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Energy and Climate Change Committee - Minutes of EvidenceHC 275
Taken before the Energy and Climate Change Committee
on Tuesday 12 June 2012
Mr Tim Yeo (Chair)
Mr Dan Byles
Mr Ian Lavery
Dr Phillip Lee
Mr Albert Owen
Mr Christopher Pincher
Mr John Robertson
Ms Laura Sandys
Sir Robert Smith
Dr Alan Whitehead
Examination of Witnesses
Witnesses: Keith Anderson, Chief Corporate Officer, Scottish Power, Ian Marchant, Chief Executive, SSE, and Sara Vaughan, Director of Strategy & Regulation, E.ON UK, gave evidence.
Q1 Chair: Right, good morning and thank you very much for coming in. You will be well aware there is a lot of interest in this subject. I appreciate it is important to you. It is important to us. We think it is important for the future. Unfortunately, the timetable means this Committee has to conduct its scrutiny in an unprecedentedly short time on a Bill that has some quite complex issues. We are, therefore, focusing on the sections of the Bill that I think are of most concern to you and to us and where I suspect there is also the greatest scope for modification of what is in the draft.
Could I start by asking whether you think the Bill is actually needed or whether we could have got by with just making incremental changes to the existing arrangements? We have a new carbon price floor. We could make some legislative provision for an EPS. Would all that have been enough to deliver the aims of secure, clean and affordable electricity?
Ian Marchant: I think that it would have been, and my views on this have changed. Back in 2006, 2007, which is the genesis of this Bill, we were seeing rising electricity demand and increasing gas shortages; Russia had just cut off the Ukraine; we were seeing very poor performance from the nuclear power stations-they were actually in state ownership back in 2006. If you look now, we have seen four or five years of falling electricity demand, and most forecasts of demand for this year are about a 10GIGAWATTS lower than the forecast for this period six years ago. We have seen a revolution in unconventional gas, particularly in the US, meaning the US is now an exporter rather than an importer of gas. We have seen the old nuclear power stations being significantly turned around, so that life extension is now a credible option. We have seen great moves in technology and enhanced co-firing of biomass, which means that coal will be around for longer. I don’t think we need £110 billion of investment, which is stated in the preamble. I think it is more like £70 billion to £75 billion, and that the existing mechanisms that we have could well deliver that investment. I am not convinced that we need a Bill-I am convinced we don’t need this Bill, but that is maybe for later.
Sara Vaughan: Could I come in with a different view? I do think we need this Bill. I think if you look at the impact of the targets that we, as a country, have signed up to, if you look at the 2020 renewables target, if you look at the challenges under the Climate Change Act in terms of decarbonisation and you look at the impact of those on the system and, in particular, the impact that that greater quantity of intermittent renewables will have on the system and on the energy price, that takes you to a world which is a very different place where intervention is needed.
Looking at what we have in place-the renewables obligation-I don’t believe that you can continue with the renewables obligation against that background, because it operates as a premium on top of the energy price. As the energy price falls under this scenario and when renewables don’t get the opportunity of gaining those peak prices, whenever the peak prices come up because, by definition, the peak prices when the wind is not blowing, not when the wind is blowing, then I think that in that world the risks are far greater for renewables.
If you want to see continued investment in renewables you need a mechanism that goes above and beyond the current one that we have. Also, if you look at the situation in terms of the back-up plant and how you are going to keep that back-up plant on the system, certainly the modelling that we have done showed that you need the capacity mechanism and the certainty around a capacity mechanism to enable back-up plant to have the security to come on to the system.
I think also now you have had that capacity mechanism out there as a possibility, what we are seeing is that people are not investing and I don’t believe that they will now invest until the capacity mechanism is on the system. So, my view is somewhat different.
Keith Anderson: I would agree with Sara. I think it is vital we get this new Bill. I think no matter which way you look at it, where we are in the energy sector in the UK, if we want to see the UK continue to have a good, strong, robust mixed-generation portfolio it will require significant investment over the next decade. I think the existing frameworks that are in place won’t bring forward the size and scale of investment that we require.
I think the existing frameworks won’t bring forward the investment in a mixed generation portfolio that we require as well. So, I think from that point of view the Bill is absolutely vital. What we need to do is to move it forward as quickly as possible, get it implemented as quickly as possible, get the mechanisms bedded down, because that is what will give investors confidence. Right now that is what people need most. We need clarity, transparency and confidence.
I think there’s a fantastic opportunity just now for the UK to go out and grab a huge slice of that investment potential, given the slowdown in other economies and the slowdown in other countries’ generation investment and energy investment. I think right now is the time for the UK to put in place a very clear, good, robust, long-term framework and that investment will flow into this market and the UK should be using that to help regenerate this economy, create jobs and create a generation portfolio that will last us for 30 or 40 years.
Q2 Chair: I am sure we would all like to see that investment coming forward and the UK getting a lion’s share of it. But does the Bill, as it stands in draft, make it more likely now that companies like yours will feel incentivised to invest or would it be better, for example, if there was a bigger emphasis on demand-side reduction in order to get to where we want to be in energy policy goals, or should there be a specific decarbonisation target such as that suggested by the Committee on Climate Change? Would those be helpful additions to the Bill? Really I want to find out if you think this is a Bill that is going to make investment more likely or less likely?
Keith Anderson: There is a lot of work still needed on the detail of the Bill but I think if we get the contracts for difference structured correctly and they give enough long-term certainty to investors, then you will see that investment come forward. I think one of the biggest challenges for the UK and for the Government right now is some of the uncertainty about investing in this sector, partly created by the fact that we don’t have all of the answers around the contracts for difference and the energy market review but also key to that is what is going on just now with the banding review and the RO.
This country used to be seen as a fantastic energy market to invest in because everybody had absolute faith and trust that it was done on an evidence base. We have been through a banding review where there was a massive amount of work done in a consultation process. All evidence-based research that came up with recommendations for future investment through the RO banding and what we have seen now since October is an awful lot of noise being created politically and in the media and speculation about arguments between Government Departments and speculation that there will be political influence and an outcome of that consultation that is not evidence based.
I think that is what damages investor confidence. That damages confidence in looking forward to what comes out of this Energy Bill, because if we start to think that the reviews over the contracts for difference, the reviews over the strike prices won’t be evidence based, that detracts and damages our confidence to invest in this market.
Sara Vaughan: I do think we are seeing some conflicting tensions here as well because what we really want to see is the timetable moving forward and the Government getting on with it. We are already seeing some slippage because we expected the Bill to be introduced in May. It is now going to be introduced probably around the end of this year. Clearly we have got the scrutiny that this Committee is doing but this is going to lead to a delay in the secondary legislation as well and that does cause concerns for us.
We want to get on with it but part of the price of getting on with it is the Bill that we have retains a lot of powers for Ministers. There’s not a lot of detail in what’s on the face of the Bill. A lot of that will appear in secondary legislation and to the extent that we don’t have the Parliamentary scrutiny and things being laid down in primary legislation, then that clearly creates greater uncertainty and greater risk for investments because things can be changed much, much more quickly if it can be done either by a decision of Ministers or in secondary legislation. It is really the horns of the dilemma, trying to get on with something but, at the same time, make sure that there’s enough detail in the Bill to give us confidence around that certainty point.
Ian Marchant: I would make three very simple points. I think that demand is yet again being ignored. There are warm words about demand being put there. There is no detail to that. It is a frightfully difficult area but I just don’t think the attention is being placed on demands as it should be, that is my first point. The second point: the CFD mechanism is investable but at what price? My fear is that consumers will end up paying a higher price because of the complexity and additional cost and risk that has been imposed on the industry through the CFD mechanism.
On the third bit, the capacity, I agree with my two colleagues that the biggest issue at the moment is the uncertainty: effectively, the Government has created a known unknown. They have said there will be a capacity mechanism but not what it will be, and once you’ve gone down that road you’ve got to get it certain quickly so that any investments can be decided, because boards, my board included, will say, "We will wait until we see what that mechanism is." We have created a situation where we now need to get a capacity mechanism in. I believe a good capacity mechanism will be good for investment but it is still early days in that.
Q3 Sir Robert Smith: Can I just ask, just broad brush, where in the world is it more attractive at the moment for an energy utility company to invest than the UK?
Ian Marchant: As I only invest basically in the UK and Ireland, I am not the person to answer that question. I want to make sure that this market is investable.
Keith Anderson: I think the UK remains one of the most attractive markets to invest in. What I would cite to you is, if you take renewables and offshore wind, what’s going on in Germany and France right now: Germany have very, very quickly reintroduced an accelerated tariff that is creating lots of investment interest in the German market right now and a lot of investment into port infrastructure and into manufacturing capacity.
France have just announced the results of their first offshore wind tender and they are driving that whole process incredibly hard through an industrialisation plan and inward investment into France, and that is now moving incredibly quickly. Those markets have got a lot of clarity, a lot of transparency and a lot of investment interest going into them. The thing for the UK is we need to get ourselves in the same position to make sure that investment flows into this country as well.
Sara Vaughan: From an E.ON perspective the UK is one of our key markets for investment, particularly in renewables and, therefore, it is very, very important for us that this framework is put in place in a robust manner and in relation to capacity-we have talked about that-we would equally like to invest in conventional sources of generation but we need to get the capacity mechanism right.
Q4 Dr Lee: This is also a broad-brush question. This is the biggest pile of paper that I have had so far as a member of the Select Committee, and that makes me suspicious. Complexity: I get suspicious, it should be simple, and it isn’t. I look at all these diagrams-it is almost comically complex. Would you prefer it if the Government built their nuclear power stations, built their wind farms and then privatised, and would you invest? Would you find that an easier investment than going through this complex process of trying to hide possibly state aid, subsidy, trying to hide the fact that it is being passed on to the consumer? Who is liable? Is the Treasury liable? Are the producers liable? Would you just prefer it if the Government set a target, "Right, we are going to build X, Y, Z so that we hit our low-carbon targets and then we are going to privatise it and sell it to the industry"? Would you prefer that? Would that be an easier investment decision than trying to wade through this, which is an exercise in job creation it seems, not in actually delivering the goals?
Ian Marchant: It is an exercise in job creation for lawyers.
Dr Lee: Yes, that is my point, yes.
Ian Marchant: And economists rather than engineers.
Dr Lee: Yes, absolutely, I agree.
Ian Marchant: I think the answer to your question is different between wind and nuclear. I think our industry is demonstrating we can invest in wind, be it offshore or onshore. We are doing 500MW, 600MW, 700MW projects now. We are developing Round 3 projects-they can happen. They are much more manageable investment decisions. You are talking about a few hundred million of capital being deployed at a time, and a period of construction of two to three years.
Nuclear is a completely different animal, you are talking billions of pounds of investment and seven to 10 years of development and construction time. The way I would answer your question is definitely not for offshore wind but I think for nuclear an honest, open discussion about whether the country needs it and what is the cheapest way of doing it-as opposed to disguising it through a very complex series of instruments, which then have negative connotations on the rest of the industry-is one we should be having.
Keith Anderson: The answer to your question would be no from me, I wouldn’t prefer that. I still think that delivering these investments, delivering the construction, the development, all of that process through the market is a more effective and efficient way of delivering it for the consumer as well.
Q5 Dr Lee: But it is more expensive for you to borrow the money than the Government, so immediately in all of this is a mark-up for the people who are financing it-they are making money out of it, aren’t they?
Keith Anderson: I think the whole construct of the Bill and the principle behind the Bill and moving to contracts for difference is that they will try and drive down that cost of capital because what you are doing is giving investors greater certainty in terms of being able to sell their output at a loan price and a loan value. I think that whatever you do with the energy sector, if, as a country, we continue to want-and I believe it is the right thing-a mixed generation portfolio, then you need to put mechanisms into the market to deliver that. If you just leave the market totally liberalised without any mechanisms then you will just drive investment to the cheapest form and the quickest form, which would likely be gas generation. Now, in the assumption that the UK still values-and I think it is the right thing-a mixed generation portfolio-gas, coal, nuclear, wind-then you need to have some form of mechanism to direct and incentivise that investment. But I still believe doing that through the market is the most effective, efficient way of delivering-
Q6 Dr Lee: But your point about the cost of capital is absolutely right-the state would have the cheapest cost of capital.
Sara Vaughan: I can’t disagree with the fact that the state would have the cheapest cost of capital but it has to be said that back in 1990 the state decided that the State was no longer going to own the electricity industry and it was going to put it into private ownership. That ship has sailed and against that-
Q7 Dr Lee: I am not suggesting owning it, I am suggesting building it and selling it.
Sara Vaughan: But against that framework the point is to set up a market in which private investors have the confidence to invest. I set out in my first answer the reasons why I believe that this market needed reform. What we are trying to do with this Bill-or what the Government is trying to do with this Bill-is set up a framework in which the cost of capital is lower with a CFD than it would be with the renewables obligation. I know Ian does not agree but that is our view.
