    —  The Carbon Trust, an independent not for profit company, will recycle about £100 million of climate change levy receipts over three years to accelerate the take up of cost effective, low carbon technologies and other measures by business and other levy payers.

    —  New Building Regulations to come into effect from April 2002 will include much higher energy efficiency standards for new buildings and those undergoing refurbishments.


  2.25  It is not possible to identify a specific mix of fuels in energy supply that would maximise security. This is for two basic reasons. First, energy security has a number of components. It encourages strategic risk attached to the possibility that fuels might be physically unavailable from exporting countries, or available only at high prices. It encompasses system risks attached to the ability of energy networks and infrastructure to deliver to customers (which may relate to factors such as the capacity of the network, the impact of bad weather or industrial action). A particular fixed mix of fuels in unlikely to be best placed to cope with each of these different aspects of security. Whilst greater indigenous supplies, for example, may help to lessen strategic risk, they are no guarantee of security in response to system risks.

  2.26  Second, the most appropriate mix of fuels will change over time, in response to perceptions of security risks and to wider market conditions. Whilst recognising there are significant roles for Government in this regard, open and competitive markets are the best foundation for security in the long term. Although the Government has set a target of 10 per cent of electricity to be from renewable sources, it would be counter to the belief in the role of markets for the Government directly to specify a particular fuel mix. However, in line with the Government's overarching objective of sustainable development, a fuel mix that encourages security of supply while at the same time minimising the environmental impacts of the production and use of those fuels, is clearly preferable to one which ignores environmental considerations.

  2.27  Having said this, diversity of energy supply will as a general principle contribute to our energy security. This can, of course, include diverse sources for a single energy source as well as a balance of different energy sources. At the moment UK electricity supply is divided between gas, coal, nuclear and (to a much smaller extent) renewables but we expect an increased proportion of gas in the future. The robustness and flexibility of the UK's gas infrastructure and the diversity and security of gas suppliers will be particularly important in the medium and long term.

  2.28  So far as coal is concerned, coal has the potential to make a huge contribution to security of supply bearing in mind our own industry and the availability of coal from diverse and secure sources on international markets. However, its main disadvantage is the high emission levels arising from power generation. Cleaner coal technology is the key to reconciling coal and challenging environmental targets particularly on emissions. In this context the DTI has launched a review of the case for government support for the development of commercial scale cleaner coal technology demonstration plant. The review is being undertaken in parallel with, and will feed into the PIU's review of energy policy. It will report to Ministers about the turn of the year.

  2.29  Nuclear Energy—a proven technology, generating on a large scale and with almost zero carbon emissions—also provides energy diversity and security benefits as well as contributing to the achievement of UK and international carbon emissions targets. Nuclear power currently provides about 25 per cent of UK electricity generation. DTI energy projections (EP68) estimate that by 2010 this will have declined to about 17-18 per cent of generation and by 2020 to about 7-8 per cent in the absence of any new build. Whereas fossil fuel generation is fuel intensive, nuclear generation requires minimal quantities or uranium. This is in abundant supply: the European Commission Security of Supply Green Paper recognises 40 years known reserves of uranium at current prices and the NEA estimates reserves at some 250 years at current consumption rates. Unlike some fossil fuels, import dependence is mitigated by large numbers of world-wide supplying countries generally in stable areas of the world including Australia, Canada, Russia, South Africa and the USA. Output from nuclear stations currently avoids about 12-24 million tonnes carbon (MtC) pa (depending on the generation mix displaced). The PIU Review is currently considering the balance of fuel mixes required to meet the UK's future energy needs including the role of nuclear energy.

  2.30  The costs of managing radioactive waste and decommissioning of plants once they reach the end of their life-cycle are potentially very large. The Government published in September 2001 a consultation paper, "Managing Radioactive Waste Safely" which seeks views on the management of radioactive waste over the long term and ways of ensuring public confidence in the decisions to be taken. Discharges of radioactive waste, both to the air and to water also need to be managed safely. The Government consulted last year on proposals to reduce radioactive discharges to the marine environment over the next 20 years, and also about proposed guidance to the Environment Agency about the setting of radioactive discharge limits. Final versions of both documents will be published early in 2002.

