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Energy and Climate Change Committee - Minutes of EvidenceHC 275
Taken before the Energy and Climate Change Committee
on Tuesday 19 June 2012
Mr Tim Yeo (Chair)
Dr Phillip Lee
Sir Robert Smith
Dr Alan Whitehead
Examination of Witnesses
Witnesses: Dr David Kennedy, Chief Executive, Committee on Climate Change, Professor Catherine Mitchell, Professor of Energy Policy, University of Exeter, Professor David Newbery, Emeritus Professor of Economics, University of Cambridge, and Simon Skillings, Senior Associate, E3G, gave evidence.
Q96 Chair: Good morning. Thank you very much for coming in. You will be aware that there is a lot of interest in both this session and the work that the Committee is doing on the Bill generally. I apologise in advance for the fact that we are extremely tight for time. We have been required by the Government to complete this scrutiny in five weeks. Parliament is normally allowed 12 weeks, so we are working at two-and-a-half times the pace that we would normally do, which means, I am afraid, that our witness sessions are even more compressed than usual; we have an hour to get the best out of the four of you. Thank you for coming in. We will do what we can.
Could I start with a general question about whether you think the Bill is actually needed, or whether we couldn’t have done all this by incremental changes to the existing arrangements? Would that have perhaps been a simpler way of delivering the aims of greener, secure electricity at the most affordable price?
Professor Newbery: The answer is that the core of the Bill is the long-term contracts, and in the past we have had NFFO contracts, so one can imagine setting up a public sector investment bank that is willing to offer long-term contracts, in which case perhaps you didn’t need the rest of it, but we are where we are. The Bill allows these contracts in some form to be implemented.
Dr Kennedy: We think the Bill was needed, given that we recommended the need for electricity market reform in the first place. We have highlighted the importance of decarbonising the power sector in the context of meeting carbon budgets and the 2050 target. We presented an analysis back in 2009 that said that if we stick with the current arrangements we wouldn’t expect to decarbonise the power sector. We would expect to continue to invest predominantly in unabated gas-fired generation, which would be a bad thing, and that the way forward is to offer investors long-term contracts that give you security over your revenue, which says to investors, "If you can build me a plant, we will provide a market for it. We will give you stable revenue". That is the best way to bring forward low-carbon investment at least cost to the consumer.
Professor Mitchell: I am 50:50. I think we need to have a new Energy Act that is about the future and taking the current energy system to the future. What we currently have in the Draft Energy bill is not about getting a smart, flexible, interconnected, whole system approach at all, and we do need to have that. But as it stands, unless there are fundamental changes to it, I would scrap it. I think for the other 50% there is quite a bit that we can do with what we had before, I think what we should do is scrap the CfD anyway; we should have a fixed feed-in tariff, which we could do from previous legislation; we should have an analogous mechanism that is for energy efficiency, which I think you can do from previous legislation. We do need to have somewhere legislation for decarbonisation, which the CCC calls for, but which is currently not in the Draft Bill . So, basically, I think it is a very bad idea to carry on with CfD as it currently is, but if we stick with what we have, we are still in the problem that we are not, as a country, getting ourselves organised to have the kind of interconnected, forward looking energy system that we need if we really want to get those opportunities for Britain.
Simon Skillings: I would agree with the premise that we need an Energy Bill if we are going to deliver the policy objectives in a remotely efficient and balanced way. I think the challenge that everyone faces is the "when" question. How long do we take to get it right? What is the penalty for letting it stagger on for a few years? Clearly there is a cost penalty. The longer it goes on, the more costly and the more difficult it is, and yet these are very complicated matters that will take time to sort out. I am of the view that the current draft is not perhaps very close to where we need to be to meet those objectives. So that is the challenge: how long do we spend getting it right against the penalty of delaying and increasing the cost of delivery?
Q97 Chair: There is a bit of diversity there. It is tempting to try to pursue it in more detail, but I think we have to move on quickly. Do you think that the proposals as they stand will reduce investor risk and therefore cut the cost of capital or not?
Dr Kennedy: I think they could do. Again, the principle that we should have long-term contracts that provide revenue security to investors is the right way forward. I think what is in the Bill is very high level, and so I don’t think we can look at the Bill now and say this will bring down the cost of capital. It comes down to whether we can get a legally robust form of the contract, and then whether we get all the details right, and whether we can get the risk allocation right for investors. None of that is settled yet. That will be the test of whether this is successful-whether it brings down the cost of capital and whether it brings forward the investments that we need. So there is still a lot to do. As for whether you deal with this in the primary legislation, I think some of it you do. As to whether some of it has to be dealt with through the implementing arrangements, I think that is the case as well.
Simon Skillings: It seems to me that again the answer "It may do" is right, but the idea that somehow or other a single instrument as set out in the Bill can reduce investment costs for all investors at all times, investing in all technologies, seems to me beyond preposterous. Different instruments will be appropriate at different times for different investors in different circumstances, and to try to constrain the instruments cannot, in my mind, lead to efficiency in bringing forward investment.
Professor Mitchell: I would say no, it won’t bring down the cost of capital because of the increased risk. You have increased risk for renewables from the proposed CfD mechanism and certainly from the fixed feed-in tariff. I don’t feel that nuclear is where my expertise is, but from what I understand the costs that are being discussed in terms of nuclear are getting higher and higher because of concerns about who the counter-party is and so forth, and that is leading to greater risk again. So I would say no.
Chair: We might return to some of these in a moment.
Q98 Sir Robert Smith: If we could, let’s just explore a bit more. There is a bit of a range of views on the Contract for Difference. I think, David Kennedy, you are reasonably keen on the Contract for Difference.
Dr Kennedy: We are keen on the principle of long-term contracts that provide revenue security. There are different contract forms. When we made the recommendation at the end of 2010, we said it could be Power Purchase Agreements. They are pretty standard around the world. They give you a secure revenue flow. You can design Contracts for Difference to be pretty much the same as a Power Purchase Agreement. You can design a Contract for Difference to be the same as a feed-in tariff, with a legal underpinning. It comes down again to how you design the Contracts for Difference, rather than the principle of having them in the first place. I think that is where a lot of the uncertainty is, it is where a lot of the pushback is, because we haven’t seen any of the details. I am sympathetic to Catherine, who says we are going from a system that is well understood by investors to one where it is not well understood because it is not well laid out at the moment. The challenge then is to put in place the detail very quickly, to win back the confidence of the investors and to avoid a hiatus in investment. I think it is to play for. I think you can do that with a Contract for Difference. In the case of renewables, I would make it much like a feed-in tariff; in the case of nuclear, maybe not as much so, but again that remains to be done, and until it is done I don’t think we will have investor confidence.
Professor Newbery: Looking on the positive side, the Bill, as I understand it, does allow for some flexibility in the design of Contracts for Difference. I am looking at paragraph 54 of the preamble; the system operator is supposed to go ahead and design these, subject to your approval. If you tell them to get on with it and propose sensible-looking contracts for different technologies, some of this uncertainty might be resolved fairly soon.
