Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 360-374)

MR DAVID BYERS, MR DAVID WILLIAMS AND MR DAVID MILBORROW

TUESDAY 20 NOVEMBER 2001

Linda Perham

  360. The major barriers to the development of renewables: you mentioned planning, the other piece is NETA. I think you said in your submission that you want to tackle the root cause of the problem to modify NETA. On November 1 the DTI did publish its response to Ofgem's assessment of the impact of NETA on small generators in the first two months of operation. Did you see anything in that response that would help your members?
  (Mr Byers) We are replying to this consultation by the 1 December, we will send you a copy of it. The fundamental problems of NETA were recognised, its dual imbalance price mechanism, basically insurance in case you cannot produce what you say you are going to produce on a rolling three and a half hour basis. We are trying to balance the whole of the network locally now rather than in aggregate. The costs of holding that insurance are very severe for small generators. What has happened is that where you are exposed to NETA small generators have effectively agreed to a major discount for somebody else to take the risk, the supplier company, or they are extracting that value for the risk of accepting NETA. We believe, and I make two positive suggestions, that this can be addressed. We would, for instance, in the first case like a single cash out price rather than a dual one. If this is rejected we cannot see a difficulty in actually exempting small sites from the imbalance risk. What Ofgem wrote was that there was a major reduction in CHP and renewable generators' income and output. They underestimated it quite significantly. From the survey we conducted among members it is minus 40 per cent, it is minus 40 per cent on revenue, and about 14 to 17 per cent on output. It may get better as NETA beds-in but we do not forecast it making much of an improvement on those figures. If it is not addressed we have on the one hand a trading system which is in place and under trial, completely at odds with government policy on promoting renewable energy. There are fixes to make.

  Linda Perham: Thank you.

Richard Burden

  361. I understand the concerns about NETA and the way it operates, I just want to get a sense of how fundamental those concerns are about the structure of NETA as a whole where there are fixes. You, I suppose, put bluntly if you have a system that minimises very short term balance and minimises the need for balancing demand and supply that should be actually one that maximises benefit to consumers. Does your wish for a fix say that actually your way of looking at it is wrong anyway or it is not wrong?
  (Mr Byers) My point is that it is not completely cost reflective because it is being applied locally and it is disproportionally punative to small generators who cannot afford the cost of all of the forecasting and all of the involvement that NETA might require to manage that risk. Basically their revenues are being eaten up by suppliers discounts for taking that risk. I would really dispute that the system we have currently got is optimal, there is probably five gigawatts of pending reserve spinning, waiting to cover situations just in case you gained an imbalance. This is not good for the environment, it is inefficient. Before NETA we had about one gigawatt, now we run five gigawatts just in case.
  (Mr Milborrow) One gigawatt or less, before NETA, Mr Chairman. The fundamental problem with NETA is the way that it affects renewables is that NETA disaggregates supply and demand. We have an integrated electricity system for very good reasons, and that integrated electricity smooths out the perturbations in both supply and demand. NETA takes you down the road of mini national grids almost, as David just said, each with their own standby plant to balance out when supply does not match demand. Statistically, or any other way you look at it, this is not an efficient mechanism. A couple of respected power magazines have drawn attention to the figures that David quoted, that we are now wasting energy because of the surplus power that is kept on standby for the individual suppliers. Of course as far as the intermittent renewables are concerned all this is lethal, as you have already heard.

Dr Kumar

  362. I think you partially answered my question. I will ask it just in case you wanted to add to what you said, what changes to the operating rules would you like to see to encourage consolidation so that small companies can participate in the market alongside the major producers?
  (Mr Byers) I think Ofgem drew attention to the fact that consolidation has not arisen as had been expected. We actually think that it is only a partial fix, I think even if we were aggregating across the entire renewable capacity there would still be a discount to pay for participating or accepting some of the risk under NETA.
  (Mr Milborrow) I have been in dialogue on this very topic with the Performance and Innovation Unit and I have done some modelling, which I must accept personal responsibility for, even if you aggregated wind over the whole of the country you would still get a significant penalty in the order of three to five pounds per megawatt hour. That sort of penalty is going to distort the market, because it is the sort of difference between gas at the new prices and gas at the old prices which, as I am sure you are aware, has led to the suspension of contracts for 8,000 megawatts of gas plants in the last few months.
  (Mr Byers) NETA values flexibility too highly. I think we are pretty sure that the National Grid can cope with intermittent supplies of up to about 20 per cent of the total amount.