It is also our view, as I said earlier, that over time as the market changes, as the electricity price gets lower and as the intermittent renewables are not able to take advantage of any of the higher prices, that that becomes much riskier to invest in renewables as well. So, if you look at investment both in development and construction stage and if you are looking at investment once the station is built and you are looking at the income going forward, to me the CFD is a better mechanism than continuing under the renewables obligation. I would be in favour of having a change in mechanism, as is proposed, but within a market-based framework.
Q8 John Robertson: Yes, I wonder if some of the answers are about who owns the company, whether it is a foreign-owned company or whether it is a UK-owned company. But I want to ask you questions about what are your views on the proposed methods for setting strike prices.
Ian Marchant: I think it is a mechanism designed to mean negotiations are conducted in a smoke-filled room on nuclear. There is a lack of transparency. The clause has three different mechanisms that allow the Secretary of State to do what he likes, so there is a discussion going on. My experience in the industry in the last 20-something years is there has been a lack of transparency about the cost structures of the nuclear industry over many years and we are facing the same. Keith talked about the RO banding, and that is a public consultation with evidence submitted in public and a debate about what the right price should be. We could debate whether there are conclusions but there is a clear transparent process. That is not going on on nuclear strike prices, so I am very concerned about that process.
Keith Anderson: I’ll turn just briefly to your first comment about ownership. I think what I would say to you is an organisation like ours, where we are present in over 40 countries across the world, we have probably seen every conceivable mechanism that has ever been invented, so we are quite comfortable, generally speaking, with changes, whether it is ROs, CFDs, whether it is fixed-rate tariffs, feed-in tariffs, we can work with any of them and manage with any of them, so they don’t really bother us from that perspective.
With regards strike prices the methodology that is being discussed and debated for looking at the strike prices and the setting up of a committee and the feeding in again gives us a lot of confidence because what it directs and says is it is going to be evidence based. The strike prices are going to be set on an evidence base and a relatively open, transparent manner and I think that is a good thing. That is what we have seen in the past. That is what we’d like to see as an organisation because it means there’s something there we can get involved in. We can debate; we can understand the answers and the conclusions.
What’s bothering us just now is what’s going on in the banding review because that is moved beyond evidence based, way beyond evidence based and that is when we start to get concerned. But we now no longer understand how the decision is being made under the banding review because it is gone way, way beyond all that consultation process. I think what’s happening just now with regard to nuclear-what is also discussed and debated in the papers-is that if companies are wanting to move forward and make investment decisions now the Government have said that they will enter into bilateral conversations to try and get the companies that surety and that clarity.
I think Ian is absolutely correct in one way, which is what we need to make sure is the detail of those conversations end up becoming public. The others in the industry end up being able to see what has been agreed, what form is that contract taking, how will that contract work in the future, so that if we are looking to bring forward investments of a similar nature we understand that process. I think it is perfectly okay for bilateral conversations to happen to make sure the country is still encouraging investment before the Bill and all the mechanisms are in place. But what we need to make sure is that those conversations then become transparent.
Q9 Albert Owen: But these bilateral discussions go on anyway, and what you are concerned about is that there is not enough on the face of the Bill. There is going to be an opportunity further on when the Bill is passed to have these discussions to strike a price. Is that what you are worried about? The Secretary of State said he is going to extend the grandfathering now to 30 years. There have been bilateral conversations between industry lobbyists and the Government on this, so it is not unique to nuclear.
Keith Anderson: Bilateral conversations are fine as long as-
Albert Owen: But I haven’t seen the outcomes on this and I haven’t seen the discussions that took place, so this happens anyway. It is naïve to think that it is only nuclear that have private discussions. It happens-
Keith Anderson: No, it is not only nuclear and one of the things we like about the ability to do that is because, for example, if we want to encourage the investment coming forward on the big new offshore wind projects the likelihood is we are going to be asking companies like ours to invest £100 million or £150 million in early stage development of those projects before we understand the strike price, before this Bill is complete and before we can write a contract for difference and that will require bilateral conversations.
Sara Vaughan: I don’t see that the ownership of the company-to come back to that original point that you made-is relevant to the position that we take. From an E.ON perspective we believe in competitive markets and it is important for us that this mechanism that is being put in place in the UK should continue to operate within a competitive market framework.
To come to your specific point on the setting of strike prices, we are in favour of a method similar to that that has previously been used in respect of renewables, so an administered approach on a cost basis, looking at the costs of the technology and what’s required. I would agree with Albert that there are always going to be some bilateral conversations that will take place. I think we would all say, looking at nuclear, that you couldn’t possibly hold an auction-type process to set a strike price for nuclear at this moment in time because it would be a very, very small auction with very few participants.
Q10 John Robertson: That is what the Government stay in it for. But would you not agree though that perhaps the sort of subsidies that renewables have had in the past were excessive?
Sara Vaughan: What we would say is that what we are doing as a company is that we are looking to improve the efficiency-
John Robertson: I understand that companies want to make as much money as they can. What I am saying is do you not feel that the actual subsidy itself is a bit over the top?
Ian Marchant: No, I don’t believe that.
Q11 John Robertson: But you would say that, wouldn’t you?
Ian Marchant: So, therefore, because I would say it, it means I am wrong. I mean the returns-
John Robertson: No, what I would-
Ian Marchant: The returns that we make on our investments and renewables are fair and reasonable. It is right that the Government goes through an evidence base gathering that involves bilateral discussions about whether those bandings should be reduced and we agree that for onshore wind they should come down from 1.0 to 0.9 and in the future come down further as the technology matures and the costs come down.
The point there is, I don’t get involved in bilateral discussions about how much I am going to invest. Government decides, that is the level, and I then make the decision. In nuclear they are all being conjoined into one discussion and I do not believe that the returns that are being made on renewables are excessive.
Q12 John Robertson: Can I ask a question about the CCS strike price? Do you think it is appropriate?
Ian Marchant: My own belief on CCS is we are at the demonstration stage and what is principally needed is capital support. We do not know that this technology will work. We need to demonstrate that it will work and a CFD is predicating the fact it will work. I think we should be much more focusing CCS on capital support and that is the lowest cost to the State because I am not looking for a return on the capital I am not putting forward.
I have to put forward the capital into a risky project, the most risky project I’ll ever invest in, on a CFD mechanism that is a first of a kind. My shareholders will demand a high return. The State should not have to pay for that. It is much better to put capital support at this stage in that technology.
Keith Anderson: Let’s just come back briefly also on the returns on the RO perspective, which is the other thing you always need to bear in mind if you are comparing the UK to any of the other northern European countries is your planning consents take longer in the UK. Upfront development costs are more expensive in the UK. Land rentals are more expensive in the UK. Transmission costs are more expensive in the UK and they are all borne by the developer in upfront risk in those investments.
The returns we are making are sensible, they are reasonable. I agree with Ian and we are perfectly happy to look at that coming down in the future and we went through all of that process with the Department of Energy and the consultation review and that is what got us to 0.9.
Sara Vaughan: I would completely support what the other two have said. I think the returns are reasonable and I would just like to make the point that we don’t just sit there and take the returns. We are looking at improving the efficiency of our builds and of our processes and we would expect that over time the rates and the ROCs or the replacement would fall.
Q13 John Robertson: Okay, well that is one of our jobs to keep an eye on everybody and give you a hard time when you deserve it. Do you think there’s a place for the Committee on Climate Change in all this?
Ian Marchant: I am concerned about the governance of the energy industry going forward. We have a Bill that is more interventionist and gives the Secretary of State more discretion than I can remember. I think it probably gives him more discretion than he even had in the national industry days where his discretion was to appoint the central ownership to the generating world.
It gives him a lot of discretion and then the powers and duties seem to be muddled between Ofgem, the Secretary of State and the Grid. We have seen tri-part type regulation not work before in other sectors, so the solution seems that we have to have an expert panel advising I am not sure whom and then to say, "Should there be a role for the Climate Change Committee?" We could have five bodies all debating this and none of those five bodies build absolutely anything, we do. I do not think the governance is properly sorted out for the degree of intervention and state control that is being taken.
Q14 John Robertson: So, you wouldn’t mind us having a formal role then?
Ian Marchant: I think the Committee could do the country a service at looking at the whole governance issue from first principles, rather than adding more sticking plaster to what I think is potentially flawed.
Sara Vaughan: I think that there would be value in them having a role advising on the potential impacts of the strike prices on the ability to decarbonise the system. But I would agree with Ian’s point that you have to be very, very clear on the governance and exactly what that role is, whether it is purely an advisory role, whether it is an expert role, whether it is part of a decision-making role-all of that needs to be sorted.
Keith Anderson: I think that the targets have been set. I think that we have enough targets; we have had enough overview of what we need to do and what we need to deliver. What this Bill needs to remain focused on and the processes that come out of this Bill should be focused on is about delivering, creating the frameworks and getting on and delivering. I do not think we need anybody else involved in that process.
Q15 John Robertson: A bit more liquidity, do you think there is currently enough liquidity in the whole framework to provide that and what is the reference price for CFDs?
Ian Marchant: No, I don’t. I mean we are, as an industry, trying to solve the liquidity issue and a number of us have taken initiatives there. It is less bad than it was, say, back in September/October last year but I am not convinced that there is liquidity of the products that will be needed to settle different CFDs for different technologies because that is imposing additional burden on the wholesale market.
We struggle to cope with the business-as-usual burden of making sure that we have price transparency and consumers are getting a good deal. I don’t believe that the market is currently liquid enough to support a CFD mechanism.
Q16 John Robertson: Would you be willing to make an additional commitment to improve the day-ahead and forward market liquidity?
Ian Marchant: I’ve committed to do 100% if the other guys get on and do their bit.
Sara Vaughan: We will.
John Robertson: Okay, there’s 24,000-I hope you do.
Sara Vaughan: Yes. Look, we are already putting 60% of our generation through the day-ahead market. I just pulled up a little chart that I happen to have with me that shows how the liquidity is increasing. We have put more volume through the N2EX day-ahead market than any other player this year. We are absolutely committed to that market. We were the first player to sign a gross bidding agreement with N2EX. We are glad that other players are now coming on board and signing those agreements. We all, as an industry, really need to get on with it.
John Robertson: Okay, that is the E.ON advertising over.
Keith Anderson: Before we all start advertising and trumping each other I think all I would say is I think you’ve heard enough. The industry is moving forward. The industry is working to try and drive more liquidity in the market and I think that will end up being delivered. I think the market will deal with that issue.
Q17 Albert Owen: Can I move on to clause 8 of the Bill and the management of the financial exposure of the proposed levy control framework-what are your views on that in general or specifically?
Keith Anderson: The principle of having a levy control framework is that it is absolutely sensible and it exists under the existing mechanisms as well and that is fine, so I have no issue with the principle of a levy control framework. I think what we need to watch and be careful with is the operation and the flexibility of that control framework because what you are likely to see, if you take offshore wind, is quite a lot of lumpy investment coming through the market.
So, for example, we have set this industry targets to deliver Round 3 offshore wind projects and most of the developers are aiming at the same timeframe to have those built and developed, so you are quite likely to see quite a lot of investment come through in one or two years to kick start that part of the industry. What we need to make sure is that the levy control framework does not then curtail that and cap that, that there has to be flexibility from year to year to move-
Q18 Albert Owen: I think that as it is currently drafted it could do.
Keith Anderson: It could do and I think that is what we need to be careful of because I think the worst thing you could do to the offshore sector is to end up telling people to delay projects. I think that is the worst message you could send support with the supply chain.
Q19 Albert Owen: What sort of fine-tuning mechanism do you think should be used?
Keith Anderson: I think one of the things that need to be given consideration is: can you have flexibility within a year? Can you do the levy control framework over a number of years? How do you shift the levy control framework from technology to technology? I think there are various ways of solving it but we need to work-
Q20 Albert Owen: The technology value targets you would prefer.
Keith Anderson: I think we need to look at the detail and work through the detail of that and just make sure we understand how it works and I just think that-
Q21 Albert Owen: We are all trying to get through the details but we are really asking for opinions from you as representative of the industry.
Keith Anderson: Right now I would like to see that there is flexibility within a time band so that if you set a levy control framework over a four or five-year time band and then you could shift the investment within that.
Ian Marchant: I think the levy control framework seemed to just appear in this industry about 18 months ago without proper scrutiny or debate as to what it was trying to achieve, whether it was compatible with EU or UK law and how it was worked. I do not know whether it had Parliamentary scrutiny and yet it is now a fundamental driver of policy. I am quite concerned about the democratic process around this levy control framework.
We have statutory targets under the EU renewables and under Climate Change. We want to keep the lights on. What comes first, them or the levy control framework? We should have a value for money framework, absolutely and making sure that returns are not excessive, and the consumer is getting a good bill, paying the right price, absolutely; but is the levy control framework the right one? I am not sure. It seemed to have come out of Treasury as part of the last Comprehensive Spending Review and I am not sure that a two to three-year politically-driven framework is the right one to manage an industry where we are talking 20 and 30-year investments.