Simon Skillings: I think it is possible to reconcile the drafting with a few amendments, which are perhaps minor in size but significant in effect, that can create a more general contract form that, for renewable investors, replicates a feed-in tariff. So we shouldn’t think that the Bill cannot be saved, but I would certainly concur that it has to be made more flexible in contract form.
Q99 Sir Robert Smith: Professor Mitchell?
Professor Mitchell: It is just the continuation of the last 20 years. That would be what it is. What I really feel about this Bill is that it is just playing catch-up in that the focus is supporting low carbon generation rather than promoting an efficient whole energy system. We started off with a mechanism 20 years ago, at the same time as Germany and the Netherlands. We have not been successful. We have changed it twice. We are having this Bill, which is a kind of a catch-up, just to start getting low-carbon capacity going, and that at best will not be successful and it may be a complete failure. Meanwhile other countries that have had successful mechanisms to support low carbon generation for the last 20 years are at the next stage of developing efficient whole systems-interconnected, flexible energy systems. So they are going to be doing that for the next 20 years, and we are just going to be playing catch-up again. I would say, yes, you can tweak it. I don’t know what you do with nuclear, but with the CfDs for renewables there are so many details that have not been worked out that it is almost impossible to say what the effect of it is going to be on renewables.
Q100 Sir Robert Smith: Do you agree with SSE that they could maybe keep open the option of a premium FiT?
Professor Mitchell: I don’t like premium FiTs because-and there is a lot of evidence about this from other countries-the incentive for generators is just to get a higher and higher electricity price so that they get pad more through the premium FiT, and so what happens is that all those extra bits that add on to the electricity price tend to be supported by those who want to be paid more through the premium FiT with a bigger payment. I much prefer fixed feed-in tariffs, which you can degress quickly. You can start off, as, for example, with PV, which was very expensive, but you can quickly reduce down the price paid to generators, so that you are only a few per cent. over the traditional electricity price.
Dr Kennedy: There will be an overlap between the renewables obligation and the electricity market reform, so they will both be in place for a period. I think what you will find if we get the electricity market reform right-and that means designing it to give renewables something equivalent to a feed-in tariff-is that people choose to go with the EMR and not with the renewables obligation support mechanism.
Q101 Sir Robert Smith: Do we need to extend the life of the renewables obligation to give a better overlap?
Professor Mitchell: It depends what it is you are putting in place, doesn’t it?
Dr Kennedy: That would have to be plan B, I think, but plan A is to get this set of arrangements right to make them such that they bring forward investment in renewables, and then you don’t need to extend the renewables obligation. I think if we get it wrong, if we delay with the legislation, if we delay with the implementing arrangements or if we don’t get the implementing arrangements right so that we have too much risk with the investor, you may then want to extend the renewables obligation, but that would be a bad thing. We have the opportunity to get EMR right.
Professor Mitchell: My preference is to have a straightforward fixed feed-in tariff, but if you don’t want to have it open, as the German mechanism is, then you can cap it-have percentages each year until you hit your 15% of energy supply as required through the EU Directive. So you can know that you are going to meet your legally required target, but at the same time you know that probably it is going to be a whole lot cheaper than the current CfD mechanism, because it does reduce risk and you are going to bring in far more new entrants as well.
Q102 Sir Robert Smith: The mechanism itself alters the cost of capital by giving an indication of the kind of returns that people can get from their investment and how long-term they are, but there seems to be a lot of concern by the industry that the actual counter-party they are contracting with is going to undermine any savings because of the risks of having multiple parties to the contract. Is that something any of you have a view on?
Professor Newbery: It is critical that you have a credible counter-party and I cannot understand why, certainly for renewables where there is no state aid issue, that counter-party can’t be the Government, because the Government can borrow at the moment at unbelievably low real interest rates.
Dr Kennedy: Having worked at the World Bank on the kind of investments we hope to mobilise here, it is pretty standard that with a Power Purchase Agreement, for example, the Government would stand behind that one way or another through a guarantee or a partial risk guarantee or a support agreement, and that would be helpful here. Whether you can do it within the Act itself and have a statutory contract that doesn’t have the Government standing behind is one for the lawyers, which they are all working on at the moment.
Q103 Dr Lee: One question: if it is cheaper for the Government to borrow money at the moment on the markets, why are we persisting with all this complexity over FiTs and CfDs and all this other nonsense that is keeping lawyers busy? Why don’t we decide what our energy policy is, go and borrow the money, build the things and then sell them back to the market? Isn’t that cheap?
Professor Newbery: It is cheap. If you convince the Treasury, it would be a straightforward thing to do.
Q104 Dr Lee: It is cheaper. They are busy trying to run away from liability on social care at the moment, Professor, for the same reason. They are worried about their long-term liabilities with the CfDs. Why don’t they just go and borrow the money, decide what their energy policy is, build the things and sell them back to the market?
Professor Newbery: It makes sense. It also, with a proper public sector balance sheet where you have assets as well as liabilities, would be a sustainable economic policy for growth and it should be done.
Professor Mitchell: They are doing it because they want to support nuclear. If they didn’t have this desire to support nuclear come what may and try to get out of the Minister saying there will be no public subsidy and get around State Aid rules, life would be a lot easier. Because the Minister has said no public subsidy and they want to have nuclear, they have got themselves into this complete pickle. If one were to scrap CfD, say, "Okay, you can have nuclear but it is a mature technology and build it within the marketplace", which of course won’t happen, then you could set about having a sensible energy policy whereby you brought forward your renewable energy. The subsidy that would have to be paid, that would be incredibly difficult to work out for nuclear, could go into energy efficiency to make our houses much more efficient and make the issues around affordability much better. That would be a very sensible policy.
Q105 Dr Lee: So why aren’t we doing this? I am a bit confused. We are all wading through documentation as fast as we can at the moment and I keep looking at it and saying, "Why don’t we just say 10% nuclear, 10% renewables, 10%-just do it and then sell them back as an ongoing concern?" Indeed, if it is more expensive to maintain those things, take the hit on what you are selling it for, in relation to how much it has cost, instead of jumping through a series of complicated hoops in an attempt to try to hoodwink people as to where the subsidy is going.
Professor Newbery: That is the whole point of public private initiatives and everything else. It is hoodwinking the public, getting it off the public-sector balance sheet, because the balance sheet isn’t a balance sheet because it doesn’t have the assets there. We have been in this mess for the last 20 years.
Q106 Chair: Is this problem really one of Treasury theology rather than anything else?
Professor Newbery: Yes.
Q107 Chair: Do you think it would be helpful for this Committee to hear from the Treasury Minister about this?
Professor Newbery: Yes.
Q108 John Robertson: We have heard that awarding CfDs at the point of final investment decision will increase the risk for project developers who won’t be certain that a project will be able to get a contract. Do you agree with that, and, if you do, how do you think we could solve the problem?
Simon Skillings: It is to do with the fact that the CfD provides certainty over a difference. It doesn’t provide certainty over the base income. The investor still has to sell the power output to market and different people have different views as to how easy that is or is not. My view is we don’t know, and if we don’t know, a properly risk-managed Bill puts in place provisions that enable us to cope with a situation in which investors find it difficult. The easiest way to deal with that is to include provisions to allow suppliers to be charged on the basis of the output as well as a difference basis, so in other words you mimic a fixed FiT, which I think everyone else has said.