Sir Robert Smith

  363. Is there a converse argument in terms of energy efficiency: transmission lines use energy and a lot of renewable sites tend to be far away from the potential consumers. Is there an argument that therefore you are going to have more energy losses that way and instead of having a little mini grid whilst it is wasting money in standby it is saving in terms of transmission losses?
  (Mr Milborrow) Yes, I think I understand you. Renewable plants are no different from the large thermal power stations. You need to be selective where you put them. It is no good, as I think we heard earlier from the Minister, putting them at the end of a long line in the remotest corners of the Kingdom. They need to be reasonably close to demand centres. You have much more flexibility for renewables, because, roughly speaking, planning considerations apart, they can go pretty well anywhere. I may not be fully understanding your question.

  364. A lot of the wind and the waves tend to be in the northwest of the country and along the northeast. From the point of view of energy efficiency you are going to have transmission losses from these sites.
  (Mr Williams) I am not sure that is correct. With most renewables one of the big advantage is you are putting the generator closer to the load centres. The only way you will still see those losses is if you maintain the central infrastructure as well, what you would have then is large transmission lines not doing a lot. As the system evolves to a more locally based generation distributed network I would say that losses would have to go down. You can think of offshore wind, and the large transmission distances there, but renewables also covers biomass and waste produced products which are inherently within towns at brownfield sites and biomass is certainly fairly close to the population centres as well.

  365. In terms of renewables, of course, if you are losing energy from renewable sources obviously you are not affecting the carbon uptake. Can you see a way of juggling this, the long distance renewables supply may lose a lot of energy on its way, but it will not contribute to the normal —
  (Mr Milborrow) That is a fair point, Mr Chairman, but if you look at the map published by the Crown Estates, where the first batch of offshore wind sites are, they are well distributed round the country. The wind speeds offshore off the south coast are lower admittedly than they are off the western isles but that difference is not such as to necessarily kill the viability of the project. I used to work for CEGB and the CEGB, as you may know, wanted to put a coal fired plant on the south coast because it would reduce the north to south flows. So, yes, there has to be a balance, but there normally will be an economic balance and that economic balance is fixed partly by the transmission charges which the National Grid sets and partly by the distribution connection charges which have already been discussed earlier this morning.

  Chairman: Thank you.

Linda Perham

  366. You do say in your submission, you make the point that renewable energy is indigenous with implications for the security of supply, is that really the most important thing, because lots of contributors to this Inquiry have lauded the effect of the market, saying that the market which generally sort things out does not regulate things too much. Is it really necessary to hone in on the indigenous supply? Do we really have a problem with that, because security and diversity is something that we want to have a balance of fuel mixes, do we not?
  (Mr Byers) I do not think we are qualified to advise the government on what ideal fuel mix should exist. Undoubtedly it is beneficial if you do not have to import the fuel if there are security risks. The fuel source is actually usually next to a renewable generator, otherwise you do not put the generator there. It is difficult to disrupt the fuel supply unless say the wind stops. I would say that is to the benefit of security of supply; the diversity of distribution and lack of vulnerability to terrorism and the fact that there are not many people who are able to stop the fuel arriving.
  (Mr Williams) In the case of biomass, the benefit is not just indigenous fuel supplies. You are putting a lot of money into the rural economy and the one thing that is going to suffer under the new Renewables Obligation is biomass projects, that is fairly well acknowledged. In the six pence electricity price, three pence goes to the rural economy and in the fuel purchase agreement set up last year the Ely Project spends £5 million a year, which it pays mostly to farmers or rural haulage contractors. That is a huge resource and the farmers of the United Kingdom have been complaining for some years that farming is in big decline, but half of the United Kingdom capacity could come from British farming. Probably the largest land based resource we have is biomass, and that is pretty much being ignored at the moment. Yes, offshore wind will be another very big resource.