Sara Vaughan: Yes, a couple of things. I would agree with Ian’s point about, what is the more important? Is it the target that we are supposed to be meeting or is it the levy control framework and are you saying that we are allowed to almost bust the levy control framework as long as it is within the targets? I think we need a lot more clarity around that. If it is the levy control framework that is the key, then, to my mind, that would have been exactly the same under the RO. So you would have found yourself investing under whatever mechanism but within the context of the levy control framework. We need some clarity about how that is going to apply to CFDs and to the lumpy investment, the point that Keith Anderson made. I think there is a lot of uncertainty around that.
Q22 Albert Owen: As the Chair said, we only have a few weeks to scrutinise this and it has been coming along and it has been changing. But this is the opportunity for you, with respect, to put forward your views as well so that you can help with the scrutiny of this.
Sara Vaughan: Yes.
Albert Owen: Two out of three of you have talked about the Government and the politics involved in this, but I have certainly sympathy for the Government when the industry isn’t speaking with one voice as well and this is a general question I want to ask. As an industry, do you meet and have you put forward to Government, collectively, what you think? I know you have commercial interests as a company.
Ian Marchant: We don’t agree as an industry.
Q23 Albert Owen: That might be useful because it is all right criticising different departments within Government, but if industry isn’t speaking with one voice as well-
Ian Marchant: I am probably at one end of the extreme of the industry and in the second session you will probably hear people at the other end of the extreme of the industry but, no, we don’t agree. We are competitive players.
Albert Owen: No, I fully understand that, but we are talking about frameworks and mechanisms for a long time before-
Ian Marchant: The levy control framework is something that we probably haven’t discussed as an industry because, as I say, there has been this creeping importance and that is something that we will-
Q24 Albert Owen: Can I put it to you that there are a lot of written submissions going in and it would be useful if you got this in and it would be helpful to us. Not talking about extremes at all but I am going to quote EDF, which has concerns about legal enforceability of the CFDs. Do you share those concerns?
Sara Vaughan: Is that against the background of the state aid question?
Albert Owen: Yes. They are concerned about the whole process of the contracts for difference, that there would be legal challenges.
Ian Marchant: So am I. Fundamentally, I think that CFD is the wrong way to solve this problem. There are a number of problems; firstly, the degree of Government control and discretion, which we have talked about. The second is the counterparty. It is a contract. It has to have a counterparty and it is not clear to me whether it is the state as based in the impact assessment-there is a very clear statement in the CFD impacts that the state is the counterparty, yet the Bill is basically some sort of statutory arrangement imposing obligations on suppliers-or whether it would be some sort of third party. We need to be absolutely clear who the counterparty is. You can’t have an enforceable contract against nothing. So you have control issues, you have counterparty issues and you have complexity issues. It is a contract. It will need to be marked to market. It will need to be hedged. It will need to be settled.
It will impose costs on the suppliers, potentially the middle party, and if the generator is saying that they are not concerned about its enforceability, why are we doing it? As a supplier I certainly don’t want it. Then you have, is it compliant? Does it comply with state aids? To my mind this comes back to the counterparty. You can only deal with compliance when the counterparty. If it is the State, which will lower the cost of capital, then it is probably State aids. If it is not the State, it will not lower the cost of capital but it might get through State aids, but why are we doing it in the first place? It is almost the unanswerable question. I just think that CFDs-particularly if EDF don’t like them, why are we doing it?
Keith Anderson: When we started the conversations going down the energy market review one of the things the industry did agree on-not that we agree on lots-the preference was to have the Government as the counterparty because if what we were doing was trying to drive this into a mechanism where we reduced cost of capital. If you have the Government as a counterparty sitting back on those contracts that gives the financial security anybody would want and anybody would desire. Now, what is coming out of all of the process going through the Bill is that the Government have a desire not to be the counterparty and, therefore, they are trying to come up with another model and another mechanism and that is creating some issues; questions around the enforceability of the contracts, as Ian explained. I do not think that makes Contracts for Difference wrong or that it means they do not work.
I think it just means we need to sit and sort out who is the counterparty and how to make sure the contracts are legally enforceable and come up with a model designed to do that and to deliver that. I think the issue that in some respects is a bigger concern to us is the accounting impact, of making sure that the contracts don’t have to be marked to market. Our concern would be that if we end up having to write and hold a set of contracts, where we end up with huge volatility going through our profit and loss account because of mark to market value changes, that would be a big negative on us as an organisation. It would be a lot of risk and volatility. It would make our investors more nervous and that would be a big negative outcome.
Sara Vaughan: There are probably three points here. First of all, on the state aid point, that is a hurdle that needs to be gone through but if you look at-to take something we all know-the renewables obligation, the renewables obligation went through a state aid process, was declared to be state aid but was approved and we have all operated under it perfectly happily for the last however-many years. Moving on, the Government chose to go with a contract for difference because it was a contract and because they believed that it reduced the cost of capital. I am happy with the concept of working under a contract. That has some advantages in terms of protection against political risk because, while Parliament can always change things being sovereign, once you are within a contractual rights framework then you have the ability to take action against whoever your counterparty is.
That then brings me on to the third point, which is the question of the counterparty, which is a concern because there is uncertainty around who the counterparty is going to be; where we have the possibility that it could be the bunch of suppliers where the question then is, well, who do you sue in the case of any disputes between you? Who is the person that you are sort of facing up against in negotiation or potentially you have another model where you have a sort of fatter counterparty, single party, with other suppliers standing behind it and backing it up? I believe these issues are capable of being resolved.
Again, we operated under contracts for difference through the pool for 10 years or so. There is no magic in a contract for difference. We can all operate within them once we know what the rules are and, to come back to your previous point, we are making representations on what that should look like. The derivative point is a real worry and I would share the concerns already expressed on that. It is important that the contract, whatever it is, is not viewed as a derivative. We have had some good news on that in that if it is attached to a particular asset then it is less likely that it will be viewed as such. We have had a rather wishy-washy paragraph in the acres of consultation documents on that. I think we need some greater clarity on that point.
Ian Marchant: I hear my colleagues say that all these details could be worked out. It has been being worked on for a year and we can’t answer the simple question: who is the counterparty? If we can’t get to that fundamental question in a year, I worry that we don’t understand the fourth or fifth level questions.
Chair: I want to stay with the counterparty point, if I may.
Q25 Sir Robert Smith: If the Government were the counterparty, that was what the industry originally saw-
Ian Marchant: It is what the impact assessment is based on. The £2.5 billion of cost saving compared to a premium feed-in tariff is based on the Government being the counterparty. As a minimum the Committee should ask DECC to redo the impact assessment on the basis of the counterparty arrangements that will apply, not the ones they thought would apply last summer. As a minimum they should be doing that.
Q26 Sir Robert Smith: Then it goes to the multiple counterparties or another body acting to at least bring that all together. Does the other body bringing it all together improve the situation at all?
Sara Vaughan: It depends on the nature-
Keith Anderson: Sorry. I think the attractiveness of the Government being the counterparty was the credit rating impact. If you are talking about an agency that gets set up, what is its credit rating? What is its financial security? That creates an issue because that is what drives down our costs.
Sara Vaughan: Is it a public company?
Ian Marchant: That is the key. Is this body in the middle part of the public sector, in which case you need to ask the Treasury their views of that being on the State managing-or is it in the private sector where all the issues still apply?
Sara Vaughan: Yes.
Q27 Sir Robert Smith: So if it is staying in the private sector might it as well stay as the multi-party-
Ian Marchant: To my mind, the only way that you could get CFDs to work is to have a genuine multi-party, not-for-profit mutual running the CFD process, but I believe that it also needs to include the system operator role. I think if you put that agency into National Grid the conflicts of interest would be impossible for Grid to do a proper job for the system, because they have duties to their own shareholders and their own businesses. So I think you could set up an industry mutual but I think the State has to provide some element of financial backstop to make sure you don’t get credit leakage out of that individual entity into the private sector, otherwise you lose the cost of capital benefit. So it could be 60/40, 60% private owned and 40% public owned. There are ways of creating it, but they are not what are in the Bill. The Bill envisages National Grid acting as the agent and so we create a problem in Chapter 1 that we then try and solve in Chapters 2 through 8 in the Bill of all the consequences of the CFD.
Sara Vaughan: We have to be fair and we have to say that DECC has made it very clear that they were only able to put in the Bill what they had originally instructed parliamentary counsel to draft, which was on the basis of the original counterparty proposal, but that they have heard the concerns expressed by the industry and, therefore, they are looking at whether they can meet those through an alternative proposal. So I think we are all accepting that what we have on the face of the Bill is not necessarily where we are going to end up.
Ian Marchant: But the impact assessment is based on another version.
Sara Vaughan: That is true.
Q28 Sir Robert Smith: How much difference is the risk of capital given that it is spread across all the suppliers as opposed to-
Ian Marchant: If you take the industry as the three bits, the creditworthiness is strongest in the networks where we have an asset business and a regulatory company. Second-best in generation we would have assets. So the lender can see security against the asset. It is weakest in supply, which is exposed to the customer vagaries, bad debts, hedging and trading. The risk of the counterparty, we take the credit risk out from the generator and put it to the supplier. When you take it from an industry point of view, the cost of capital will go down. The impact assessment says take it from the generator and improve it by putting it through the State. If you take it from the generator to the supplier you are in a worse off position. That £2.5 billion benefit, I think, swings to a cost from an industry point of view.
Keith Anderson: I do not know the answer in terms of what its impact would be but somebody would have to go a look at that. I think there is definitely an impact because having the Government sitting at the back of it-if you can still do this through an agency that is partly Government-backed or underwritten by the Government then I think you can potentially still deliver the same answer.
Sara Vaughan: I would say it depends on the treatment of it because the principle should be that it is not on the supplier’s balance sheet, that it is being underpinned by all of us as consumers of electricity in the UK.
Q29 Dr Whitehead: Before we move off this general topic, I would like to seek some clarity about the levy control framework from you. While it is true the levy control framework came from nowhere, it nevertheless came from nowhere with substantial clarity in its own right, i.e. you have a certain amount of funding over the spending period. That is then longitudinally capped and it is also horizontally capped in each category each year with a 20% maximum headroom, I think, put into it. Presumably, a levy control framework would, in this context, move forward to the next spending round. Now, is it your view that, if the architecture of the levy control framework that we have at the moment were moved forward, that would then produce very substantial difficulties, as you suggested, for the lumpiness of investment coming forward and the way in which that might then move through the framework?
Ian Marchant: Yes, I think it would because we are seeing the impact of the levy control framework with the very prescriptive rules that appeared on policy making. If you take the banding review, it is already six months late. Back in October 2010 we were promised the banding review for December 2011. It is 12 June and we haven’t had it. So forget the outcome. The process is just taking too long. That is what delays investment, as much as the actual control framework. It is a very, very prescriptive framework. It is more prescriptive than the old EFLs, external finance limits, that were imposed on nationalised industries going back 22 years, but that was the mechanism the Government used to control. They were at company level. That was it. Companies then decided beneath that what they were going to invest in. They were very prescriptive and the more prescriptive the more problems you end up with.
Keith Anderson: The concern for us would be that once we start investing-if we take a large offshore wind farm and we start that investment process-we can get a contract at FID, final investment decision, and that is fine in principle. But, on a large offshore project where I am likely to have put at risk £100 million to £150 million to get it there and then I get to FID and I do not know if I am going to get a contract or not, that is an unacceptable risk. So there needs to be enough transparency of how that levy control works and where we are against it all the way through that investment process and we would want enough flexibility in the way it is moved to say, "By the time we get to FID bring forward your project and look for the contract", you are not going to get told, "Wait 18 months because there is no money left". That would be absolutely unacceptable. The other slight complexity that needs to be worked through is what wholesale price do you use when you are measuring it against the levy control framework, because the value that goes against it will fluctuate with the wholesale price. As the wholesale price moves up and down you could see huge volatility in terms of where are you resting against the levy control framework and, again, that would create massive issues. Our recommendation would be to use some form of notional price when doing that to give us a little bit more clarity and transparency as well.
Sara Vaughan: I would strongly support what Keith has just said. The Bill also talks about other targets that the system operator has to have regard to in relation to allocation. What technology is it? What is the capacity? What about the geographical location? That, again, raises the risk in relation to development, that you go ahead and you have developed your project, which is this technology in this place, and then that is not what the system operator happens to want at that point. How are they going to differentiate between bankable projects? How are they going to decide which project gets that CFD? All of that needs to be very, very clear, upfront, so that that, if you are starting to develop a project over there, that has a very good chance or that one over there has not.
Ian Marchant: We have lived through an example of an attempt almost to proxy this in the CCS demo where we had a competition that started in 2006 and we haven’t got a project at the feed study stage yet in the UK. So I don’t hold out much hope.
Q30 Dr Whitehead: You did the feed studies, both of you?
Sara Vaughan: Yes.
Ian Marchant: Yes, as it happens, but both of those projects didn’t go ahead for various reasons.
Q31 Dr Whitehead: You have said that industry does not agree on the number of things. On this particular point would you say there is general agreement that the levy control framework as it stands is potentially inimical to that period of investment and that, secondly, the variability of CFDs against the absolute level of levy cap could be a potential difficulty? Is that what you are saying and is that a point you agree with?