Professor Newbery: I detect that there is some concern that the Treasury might say, "Oh dear, we’re not meeting our fiscal requirements this year so you can’t have the money to pay for the FiTs". If you think that that might happen two or three years down the line at the point at which you are about to get the contract, you might be very nervous. It does require a guarantee that there will be a certain amount of contracting, or finance available for that contracting, ahead of time. It comes back to the problems of doing annual budgeting for an industry with a 40-year time horizon.
Q109 John Robertson: Allowing for that, how would you try to prevent a boom-and-bust scenario? How could you protect the system from that?
Professor Newbery: The simplest way is just to say, "We are minded to contract for so many gigawatts of such and such technologies in the next few years."
Dr Kennedy: It comes down to what the objective is of this whole thing. I think we know there is not a clear objective for the EMR, and to set one would provide some confidence about what we are trying to achieve. Investors could then look at that and make their plans. It is not only having an objective-and we might talk about that in more detail-but it is also knowing that the objective is funded, which takes you to the Levy Control Framework, where we have some visibility, as we know what that is out to 2015, but it is important to understand what that is going out beyond 2015 to 2020. We need to see a high-level number that is commensurate with the required power sector decarbonisation in 2020 sooner rather than later, and we need to see some flexibility in that number, given the huge range of uncertainties around the kind of support that might be required. At the moment you could not look at this as an investor and say, "I feel really confident. I am going to start developing projects". That is not where we are at the moment.
Q110 John Robertson: If you introduce flexibility, does that not increase the problem?
Dr Kennedy: It depends what the flexibility is. The flexibility I have in mind is you agree a number for the Levy Control Framework, but in a low gas price world that number would increase so that you can still go forward with your low-carbon projects. If renewables costs don’t come down quite as quickly as you think, again you can increase the envelope, so that provides more confidence, not less. I think if you are stuck with one number, given the range of uncertainty, then you can’t take a view at the moment on the number of projects that will be funded.
Professor Mitchell: There is so much evidence out in the world about how to move to a low carbon economy and we, Britain, should be taking note of this. The evidence for these sorts of mechanisms is that they have to reduce risk, be very simple, and be inclusive, not exclusive, and so work not just for a few incumbents. If you keep to that, then pretty much you will be able to deliver low carbon generation, provided you just pay enough-not a great deal of money. The kind of complexity that EMR has got itself into is just completely against all the evidence that is out there of what a good policy is. I know this is not answering your question, but the key question that hits me when I read this draft Energy Bill is how has the decision-making process got us to the point where we have this unbelievably complex process where very large swathes of the energy community, with good will, have been trying to point out the difficulties of successfully implementing EMR, given that, as I say, the evidence is that if you reduce risk, keep it simple and make sure it is inclusive, things will work.
Simon Skillings: Picking up the point, I don’t think there is an investor who would put any faith in false certainty about the future. Everybody knows the world changes, and everybody knows that priorities change. The key missing element of the whole policy framework here is setting sensible objectives over time scales that investors believe in, and that is about giving a level of not just certainty but flexibility, which everybody accepts is needed. It is about saying that we need minimum levels of different technologies to help manage risks of delivery, but we don’t want to lock everything in, because we want to take the opportunities of technology innovation, and of reduced costs.
Q111 John Robertson: It seems there is consensus that the Government has to set out a level of deployment for each technology. Would that be a fair assessment?
Simon Skillings: What I would say is a minimum level of strategic technologies, but what you don’t want to do is pretend that you can fill up the entire need and say, "It should be that much of that, and that much of that," because you would be locking in unsustainability. One of the lessons of long-term contracts is someone is out of the money. That always happens.
Q112 John Robertson: But if you did not do that, would there not be a problem with the levy cap itself? How could you set a cap?
Professor Mitchell: I don’t think that you should be deciding on a cap for each technology, giving this one 10% and that one 10%. I don’t think that. If you look at the small FiT, the appetite out there to invest is huge if you have a simple mechanism that everybody understands. I think the way forward much more is to set the price and make it simple, and then you will have that technology come in. If you are worried about the cost of that, then you set a percentage for total renewables, for certain percentages each year going up to your 15% of energy by 2020, and then upwards, if it goes up further beyond that. The point about the success of these classic FIT mechanisms is that it is because there is not a cap, but on the other hand, it is perfectly possible for you to implement one if you wish to know the total cost per year.
Simon Skillings: Another very important point is that people often believe we know what the costs are going to be. People say, "Gas is cheaper than renewables," or "Renewables are cheaper than gas," which is nonsense. We don’t know what is going to happen in 10 or 20 years’ time. Therefore, what is critical is that we have a governance framework that enables the delivery agent to manage costs in an efficient way. Don’t constrain the delivery agent. One thing this Bill does that is so unfortunate is it gives the system operator no flexibility and no incentive. If you give them a strong incentive to deliver efficiently, if you align their business imperative with the public interest, give them a strong incentive to deliver efficiently and give them the flexibility of instrument to do it; then you are helping to manage costs.
Q113 John Robertson: You made a point, Dr Kennedy, about the volatility of the market. Of course, that would be presuming that we were buying fossil fuels or the equivalent from abroad into the country. If we set up our own internal nuclear-one of the areas in renewables-would that not help to improve the situation in that volatility?
Dr Kennedy: Absolutely. It would do two things. It would put us on the low-carbon path and it would take us off relying on imported fossil fuels with volatile prices. Just to come back on what you asked, though, I think we can be confident. Our analysis says we can be confident about the low carbon objective, and that we should be aiming to decarbonise the power sector through a range of technologies without being too specific about whether it is 40% nuclear, 40% renewables, or a different balance. The principle is that we should be aiming to get to something like 50 grams of CO2 per kilowatt hour, from 500 grams of CO2 per kilowatt hour at the moment, as the carbon intensity of power generation applies across a whole range of scenarios for costs, for carbon prices and for gas prices. Locating that objective in the legislation and the implementing arrangements would very much help to improve confidence for investors.
Q114 John Robertson: A last question: should CfDs be allowed to bust the levy cap in order to achieve energy scrutiny and climate change objectives?
Dr Kennedy: I think from a legal perspective, yes, in the sense that we have the Climate Change Act, and we have carbon budgets under that Act. There is an obligation to meet those carbon budgets, and within the climate change legislation to put policies in place that will deliver the carbon budgets. The EMR is the key policy here, and if the funding implication of that policy goes beyond what has been agreed in the Levy Control Framework, you have a choice. You can either be consistent with the Climate Change Act, in which case you increase the funding envelope, or you can go against the Climate Change Act and say, "We are going to miss the carbon budget."
Simon Skillings: Of course the important point is not whether but how. There needs to be transparency in how it happens, so that people can understand it and prepare and make the investments that correspond to that.
Q115 Chair: The example of what happened last year on solar is not exactly encouraging in this respect.
