Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 700-719)

STEVE HOLLIDAY, CHARLES DAVIES AND JEFF SCOTT

TUESDAY 4 DECEMBER 2001

Mr Hoyle

  700. If there were gas—and there is a question mark over peak times and ensuring supply of gas to power stations—yes, they may have the ability to meet the need if they can generate it, but it is whether the gas will be there to produce the electricity. Are you not worried about that?
  (Mr Davies) I would look at that from the point of view of price in the sense that, unless one is talking about sudden interruptions in gas supplies, if gas supplies are short, the economics of gas generation will change and it will not be the preferred fuel to meet the needs of the power stations being built.

  701. Or we see bills increase at peak times.
  (Mr Davies) Yes, that is the common phenomenon.

Sir Robert Smith

  702. In that answer you mentioned oil in the range of fuels. Where is oil at the moment in terms of electricity generation?
  (Mr Holliday) In terms of its percentage of the total?

  703. Yes.
  (Mr Holliday) Pretty small. There are some oil-fired stations producing as we sit here today.
  (Mr Scott) It is about four per cent.

  704. Is there a potential to grow that?
  (Mr Holliday) It is a function of economics. If you put oil prices, electricity prices, the difference in technology, in power station design and then all the environmental constraints on oil versus coal versus gas, all in the mixing pot, the simple answer is that you can create scenarios in which oil stations could be built. It has not been happening for many, many years.
  (Mr Davies) About 3,000MW of oil plant is in mothballs at the present time, primarily on the Thames estuary. In addition to building new oil plant, the economics could be there to bring those plants out of mothballs.

  705. When you are looking at the seven-year plans and looking at the network investment, you have suggested that there should be other methods of getting investment into the network which should be encouraged. Do you believe that the market is unable to provide the signals for suitable investment in the transmission improvement?
  (Mr Holliday) We have been investing very heavily. We have invested £3 billion in the past decade, £360-odd million in the last year, in excess of £300 million in the course of this year. Our regulatory review period will invest something of the order of £1.3 billion in a five-year time frame. Investment is going in. The question is more about the incentivisation to continue to invest at that sort of level. There are two issues there. One is this continued question of RPI-X. We agree, as well, that has delivered a huge amount of cost efficiency in our industry over a decade or so. There is an issue of how you continue to incentivise organisations to keep driving down their cost base. Some new form needs to be created to ensure that. The capital investment is as much an issue of cost of capital and one of the things that the regulatory environment in this country has continued to do in review after review is drive down the allowable cost of capital. Considerable work has been carried out looking at when you begin to hit a margin. The Civil Aviation Authority in particular did a huge piece of work looking at the efficiency and the social benefit of driving down another increment on the cost of capital versus the cost of under-investing in networks going forward. There is an ongoing debate with regulator and government about where the limit of cost of capital is to ensure that companies still have the investment incentive which is required in major infrastructure.

  706. How are you finding that debate going in terms of the regulator?
  (Mr Holliday) Very constructive.

  707. What is the scope for reducing transmission related losses? This is something which keeps coming up.
  (Mr Holliday) The transmission system, the high voltage bit, is responsible for about two per cent of losses; two per cent of the power which is transferred around is lost across the transmission system. There is nine per cent lost in total in getting from a generator through to an end consumer, the rest being associated with the distribution wires part of the business.
  (Mr Davies) If you look at the two per cent which is lost on the transmission system, about one quarter of that is due to transformer losses, losses on conductors when going from one voltage to another and just energising the lines. About three quarters of it is down to the distance travelled, the fact that we have large power flows on the system from the north of the country to the south of the country. The issue then comes down to what can be done about those two components. In the case of transmission losses and losses on the lines, we optimise our investment in terms of looking at transformers which can be designed for higher losses or lower losses. What we do is to optimise them against the expected energy price as against the incremental capital cost, so we are looking at an economic efficiency element. When it comes to distance over which electricity is transported, the main impetus we put into this is our structure of charges and particularly the locational elements; a generator in the north, just to take an extreme example, compared with a generator in the south west of England. Let us take a 1,000MW generator which is a fairly typical size of generator on our system. The generator in the north will pay £17 million a year more in transmission charges than the generator in the south west. That is a big incentive. I have taken the extremes of the system but if you take the South Coast or the Thames estuary as against the North Midlands or Humberside or something like that, there are smaller differentials but they are quite significant. So we give large incentives for the location of generation which impacts both on losses and on the investment cost in our system.