  367. I have just got something else I wanted to ask you about which was in the submission by DEFRA and the DTI where they end by saying "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 technologies to market participants." Is that something that you support?
  (Mr Williams) It was a very interesting question you asked about the Treasury this morning. I think you are probably capable of finding this out, but I am told that this started with a Treasury decision that NFFO was a tax because it was specific to technology. It went beyond that and said to the DTI "you will produce something that is not technology specific so it cannot be perceived as a tax," which brought out a single price instrument. That is like saying to the car industry that all cars will be sold at Mondeo prices. You will get a lot of Minis and the Rolls Royce manufacturers will be up in arms. Renewables are at different prices but we have a single price. We think that is from a Treasury ruling originally. Having said that, we do not want to change this obligation, we want to work with it, and try and find ways of getting money into those technologies, that will not come off at a single band price.
  (Mr Byers) I think the DTI has done a good job in bringing the RO forward. It is likely to start fisticuffs if you suggest that we have banding again. So we acknowledge that this is a genuine attempt to stimulate renewable energy but, rather as David said, it is de facto picking winners because for example photovoltaics are not going to go very far until costs go down and the intention is to adjust, one could say tweak or twiddle, by applying grants and various award mechanisms to encourage reduction of cost and research. While the RO is welcomed, it does discriminate against more expensive technologies.

Sir Robert Smith

  368. Very quickly on biomass itself, is there anything DEFRA could be doing specifically with its agricultural hat on given the crisis in agriculture to make biomass an option?
  (Mr Williams) I proposed giving two green certificates per kilowatt hour for biomass, one for the renewables content, one for the agricultural benefit, and call the second certificate a "rural development certificate". DEFRA, I believe, are quite keen to have that. The problem that we had of course is that the DTI instantly saw it as something DEFRA could handle and not something they could handle in the renewables obligation, so we saw it go straight out of the window into another department, but a rural development certificate would solve it for biomass. The other problem is of course that if you look at wind and hydro they have free fuel. They are capital intensive technologies so of the 5.5 pence offshore wind price 4.5 pence is probably capital and if you give it a capital grant it makes a significant difference to the electricity price. In a biomass project, in a 6 pence price, 4 pence is operating cost and the last 2 pence is capital. They say to us, "What sort of capital grants would you need if you are to come down a penny?" I am saying 50 per cent. We are probably down tuppence in long-term contracts. We therefore need 100 per cent capital grants because the capital subsidy mechanism does not work.