Professor Mitchell: I don’t necessarily agree with that. Solar was very expensive and so everybody jumped on the bandwagon, and you have loads of new companies going, loads of new people in businesses, all sorts of things happening, in a very short period of time. Now that price has been halved. The cost of that technology has also been halved, so people are making a lot of money again. That price needs to come down again, so that we get to a low cost. However, we needed that original high price to get through that whole momentum and start of an industry, which we have pretty much failed to do for our other renewables other than wind. If you think back to 1990, when we were trying to bring in new entrants and new ways of doing things and all the rest of it, it has to be said the small FIT has been one of the most successful policies in a very short period of time. That is not to say that you carry on giving such high profits to people, but the basic idea of keeping it simple and being inclusive to bring people in has worked, and now you just have to degress down.
Q116 Chair: I think it depends on how you judge success. The vast majority of economic activities and jobs in relation to both solar and wind are located outside the UK, despite the fact we have a rapidly growing consumption of those inside the UK. It was the transparency point I was thinking of really. I thought the way in which the quite justified and necessary decision to reduce the feed-in tariff for solar was taken did not seem particularly transparent. The figures were available to DECC last summer, and they could see this was rising at an unsustainable rate. They did nothing until the beginning of November, by which time a sudden decision, imposed almost retrospectively, seems to me to guarantee that future investors in these technologies will require a higher return.
Dr Kennedy: It has committed the country and the consumers to pay £700 million a year every year for the foreseeable future, and that is a problem in the context of a constrained Levy Control Framework; it might squeeze out investment in other things. I think it tells you two things. One is that you have to think sensibly about technology policy in advance, and the second is that you have to think long term about the Levy Control Framework and how to sensibly use a fixed envelope to get the biggest bang for your buck.
Professor Mitchell: I agree entirely with that, but on the other hand it does also show you how, if you keep policies simple and reduce risk for people, you will get investors in. I agree entirely on technology policy and the question of how you do that, but it has been one of the first energy policies that actually worked in Britain since I can remember. Okay, understand the bad bits, but don’t necessarily throw out the baby with the bathwater by not thinking about the good bits as well.
Q117 Dr Lee: This is the point. Yes, it was simple, but it was the wrong policy. Why on earth did we make a decision to go for solar when we are surrounded by water, for example? It is all very well saying, "Lots of people put them on their roofs." We would have been better off giving the money to the Spanish, which incidentally is probably what we are going to have to do anyway for other reasons. It just defies belief that we don’t take a strategic view of this and say, "What can Britain do well?" instead of just trying to interfere in a market and then creating a distorted market where a bunch of cowboys come in and stick loads of solar panels on, and make a huge amount of money.
Professor Newbery: PV has peculiar properties. You can order them and in a couple of weeks get them flown in from China and screw them on the roof, and there isn’t any other technology quite like that. So this boom and bust is going to be absolutely concentrated in that sector.
Q118 Dan Byles: But the boom was in men with screwdrivers, perhaps. It wasn’t in producing solar panels or any sort of sustainable long-term-
Dr Lee: Or indeed generating energy at a realistic cost to consumers.
Professor Newbery: Absolutely. So you take a view on PV, and you can say maybe we should be using the foreign aid budget to subsidise its production or use in central Africa, or places where it really is sunny and where they have no grid electricity, but to do it in cloudy England doesn’t seem to make a lot of sense.
Simon Skillings: Picking up Catherine’s point, just because a technology policy may be bad doesn’t mean to say all technology policy is bad, so let’s learn the good lessons. We all accept we need to make some technology choices, and it can be done and it can be delivered in an effective way.
Q119 Laura Sandys: You covered the issue about having a decarbonisation objective. One of the things that we feel quite concerned about is what you have covered about nuclear, and whether this is a regime that is bankable, investable or will actually happen at all. How do you believe that this particular framework is going to be able to deliver on your objectives and on our statutory requirements if, as the investors have very clearly said to us, they will not fund under this regime, unless Government does the builds at least?
Dr Kennedy: We should be very clear. Going back to the objective, I have said it should be to get emissions down on the power systems to 50 grams over two decades. Within that there is a crucial role for nuclear, so we should be clear about that. If you don’t have nuclear in the mix it is very hard to decarbonise to 50 grams.
Q120 Laura Sandys: If this regime does not deliver nuclear or creates a major difficulty and certainly increased cost of delivering nuclear, where do you think it leaves us?
Dr Kennedy: This regime is about delivering nuclear and all of the other low-carbon technologies; we should be clear about that. It is not just about nuclear. It improves the prospects potentially for renewables as well. Again, it is all to play for. All of the concerns that have been raised can be addressed, potentially, and the challenge is to make sure that we do address them and bring forward the investment. If we can’t do that, then we have a problem. If we can’t do that, we won’t have nuclear, and if we don’t have nuclear, we will be investing much more in unabated gas-fired generation, which is bad from a carbon perspective and bad from a security of supply perspective. That is the challenge, but I think it is a challenge that can be addressed within the arrangements that are being proposed.
Simon Skillings: I think it highlights the fact that all these technologies are very different. I would argue there is a much greater strategic benefit from really driving forward with carbon capture and storage, which has another, different set of problems. As for having the flexibility within the Bill to accommodate this, you read in the Bill notions about turning to technology-neutral auctions as soon as possible. This is clearly pandering to an agenda of market efficiency that simply does not exist in this world, and will not exist for the foreseeable future that we are concerned with. These technologies are very different, and they have their own characteristics, and we must make some strategic choices, leave ourselves flexibility to adapt, and benefit from those that work and learn from those that don’t.
Q121 Laura Sandys: Do you believe that the Bill has clarity of objectives, or just lots of mechanisms? The clarity of objectives could be, for example, decarbonisation targets. It could be issues on security of supply. There could be elements about fuel poverty, and there could also be other dimensions. We are trying to identify where those objectives are going to drive investors, and what I feel personally is that there are lots of different mechanisms that all seem to be designed around one issue, one problem-nuclear, say-but it is impacting a whole load of other technologies that don’t require that sort of mechanism.
Professor Mitchell: I agree. In my written evidence I have talked about the complementarity of technologies. The underlying argument is that all technologies are complementary to each other and climate change is such an important issue that we have to throw them all into the pot, and only in that way are we going to meet the challenge of climate change, and I fundamentally disagree with that. I don’t agree anyway that you need to have nuclear power, but nuclear power is not complementary to renewables. What this Bill is about is concentrating on one technology that is providing a relatively small amount of the energy that we require to decarbonise and it is undermining the other technologies that you need to get there, and that is if it works. If it doesn’t work-I think it is unlikely that it is going to work as well as is hoped-then you have a problem.
The Government has done its best, it has tried. It inherited EMR. It has tried to move forward. All these new issues have occurred over the last four years. Renewables all over the world are falling in price, huge amounts of investment is happening in renewable energy globally, there is increased LNG, there is lots more conventional gas around, we have had Fukushima, and we know about the increasing costs of nuclear. All these things have happened at the same time as there have been questions about the details and workability of EMR. It seems to me we should not just continue to plough on. We have to take account of what is going on around the world and start to think: is it sensible for the country and for decarbonisation that we do keep ploughing on? We should say, "Okay, hang on, let’s see what the situation is."
Q122 Laura Sandys: Do you think you should have a role in the strike price?