Is there a Conflict between Achieving Security of Supply and Environmental Policy? What is the Role for Renewables and Combined Heat and Power Schemes?

  3.1  The Government has placed the environment at the heart of policy making and is committed to combining environmental sustainability with economic and social progress. Prudent use of resources, including energy, is a key part of the UK's sustainable development strategy. The Government sees no necessary conflict between achieving security of supply and environmental policy indeed, the Government sees important positive interactions. For example, policies to promote the development of renewable fuel sources will not only contribute to the diversity of our energy supplies, they will also contribute to the achievement of carbon reduction targets. Similarly, policies aimed at promoting efficiency use of energy not only help to bring down total carbon emissions, they will also help to meet social policies such as fuel poverty.

  3.2  The Government is fully committed to moving the UK down a more sustainable energy path, including the major potential that energy efficiency offers to save carbon cost-effectively and ensure security of supply—the less we use the less we need to produce or import and the less environmental impact. Energy efficiency is a very sustainable approach contributing not only to security of supply but also to the Government's social and environmental objectives—can help to reduce fuel poverty and makes a key contribution to the achievement of climate change objectives. We believe that renewables also have to play a much bigger role in supplying our energy needs. Our future must be one in which we have a significantly lower carbon economy and both renewables and energy efficiency will be major vehicles for delivering this.

  3.3  It has been explained above how the impacts of the specific environmental impacts of carbon emissions from energy generation and use is lessened. National, regional and local planning policy must fully assess the wider social and environmental impacts of new energy generation developments. Environmental Impact Assessments usually cover biological, conservational, existing landscape, human social and economic effects of new developments.


  3.4  The recent report of the Royal Commission on Environmental Pollution (RCEP), "Energy—The Changing Climate", confirmed that renewables will play a key role in future greenhouse gas abatement and that increasing the uptake of renewables has to be a non-negotiable element of future energy use. The Government has put in place a range of measures to achieve that target and promote the uptake of renewables of which the Renewables Obligation is the key policy instrument. This will succeed the Non-Fossil Fuel Obligation (NFFO) and require licensed electricity suppliers to secure an increasing proportion of their sales from renewable energy sources. Our target is that by 2010, 10 per cent of electricity sales by licensed suppliers will come from sources eligible for the Renewables Obligation. A statutory consultation on the detail of the Obligation closed on 12 October 2001 and the Department is currently considering the responses received with a view to laying an Order before the House before the end of the year, subject to State Aid approval. The Obligation would then come into effect early in 2002 and last until at least 2027. The PIU energy review is also assessing the feasibility of 20 per cent and 30 per cent targets by 2020.

  3.5  The Obligation is one of a series of measures the Government is taking to promote renewable energy, which is set to make an increasingly important contribution to the provision of secure, diverse, competitive and sustainable energy supplies. Other policy strands, aimed at creating a £1 billion market for renewable energy by 2010.

    —  Exemption of renewables from the Climate Change Levy.

    —  Putting in place legislation to protect contracts concluded under the Non Fossil Fuel Obligation (NFFO) arrangements and amending legislation to provide flexibility in the location of NFFO projects, enabling more projects to go ahead than had previously been possible. The industry has estimated that this new flexibility could free up perhaps 100 renewable energy projects.

    —  A supporting programme, with funding of more than £260 million over three years including:

        —  £39 million from the Climate Change Levy Fund for offshore wind.

    —  £50 million from the National Lottery New Opportunities Fund, of which at least £33 million will go to the development of energy crops/biomass power generation; £10 million to offshore wind and £3 million to small scale biomass heating.

    —  £100 million to be allocated in the light of the PIU's recommendations. The Prime Minister has indicated that this new money will help to promote solar photovoltaics, boost offshore wind, kick start energy crops and bring on stream other new generation technologies;

    —  £29 million (over six years) from DEFRA for their Energy Crops Scheme, part of the England Rural Development Programme.