Mr Lansley

  369. You talked about industrial competitiveness and fuel poverty and, in effect, you appear to be saying the extra costs have to be borne, that is in the nature of other people externalising their costs through climate change, we internalise our costs and they then have to be met within the industry. Likewise, with fuel poverty you say the external costs will be met and the industry seems to have sufficient profit margin to absorb those costs. That seems to be a pretty easy gloss on things. What level of profit do you think the electricity supply industry ought to be generating compared to other industries? What is it generating now and therefore what facts are available to be taken into this purpose?
  (Mr Byers) I will make the first point and then I am going to hand the hard bit to my left. We do acknowledge that renewable support mechanisms eventually get paid for by the consumer, as indeed do some costs attached to security of supply. I think there are examples of renewable energy technologies which are now extremely competitive with nuclear and fossil but to reach the growth targets that are implicit in the policy, and beyond 2010, they will require on-going support. As to the squeeze on the rest of the ESI, Mr Milborrow is going to cover that.
  (Mr Milborrow) Before I do so, Mr Chairman, could I pick up on what the questioner said about external costs because that really is the crucial issue. The external costs of thermal generation sources are not internalised and the whole reason we are here is that we are trying to ameliorate climate change and the deleterious effects of the thermal sources of generation. A very recent European Commission Report has been published and it quantifies the external costs of the thermal sources much more accurately than had hitherto been possible. In rough numbers we are talking about a half a penny to a penny per kilowatt hour for coal, 0.3 pence per kilowatt hour for gas and I cannot remember the number for nuclear. That is the first very important point to make, that we are saving the enormous costs of climate change, the erosion of the stone work in York Minister and damage to Scandinavian pine forests and so on. As far as absorbing the cost, it is just a question of observing somewhat wryly that the early consultation papers from the DTI suggested that the cost of the obligation would be in the range £155 to £355 million, from memory, and they have now escalated to £778 million mainly because, as I think it was David Porter saying here earlier today, they have gone for this buy-out mechanism and the assumption is that the price of all renewable contracts will gravitate towards the 5 pence per kilowatt hour which is implied by the 3 pence buy-out price. To a certain extent this is a downside of the market mechanism. Turning now to the other side of the equation, the ESI, although the Regulator has done all sorts of things to promote competition, he has also promoted increased profits. 12 years ago there was no such thing as a supplier, suppliers were an unknown beast. The fact that the regional electricity companies were forced to separate distribution and supply created another species of animal which naturally wanted its own profit margin. Fair enough, no criticism. We simply observe the total profit in the ESI for the last financial year for which data are available was £3,687 million. Would it not be nice if Ofgem could come up with some creative accounting or a formula even more complex than the distribution price controls to ensure that not all the renewables costs were passed to the consumer?

  370. What sort of rate of return do you look for on your own projects and how does that compare to the rate of return applied that you expect others in the industry to achieve?
  (Mr Milborrow) I am not making any comment about whether these levels of return are acceptable or not, I am merely commenting on the total size and perhaps the fact that some of the regulatory actions may not —

  371.—Total size is meaningless, it is just a very large number but then we have a very large amount of capital?
  (Mr Milborrow) Precisely.

  372. So the number of the profit margin is sure to be large in absolute terms, it is rates of return —
  (Mr Byers) I do not think the rates of return expected from private investment in renewables is substantially smaller than those in fossil fuels. It is largely governed by the banking attitude to it and how much you can gear the investment in the project. I would be surprised from my experience for there to be a substantial difference in expectation.

Mrs Lawrence

  373. On the issue of subsidy you mentioned there about one of your tasks being to counter climate change. Does that effectively mean when you are talking about subsidy that the 17 recommendations in part 2 of your memorandum imply a government hands-on approach as in Denmark? That is one point. The other thing is if there is a question of subsidy in energy production why should it go towards the renewables sector rather than, say, clean coal technology? You lay great store in your evidence about indigenous supply and coal is another large indigenous supply. Why should any government involvement involve your sector rather than clean coal technology? Those are my two points.
  (Mr Byers) We are aiming for a time when convergance, as it is called, allows renewable technology to compete on a completely open playing field. The arguments on carbon saving technologies are pretty well advanced. If the "dirtiest" renewable technology is a zero carbon net generator, there are clear arguments for investing some of consumers' money or government money in supporting sustainability through renewables. I do not think there will be a situation where in the foreseeable future we can remove fossil fuels from our supply chain but the cost-benefit analysis on a lifecycle basis has been demonstrated for renewable energy and we should continue to support the development of the renewables as in all other European countries.