Dr Kennedy: I wouldn’t want to tout for work here. I think you have hit the nail on the head and said this is a set of mechanisms in the legislation without a clear objective, and I think the way to address that is to put a clear objective on the face of the Bill. At the beginning of the Climate Change Act, we have, "This is about this is the long-term target". I think in this piece of legislation you write, "This is about decarbonising the power sector to achieve legally binding carbon budgets", and then you put a process in place to make sure that the governance arrangements following the legislation achieve the objective.
Q123 Laura Sandys: Do you think changing that hierarchy by having that objective would allow things to start to fit into place?
Dr Kennedy: I think it is having the objective and a process. The delivery plan has to be about-
Q124 Laura Sandys: Yes, but the process would be much clearer because the objective would be-
Dr Kennedy: Yes. I think the delivery plan would say, "Here is the objective that comes from the carbon budgets: to get to 50 grams of CO2 per kilowatt hour. Here is how the investments are compatible with the objective." It would be natural that we would have a role scrutinising that, given that we have a statutory job to say, "Are our policies compatible with carbon budgets? Is the EMR compatible with achieving electricity sector decarbonisation, which is central to the achievement of carbon budgets?" We will have to advise on that anyway, given our obligations under the Climate Change Act, but I think it would be very sensible to join up the legislation.
Professor Newbery: I am a little puzzled. Paragraph 2 says the Government is committed to achieving its climate change and renewables targets, and spells them out, and then it says it wants to do it in a cost-effective way. That is exactly what a contractual framework, if it is well designed, would deliver. So I don’t think there is any ambiguity about the targets and there is not a lot of ambiguity about the modality of doing it, which is the contracting. All the problems arise as to how these contracts are going to be designed, who is going to be the counter-party, will the Treasury say, "Stop, you can’t have any money", and things like that. The core objectives and the delivery mechanism in its broadest outline are in there.
Q125 Dan Byles: Isn’t the danger of what you have just suggested that the emission reduction target would then be seen to trump issues of cost and security? It is almost a "decarbonisation at any cost" approach. No nation can say, "We are going to decarbonise and get 50 grams per kilowatt hour regardless of the cost".
Dr Kennedy: It depends. If you put "50 grams at any cost", I think I would agree with you. If you put "this is about achieving the carbon budgets, where the carbon budgets are agreed, based on a full analysis of the cost and affordability implications", that just joins up legislation that already exists. I don’t think you want a new piece of legislation that has a different objective to stuff we have already committed to. So, joining up is a sensible thing. I agree with David that there is some high-level stuff in the package, but I think there is more to do to go from that very high level, now we have a lot of good intentions. I think the Government wants it both ways at the moment. It wants to have a decarbonised power system and a second dash for gas at the same time. Those two things are incompatible and we need to be very clear around what we are trying to achieve.
Simon Skillings: What is important is that we have the debate you describe over time scales that are consistent with the way investors think. So, absolutely people know there are trade-offs that need to be thought about, but the way the Bill is written at the moment is that the clause says that the levy cap can trump everything over shorter time scales, and people don’t really understand how that happens, which creates great uncertainty. If that debate about the trade-offs in affordability, security and decarbonisation happens over perhaps the five to 10-year period, and then you say, "We believe it is sensible to head in that direction over that sort of time scale", and we put in a place a framework to do it as cost-effectively as we possibly can, that does create a balance. It is not at any cost, but it creates some transparency.
Dr Kennedy: A fourth carbon budget, which we legislated for last summer, will be reviewed in 2014, and a fifth carbon budget covering the period 2028 to 2032 will be set in 2015. So we will have all the debates around cost and affordability as we go through legislating for the fifth carbon budget. To join those up, and to make sure that the Levy Control Framework is adaptable to what is agreed in the context of carbon budgets, rather than the other way round-that we miss carbon budgets because it doesn’t have the support in the Levy Control Framework-is the right way forward.
Professor Mitchell: I do think there is a real gap, though, in that there is not anything about demand reduction or energy efficiency in the Bill. If the centre of the Bill, and the main thing that you are trying to do, is reduce that total amount of energy that we use, but also to have demand response and so forth, then you could meet your issues to do with affordability much more easily. I think you could also get away from the details of the Bill and say that this Energy Bill should be taking us to an energy future that is right for Britain, and about understanding what it is that we are trying to do with the energy system in order to take us to a sustainable, secure and affordable energy system. I think that we ought to be having that demand at the centre.
Q126 Sir Robert Smith: Simon Skillings, you have mentioned an enthusiasm for CCS. Is there anything in the Bill that is missing to unlock CCS, or is CCS still more about successful demonstration and capital projects?
Simon Skillings: I think it certainly is about successful demonstration. It is absolutely critical, I think, that we create a credible CCS option. The trouble with demonstration is the risks of demonstration are about kit working or not working. They are not about what the energy price is. So the instruments that are set out within the Energy Bill help an operational asset risk-manage its earnings. They don’t manage the risk of construction and performance that are associated with demonstration, so you need some very different fiscal instruments to help drive demonstration. This sort of links in with the emissions performance standard point: I don’t think there are many people who believe that a single carbon price by itself can drive all the investment, and importantly disinvestment, that is needed efficiently to meet our targets. We need other policies. We need technology targeted support, and we need an emissions performance standard.
If you throw away that lever, you could end up in the situation where we have a hugely inefficient vehicle to drive this investment, which is a very, very, very high carbon price-and it will need to be very, very high. Germany has a big problem. It has exactly this problem. It has lots of coal on the system, and it doesn’t matter how much renewables it subsidises on the system; if the carbon price stays at low levels, the coal is going to be pumping it out. It can’t get rid of the carbon. This is where an emissions performance standard provides another tool, and we are going to face that situation with gas plant as we go through the 2020s.
Q127 Albert Owen: I have a number of questions on the emissions performance standard, but because of constraints on time, I will try to condense them. First of all, do you think the Government was right to extend the grandfathering provisions to 30 years? The second and third parts of that question are: do you think it will lead to a dash for gas, and is it compatible with reducing emissions by 80% of the 1990 level targets by 2050?
Simon Skillings: I will just augment the point I have already made. Clearly those that get built will not be subject to emissions performance standard regulations, and the Government of the time will therefore be left with only one option for reducing that generation-a very high carbon price. That could be very, very costly for consumers, so I think it risks being very, very costly. As to whether it is going to create a charge of investment, I suspect probably not, because there are a lot of other risks that are lurking around, but it may create some increased investment, and that stores up risk for the future.
Dr Kennedy: I think people were surprised that we didn’t come out in stark opposition to this when it was announced. The reason we didn’t is because even in 2045 we envisage we will need some unabated gas-fired generation on the system, so for us an emissions performance standard that acknowledges that is okay. There is a real risk of a dash for gas, possibly aided by the capacity mechanism in the legislation, so whereas we envisage some investment in gas that goes alongside the unabated gas we have on the system-that generates falling load factors through the 2020s, because we have low carbon coming on to the system-I think there is another world where the low carbon doesn’t come on.