    —  £10 million from the DTI for PV roofs.

    —  £55 million over the next three years for DTI's new and renewable energy research and development programme which will cover a range of renewable technologies and resources.

    —  Development of a proactive strategic approach to renewables planning in the regions and the introduction of renewables targets.

    —  Capital grants for early demonstration offshore wind and energy crops projects.


  3.6  A key technology for the promotion of energy efficiency is CHP—the simultaneous generation of usable heat and electricity in a single process. The Government has a target of at least 10,000 MWE of Good Quality CHP capacity by 2010 and DEFRA are leading the development of a Governmental CHP strategy to be issued for consultation in the coming months. However, we recognise that over the past year the relative prices of gas and electricity and the impact of NETA have made CHP less commercially attractive. The CHP Strategy will set out a range of measures to support the industry in meeting the target and the Government is considering which measures for CHP could be brought into effect as a matter of urgency.

  3.7  Existing support measures include:

    —  Climate Change Levy (CCL) exemption for Good Quality CHP electricity used on site or sold directly to other users.

    —  Recognition of CHP as one of the key options available for energy intensive industries to use in making negotiated agreements to secure an 80 per cent reduction in the Climate Change Levy.

    —  Enhanced Capital Allowances, which are worth £70 million (dependent on take up) this financial year, offering tax incentives to companies investing in energy saving technologies, including Good Quality CHP.

    —  Exemption from business rates of electricity generating plant and machinery in CHP schemes.

    —  The Community Energy programme (referred to in detail above).


  3.8  Some of these options are already commercially viable (CHP, offshore wind, landfill gas, biomass, hydro and waste generation). Others, for example energy crops PVs, tidal and wave power) remain in development stages but have the potential to make an important and increasing contribution to delivering diverse energy supplies.

  3.9  The intermittency of some renewables generation, such as wind and wave energy, does raise security issues in relation to the ability of the network to maintain supply and manage volatility in output. However, the National Grid has said, in an initial paper input to the PIU review, that it has no concerns in respect of being able to continue to balance the electricity system securely at the levels of intermittent renewables envisaged in the current targets for 2010. Most analysts suggest that the current UK grid system could accommodate around 20 per cent of electricity from intermittent sources before technical and managerial changes are required. Further work and analysis to consider the implications of rising intermittency would be useful, and is underway.

  3.10  We expect embedded generation (including renewables and CHP) to play an increasingly important part in the future of the UK energy industry, particularly in the form of micro generation. For example several companies are in the process of developing micro CHP units that could be used in a domestic environment and we expect that, once commercialised fully, these could transform domestic energy supply, energy security and efficiency while also producing real carbon savings in the years up to 2010 and beyond.

  3.11  A joint DTI/Ofgem Co-ordination Group will take forward the recommendations of the Embedded Generation Working Group earlier in 2001 aimed at helping embedded generators link to local distribution networks.

  3.12  The Embedded Generation Working Group made a number of recommendations concerning distribution company incentives, connection charging arrangements, provision of information and other issues that they considered necessary to achieve a level playing field and generally create an environment which facilitates the development of embedded generation. The creation of the Co-ordination Group was announced in July. It will be chaired jointly by DTI and Ofgem and consist of senior industry representatives to monitor implementation of the EGWG's recommendations. Measures to be addressed include:

    —  The way that embedded generators, connected to electricity distribution networks, can contribute to overall power needs.

    —  How they are charged for using the network, and

    —  How to make connection information from key local operators more transparent.

What Scope is there for Further Energy Conservation?

  4.1  The scope for further cost effective energy efficiency improvements is expected to continue. Improvements occur continuously as older equipment is replaced by newer models. However, for a variety of reasons most businesses do not make additional cost-effective investment in more efficient equipment. This is one of the main reasons why there remains a considerable potential for cost-effective energy efficiency. Analysis by DEFRA for the PIU Energy Review has shown that under normal circumstances this potential is likely to remain around a constant fraction of current consumption. In the UK this is about 20 per cent—higher in the domestic sector, lower in energy, intensive industry (where energy costs are more important).