Chairman

  374. You have made the point that you want to see renewables involved through a competitive system. You say that roughly at the end of the day, once the subsidies are removed, it should be competitive but it does involve a degree of government intervention which is not always compatible with concepts of the free play of market forces. You prayed in aid the Danish example which, as I understand it, is very much government-led and even then it has been suggested that the topography of Britain is such that only 20 per cent of our energy supplies could ever be secured from renewables. There is a possible consensus as to the maximum. There are means of getting there but they do seem to involve a degree of government intervention and support which is far greater than we would have expected when we are talking about the free play of market forces.
  (Mr Byers) There are several comments there. There has been support for renewables for some time largely through NFFO contracts which were sustainable and bankable. There is on-going support plus an indication of "kick-starting" the support of more expensive technologies and implementation of novel ideas, research and development, because there are certainly many technologies which are extremely difficult to finance on a commercial basis until they have been developed and prototyped. I would hope that any forward-thinking government would continue to support that either in the infrastructure or the framework for R&D. What is true is that it is obviously pretty visible in the RO what the support is going to be. We do know that subsidies for fossil fuels are not always quite so visible. I must admit 26 years ago I worked in the nuclear industry and I could not find any reference to some of the costs that were then being piled into the CEGB to support nuclear. I think we have got transparency in the current proposals, they are published. To take up the Danish argument, why wind works so well in Denmark is that communities own it. They feel "that is my windmill, it is not Enron's windmill, it is not National Power's windmill, it is my windmill", and I am not quite sure we have the culture or the history or the kind of framework to move from where we currently are in Britain to that model. But from a personal perspective I would not mind a little more of that decentralised public ownership. We are investors, we do seek a return generally on investing and I think the subsidies for the renewable sector are rather marginal, rather small by comparison with the masses of money that goes into other technologies. We are thinking of offering to answer The Guardian's challenge of how would you spend £6 billion in a serious renewable effort because that was a challenge recently to the renewables community. "If nuclear wants £6 billion for 3.6 megawatts, what would you do, sir?" So we are seriously looking at addressing that question.
  (Mr Williams) I would like to add to that as well. It depends whether you look at it holistically. At the moment the fossil generators are not being asked to pay for the cost of environmental damage. At the moment renewables are not being paid for the benefit of being closer to the customer. At the moment the European mechanisms pay farmers to not grow food. That same money could be put into growing energy crops and reducing fuel costs. And then there is the issue of competitiveness. It is not just asking for intervention, it is asking for manipulation of existing mechanisms as well to look at it in a broader sense. The last point I want to make is that we are assuming the barriers are planning and economic but I wanted to stress that one very big barrier as far as we are concerned is Ofgem itself. If you look at every NFFO Order Ofgem's response to each Order is,"God, this is expensive to the customer, please go for a few cheap projects" and in every Order the government has not taken Ofgem's advice and has included more expensive projects. It then rests with Ofgem as arbiter as to whether they come off later. Almost exclusively we find that if there is a grey area of law, Ofgem will determine against projects. As a company we lost 60 megawatts of plant in the last year purely on technical minutiae when those projects had planning consent, the money, the technology and all the contracts in place, they just wanted one clarification from Ofgem and they were killed. To put it in perspective, the Prime Minister made a big thing about supporting around 30 megawatts of biomass from a share of this £100 million announcement. Ofgem has killed double that, as I say, on technical minutiae.
  (Mr Milborrow) To get back to the original issue about subsidies, it is not for us to speak for the DTI but, as I understand their policy, it is to promote industries such that costs will come down. As my colleagues have said, costs fell throughout the period of the NFFO regime. I note with interest that one of the Cabinet Office papers looking ahead to 2020 forecasts that, by that time, onshore wind, for example, will have a price range of 1.5 to 2.5 pence per kilowatt hour and that is cheaper than coal, nuclear, the thermal sources, and even to offshore wind (presently regarded as needing additional subsidy) they assign a price range of 2 to 3 pence per kilowatt hour. Again, we are cheaper than coal and cheaper than nuclear. It is not for us to speak for the DTI but it looks as though, if learning curve price reductions can be achieved, we will be in the happy position that they will be able to stand on their own two feet.

  Chairman: We will leave that for the moment and take up some of the other points with others who are coming this afternoon when we meet at 4.15 for our public session. Thank you for your evidence this morning. If there is anything else we want to pick up on we will get back to you. Thank you very much





 
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