Q128 Albert Owen: Do you think this is giving out mixed messages? You are saying that on the one hand we are going to move to nuclear, and-
Dr Kennedy: Absolutely, yes. There is a real risk, and as for the mood music, listen to what people are saying about onshore wind, and what different groups are saying against offshore wind and the problems we have had with CCS. There are questions over nuclear, and opposition to nuclear, and people who say that shale gas is a game-changer and we should have it. I think there is a real risk that we end up with much more gas-fired generation as part of the mix than is sensible for the future, but again the way to address that is to make sure we have a set of arrangements in place that bring forward the low carbon, in which case we will have less use for unabated gas. I think what we should not rule out, and it is different to an EPS, is limiting the running hours of unabated gas-fired generation as we get into the 2020s. That is something that should happen naturally, but if the market doesn’t drive that to happen, then I wouldn’t rule out that being a very sensible instrument. You have seen that with coal we have limited the running hours under the European legislation over the last few years. I think we should keep something similar for unabated gas as an option.
Professor Mitchell: I agree with the need for an emissions performance standard, but I was surprised that there was grandfathering in there. It seems like a very detailed thing at this level, and not necessarily the right thing.
Professor Newbery: The projections for the carbon price are indeed high. There is an EU dimension. If the EU as a whole and if the world as a whole is serious about climate change, then the carbon prices will have to be pretty high. If the carbon prices are pretty high, then the economics of running coal are very unattractive, and it is probably the same with gas, for more than the balancing that will be needed with the other technologies on the system. On the question about grandfathering, it is about reinforcing the message that is important that contracts are going to be worth the paper they are written on. If you say, "We will change our mind and say that you can’t run this power plant for more than a few hours a year," that tears up the contract.
Q129 Albert Owen: I fully understand that. Those that have coal and gas at the moment want certainty, but if they have a large portfolio and you have potential investment in nuclear and renewables, isn’t this just going to extend the investment by those companies into gas-fired over a period? Then we will have a dash for gas, as we have had before. Professor Mitchell, I know you and I don’t agree on nuclear, but when you say we keep ploughing on, this is exactly what we are doing. We keep ploughing on and thinking that gas is the answer-that gas is going to be cheap. The price goes up, and then we are back where we started. We need to look at nuclear again; we need to look at more renewables. I am concerned that there will be a dash for gas with this, because those companies that were in front of us last week were talking about certainty, yes, but the minute they get the opening for more gas, that is the simple answer; that is what they hang their investment on. That is the concern I have. That is why I have asked the question in that way.
Dr Kennedy: I think that we have a carrot-based approach under this legislation, and there is a lot to do to get the carrots right, and even if we do, it is not clear that the investment will be forthcoming at the kind of levels we need. So that takes you towards a stick approach, which the Government has avoided here, and that is something we should keep open.
Q130 Albert Owen: You ducked, Dr Kennedy, the question from Laura when she asked should you be advising on the strike price and should you be part of the advisory. It is a question I had further on, and we may not get to it, so I am going to take this opportunity now.
Dr Kennedy: Just very quickly on that, if we were scrutinising the delivery plan, which I think would be a sensible thing, given our duties under the Climate Change Act, you would be looking at all of the aspects of the delivery plan. For stuff where there is a price proposed for the Government, for example for onshore wind or maybe offshore wind, we could say is that price likely to bring forward investment. It won’t all be about price. There will be nuclear, where we would be looking whether there is enough quantity as well as price, and the two things are as important as each other-price and quantity. So we would look at both.
Q131 Albert Owen: On separating the strike price from an administrative role with the systems operator-Government and Ofgem-do you think you should have a role alongside them?
Dr Kennedy: Scrutinising the delivery plan that includes proposed prices, and other aspects as well, would be a natural role for us to have, given our duties under the Climate Change Act. It would just join those up with the EMR. Let’s remember, the origin of the EMR was to achieve carbon budgets. It seems to have been lost along the way, but to make that link very explicit is, I think, a sensible thing to do.
Sir Robert Smith: Chair, I think I should remind the Committee of my entries in the Register of Members’ Interests to do with the oil and gas industry, given what we are discussing, in particular a shareholding in Shell.
Chair: I should remind the Committee of my interests in several companies involved in renewable energy, in view of the discussions. Also, ahead of the forthcoming session, I am the unremunerated President of the Renewable Energy Association.
Q132 Dan Byles: Professor Mitchell, you touched on demand-side responses, which is something, as you say, some people are concerned is lacking quite significantly from the Bill. Some people are concerned that DECC has been giving mixed messages about the role of demand-side reduction, as distinct from demand-side response. Do you see that there should be a role for demand-side reduction in electricity market reform, and, if so, how could we encourage it?
Professor Mitchell: I think there should be a greater role for managing energy demand in general. Whether that is making the energy and the appliances that we use more efficient, whether or not we are moving demand to different times of the day to make it more efficient, or just trying to reduce energy full stop, yes, absolutely in every way. Doing demand response through the market is one way forward. I think that there should be an analogous mechanism to the supply mechanism for the demand side.
Q133 Dan Byles: Like an energy efficiency FiT?
Professor Mitchell: Something like that, yes. It seems to me completely wrong that we have a supply-side mechanism and not a demand-side mechanism. While different people have looked at how to do that in different ways-it may end up being more like an end of year grant that is linked to measured energy-we absolutely should be doing that. I think it is wrong that the draft Bill doesn’t do that.
Q134 Dan Byles: My understanding is that DECC are currently reviewing the potential for incentivising further demand reduction, and that we may see fruit from this work some time over the summer.
Professor Mitchell: The problem for me is that incentivising the demand side is going to happen through the Green Deal, but the Green Deal is going to have borrowing requirements at certain rates of interest and, intellectually, if you have a mechanism to support supply, you should be having a mechanism to support demand. Given that one is going to be cheaper than the other, you should be going for that cheaper one.
Q135 Dan Byles: Is the Green Deal not more about heating than electricity generation?
Professor Mitchell: But it is also about trying to make buildings more energy efficient at the same time.
Simon Skillings: If you consider that this Bill is about effectively risk-managing delivery of our policy objectives, there is no option that is more effective at doing that than demand, and absolutely it should be demand reduction as a very discrete product from demand response. There are two problems with the demand side. Firstly, it is different, and people are used to supply side, where they can go and touch it, measure it, feel it, monitor it, verify it, all this sort of stuff; and secondly, it is immature. We need mechanisms in place that make people do it so they don’t shy away from that difference and put in place some targets that help overcome that immaturity. It absolutely should be at the centre of the Bill.
Professor Newbery: I disagree. I think this Bill is overly complex as it is, and the idea that you keep ladling on extra requirements is absurd. We have an incredible range of demand-side policies already in existence. Maybe they need to be tidied up, maybe they need to be more carefully managed, but as for the idea that you will improve this by adding a whole bunch of extra unsubstantiated claims that all demand-side is necessarily cost-effective, some of the proposals, when you look at the impact assessment, suggest costs per tonne of carbon saved that are extremely high. Some of the building regulations have that characteristic. If we are intent on making this an affordable policy, then I think we need to be very careful about just assuming that demand-side responses would be automatically better.
Q136 Dan Byles: The supply-side responses that we are putting in place are going to significantly push up consumer bills. Will that in itself not lead to self-regulating demand reduction?