  708. Presumably a low loss transformer costs more than a high loss.
  (Mr Davies) Indeed; yes. What we are required to do and what we do do is to look at the trade-off between the energy cost of that and the incremental investment cost.

  709. Looking back in history over electricity transmission, has there been much movement on losses, or is it really physics?
  (Mr Davies) It has come down a bit. In terms of transmission losses it has come down from a figure a few years ago of 2.3 to 2.4 per cent and the precise figures now are about 1.8 or 1.9 per cent. So there is a trend downwards and partly that is a movement towards lower generation and improved investment.
  (Mr Holliday) Technology and replacement with cables and conductors which have better characteristics. It is small increments.

Mrs Lawrence

  710. Renewable generators complain about the cost of connecting to the infrastructure. Can you give an outline of what connection involves and where the costs arise?
  (Mr Holliday) We do play our part in helping everyone connect to the transmission system who requires to connect. The issue on renewables is the size of their generation capacity. You normally find that it is not economic to connect anything less than 300MW to the high voltage transmission system. By definition they tend to find the economics are driving them to connect more locally into the distribution system.

  711. I can think of one particular example which was a photovoltaic system just up the road in my constituency and they had tremendous difficulty in getting onto the system. What are you doing to alleviate that problem?
  (Mr Holliday) That is a very good example of what I have just been describing. Perhaps Charles can just enlarge on what a generator of that size would do to try to connect into a distribution system.
  (Mr Davies) A typical size for a photovoltaic system would be something of the order of 4 or 5KW or that sort of size. Clearly it is not going to connect to the transmission system, it is going to connect to the distribution system. There are several issues associated with both technical standards and connection charging principles which the distribution network operators are considering and which are being looked at by the Embedded Generation Working Group. What I am really saying—I am sorry it may sound slightly lame—is that it is an issue for the distribution network operator not for us. What I can say is that when you have large renewable developments above the 300MW level, and potentially the Severn barrage might be one of those, or, large offshore wind farms, particularly if you take two or three of them together and bring them ashore, could easily get up over 300MW. Our approach to charging is very different from that of the distribution network companies. Our approach is what is called the `shallow' approach where we only charge the immediate connection charge to the generator concerned and the deeper investments in the system are recovered through this locational tariff I was talking about a minute ago. In the case of the distribution network operator, they tend to charge on a `deep' basis, in other words all reinforcement costs through their system. This is an issue which is at the forefront of the agenda of the Embedded Generation Working Group, in which I am actively involved and which had its first meeting last week, are to look at those principles, to see how they ought to be changed, to put it bluntly.

  712. Do you have a view on the submarine cable which was announced a couple of weeks ago in terms of the effectiveness of bringing renewables onto the infrastructure?
  (Mr Holliday) We do not know a great deal about that. We have been in conversation with a number of companies who bid for the original 18 offshore licences which were leased by the Crown Estates, talking about how we can help them facilitate a tie-in to the transmission system, help them understand what the hurdles would be in terms of economics and size. At this stage we are not in conversation with anyone associated with the Western Isles, so it is hard to answer anything without doing a desktop exercise first of all. We look forward to seeing that in the very near future.