Ian Marchant: I am certainly hearing a fair degree of similar concerns about the levy control framework from the three of us. You need to ask the next three because, as I say, it is not something the industry has specifically debated. Maybe we will be soon, after today.
Q32 Chair: I think you should do it sooner rather than later. Given the difficulty we are having in getting a Treasury Minister to even answer our questions in front of this Committee, if there was a unanimous voice from the industry that would be extremely helpful, I think, in a number of respects. We have about three more topics I need to deal with in the next 10 minutes, so we are going to have to speed up a bit. Could I just touch on the choice of CFD, in particular in relation to intermittent generators? Do you think that is the most appropriate form of support?
Ian Marchant: No. Premium feed-in tariff, which is effectively what the renewable obligation is. It is a tried and trusted method. It is delivering investment. It is simple, understandable and bankable. It allows me to make long-term decisions, develop supply chains. Please don’t change it.
Keith Anderson: I am going to say the exact opposite. It is perfectly all right as a mechanism for renewables. The RO has done what it has done. It has got us to where we are today. It has been fine. It has worked well. I think, given the size and scale of the investment, it has to come forward because we are talking about a huge ramp-up in investment activity and we are talking about asking people to start investing in offshore wind projects that are of a multiple of 10 or 20 times the physical size and the capital size of previous projects and I think the Contract for Difference mechanism provides more certainty and stability for investors. I think it is more likely to attract more investment into that sector and into that industry because of the certainty it gives in terms of a revenue stream and, therefore, it is probably more suitable long-term.
Sara Vaughan: I am with Keith rather than with Ian on this one and it is a point I made earlier about it operating at a premium over the power price. As you see the power price changing over time as more investment comes on to the system, the power price gets lower. You have the cannibalisation effect, which means that the wind isn’t getting the benefit of the power price when the power price is higher. So the risks for investment in intermittent generation have increased and we see the CFD as offering a more certain and robust framework within which to invest in renewables looking forward to that future world.
Q33 Chair: Just looking at CFDs in relation to CCS, how can the Government make sure we get value for money if we are doing that?
Ian Marchant: CCS is a demonstration technology. The Government needs to go through a sensible procurement process to say, "What is the right project for the UK to support", and then effectively run it as open book. If it is my project, I don’t want to spend any more money with the OEMs than Government does. I am on exactly the same side of the table as Government in making sure that project comes in at the lowest possible cost. The reality is, however, for the first CCS project nobody knows what that cost will be. It will turn out to be what it is. So align the incentives between those who are delivering it and the State and you will get it at lowest cost.
Keith Anderson: The reality is the amount available from the Treasury for investment in large-scale projects is limited. If you can balance some of that off by using CFDs as well then fine. I think you could say the marine sector is in a similar state, where there is some capital funding going in to help projects but also what is being used to try and attract investment is a very, very attractive RO band in terms of generation and output. I do agree with Ian. It is still absolutely about demonstration and we need to prove it can work. Therefore, it does require some capital support. It is perfectly feasible and sensible to use a CFD to help incentivise it and to help drive it because I think it always quite good with demonstration and with R&D also to make those people involved in the R&D aware that part of the funding is reliant on it working and that is never a bad thing.
Q34 Laura Sandys: When you are presenting to your board, whether in the UK or abroad, an investment profile into the UK energy sector what are, let’s say, your three concerns; your three key big questions that the board is going to ask you and you, under this existing framework, are going to have problems answering? Maybe they fall into policy and market risk but also cost of capital, i.e. investment profile.
Keith Anderson: Right now, today, I am looking to try and take papers forward to carry on investment in Round 3 offshore wind projects, projects that are likely to deliver in terms of generation output 2017-2018. So they’ll be on the cusp of probably falling into the new mechanism. Putting forward right now a paper to ask for £50 million of investment, the questions I will get asked is how does the mechanism work? The answer, right now, I do not know. What is the strike price? I do not know. What is the rate of return? I do not know. Do I know when the mechanism will be in place? I am not too sure.
Laura Sandys: That is an interim-
Keith Anderson: That is where we are today and one of the key messages we have been saying and will continue to push us is the faster we get through this process the better because then you will not stall investment. The risk is if we don’t hit the timetable that is laid out investment starts to slow down. It gets stalled and that will be incredibly damaging, particularly to that offshore sector and particularly to the confidence. It relates back to previous comments about trying to drive down cost. We as an industry are working out there going hell for leather trying to convince companies to come and invest in the United Kingdom; to build manufacturing plant; to invest in port infrastructure, vessels, cabling; a huge amount of investment to try and get into this country. They want to know are you confident you can build these projects? Are you confident that this mechanism will work? Are you confident? I need to be able to say yes, and if we miss the timelines I can’t say yes. So we need to hit those timelines.
Q35 Sir Robert Smith: And they need to be able to believe you from what they-
Keith Anderson: Yes.
Ian Marchant: I took an investment decision to my board last month, about £150 million on an onshore wind farm, and the three questions that they asked were, first, "Can you build it to time and budget?" Nothing around here can touch that but it is a key question any board will ask about any investment decision. The second is, "What is the mechanism? How can you give certainty of revenue?" All I could say then was, "We are doing it under the RO. We can get this built in time. We are going to come in under the RO. So I know I can get the first machines on before 13 March." So, yes, EMRs-tremendously uncertain but I can get through. I am glad I could get it through last month. The third question that the board will always ask is, "What does the market look like? Is there too much capacity? Too little capacity? Who else is building wind farms and things like that?" My next investment decision is a gas-fired power station and at the moment I can’t answer the second two questions. I can’t answer, "What mechanism is going to be there for capacity", and I can’t answer, "What else are other people going to build", because I can’t answer, "What is the mechanism?"
Sara Vaughan: I think we have probably a pretty good-
Q36 Laura Sandys: So we have this interim period where we have this problem where you don’t know what regime you are going to be moving in and it depends on the timescale of the investment materialising, but then, let’s say under the EMR, what are your three key concerns and problems when you are looking at going to your board and saying, "This is the new regime. This is the sort of investment I am looking at"? Where are the problems that you-
Ian Marchant: You go first, yes.
Sara Vaughan: If I was talking to my board-not my board, our board-about this, we would be looking at-
Laura Sandys: They think it is yours.
Sara Vaughan: Thank you. Can we meet our hurdle rate? Can we guarantee that we will get the revenue back from this plant that we are looking to put into it? The key question about that in this world would be about the robustness of the framework that we are putting in place through EMR. In the old world, if you like, you would be looking at the electricity price, the forward price and what you expect that to do. But in this world, because you would be looking at a contract for difference that is effectively providing you a hedge against the electricity price going low against where the carbon price is, then you would be looking at, "Okay, what certainty have I got around that mechanism, around the robustness of that mechanism, around the Government not turning around and saying, ‘Gosh, this is looking a little bit expensive’".
Q37 Laura Sandys: But you are in the boardroom now and I am saying to you, do you feel confident about the political environment? Do you feel confident about the contract for difference?
Ian Marchant: Today, no. If the Bill is passed in the form we have, which I think is what you are trying-so imagine we have this role. I have to put aside all the problems it is causing in my supply business and say, "Can I invest on the back of a CFD?" Well, I am going to have two questions. Is it bankable? Is that contract robust and defendable? Because I don’t like CFDs, I can’t answer that question. You should ask people who are thinking about investing under that basis that question. The second thing is, which is Keith’s point, will I get this contract, because I have to either negotiate or take part in an auction and then wait for someone to decide. Yes, you have approved this but it is more like an acquisition where you are dependent upon a process going on and you don’t know until you get the phone call that the contracts is yours.
Sara Vaughan: But you would only be able to take your FID if you knew that you had the contract.
Keith Anderson: Sitting in front of a board in the new world the main question will be, "Do you know you are going to get a contract? Do you know you are going to get that contract and do you have that certainty?" The question that gets asked quite often when we invest in other countries is about political risk and interference. We have never had to ask that question in the UK because, all of the reviews and all of the work, we have always understood how it has been done; an evidence-based, good, robust process. The concern I have now is, given what is going on with the banding review, that question might well start getting asked.
Chair: Okay, that is helpful. Sorry, we have to move on.
Q38 Dr Whitehead: You mentioned a little while ago the general view there was about the capacity that was needed four years ago and now that has changed substantially.
Ian Marchant: Yes.
Dr Whitehead: The capacity that is required to be estimated is barely four years ahead. Do those two facts add up?
Ian Marchant: Let me give you the facts. In 2006 National Grid’s forecast of peak demand for 2012-13, the year we are in, was 68 gigawatts. Their forecast now is 57 to 59 gigawatts. That is a significant difference and if you then roll forward their projections for 2017-18, which is the last date that they have published those, they are for around the same level of capacity, maybe a little more, which is significantly less than Government has assumed in its impact assessment. The principal reason for that is demand destruction. We can have a debate about how much of that is because of the poor economy and will there be a bounce back, but I think a lot of the demand is gone for good because our analysis says that two-thirds of it, at least, is due to energy efficiency. It has gone.
We simply need less capacity from 2015 onwards than we thought we did five or six years ago. Therefore, we may be trying to solve a much bigger problem than the actual problem we face. I have changed my view. I thought a capacity mechanism was essential. I now think it is desirable but it is not essential. I thought intervention mechanisms to improve investment were essential. I now think they are not essential. The industry can deliver the scale of investment needed in the next decade. The real debate in my mind is what technology is the UK going to deploy in the period 2025 to 2030? Is it CCS? Is it offshore wind? Is it nuclear? It is not the next 5 to 10 years. It is later. So the world has changed, in my view.
Keith Anderson: Some of what Ian said I agree with. Things change and move. The demand projections change and move. The capacity projections change and move. But, to me, fundamentally what this Bill is about is putting in place a good, robust, long-term framework, which is, to me, what this industry always likes, and it is about giving us a framework that continues to deliver for the UK what it has had over the last 40 years, which is a good, healthy, mixed-generation portfolio. Whether that is about £80 billion of investment, £150 billion of investment or £200 billion of investment, to some extent, is a little bit irrelevant. It requires being a mixed investment portfolio and right now I do not think-the way the market is set up and is structured-that is what it will deliver. So I think the Bill is essential from that point of view and that is why we want to see it carry on and we want to see it delivered.
Q39 Dr Whitehead: The annex to the Energy Bill states that DECC, although, as we have discussed, most of the detail of the capacity market is pretty vague, they have said they expect to choose "a capacity market that provides assurance that physical capacity is in place". Does that rule out demand reduction?
Sara Vaughan: No, I don’t think it does and I think, if you look at the section of the Bill that deals with capacity, the way that it defines capacity also includes demand reduction. We see that as an important part of ensuring that you have the right balance and I think that, as part of the development of the capacity mechanism and capacity auction, demand reduction is very much going to be part of that. That does not mean that we should under-estimate the difficulty not only of ensuring that you have something that works in the right sort of timescales, because timescales of power stations and timescales of demand reduction are not the same, and also the ability to monitor and ensure that that demand reduction has happened and that it is happening on an ongoing basis. But, yes, we see that as very much part of it.
Ian Marchant: I would absolutely echo that and I think that the words are fine, but I don’t see the level of detail on how the capacity mechanisms will work with demand. As I see it, it is outward working generation and I think DECC should be asked to be clearer about how they can put demand pari passu with generation.
Q40 Dr Whitehead: I think there is one paragraph in the commentary that suggests that DECC may be working on some demand reduction ideas that might be ready for legislation.
Ian Marchant: There are quite a few "mights" in that sentence.
Dr Whitehead: Yes. Well, I am merely reporting on it.
Sara Vaughan: I think there is going to be another consultation, isn’t there, dealing with demand reduction specifically?
Dr Whitehead: Yes. Bearing in mind that obviously demand reduction is not physical capacity, what sort of ideas have you, as the industry, been putting forward on how demand reduction might play a role in a capacity market in the absence of anything coming forward?
Ian Marchant: Being able to bid in controllable electric heat. There is a simple example, the storage radiators that members of the Committee will be aware of. If you aggregate over many, many customers, you can get 10s to 100s of megawatts of load. The ability to turn that off at system peak should be valued in exactly the same way as the ability to turn an open-cycle gas turbine on at system peak because it has the same economic benefit to the system. So there is a domestic example. In the industrial world it is how do you properly bid in interruptible load and then enforce that it does get interrupted, because in the past in the UK people have just taken interruption as a way of getting a cheap price. What we are talking about is there is a service to the system and people who are prepared to offer it should get remunerated for it. You just need mechanisms and the biggest challenge is aggregation, because National Grid has a big button that has on it "200 gigawatts" or "500 megawatts". They want to operate at scale. Demand tends to be in a few kilowatts to a few megawatts. You need an aggregation that demand can bid in, in the same way.
Chair: I am sorry, we are already over time. There is one more issue I want to raise.