  4.2  One challenge for energy and environmental policy is how to increase the "normal" rate of energy efficiency improvement—the Climate Change Programme is Government's response to that. Another challenge is how to ensure that the potential is "replenished" at a correspondingly higher rate, so that there is always a steady stream of higher-efficiency equipment available. DEFRA's analysis for PIU has also looked at this and suggests that normal market mechanisms might help achieve this. For example, if more energy efficiency equipment is sold the sector becomes more attractive for investors and innovators, so new companies are formed, new products developed and so on. More R&D will be required and this may possibly need some support from Government.

  4.3  Energy efficiency is contributing substantially to the Carbon abatement targets in the Climate Change programme—over 10 MtC can be attributed to energy efficiency outside the transport sector.

What Impact would any Changes have on Industrial Competitive and on Efforts to Tackle Fuel Poverty?


  5.1  A number of analyses have been conducted of energy costs across industry. In general these indicate that energy comprises a relatively small proportion of overall costs. Thus:

    —  analysis reported in Lord Marshall's report on economic instruments and the business use of energy<mr13>, indicates that over industry as a whole, non-transport energy costs amounted to around 1.4 per cent of the value of gross output;

    —  analysis reported in a joint HM Treasury/DTI memorandum to the TISC Enquiry into the impact of motor fuel taxation, indicated that expenditure on road fuels amounted to around 1.3 per cent of the value of output in the productive industries.

  5.2  Clearly, there is some variation across industrial sectors. Certain manufacturing sectors tend to be relatively energy-intensive. Some of these sectors are also relatively heavily traded. So in a few sectors the impact of changes in energy costs may be rather more significant. But in general, the impact of energy price changes on industrial competitiveness is likely to be fairly small.

  5.3  The implications will, however, be different depending on whether they are driven by:

    —  rising costs of securing energy supplies reflecting rising energy prices on international markets. In this case, there would be implications for energy consumers more generally, and the impact on the UK's relative position could be limited. Measures pursued internationally would also lessen competitiveness concerns; or

    —  rising costs reflecting a premium placed on security by the UK alone. Competitiveness implications could be rather greater in this case, depending on the scale and nature of the measures taken. Market-based measures or instruments focusing on improving the uptake of energy efficiency opportunities, for example, may increase security at nil or low cost.


  5.4  The Government published in February this year its draft UK Fuel Poverty Strategy for consultation. A final Strategy will be published in November. While the Government's overall goal is to seek an end to fuel poverty in the UK, its first target is to ensure that those householders most vulnerable to cold-related ill-health (that is those aged 60 or more will by 2010 be removed from fuel poverty (defined as needing to spend—but not necessarily spending—10 per cent or more of income to maintain an adequate standard of heat). Households who are less vulnerable—essentially healthy adult unemployed—will be helped once progress has been made on the priority group.

<mo13> "Economic instruments and the business of energy". A Report by Lord Marshall November 1998.

  5.5  The principal causes of fuel poverty are low income and energy-inefficient housing, although the level of fuel prices is also important and, in some cases, under-occupation (single people living in homes larger than they need) can play a part. The final Strategy document will set out the main Government policies to address these issues, together with the major concerns raised in the consultations exercise. Improving the energy efficiency of housing forms a major element of the response to fuel poverty: these programmes are for DEFRA in England and for the Devolved Administrations elsewhere.

  5.6  It is not likely that measures to promote supply security with respect to generation mix or energy efficiency would undermine the objectives of the fuel poverty strategy—indeed, improving energy efficiency in the domestic sector will have security of supply benefits and is fundamental to the Government's fuel poverty strategy. However, insofar as work to improve supply security might involve additional costs, and if these were to feed through to higher consumer prices, then this could have an impact on the fuel poor. In addition DEFRA and DTI are currently undertaking a pilot programme to evaluate the potential role for alternative approaches to tackling fuel poverty in difficult to heat properties without access to the gas network. The pilot will test renewable and micro-CHP technologies in households and communities.