Chairman

  713. One of the concerns we had about this was that it was put to us that if you are putting cables over inhospitable rock surfaces, they have a tendency to shred. We just wondered whether there was perhaps a degree of optimism about certain aspects of this. I am not asking you—well I am—to sell your soul here, but you are obviously experienced, you have been looking at the Netherlands and connecting —
  (Mr Holliday) And we are building one in Australia as well, so yes, we do have some experience. The reason why I am going to avoid the question is that I do not know the route and we do not understand the geology of the sea floor. In our planned link between England and Norway we found that as the cable actually went in through a fiord there was a huge amount of volcanic rock which was going to cause it tremendous problems so the route was planned to avoid that completely. If there is geology in this area then you can get around it, but the question is going to be what the exact route is, what it looks like, what is the extra distance required, etcetera. Without knowing all the details we cannot make a comment.

  Chairman: We asked the Minister and he was surprised that anyone should ask a question about this. We are still awaiting his answer. In our search for truth we came to you, but we shall wait with interest.

Mr Lansley

  714. You referred in your memorandum to the issues surrounding balancing the supply and demand, plant and demand balance. In effect, if I paraphrase, you could see how problems might arise under the new electricity trading arrangements as compared to the old pool arrangements but they had not yet arisen. Tell me if I got that wrong. If problems did arise, would you see them being able to be managed with the new electricity trading arrangements or by some change in the structure of those?
  (Mr Holliday) Do you have a problem in mind?

  715. If for example the surplus, the margin of plant over current demand fell below whatever you would regard as an acceptable level, 20 per cent or something. If it fell below that level would you see the responses coming in terms of perhaps facing purchase requirements inside the electricity trading arrangements?
  (Mr Holliday) I shall let Jeff describe some of the details of what is happening here at the moment. I have to say NETA has been hugely successful for us. It was a tremendous change for an industry to switch on a whole new way of working at midnight one night and find the suppliers and generators and National Grid and distribution companies, everyone, just continued seamlessly. It has been putting some very strong commercial signals into the market. Those commercial signals are benefiting consumers and I know Ofgem will talk about a 20 per cent reduction in power prices since the introduction but nonetheless it is working very, very well. Our daily experiences are causing us as National Grid to take some commercial decisions to find the cheapest way which benefits consumers ultimately in balancing the energy balance in the system. That has created some new marketplaces where previously there were people who supplied certain services in fast response. As that has had a price in the market, more people are coming in to provide that service which lowers the price ultimately. Jeff, do you want to talk about the issue here of demand and margin?
  (Mr Scott) From our perspective in terms of operating the system and the transfer from the pool to NETA, NETA is working very well and certainly in line with the expectations from those involved in the group putting together the new market rules. The expectation was that a large proportion of energy would be forward contracted, that we would be dealing with a relatively small proportion in the balancing mechanism which is the residual mechanism we used to balance the residual supply and demand. Current percentages are about 95 per cent being traded forward of the total energy in the market; we are dealing with less than five per cent in the balancing mechanism. That has been fairly consistent since NETA was introduced, which suggests to us that fundamental design is working from an operational perspective. In terms of the margin, as far as connected capacity is concerned, we are currently in the fortunate position that we have a connected capacity margin of about 30 per cent above demand. On the day, I and my colleagues in the system operator, deal with the pack of cards we are given in terms of matching supply and demand. With that sort of connected capacity margin, one would not expect a problem in terms of matching supply and demand on the day; certainly there are no signs that NETA is not bringing forward capacity into the balancing mechanism through the forward trading markets and with a good range of bids and offers .

  716. May I just make sure I understand that? Would I be right in deducing that the large proportion you described, which is being contracted forward, gives you some degree of assurance and a continuing check on the extent to which you are able to retain that margin against over-demand?
  (Mr Scott) It gives us comfort that we are able on a day-to-day basis to achieve the residual balance between supply and demand. In terms of looking further ahead, we have the Seven-Year Statement which we prepare, which constantly looks at the forecast demand position going forward and looks at the available generation both already connected to the system and in the pipeline, looking for connection to the system. The key question, when you have a margin of 30 per cent or so as we have at the moment in terms of connected capacity, is the extent to which people might start to withdraw generation from that portfolio. The market drivers there are associated with whether the price is right in the market for generation to continue to make itself available. Indications so far are that it is making itself available.