Q41 Christopher Pincher: You have all been pretty clear in what you have said already; that you think the draft Bill gives significant scope for ministerial capriciousness and that can affect investor decisions. With respect to the EPS, do you think that giving the Secretary of State authority to exempt coal plant from the EPS on the grounds of security of supply without parliamentary scrutiny undermines the whole concept of an EPS or do you think that is a reasonable proposition?
Keith Anderson: I think it is a perfectly reasonable proposition. I think it is perfectly reasonable for the Secretary of State to be able to have the powers to fundamentally keep the lights on in this country, if that is what we have to do. If it got that bad and it got that close to an emergency, that is something you would want to see. I do not think it undermines the EPS. The EPS still sits there and will deliver what it is meant to deliver.
Ian Marchant: In the spirit of things, I fundamentally disagree. Either you have an emissions performance standard that bites or if you have doubts don’t bother to have it, because who decides how the lights are going out? You could decide in two years’ time, "The system looks a bit stressed. We’ll relax the EPS". Either have it or don’t have it.
Sara Vaughan: What I would say is I do not think it is that likely to be used but it does provide that additional insurance, but the absolutely key thing is that it would only ever be used for genuine emergencies. Now, Ian’s point, "Well, does it get used when the system looks a little bit tight", that then becomes a concern because, in my view, is that or is that not a genuine emergency? So I would bow to the side of, yes, have it in, but make the conditions around its use be so tight that it is only ever used in a real emergency.
Q42 Christopher Pincher: So, although in your previous responses you suggested that ministerial scope of operation is significant, this is an area where you think that Ministers have an absolute right of operation. What sort of controls-
Ian Marchant: No, I don’t agree.
Sara Vaughan: No, within very-
Christopher Pincher: Some of you. What sort of controls there ought to be around ministerial decision-making?
Sara Vaughan: I am not an engineer. I can’t start drafting them but within some very, very narrow constraints, such that you would really have to think that there is a present and imminent danger that the lights are going to go out, say.
Keith Anderson: That is something that would have to be managed in conjunction with the system operator. I am saying, yes, in the context of you have the system operator jumping up and down, shouting, saying, "We have a significant problem on the grid today/tomorrow". I absolutely agree with Ian that if it started being used to say, "Oh, well, in 18 months we might have a little bit of a capacity shortfall; let’s get rid of the EPS", that becomes a disaster. That becomes a waste of time. I am talking about having it there as an emergency power so if the system operator is jumping up and down saying, "Tomorrow at 5.00pm we have a significant risk of a blackout in that part of the country and we need to turn on the coal plant", absolutely I think that-
Ian Marchant: Because the emission performance standard works over an annual, that could only happen in the last few weeks in March because any other time the coal plant could still run. It is choosing not to run later in the year. So it is a very, very odd set of circumstances that means it would be used. I would rather it not be there.
Q43 Christopher Pincher: Do you think the constraints are in the Bill to ensure that the Secretary of State can’t simply say-
Keith Anderson: I am not sure if all that detail is there.
Sara Vaughan: I think the question we all have to ask ourselves is: if it were not there would it happen anyway? If you have a Secretary of State who is faced with, "At 5 o’clock tomorrow the lights are going to go out". "What is stopping them going out? "Oh, we have got this EPS and therefore this plant can’t run", I think it is going to happen anyway. So let’s make it legal.
Q44 Chair: Okay. I am sorry to cut you all short. If there other things that you were burning to get off your chest in answer to any of the questions when you have looked at the evidence by all means drop us a note about that.
Ian Marchant: We were going to come back on the Levy Control Framework
Chair: Sure, specifically. That would be good or indeed other issues as well if that is helpful to you. Thank you very much for your time this morning.
Examination of Witnesses
Witnesses: Vincent de Rivaz CBE, Chief Executive Officer, EDF Energy, John McElroy, Director of Policy and Public Affairs, RWE npower, and Sarwjit Sambhi, Managing Director of the Power Generation, Centrica, gave evidence.
Q45 Chair: Good morning. Thank you very much for coming in. Our apologies for overrunning on the first session. There is, as you will appreciate, a great deal of interest in this inquiry. Witnesses have things they want to say, we have questions we want to ask, and I will repeat what I said at the start of the session, that the Committee has been tasked with trying to conduct scrutiny of a complex Bill in an unprecedentedly short time by the Government. We have five weeks instead of the normal 12, and so we have to drive through at a pace which is rather faster than we would ideally wish, so forgive us if we deal with some very important issues either in shorthand or rather more briefly than we would have liked. Could I start with a general question about whether we need this Bill at all, or could we have made incremental changes to the existing arrangements? We have a carbon price floor now; we can legislate for the Emissions Performance Standard. Would those sorts of measures have been a simpler and easier way of delivering the Government’s objectives of secure, clean and affordable electricity?
Vincent de Rivaz: The answer is yes, Mr Chairman. Yes, we need this Bill. I may say in the first place that we take this pre-legislative scrutiny process very seriously. It is a key opportunity to make any necessary improvements to the Bill in a timely way. As I have said, the Bill is an important milestone in the delivery of all forms of low carbon investment. It sets out a package of reforms which, if taken together, sets our industry in the right direction to deliver affordable, secure and low carbon energy. The contracts for difference which sit at the centre of this Bill will be key to delivering investment to represent value for money and to protect customers. It is, to answer your point, simple, transparent and a proven instrument and through it both Government and the industry would be accountable to both shareholders and customers. The Bill is also clearly consistent with the European Union environmental competition and market legislation. It provides a fair framework for both consumers and low carbon investors, so globally I think subject to some fine tuning we believe the reform package is needed and will deliver the low carbon investment the UK is seeking. Indeed, the job of the Committee, which we take very seriously in this process, is now to work with stakeholders to deliver tangible improvements. I will mention which ones briefly. To take our own multi-billion final investment decision for our new nuclear project in a few months’ time we need three clear, concrete priorities for this Bill. First, moving to a tangible counterparty contractual model, which is clearly understood and precedented. I will talk further about this tangible counterparty. The second point, ensuring that the early contract for difference which would be delivered through the transitional arrangements is legally robust for the long term. Third, working to ensure the Government keeps to its original timetable of spring next year. I think the Committee’s report and you are right to say it is a very short timetable, should be able to recommend, and we are here to help, solutions for the issues that we are facing and very importantly to maintain the momentum that this draft Bill has created after all the process of consultation. It is momentum that we need to run up to our final investment decision and for us it is in a few months’ time.
John McElroy: If I can present a slightly different picture possibly, I have to say that if you go back to two years ago when we started on this journey, at that stage we were very much looking for something which was more incremental in nature. The big challenge was to get such things as Round 3 wind away, the first wave of nuclear away and issues around CCS as well. We are now in a situation where we have a very complex EMR with four elements and many levers and we are in a position where almost because we have said we are going to introduce a capacity mechanism we now have a hiatus in investment. We are at a point where we really need to move ahead and get this Bill finalised and there is a lot of work to do in terms of pinning down and sorting out clarity around what it is we are implementing and trying to refine and reflect that in the Bill before it finally comes in front of the House.
Sarwjit Sambhi: We think the Bill is needed. If you stuck with what we have today we have to remember that the RO expires in March 2017. It is not available to all low carbon technologies. It excludes CCS and nuclear. Without the Energy Bill we would not have a capacity payment. A capacity payment is needed for two reasons. One, we need gas-fired generation in the back end, second half of this decade and we also need gas-fired generation to take up the slack when wind is not blowing, predominantly in the next decade. So as far as we are concerned the Energy Bill as presented is something that is needed.
Q46 Chair: If the Bill is passed in its present form-and with the other documents that have already been published associated with the Bill-will that be sufficient to bring forward investment decisions or will there still be a hiatus while we wait for some of the secondary legislation to be passed as well?
Vincent de Rivaz: As far as we are concerned the draft Bill, subject to the tangible improvements I have mentioned and crucially on the counterparty issue, and subject to the timetable of the Royal Assent will allow us to make our final investment decision in time and I think the important thing is to focus on the key principles, accept that there are some details that will have to be presented to Parliament for the scrutiny part of the second legislation process, but we do not need to have in parallel the details to be able to discuss and to agree on the principles and to make the improvements which are needed.
John McElroy: I would have to say that given the powers conferred on the Secretary of State by the draft Bill as it stands are so wide-ranging, and largely that is because we don’t have the clarity around the CFD or the capacity mechanism that we need, I would suggest that as the Bill stands at the moment it will not provide the confidence that investors need. We need to do a lot of work between now and the Bill going through so that we understand the issues around counterparty risk, legal structure, dispute resolution in regard to CFDs and that we know what the capacity mechanism is, how it will work, how it will be triggered, and we need that before investors are going to be willing to push the button.
Sarwjit Sambhi: I think it depends on which technology we are investing in. We invest in offshore wind, gas-fired generation and nuclear. With offshore wind we continue to invest in the RO, given that the window is still available until March 2017. On gas-fired generation the current market environment makes it problematic in terms of going forward with an investment decision, therefore for us expediency on implementing capacity payments is important. On nuclear what is important is making progress on what’s termed the investment instrument or FID-enabling instruments and clearly the DECC commercial team is very much focused on arriving at an instrument that is investable.
Q47 Sir Robert Smith: Just one broad-brush thing: when your board is looking around the world, where does the UK rank in this model in terms of investor attraction?
Vincent de Rivaz: We should not underestimate the very positive impact that this electricity market reform is having when people from outside are looking to what is happening in Britain. This reform is not complex; this reform is comprehensive. This reform is addressing the challenges of the decades ahead of us and we have been for years, and I think with a large consensus, advocating for reform. This reform is coming, it is there, there is a draft Bill. It is changing in a way the business model paradigm for investors for large investment in low carbon technology for the good. It will introduce something for the customers that is extremely important-stability. It will introduce for the investors something very important-certainty. Both elements have very simple consequences. It reduces risk to see the prices going higher than they should go. We are in a context where £100 billion of investment has to be made. Maybe it is not exactly the same timetable as the one we were discussing two or three years ago, but does it matter? Who can imagine that these investments are not going to happen? If we want to avoid that, the consequence of this investment is the price of electricity going too high, we need this reform. If you want to have the investors ready to put that investment into long-term investment in this country we need this reform. So the answer to your question, this reform is perceived as a positive reform and in a sense a show of leadership from Britain to address the challenges of this first part of the 21st Century-security of supply, climate change and affordability.
John McElroy: If I can come in there, I would have to say that certainly RWE has found the UK one of the most attractive markets to invest in up to now and we have put very significant investment-
Q48 Chair: You have just started to pull out.
John McElroy: We are still investing in the UK in terms of CCGT plant, we have Pembroke commissioning at the moment. We will continue to invest in the RO while we can deliver projects ahead of 2017. I would have to say that there are issues about EMR and making certain that we can provide the clarity necessary because there are alternatives out there. The situation in terms of offshore wind in Germany has been mentioned and that would be a very attractive market, so we have to make certain that what is delivered in the UK maintains the attraction for investment but it is wider than that because it is also the issue of the supply chain and the jobs and everything else that goes with low carbon investment and we need to provide that confidence so that we don’t stop-start-we can maintain the momentum, and we don’t see the drift to investment in other markets.
Sarwjit Sambhi: 80% of our investment is in the UK so obviously the UK is a critical market. For us it is the trade-off between investing in a power generation asset or investing in, say, oil and gas in the North Sea. Whichever way you look at it the UK is a very important market for us.
Q49 John Robertson: I want to talk about the strike price and the wholesale market liquidity. There are a number of questions here so if you could try and keep your answers as short as possible. What are your views on the proposed methods of setting strike prices?
John McElroy: I think we have built a lot of confidence in the price setting mechanism for the RO over the years, and the administrative process although there are, as I have mentioned, issues around the current banding review and the political interference. We have concerns in that regard in terms of how that might reflect on the strike price setting process on the CFD. What we want to see is very much an evidence-based strike price setting process and where there is plenty of opportunity for input from industry and other key stakeholders. We have some concerns around the fact that we now have the proposal that the system operator will be involved in setting the strike price and making recommendations to the Secretary of State. Equally we have a group of technical experts, interestingly no one from industry as far as we are aware are going to be on that technical experts’ group, but there is potential for conflict there and quite how the Secretary of State is going to resolve those conflicts we do not know. I think what we want to see is an open, transparent, evidence-based process that we can all have confidence in.
Vincent de Rivaz: I can confirm that for me the contracts for difference mechanism will necessarily by nature be transparent and open to scrutiny. The strike price will not be defined in a cosy way and through hidden decisions. It will be the result of negotiation and the result of negotiation will be absolutely open and transparent. The fact that today we cannot say, and I have heard many times, that the Bill does not provide all the details of the CFD, of course the Bill has to provide the principles. I think we have to be clear that the CFD is a better solution for the customers than a situation in which we take the power price and we add a premium on it. I can understand that some may prefer a solution which can create excess profits. We are in favour of a balanced deal, because what is not balanced is not stable. We want a durable deal. It is a balanced deal principally because it will cut the risk for investors and they will be able to seek a return which is commensurate and reasonable with the risk and it will provide the certainty that if there were excess profits because of the situation of the power market these excess profits will be reattributed to consumers. That is the novelty of the CFD and is a better solution for the customers and therefore for the investors than a premium above the power prices. It is better for the investors as well because I do not think that a deal that is not fair has any chance to last. I think our model is that there should be no winners and losers. Customers may have to win from this reform, investors as well and policy makers to see their policy implemented. That is the important thing about these contracts for difference-fairness and transparency.