Professor Newbery: Some of the evidence you have already had is that two thirds of the fall in projected demands that National Grid made are the result of efficiency saving. So, yes, the fact that the cost of energy will feed through to reductions in demand will, one expects, have an effect.
Simon Skillings: Many of the same investment challenges affect the demand side and the supply side, and why we should differentiate between them I don’t understand. If it is effectively written in, it can be a one-way bet. You are not depending upon it working, but if it does work, the benefits are enormous.
Professor Mitchell: Some of these things are very expensive but, on the other hand, some of them are not, and therefore we should be looking at that option.
Q137 Dan Byles: David, do you have a view on that?
Dr Kennedy: I think there is an important opportunity on the demand side, both in terms of firm demand-reducing demand so you don’t have to invest in low-carbon power-and in terms of flexibility, which is important on an intermittent system. I think the challenge is to show what you get from the EMR over and above the full range of policies that we already have to incentivise energy efficiency on the electricity side, as opposed to the heat side that you mentioned.
Professor Mitchell: This is not part of this energy system that we should be moving towards. We should not be thinking of the demand side as sort of different from the energy system. Incorporating the demand side should be part of an efficient energy system. You should think of energy demand as infrastructure or management of the energy system. It should be part of an efficient system. We have talked about electricity market reform; this reform is to take us into this future energy system, and therefore we should be having demand as part of that system.
Q138 Dan Byles: In terms of demand-side response rather than demand-side reduction, there is a suggestion that that will somehow feature in the capacity mechanism, but I think that it is a little bit uncertain as to how that might feature. Do you have any thoughts on that?
Simon Skillings: It faces exactly the same hurdles. Incidentally, many of the things we have talked about-we haven’t touched on the capacity mechanism-and all the issues about objectives all apply. So the same obstacles apply to demand response. It is not like supply-side resources, and the system operator requiring some positive incentives to break out of where they currently are. Why should they do something that is different, that has a bit of risk associated with it, rather than just relying on tried and tested things they have always done?
Q139 Dan Byles: Is it feasible to develop a capacity mechanism that does everything we want it to do on the supply side and also to tackle demand-side response, or is that going to be too complicated?
Simon Skillings: No, it is eminently feasible. The important thing about the capacity mechanism is that capacity is unlikely to be the resource that we really need to deliver reliability in the future. There is a lot associated with that, so if we work out what the resource is and what the product is that we need to deliver reliability, and if we design the mechanism to do that, it can absolutely embrace the demand side.
Professor Mitchell: If it were the system operator that has to do that, having decided what they want, they can set that up as they wish, and that can include the demand side.
Professor Newbery: Let me just point out that we have been doing demand-side response. The system operator has been calling upon that since way back, and certainly in the 1990s.
Q140 Chair: We are running out of time. I have just one last question very briefly on the capacity market, which, as you said, we haven’t really addressed. Do you understand that the draft Bill plus the associated documents mean that capacity market auctions will be technology-specific?
Simon Skillings: I think they are technology-neutral, but they are buying firm capacity that obviously different technologies provide at different relative costs. So it is buying technology-neutral, but buying firm capacity.
Professor Newbery: More to the point, it is buying characteristics. Speed of response, and speed in coming on the system are dimensions that the system operator will require. Some pieces of technology can do that and others cannot, so it has technological implications, but the characteristics are the ones you need to balance the system effectively.
Dr Kennedy: Effectively it will be technology-specific, because it will be buying unabated gas-fired generation to balance the system.
Professor Newbery: It may not at all.
Professor Mitchell: It may not be technology netutral or technology specific depending on the decision of the system operator.
Professor Newbery: It may be from wind farms, because they have a very quick short-term response.
Dr Kennedy: Well, predominantly.
Professor Mitchell: I was just going to say that is not the case..
Q141 Chair: One of the pieces of evidence we have had suggests that a technology-neutral capacity auction in the US effectively excludes a demand-side response bid in that auction.
Professor Newbery: That is not true in NEPool. My impression is that two thirds of the capacity response was on the demand side. There was some question about whether it was as genuine and solid and reliable as it was on the supply side, but the auctions elicited that response.
Professor Mitchell: I think that is the problem for you in pre-legislative scrutiny. It is difficult for you to scrutinise when you don’t know what the details are. Depending on the details of the capacity or flexibility mechanism, you can have demand-side in there.
Simon Skillings: Part of the problem is you have to design a capacity mechanism knowing what you want to encourage. So life-extending existing supply-side assets is generally the cheapest thing to do, then demand-side, and then building new supply-side assets. You almost have to know where you are in that pecking order in how you design the capacity mechanism.
Chair: I am sorry we have to cut it short there. If there were further points you wanted to make in relation to the questions we have raised, by all means do write to us. As you acknowledge, we are driven by a tight timetable, addressing a draft Bill whose details are not all absolutely clear. Thank you very much.
Examination of Witnesses
Witnesses: Ian Temperton, Head of Advisory, Climate Change Capital, Nick Gardiner, Senior Director, Energy and Infrastructure, BNP Paribas, on behalf of the Low Carbon Finance Group, Shaun Kingsbury, Partner, Hudson Clean Energy Partners, on behalf of the Low Carbon Finance Group, Gaynor Hartnell, Chief Executive, Renewable Energy Association, and Gordon Edge, Director of Policy, Renewable UK, gave evidence.
Q142 Chair: Good morning and welcome to the Committee. I think most of you have heard a lot of the previous evidence. As you know, there is a great deal of interest in this. It is quite important. We have to do it at a rather hectic pace, and so forgive us if we are bit abrupt in some of the questions and cut you off. We need to complete this session in an hour.
Can I ask a general question to begin with? Do you think the draft proposals as they stand will achieve the original aim of reducing risks for investors, thereby cutting the cost of capital?
Gaynor Hartnell: I would say not as it stands, no. There are many issues that do need to be resolved. One of the prime ones is making sure that these Contracts for Difference are bankable. All those counter-party issues have to be addressed. We need to have some sort of pre-accreditation or means by which the process of project development can be de-risked. Generators need to know that they can access the reference price for the electricity they sell. The allocation process for contracts has to be understandable, transparent, and fair, and that is an enormous challenge. There must be no unnecessary risks for the generators with the Contracts for Difference after they are awarded them as well. That is just a few things. That is not a comprehensive list, but as it stands, these things are not clear at all and do pose big problems.
Nick Gardiner: If I can just pick up on that, from the banking point of view, no, we don’t believe, as currently structured, this is something that we can take to our credit committees. Picking up on many of Gaynor’s points, there is a high level of complexity that surrounds what is being presented here, and therefore it is difficult to attract that investment. There are a number of areas to look at: payment model, route to market, access to the contracts, and a price-setting mechanism. I know this was touched on in the last session but there is also the issue of how this all fits together. We shouldn’t just be looking at the CfD; we should also be looking at things like the capacity market mechanism. So I think there is a concern about how the whole piece works, rather than just this particular Bill as presented.
Shaun Kingsbury: From our perspective, we have been working with DECC since the initial proposals started coming out for discussion. We spent a lot of time with them and we have been trying to work through the detail, and we are committed to engaging and making sure that this process work, but as we see it today, the level of complexity actually increases the risk. There is still some detail that needs to be worked out, and that may help us get more comfortable, but today just the total level of complexity means this is more risky. We want to make sure that the UK is well positioned, relative to other markets, to attract the capital that is necessary to hit the targets. So we want to work to make sure that that complexity is reduced, but today I would say no to your question.