  5.7  Detailed figures about the numbers in fuel poverty will be published in the Strategy document: but it is estimated that there has been a significant decrease since 1996, and that over half of this reduction is due to lower energy prices. Higher prices would tend to increase the number of households falling within the definition of "fuel poor"; and such policy sensitivities will be explored in the Strategy document.

  5.8  The Strategy document is not intended as the final word in this area: it is not credible, at the beginning of nearly a decade's work to tackle fuel poverty, to pretend to know all the answers already; and the detail of the strategy will develop in the light of experience. The Government is pledged to report annually on progress, and to review programmes in the light of experience: the effect of energy price changes, whether arising from supply security considerations or for some other reason, will be one of the factors to be taken into account in the review process.


Is any Change of Government Policy Necessary? How could/should Government Influence Commercial Decisions in Order to Achieve a Secure and Diverse Supply of Energy?

Is any Change of Government Policy Necessary?

  6.1  The current review of energy policy being undertaken by the PIU aims to consider a range of future policy challenges including security and diversity of energy supply, environmental impacts and social implications such as energy prices. The PIU's report will act as a key input to the Government's future policy on security and diversity of energy supply and on climate change, including consideration of the necessity for policy change. It would not be appropriate to predict the PIU's conclusions at this stage.

  6.2  The DTI's submission to the PIU explained that a degree of reliance on imported gas, in common with the rest of Europe, seems inevitable and is not necessarily a matter of concern. Nevertheless it is prudent to consider policies which enable the UK to maintain diversity and flexibility in our energy supply. Broadly, the Government has pursued the liberalisation of energy markets and believes that competitive markets provide the best foundation for delivering diversity and flexibility and thus security of supply. However, there are many complex issues—for example concerning the international framework and the availability of supplies, the flexibility and reliability of the domestic network to draw energy from different sources, and market investment incentives—where Government, working with the Regulator and industry, has an important role to play. The PIU review of energy policy will provide direction and help to steer future policy development in these areas.

How could/should Government influence commercial decisions in order to achieve a secure and diverse supply of energy?

  6.2  As explained above the Government—and the Regulator—believe that the best way of influencing commercial decisions is by promoting competitive markets and ensuring effective regulation, within an overall framework of sustainable development, that is encompassing social and environmental as well as economic objectives. Competition provides the incentives for suppliers, and creates the markets that reveal the price signals that help consumers, suppliers and producers alike to see when supplies are relatively plentiful or tight. To the extent that Government intervenes, it must avoid blunting these signals and damaging security. For example if prices are kept low then customers will not cut back demand when supplies are tight and suppliers and producers will not have the incentive to enter the market and make appropriate investments. Flexible and open market structures stand the best chance of ensuring the right mix of fuels, the right investment in generation plant and transmission infrastructure, the right balance of indigenous supplies versus imports, and so forth, to achieve security of supply in the future.

  6.3  In the case of the natural monopolies (Transco, the National Grid Company), the two Scottish transmission companies and the electricity distribution network operators), traditional regulation has concentrated on lowering costs through a revenue cap, without defining the outputs of the business. Ofgem recognises the need to ensure that there are incentives for timely and adequate investment in the networks, against demand which is unpredictable. Its recent proposals in respect of Transco, designed to improve the signals of the need for investment and to improve the incentives to invest, are outlined in paragraph 2.13 above. In the regulated sector generally, incentives flow from the system of standards and special licence conditions backed by penalties, and standards of performance which trigger compensation payments to customers.

  6.4  Finally, this memorandum has noted the range of Government policies in support of renewable energy, energy efficiency and CHP, which contribute to security and diversity of supply. The new Renewables Obligation is noteworthy in that it will not, unlike the previous NFFO arrangements, involve the Government in supporting specific renewable technologies but will leave the choice of renewable technology to market participants.


31 October 2001

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