Sarwjit Sambhi: I think your question was more about the first phase of administrative process and then moving to auction. So I think as a principle starting with the administrative process is good. We have good experience with that on the RO and I think the long-term intention, once we have more participants in the industry, once we have more projects to offer going to competitive auctioning, is a good long-term goal as well.
Q50 John Robertson: Do you think particularly in your case the strike price for nuclear is sufficiently transparent?
Sarwjit Sambhi: We have to look at the first investment decision, which will be the joint venture that we have with EDF, Hinkley Point. That will be under the investment instrument. The team that is negotiating that is the DECC commercial team. They have laid out a-
Q51 John Robertson: That is not my question. My question is, is it transparent? It was said earlier in the other evidence session that they did not think it was.
Sarwjit Sambhi: First of all, the negotiation has not really started. The first step has been to put in a letter of eligibility. That is very transparent. We had to be clear on why we think we are eligible. We have done that and the next step is being very transparent in how we arrive at a strike price.
Q52 John Robertson: Would you see publishing the established strike price as important?
Sarwjit Sambhi: I think transparency as to how the strike price has been developed. In the case of nuclear it is about the assumptions on what are the costs to build a nuclear plant, what is the risk allocation between the developer and the buyer of the CFD is important.
John McElroy: I would have to say that we haven’t been involved in detailed discussions with the FID enabling team around strike price but certainly in terms of Horizon we still have an interest because we are trying to sell Horizon. It is important that since it is going to be the EDF Centrica project which leads on this that there is sufficient transparency around what is happening. We certainly would not want to see the Horizon project disadvantaged and we would like to see the terms and conditions that are offered, as it were. I think we do need to see openness in the process so that subsequent projects are not disadvantaged.
Vincent de Rivaz: We will see this openness and we will have that transparency.
Q53 John Robertson: We will make sure of that in this Committee, that is for sure. The Climate Change Committee-do you think there is a place for that in this process?
John McElroy: The Climate Change Committee has a very important role as an adviser but I have to say does the Climate Change Committee have competence in terms of how the strike price should be set? I would suggest that that is not a particular area of expertise. Certainly they may have a role in considering what comes out of the strike price setting process and what the implications of that are but I don’t see at first hand what they can contribute to the strike price setting process itself.
Vincent de Rivaz: First of all, the Climate Change Committee has played and is playing and will continue to play a very important role to inform, to educate, to share that, and one of the elements of the strike price issue, the contracts for difference issue is to demonstrate that the strike price is justified and compared to other low carbon technology appears to be affordable and a good deal for the customers. The Climate Change Committee can have all the freedom to enter into the details of the negotiation and to set the framework about what are the costs of the technologies, and it does the job already and it will continue to be a reference point in terms of what are the costs of various alternatives. It will be very important as a framework, as a reference, but not as a key player in the negotiation. The negotiation will be between us as investors-and, in the case of Hinkley Point, us and our partners, Centrica-and the Government. It is with them that we will define the key attributes of the contract for difference-strike price, indexation formula, duration of the contract. It is with them that we will get what we need in terms of protection against change of law. Then this contract will be administered by the tangible counterparty.
Q54 Albert Owen: You mentioned the need for transparency and you assured us that there would be transparency for nuclear. Can I just remind you of what the draft Bill says with regard to the contracts for difference for nuclear, "Ministers will also take a decision on whether those strike prices are value for money and affordable and determine whether or not to award the CFD in light of that analysis." What criteria should the Government set, given it wants this outcome? You said on behalf of the EDF, the customer, the value for the customer is important and for the consumer. So what criteria should they set when determining whether the contract for difference represents value for money?
Vincent de Rivaz: The Government will have to make its own decisions in taking into account what will be the relative costs. I am talking about nuclear but your question could apply to others. You should ask for transparency also for offshore wind farms, for instance.
Q55 Albert Owen: I am sure we are going to come to that. I want to deal with nuclear specifically if you don’t mind.
Vincent de Rivaz: I am saying that transparency should be applied to all alternatives. On the costs, we will have a process by which we can share with the Government the confidence that we have in the costs and in the timetable for construction. It is work in progress, of course, at the moment. We are not there yet but at the moment with the contract for difference, it is the cost element. The basics for the costs and the clarity of the costs will be a key issue for the Government and for others. They will have to consider the strike price and how it fits with the overall affordability agenda, for which the Government has a clear responsibility. We are both accountable. They are and we are, and at the end the priority will be: what is the return that the investor will get for their investment, and is this return commensurate with the nature of the risks they are willing to take? It is all about fairness and transparency and I think this is novel and it is positive. It creates an era of confidence that we need for investing and the confidence that the customers will not pay more than they should.
John McElroy: I would echo a lot of that. I think through the RO banding process we have seen a lot of these issues addressed-making certain that the returns to the investor are fair and reasonable and also making certain that ultimately the price to the consumer is fair and reasonable as well. The Government has to find that balance between delivering its carbon benefits, carbon reduction commitments, the affordability issue and the security of supply. All of that has to be factored in, but ultimately it comes down to the return to the investor and is it a reasonable price for the customer to pay?
Sarwjit Sambhi: I think that the test should be the total cost compared to other low carbon technologies at the highest level, and then specifically on nuclear and the construction costs, satisfying yourselves that a competitive process has been gone through to arrive at the final contractual costs and that there is transparency on that cost build-up. Then finally, an understanding of the cost of capital that is embedded in the total costs and ensuring yourselves that that reflects the risk that the developer is taking.
Vincent de Rivaz: The alternative of having an auction was not workable and the Government was wise to consider that if it had organised an auction it would be unworkable so the alternative to an auction with all the elements that people are seeking-transparency and competitiveness-will be through the process that we have described and the result will be as good as if there was an auction. An auction was simply impossible. We and Centrica are developing the Hinkley Point project. We are investing ahead of the decision hundreds of millions covering the generic design acceptance certificate from the safety authority to make the application for the consent to construct with the IPC, to prepare all our procurement documents and all our engineering tasks. It is not possible to imagine that several developers would do the same thing on the same site with the same project, so the auction is not an option. We have to find a substitute for it and I think through the transparency process we have described we will have it.
Q56 Albert Owen: Okay. You mentioned-if I can go on-that the contract for difference must be legally robust, and in the written evidence from EDF you have some concerns about that as it stands. What can the Government do and what can be achieved with the passage of this Bill that would convince you that we have a legally robust system of contracts for difference?
Vincent de Rivaz: The fact is that we have accepted, as we are all realists, that the full Bill will not be completed before we need to make our final investment decisions. So the contract we are going to negotiate and that we will have in our hands to make the decision before the consent has to be protected against any risk of its being delayed or any other problems. So we are discussing that and there are solutions and we cannot take-
Q57 Albert Owen: Sorry, I need to ask this question. Can you share that with us, because in your opening remarks you said you were very comfortable with the concept of contracts for difference? Yet in your written submission there are a lot of issues here that you are concerned about, the legality of it. This is very important for us to take forward for this draft Bill. What do you find objectionable here or that could be challenged quite easily, on the advice that you have been given?
Vincent de Rivaz: It is compatible to say that the contract for difference in its principles is a good solution, as I have said, while at the same time to be enough for making our final investment decision we need to have a legally robust arrangement when we have this contract. That is what we are working on and we will be very keen to see your Committee pushing in that direction and helping the Government to make-
Q58 Albert Owen: You can be assured of that but we do need something from you, from industry. The whole purpose of this session today is to have your written submission and for us to ask these questions and for you to try and answer them so that we can put pressure on the Government. Certainly the others will have an opinion but I was just asking about the nature of the legal uncertainties and I just wanted some clarification, but I am happy for your colleagues to answer from their perspective.
Sarwjit Sambhi: I think the issue that has been raised is around the payment model on CFDs so I think in general we are aligned on the concept of a Contract for Difference. It is the payment model that we are questioning. The one that was proposed by DECC, the statutory contract model, most of us have sought legal advice and most of the big UK law firms have consensus that the statutory contract model has difficulties in terms of legal-
Q59 Albert Owen: Are you talking about a joint venture here or are you talking about "we" as Centrica?
Sarwjit Sambhi: No, this is Centrica, and some of the other industry participants have seen the same legal advice, and that legal advice says that the statutory contract model is difficult in terms of legal enforcement and in terms of financing with other investors. We have proposed to DECC an alternative model, which is a much simpler bilateral model with a counterparty at the other end that is creditworthy and that is what we are asking for. DECC, in the draft Bill, have acknowledged that they are considering that alternative model. If you are asking if we go down that route what are the key requirements, it is a contract that is legally robust, meaning that there is sufficient change of law protection and that the counterparty at the other end is creditworthy.
Vincent de Rivaz: As has been said, there are two elements. On the counterparty issue I fully agree with what has just been said. We need to have a counterparty that has the power to raise money from all suppliers collectively. They are all going to pay the same amount of money per unit or proportion of the units they are going to ask for in order to honour the contract, so this has to be a tangible counterparty. To be clear the initial proposal was a virtual counterparty. It was not really existing, so I think it should not be too hard for your Committee to convince the Government to move to the alternative solution that we have just described. So that is a key element. In addition to that, there is a second element which is the fact that when we sign the contract for difference within the transitional arrangement framework we clearly need what I have called a robust legal framework so that we can be sure that there will be no prospect of change to the CFD, to the arrangements made, and if there is any event happening detrimental to the investors that we have some form of robust protection against these changes. Obviously when the Royal Assent will be there we will be in a much more comfortable situation, but why we are insisting on the fact that rather than to have the Royal Assent by the end of 2013 the Government should come back to its initial timetable, which was an early 2013 Royal Assent.
John McElroy: I think it is the nature of the statutory contract that is proposed with the multi-party model and it is new in concept. It is not something that we have experience with as an industry, so it raises the sort of questions that have been referred to. Normal contract law may not apply here, because this is a deemed contract on suppliers, I think even the alternative model, a single counterparty model, has its own issues and we have issues around the counterparty, the legal structure, the accounting issues, dispute resolution and there is a lot of work to do on any model to work these through and bottom them out and feel comfortable. I have to say at this stage there are issues both with the model which is embedded in the Bill and there are issues with what DECC is currently considering and we are not in a position where we can say which is the best of those options, but we need to work through them quickly and come to some conclusions.
Q60 Albert Owen: I realise the time factor, but I just wanted to ask while we have Centrica and EDF together here, are you waiting for this reform before making the final decision with Hinkley, in particular Centrica? Is that a condition, or are there other business considerations that you will need to take into account before making that final decision?
Vincent de Rivaz: It is very clear that we will not be able to make our final investment decision as we expect to make it at the end of the year without a contract for difference and without a robust legal framework for this contract through the transitional arrangements to be protected against the risks that an investor would want. It is difficult, and we raise issues, but we do focus on the solutions. We are not here to be negative against the overall Energy Bill at all.
Q61 Albert Owen: I am looking for clarity as well.
Vincent de Rivaz: You have heard different noises from different people raising fundamental issues, and with the reform itself-
Q62 Albert Owen: Sorry, you have been very clear on your answer. The other side of that coin: if this reform would have gone through earlier, would you have made your decision earlier?
Vincent de Rivaz: I think at the moment things are moving in the right direction, on the right path. The momentum is there and has to be maintained. We are working in parallel to make our decisions on all sorts of other issues. As I have said, we have been working to prepare-we submitted it last year-a consent to construct application with the IPC. It is a huge task and we will not get the answer before the end of the year and we need it anyway to make our decisions. We are working parallel with the Office for Nuclear Regulation to get the final certification and it is done in parallel and we are aiming for the end of the year so we are putting in a lot of effort in order to converge for this at the end of the year but this reform is absolutely critical.
Q63 Chair: I appreciate that it is not directly relevant to the Bill but perhaps while you are here, in view of the elections in France on Sunday, would you just like to say whether you consider that with a new President and with the prospect of a Parliamentary majority that that will have any bearing on your decision about investment in nuclear in the UK?
Vincent de Rivaz: Thank you for the question.
Chair: Don’t feel obliged to answer it.
Vincent de Rivaz: No. The energy policy of Britain is decided by the British people and I have not had at all the impression during the Diamond Jubilee period that we are under French Republic law in Britain. That is the first point. Britain decides for Britain, and Britain has decided to have an energy policy which is characterised by a diverse energy mix. Energy efficiency, with gas, clean gas and if possible clean coal and nuclear. That is the policy. I do not think this policy is in any way, shape or form under the critique of anyone in France, this diverse energy mix. The second thing, being specifically nuclear, there is nothing in what the French newly-elected President has said which can be used to say that what we are trying to achieve, to develop new EPRs in Britain, is contrary to his views of nuclear. He has been very clear that the construction of the EPRs in France should go on because it is a third generation, it is the safest technology and it will create opportunities for the French industry abroad-very positive. So I have no doubt if we have a viable project with a compelling business case, that is the decision we will have later this year. And may I take the bigger picture? In both countries we are advocating growth. We are looking for new investment and new investors. We are looking at creating new jobs and opportunities for people and crucially for young people in both countries. This investment would be clearly a massive opportunity for that happening both in Britain and in France. There will be jobs created in France from this investment and there will be jobs created in Britain from this investment. So that is also a common agenda that our two Governments, including the newly-elected Government, are sharing.