  717. The implication of your evidence to us has been that the nature of the new trading arrangements is likely to make people question generating capacity that they hold, but which they cannot sell. So by extension they will be continuously looking to reduce their own surplus margins of capacity.
  (Mr Scott) We have seen no evidence of substantial decommissioning of plant or applications for closure.
  (Mr Holliday) That is true. You have a marketplace now in which a supplier and a generator do not want to be involved in the balancing market. They want to trade bilaterally. Therefore there should be a balance in the market. If I need to go and buy some electricity to supply, I do not want to leave it until the last minute marketplace to do that because potentially I get penalised for doing that. I form a longer-term relationship with a generator. Our role is the balance of the margin because things will always move around and demand is lower or higher than expected and a generator breaks down, etcetera. Under the old world there used to be a capacity payment for people to sit and just have the generation available to them. There could be some costs in going forward which we shall have to pay, which will then be shared out amongst the participants thereafter to make sure that the surplus capacity which we require as a safety margin is available. At the moment that margin is provided by the way people are operating their plants.
  (Mr Davies) There is a bit in our submission to you which says that the margin is quite comfortable at the present time: the question is whether the market will continue to deliver that reserve margin looking five or six years out. For the reasons that Jeff particularly has explained, that margin will not disappear because of closures. There is the issue of demand growth and closures particularly of the nuclear stations which is a slightly different matter from closures of coal-fired plant or whatever, or even gas-fired plant over that period. What we just referred to briefly there was that this margin needs to be kept under review and we indeed will keep it under review in the Seven-Year Statement and will draw it to the attention of Ofgem and the DTI if we do see issues arising. They might need to look at the capacity margin system and capacity payments at that time, but there is no need to do so now.

  718. A couple of points in relation to what you had to say about real time balancing as well. In effect it seemed to be a very straightforward explanation of the factors involved, but the conclusion is that experience to date says this can be managed. Of course underlying that sentence is an expression of risk which you constantly have to be looking for. Where would you say, amongst those various factors, the greatest risks lie? Where are you conscious that if at present you do not anticipate those risks upsetting your ability to achieve real time balance nevertheless you have to watch them most carefully?
  (Mr Scott) The risks we identified there or the issues we take into account in balancing are in some sense intuitive issues. I do not expect that you read through the list and thought there was anything untoward in that list. What gives me the most sleepless nights is the question you are asking in a sense. I guess there are two factors. One is that we need to have sufficient generation capability with firm fuel supplies. If you take gas, which is relatively topical in that context because of the increase of gas on the system, then we have about 30 per cent of total plant gas fired, of that about one quarter is on interruptible contracts, so three quarters of it is on a firm supply. Of the 25 per cent of gas which is on interruptible contracts about two thirds has a back-up capability. If you look at gas, which is the growing area of "concern" because of the potential interactions between the two markets, then only about two to three per cent of the total connected capacity is at risk of complete loss from the system due to commercial interruption. That gives me a fair amount of comfort that I can rely on the new gas-fired generation which is on the system. The other issue is the flexibility of the plant on the system. If all of the plants on the system were nuclear, 100 per cent, then I would have a problem in managing the flexibility and variation between supply and demand, but we do have a very good plant mix on the system as we described earlier. There is a wide range of flexible plant and we do not see any great difficulty in managing the system in terms of flexibility going forward.

  719. Nor indeed in relation to the presently anticipated changes in intermittent supply from renewables.
  (Mr Scott) No. In some sense all generation sources to a greater or lesser extent have the capability to be intermittent. Generators can fall off and do with reasonable regularity. That can occur at any time and we have to deal with that. We provide a range of balancing services or we contract for a range of balancing services and those balancing services provide us with the ability to deal with variations in generation on the demand side.


 
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