Q64 Albert Owen: Sorry, Chair, can I go back to ask Centrica with regards to the EMR, is that the reason why you have held back?
Sarwjit Sambhi: We have been very clear in terms of what is required to make a positive FID decision. One is the business case which requires the investment instrument to be in place, the CFD. The second is all the permitting to be in place, both in terms of planning permission and the design approval and third, making sure that the project team is construction-ready.
Q65 Albert Owen: That is all done. It is just this reform.
Sarwjit Sambhi: Well, no. We still do not have planning approval. We do not have final GDA approval. So there are other things other than the investment instrument.
Vincent de Rivaz: They are other things on which we are making progress, and they are all converging for the end of the year. We know the date when the IPC will decide the consent to construct. It is 21 December. By the way, it illustrates the fact that the reform of the planning system which has been put in place by the previous Government and amended by this Government is working. It is working. It is a huge task to apply, it is a 40,000-page application file with 40,000 pages of appendices, but what is going well is that the timetable is respected, there is a framework, and we are working on that. On the GDA which is very important, and on the nuclear side with the safety authority we are working with the same objective of the end of the year. So the issue is to have all the pieces of the jigsaw coming together at the moment of the final investment decision, and we are not passive, I can tell you-we are extremely active.
Q66 Sir Robert Smith: You have already raised the counterparty’s role and obviously when the Government first looked at this with its assessment of the assumptions in the Bill that it was going to come forward with the Government were going to take the risk as the counterparty and now they are not. What difference has that made to the cost of capital for the project?
Vincent de Rivaz: The cost of capital issue is clearly in the nature of the contract. If we have certainty in the revenues, if we know because we have a fair deal that it would be durable, if this strike price and those revenues are calculated on the basis of our costs and on a fair return on the capital invested, clearly it is a business with a paradigm which is to reduce the risks on all fronts, and therefore the cost of capital. We have to be protected against change of law, clearly. Then the fact that the counterparty is not the Government, not a Government entity, is not the issue, provided that we have negotiated a contract with the Government and there is a protection against change of law. The practicalities of the counterparty are under discussion. If it is an entity or a subsidiary of the national grid we have no problem with that. It is the sense of the solution that we are working on. There are probably other solutions. This one should be workable and we have to work on the details of it and the Government, with your support, have to provide the details. We are very open to the fact that the initial proposal has to be modified. We have a few weeks to make it happen.
John McElroy: I would have to say clearly the original consultation and what was set out in that with regards to the Contract for Difference was quite important in the sense that the Government as the counterparty underwriting the contract in some way and the nature of the risks associated with these large low carbon projects, that we saw Government’s role in this as important in terms of reducing the cost of capital. Now that Government seems to be trying to push its involvement in these contracts away from itself, partly driven by Treasury constraints, partly driven by the State aid rules, inevitably that claimed cost of capital benefit is not there. I think it is very hard to say at the moment just quite what the outcome will be in terms of the cost of capital and whether it will be any better than it is under the current RO arrangements, for instance. We will have to wait and see.
Q67 Sir Robert Smith: You would share the view that a single counterparty is probably a necessary improvement on the Bill?
John McElroy: It comes back to a single counterparty and all the issues that go with that, so early days.
Q68 Sir Robert Smith: Can you see a multiple one working?
John McElroy: I think I have already said that there is still quite a long way to go through to work through the detail. I think there is a possibility that both could work but the devil is in the detail.
Sarwjit Sambhi: I think we are muddling up the payment model on CFDs with the cost of capital benefit of a CFD. The original impact assessment in terms of the cost of capital benefit arose from taking away the wholesale market power risk from the developer or investor. That, under the CFD arrangement, whether it is a statutory contract model or a bilateral, still stands. The issue we have with the statutory contract model is its legal enforceability.
Q69 Sir Robert Smith: If there is doubt about legal enforceability?
Sarwjit Sambhi: Then it becomes uninvestable.
Vincent de Rivaz: We are discussing all of that with investors, people in the City and so on. When we say that our two focuses are to reduce risks and the construction costs and the timetable of the construction, which is the job of the investor, our job, and in parallel reduce the risk on the revenues with this visibility for the very long term on how much we will get in terms of revenues, it strikes a chord with the people who are realising that it is a business model paradigm change which indirectly reduces the risks and therefore the cost of capital. That is the heart of it, and a benefit for the customers and for the investors, as I have said. The counterparty issue is a technical issue that can be fixed. The important point is the CFD and protection in the long term against any change of law.
Q70 Sir Robert Smith: The previous witnesses were all quite exercised about the banding review sending signals that might worry investors about slippage of timetables and decision-making not being evidence-based. Is that something that you would share about the current banding review?
John McElroy: I think we have seen a number of things with the changes to the feed-in tariffs arrangements and the delays around the banding review and clearly this links into the levy control framework as well. Clearly how the banding review plays out and what we see in the final numbers will I think give us some indication as to just how big a problem we have in that area.
Sarwjit Sambhi: I think the delay in the banding review has a big impact. I think it does inadvertently cause a hiatus in investment and in addition with people making up what might be in the banding review that creates further investment uncertainty.
Vincent de Rivaz: I think we must be clear that there are two issues which are different. One is we are all advocating for things going as fast as possible because we need to make our decisions. The second issue is: is the CFD a good solution for what we want in the long term? We are hearing people would prefer to be in a situation where we keep the current system which can provide them with profits which is not in a sense favourable to customers because it is above the power price on the market. As I have said this contract for difference adds something to that which is if there are excess profits they are shared and reattributed to customers and we can expect that some people would prefer to keep the status quo regarding this approach to their profits than to have a situation which is the one the CFD would provide. That is a comment that I am making and I am not in their shoes to understand exactly what they have in mind when they are that critical on the CFD but it is an assumption I am making.
Q71 Laura Sandys: Coming on to this issue or examining further this issue about the hiatus between now and when CFDs in 2014 come into place, when DECC talks about things such as forms of comfort, what do you think are necessary to attract or to ensure that your large scale investments come on line and they are not held back by the lack of regulatory framework? Are you in any discussions at the moment with DECC on any of these?
Sarwjit Sambhi: It depends on which technology, as I think Ian in the previous session mentioned. On offshore wind, we have the RO to do and providing the banding review comes out as soon as possible then we can invest in renewable technology as covered under the RO. On nuclear it is different. If the question is: what is required to make that positive FID decision in terms of the investment instrument under EMR so the CFD, then the questions to be asked are is it a robust contract, i.e. does it have change of law protection? Is the counterparty sitting on the other side of the CFD creditworthy and do you have sufficient political risk protection? So that is what is required and that is what we are trying to arrive at through the negotiation with the DECC commercial team or the FID enabling team.
John McElroy: I will just make one comment in this area regarding the investment instruments. What surprises us to some extent around what is in the draft Bill is that the powers are significantly less restrictive around the investment instruments than those that effectively relate to the CFD and I think that is something that is worth noting.
Q72 Laura Sandys: What do you mean? You mean that this hiatus period is much more flexible?
John McElroy: It seems to have quite broad powers and to go beyond what we would expect to see in the CFD to offer comfort. I mean I think from our perspective I would-
Q73 Laura Sandys: So in some ways there is an opportunity here for a dash for investment?
John McElroy: I think there is a lot more that will drive investment decisions but I would echo what has been said on my left in the sense that any investor who is going to go ahead in this period will need certainty on the counterparty, on the legal structure, on the strike price, particularly on the terms and conditions. I think state aid clearance is quite an important issue with regards to this as well, that it comes back to the creditworthiness of the counterparty and the risk transferred between the developer and the counterparty as well.
Q74 Laura Sandys: Just taking up on this issue of state aid, there are divergent views within the industry about whether some who believe that it might fall under state aid and others that do not. In many ways the industry wants it both ways. On the one hand you are looking at wanting to have the state as the counterparty, because that reduces the cost of capital and creates a much more bankable investment. On the other hand we have the issue about state aid and I don’t know how you see these-
John McElroy: State aid is not straightforward. It is not a question of yes or no, it is also, is it allowable state aid as well? So it is complex in that regard.
Q75 Laura Sandys: One of our concerns is that it has not been properly tested enough by DECC, not necessarily by the industry, to come to any clarity on whether it will fall under state aid and I would urge our Committee to be-
John McElroy: We would like to see DECC testing this a lot earlier with the Commission and starting exploratory discussions. I don’t know how far they have reached on those but given that even on a good day it is going to take you six to nine months to get state aid clearance, and if there is any difficulty or concerns that may not be compatible it could take you up to two years. That becomes quite critical in the timescale and, therefore, DECC needs to start working on that now.
Sarwjit Sambhi: We start with the assumption that clearance will be required and therefore we are working both the DECC commercial team and the EMR team at DECC are focused into building into the timeline sufficient time to get state aid clearance.
Vincent de Rivaz: We need to get this clearance but we should not be the hostage of this issue with constant preoccupation about state aid to the point that it becomes a distraction. We have to be clear that everything that is proposed is fair, and there is no element in the proposal which could be seen as state aid. It is not because there is a contract for difference we provide to customers for a better deal which protects customers in the long term that it is a state aid. The fact that there is a contract for difference means that whoever makes excess profit would have to reattribute that to the customers. I think it is difficult to deduce from that that there is a state aid issue. The policy of the Government in Britain is consistent with the European policy, environmental policy, competition policy and so on. Indeed we have to clear up this issue but not to the point where we are say every morning there is such an issue that it delays it by a few months then we are creating a problem of our own making. I think we need to be very clear. I am convinced that the idea that there is a state aid issue, that there is a subsidy issue does not reflect the facts.
Q76 Sir Robert Smith: With the very fact that without the Bill these plants were not going to go ahead and with the Bill they are, the assumption must be that the Bill enables investment that would otherwise not happen. So it must be a positive for the investor?
Vincent de Rivaz: Yes, but a positive decision for investors does not mean state aid. Is the state going to abdicate its responsibility to provide secure, affordable, low carbon technology when it is needed? Being accountable does not mean giving undue aid to the investors. It is just to take responsibility to deliver the policy and if the framework of today does not work does not mean that a new framework is state aid or is implying subsidy. It is a matter of responsibility and accountability in the first place. We should not abdicate our responsibilities and we all need to be accountable.
Q77 Dr Whitehead: Do you think there is a potential role for demand reduction in EMR and particularly in the context of the proposals for capacity payments, capacity markets, and do you consider that the-shall we say-effort that has so far been put into looking at how demand side measures might come into EMR has been sufficient?
Sarwjit Sambhi: Our assumption, and I think DECC’s assumption, is that demand side response will participate in the capacity market. The question is how well it will participate and that is a level of detail that DECC have not yet defined but I think everybody starts from the assumption that they will participate. I think it is a great opportunity to have innovation in the electricity market. Ian in the previous session talked about the need to aggregate load and I can see a market develop for these aggregator services that could take very small loads in domestic households and really aggregate them up to something big, 200 megawatts, 300 megawatts. That is a chunky piece of capacity that could participate in the capacity market.
John McElroy: One of our concerns, really around EMR is the link between the supply and the demand side. To some extent that DECC has come rather late in the day to looking at how all of this is joined up and how the two sides interact. What is absolutely critical is, the price at the interface and having the right price signals that can then encourage the demand side to respond. We are investing £11 billion, £12 billion in smart metering, which is all about facilitating demand side engagement, and potentially demand side response. We have to be careful about this. We haven’t really talked about how Ofgem interacts with EMR, but the cash-out review is very important in terms of the whole issue of how that interrelates with the capacity mechanism and what it does at the interface between the supply and the demand side. We are keen to see whatever comes out of this being economically efficient and delivering the best value for the consumer. There are a lot of issues around how you design the demand side participation in a capacity mechanism, ensuring that you actually get something which is economically efficient and gives value for money to consumers.
Q78 Dr Whitehead: As we believe, you find room in capacity market measures for demand side and demand regulation, demand reduction measures. Where does that leave the question of the estimate of what capacity will be, in order to determine how the capacity market is going to work in the first place? Doesn’t that appear to be rather a difficult question?
Sarwjit Sambhi: That is the question of how will the system be administered. That is a complex administration. You only have to look at markets in North America to understand the level of complexity. But it can be done. In a number of North American markets there is demand side response, and users, especially large industrial users, do participate in capacity markets.
Q79 Dr Whitehead: I understand that point. My point was slightly different, which is that we have heard that commissioning of new gas plants may, in the light of more recent estimates about the capacity need for the system, almost have closed the energy gap in terms of replacement of plants going out of commission. We then, perhaps, have demand reduction measures in the capacity payment mechanism. Doesn’t that overthrow the need for capacity payment mechanism for capacity?
John McElroy: Well, I have to say that RWE is not a lover of capacity mechanisms. Our position has been that we don’t believe that the case for a capacity mechanism has been made. We believe that efficient price signals in the market can deliver. We have seen quite a lot of investment in CCGTs over the last five years. Predicting the future, in terms of capacity, is not that easy and five years out you can get it wrong. We have a situation at the moment where demand has fallen, where we are now looking at nuclear life extension. It is a very different world from where we were five years ago. Our view is that a capacity mechanism isn’t needed, but we have almost driven ourselves to a position where we have to get on, and we have to provide the clarity and deliver it, because everyone is sitting on their hands at the moment and will not invest until such time as the capacity mechanism is detailed. But the issue, is quite what you are trying to incentivise and that is the problem that DECC is struggling with at the moment, in terms of the fundamental design.
Vincent de Rivaz: We are in favour of the Government decision regarding the capacity market. We believe that this capacity market should reward capacity providers based on the availability during a period where they are needed by the system. It is true that we are unlikely as a country to face capacity shortage, indeed, until early 2020. But, we should not forget that there will be fossil plants which will be closed. We couldn’t expect that the constraints, which are leading a lot of coal-fired power stations to be closed, will be lifted. We are, therefore, thinking that it is important that the Government create the conditions for the first auctions to be made in 2015, so that it works in time for 2020-ish, and the mechanism will help the market to deliver.
Q80 Dr Whitehead: Could I ask for the record whether you concur with the view of the panel that we heard from earlier today concerning the role of the levy control framework, and the role that might play, in terms of the investment that is needed, and indeed, some of the decisions that may be taken on capacity payments, or could be taken on capacity payments as a result of those investment decisions? Do you consider that the levy control framework as it stands, is likely to cause difficulties for obtaining investment decision, contractual difference and possibly what capacity payments might be required to facilitate those investment decisions?
John McElroy: Yes, I would have to say, I would echo some of the comments that were made. Large low carbon projects are pretty chunky by nature-despite when they are going to arrive-and they could arrive with two, three, or four in one year. Therefore, there is real concern for project developers. It would take maybe four plus years to get to a final investment decision, and are the funds going to be there, in terms of the levy, to allow those projects to go ahead. It is not just the issues within one single comprehensive spending review. Actually, if you are looking four or five years out that actually infers that you need to have some knowledge of what is in the next comprehensive spending review as well. I think there is a real need to provide some clarity around how Government is going to manage the ceiling on the levies going forward. There is the model that, I think, Keith Anderson put forward, which was having some means to be able to bank and borrow between years within a spending review period. But, equally we have got to manage the cliff edge at the end of the comprehensive spending review period as well and make certain that we don’t put project developers off. Because the danger is that sort of risk and they will say, "Well, we’ll develop projects elsewhere."
Sarwjit Sambhi: The concept of a levy control framework is well understood, in terms of the need to cap the total cost. The practical issue that many of us see is: how do you take out of the pot? If you are just taking out the top-up payment from the wholesale price, that is volatile, therefore, the size of the pot will be volatile as well.
Q81 Dr Whitehead: But the cap is not?
Vincent de Rivaz: It is really a matter for the Government to decide. Clearly the drafting of the Bill is a product of work across all Departments of the Government, including the Treasury, BIS and obviously DECC. It is for the Government to decide and we have no reason to believe that the reforms will be impeded by the levy cap. We have to be confident that the Government will be consistent in not making decisions that are counter to the main direction you want to follow.
Q82 Dr Whitehead: Forgive me, but is that not perhaps related to the fact that you may well clean up on CFDs and the letters of comfort that will come in early, which will then feed into the levy cap, and may well cause parts of that levy cap to be, as it were, pre-allocated prior to anybody else turning up to get their CFDs? That is good news for EDF, isn’t it, but perhaps rather bad news for others?
Vincent de Rivaz: I am not sure I understand what you mean there. Sorry.
Dr Whitehead: Well, if you have a letter of comfort prior to the CFDs within the levy cap-
Vincent de Rivaz: We are not asking for letters of comfort.
Sarwjit Sambhi: We could go back to the question that was asked earlier-how do we ensure that it is value for money? It is the comparison of, is the investment that is being enabled competitive in the world of low carbon generation. Have the costs that have been put forward, have they been arrived at in a competitive process and is there transparency on those costs? If you can tick every one of those boxes then it should have an early dip on the pot in the levy framework.
Q83 Dr Whitehead: But, bearing in mind the lumpiness of investment, if particular elements of investment coming on stream push against the walls of that levy cap, is there an easy solution to that?
Sarwjit Sambhi: Well remember it is not just about the levy control framework. It will also cover existing mechanisms, such as the RO. So, there will continue to be renewable projects that will get to the pot before something that gets an early CFD through the investment instrument.
Q84 Dr Whitehead: Presumably a levy cap would have to incorporate both continuing RO and the effects of CFD within the next spending round?
Sarwjit Sambhi: Yes, that is our assumption.
Q85 Dr Whitehead: When you say that is your assumption, you do not know?
Sarwjit Sambhi: That is our assumption. Well, I think how the levy control framework operates is not transparent to the industry.
Q86 Sir Robert Smith: Is that a bad thing?
John McElroy: I think, given the scale of the investments that we are talking about, we need a lot more transparency and predictability around that. I think it is important for us that whatever happens does not end up sort of picking winners or choosing technologies. I mean, ultimately, value to the consumer is important, and that is partly what the levy cap is there to protect. But, the last thing we want to see is it deterring people developing projects in the UK.
Q87 Dan Byles: We had a brief discussion with the previous panel about emission performance standards, and the Secretary of State’s power to exempt the generators matter in times of emergency. The consensus seemed to be that, as long as it was an emergency power, that wasn’t a problem. Would you agree?
Sarwjit Sambhi: There wasn’t consensus, I think Ian disagreed with that, and I agree with Ian that it is not necessary. If you have capacity payments in place where, coming back to Alan’s question, somebody is looking out for the required reserve margin that is required in the system, then you should not need to have the emergency measure. The 450 grams applies to a whole year. If it is just for a short period of time the generator can generate in excess of 450 for that period of time.
John McElroy: Yes, I mean, whist I hear the comment, there are unforeseen circumstances which can lead to specific emergency conditions. I mean, the Secretary of State already has considerable powers, in terms of emergency provisions with regard to other environmental standards. But given-as the point that is being made-that the emissions performance standard is essentially an annual cap, I think to a large extent that should go towards mitigating this. People have run right all the way up to the line.
Q88 Dan Byles: Things have gone very badly wrong if you needed to do it, in effect?
John McElroy: But in extremis, in emergency, under well defined conditions, I don’t see that there is a particular problem.
Vincent de Rivaz: I think the concept is fine. I think we support the concept of an emissions performance standard.
Q89 Dan Byles: It also talks about him being able to exempt parts of EPS under other circumstances, in particular around CCS. In fact, this has been quite controversial. The suggestion is that the Government can exempt projects that form part of the UK CCS programme on a case by case basis. For this purpose they define that as, "A generating station at which carbon capture and storage technology is, or is to be, or has been used in commercial electricity generation for the purposes of, or in connection with, a CCS demonstration project". Some people suggested that seems very vague. I am curious to know what your thoughts are on that.
John McElroy: Okay, you could say it was very vague, but demonstration projects for CCS come in various sizes, various technologies. They are quite project specific. It is inevitable that the powers have to be reasonably vague at this stage. What would be more important is that you have set up the appropriate criteria, in terms of any relaxation of the EPS, such that that there is fair play, and there isn’t abuse of the rules.
Q90 Dan Byles: Do you think the Bill should, for example, lay out a figure in relation to the proportion of emissions that would need to be captured before it might fall into that category?
Sarwjit Sambhi: Coming back to your own question, I think it is too vague. I think it does create an opportunity for mischief or just, for example, having a very small amount of carbon captured. Therefore, one way to mitigate that is having a minimum requirement.
Q91 Dan Byles: Do you think there is also a danger that a plant simply has to be part of a CCS demonstration programme, but it does not have to be part of a successful CCS demonstration programme. I mean, we could actually end up with, for example, new unabated coal-fired power stations that tried and failed with capture and storage but they’ve been exempt from EPS going forward.
Sarwjit Sambhi: Then I think the plant should close down.
John McElroy: I would have to say that, in terms of whatever is in the contract that the Government awards, in terms of the CCS competition, needs to make certain that the right outcomes are there.
Vincent de Rivaz: It was said earlier that this draft Bill is complex, and I said it was not so much complex but comprehensive. The emission performance standard is part of this holistic approach. I think the concept is right. Now, we have to be sensible in the way we apply it, for sure, but we have to be logical at the same time if we want to decarbonise generation. This emission performance standard is one of the tools to monitor that we achieve that, and that we need to reduce as much as possible the exemptions to this order.
Q92 Dan Byles: What about the grandfathering of plants under the EPS? There has been some criticism of grandfathering, gas plants, for example, out to 2045. Do you think that that is a sensible move that the Energy Bill is going to bring in?
Sarwjit Sambhi: I think without that grandfathering you won’t get the investment in new gas fire generation. But, I think that this general consensus will be needed at the back end of this decade. So, that time horizon covers the investment period for a new plant.
John McElroy: I would agree with that point entirely. The situation is that we introduced the EPS in 2014, and we are going to review it in 2015. Then the issue of grandfathering comes back up again. You know, there is a window of opportunity, shall we say, but we don’t quite know what is on the other side of the review. It will create some sort of hiatus two or three years down the line.
Q93 Dan Byles: Is there a danger that we could end up with more gas online as base load, than was originally intended, rather than a peaking point?
Sarwjit Sambhi: I think that depends on the success of the other instruments that are being put in place. You know, if CFDs provide an attractive return for the investor, then the UK should end up with a generation mix that it originally envisaged.
John McElroy: Gas has a key role in the transition to low carbon, and we do need some CCGTs in that early period. What happens in terms of its utilisation through life is another issue. You know, I would say for that reason we need the certainty around the emissions performance standard to make certain that we get that plant on the system.
Q94 Sir Robert Smith: Does the emissions trading agreement not working properly not send a signal?
John McElroy: I mean you could-we are going to have an emissions performance standard, and I have answered the questions in that context. I mean, quite honestly the ETS should cap emissions. All that the EPS essentially does here is limit the emissions in the UK and they will all go up elsewhere.
Vincent de Rivaz: By the way, your point is confirming the necessity of carbon price floor. The EPS scheme, does not deliver price. I think this was the right decision to introduce this current price floor..
Q95 Sir Robert Smith: The same argument applies. If you have a floor in one country, and when you are part of a single emission trading market, you are just subsidising your neighbours.
Vincent de Rivaz: The Government has, firstly, taken the right decision to say that CO2, has costs, which should be priced and the price that is at level, the people that have designed the emission trading scheme in the first place thought it should be, and delivering it for 20 years, to 2020 and 2030 is exactly where people having designed the scheme thought it would be. So, there is no initial cost. I will just finish. Secondly, the Government has taken at the same time, some specific decisions for some large users of electricity to compensate the impact in the short term. We have to hope that eventually the carbon price floor will be at the level it should be if the market mechanism was working. We believe that the market should be confident the market will deliver. At the moment, it does not. But there is constant solution with the floor. If the price are going up the floor will not apply. Without it, we have to be clear that-and we are operating coal-fired power plants, so we are going to pay our share of it. There is no doubt about that. But, in a sense, we should not encourage the polluters to pollute. A very low carbon price is a sort of windfall profit for the polluters.
John McElroy: My view is that if we are going to anything around carbon and carbon price it should be done at European level and not at UK level. I think talking about windfalls for the lower carbon prices, when there are benefits for nuclear operators from carbon floor price, is a little bit rich.
Vincent de Rivaz: You mean you are promoting the current price of the floor at the European level?
John McElroy: I was saying that-
Vincent de Rivaz: Did you properly explain that? We need to be consistent.
John McElroy: What we are saying is that you should control carbon price at the European level through the cap on the EUETS, and that is the best way forward. But, I mean, I think the point is that given the structure of the CFD, the carbon floor price has very little bearing on investment in low carbon technology. It is purely a penalty on fossil plant and a higher cost for the consumer and revenue for the Exchequer. It does not actually deliver low carbon.
Chair: Thank you very much. To just make one point at the end, which we have made to the previous panel, the more the industry has points of agreement about how the Bill should be amended, the more likely those are to be accepted, in my view. It is relatively easy for ministers to refuse to modify their proposal if they can point to people who take different views. I don’t know, maybe it is difficult to do that. We are very grateful to you for your time, if there are any additional points you want to make to us, do feel free to write to us. This is going to go on for the next three weeks, these evidence sessions. But we appreciate the time you have given us this morning and we hope that we will be able to come up with a report that actually, at least, addresses some of the concerns which you have expressed.