Ian Temperton: Once you have a CfD, then you have less market risk as an investor in a project than you do today, and you have less regulatory risk than you do today, because you have a contract that gives you a degree of surety of price and, effectively, of the regulations under which you are substantially going to operate that plant over its life. Once you have one, and if you have one with a decent counter-party, then I think this does improve things. The angst created in the industry has been around the payment model or contracting model, or whatever you want to call it, and how you actually get one of these things, which I think echoes things that other people have said.
Gordon Edge: I would very much agree with what Ian said: the development risk is at the moment unacceptable, but once you have one it may well be much better. Certainly when it comes to the allocation points, I think DECC’s current proposals are throwing in lots of additional risks that are unnecessary and add no benefit. For instance, the proposal to have a round every six months where people can come forward and apply for a CfD where you may not get one adds an additional risk to the development process, whereas a more open, "first come, first served" clarity, whereby if you are not there by a certain time, you are not going to get one, makes things better. Also, when it comes to delivery of the CfD, DECC are talking about penalties for not delivering by a certain time when, if you have committed the amount of capital we are talking about, there is more than enough incentive to deliver it as early as possible. Adding penalties merely adds further risk, and it doesn’t get you delivery any quicker. So, why would you do that? Extra risk, no benefit. We see quite a lot of areas where we can work with DECC to just work those risks away. We don’t think they have to be there.
Q143 Chair: In the light of all that, what do you think the effect of the draft Bill will be on renewable investment decisions?
Gaynor Hartnell: I think inevitably a hiatus while a lot of this is sorted out, which is something that the Government can ill afford, given that we have a legally binding target to reach for renewables and to do that by 2020.
Gordon Edge: I think we can minimise the risk of a hiatus if we keep the options open for extending the renewables obligation beyond 2017. We are not calling for that right now, but we think that Government should not take that away, because at the moment we need that insurance policy. If it takes longer to sort out all of these issues-and we think it is a very short time until autumn, when the Bill is meant to come to Parliament-and to have dealt with all these complications, then we need to have a sense that there is a plan B that will be there to support investment beyond 2017.
Shaun Kingsbury: Obviously we need to keep up the pace of the legislative process, because if it slows down, then that uncertainty continues to creep. I think we can see the potential for a slowdown. I am not saying that it has happened so far, but if things continue to slow and more and more detail comes out that makes it more and more complex, then you will see people stopping development spend unless projects are big-build, and we will create a hole in that trajectory towards the 2020 goals.
Q144 Dr Lee: Just following on from that, essentially, is the draft Bill introducing complexity, confusion and therefore delay in investment?
Shaun Kingsbury: It has the risk of doing that at the moment. There are still some details to be worked on, so some of the questions we have may emerge through the detailed process that is still to come, but at the moment, when you add all the various pieces together, we think it is unnecessarily complex, and when you are considering making an investment, most of us are international investors and when we consider one market against the other, we do not want the UK to be disadvantaged. We do not want someone coming in to make an investment, either in the development process or in building assets, to say, "Look, I really understand what is going to happen in another market. I don’t yet understand what is going to happen in the UK and therefore I am going to prioritise investment in that market over the UK market." It is not black and white-things do not typically stop completely-but there will be a gradual move away and a gradual slowing down in commitment of capital, and that is what we do not want.
Q145 Dr Lee: Moving from investment to other goals, I guess this is the problem with the Bill: it is quite difficult to work out which targets matter the most. Will the Contract for Difference approach, as opposed to types of FiT, meet the electricity market reform objectives of the low-carbon mix of generation?
Ian Temperton: Yes, potentially. Once you have one, it reduces your in danger risk, and it reduces your market risk. The two problems we have with it as an instrument, as a lot of us have said, is having a decent counter-party for it and knowing how people get one, but, sat in a position where you are a generator with one, then I think it has a possibility for improving things, yes, absolutely.
Gordon Edge: The key to this, I think, is the delivery plan and how National Grid manages the delivery plan. It is going to be a five-year plan that sets out prices and potentially volumes across all low-carbon technologies, so it is an incredibly important role for National Grid for managing, advising on how much of what gets built at what price, and how contracts are then awarded as a result. If they get that right, then perhaps we will be getting the outcomes that we need, but I think that role needs to be very carefully looked at, particularly the first delivery plan National Grid is going to start working on before the primary legislation is even in Parliament, let alone passed. So the powers will not be clear, and it is a necessity to keep confidential information within Chinese walls. All that needs to be very carefully managed if it is going to deliver on the plan effectively.
Nick Gardiner: The required level of investment is large, by any definition. Certainly the banks invested, financed under the RO scheme, recognising, though, that is a scale-up to what is needed to meet the low-carbon plan in our City quest. It is a systematic scale-up. So can the CfD meet that low-carbon plan? Yes, we believe it can, but as currently structured, no, it can’t. We need all the things-all the reducing the complexity and making it simple, to pick up on Shaun’s point-certainly for international banks, and there is a number of international banks financing in this market. We are competing; I am competing as regards investing here in the UK as opposed to investing in other markets across the EU and elsewhere. I am competing in terms of investing in renewable energy as opposed to investing in infrastructure, or indeed other areas as well. So that is all part of the challenges, but on your question of whether the CfD can be made to work with the carbon plan, yes, we believe it can.
Gaynor Hartnell: I just wanted to add to what Ian was saying. Yes, if the Contract for Difference works, this is a good objective to go for. The combination of achieving the reference price and having the CfD should give a generator a stable price, which should lower the cost of capital, so that is a worthy objective to be aiming for.
Q146 Dr Lee: Do you agree with the choice of the CfD, and do you think it is appropriate for the intermittent generators?
Gaynor Hartnell: The CfD, if it works properly and effectively, delivers a fixed feed-in tariff, but it has the advantage, if it works, of encouraging the generator to engage in the normal electricity market, so in other words, to respond to price signals in the electricity market. That is the objective. Clearly, a lot of things need to be done to make sure that objective is achieved, and it is very difficult for renewable generators to assess the implications of the CfD for their trading options and their strategies at the moment.
I would like to say to the Committee that there is a further piece of evidence or further point we want to make that has only come out since we submitted our original evidence, which is that non-intermittent generators are currently proposed to have the reference price of the year-ahead price for electricity. That may not be the best option for them. It may pose completely unacceptable kinds of burdens for posting collateral to enable them to trade electricity and deliver what the Government wants, so we would like to send in some further evidence to question that.
Gordon Edge: If I may, when we came into this process, we were very much of the opinion that the renewables obligation should be retained. The benefits of policy continuity should not be dismissed. Having said that, Government is clearly intent on its objective to come forward with the CfD, and it does have some advantages in terms of giving the kind of stable income level that Gaynor was talking about, and perhaps also it may have the systemic benefits of minimising the cost of doing all this, and will therefore be seen as a lower-risk instrument overall. If it costs less, then it is under less threat.
Q147 Dr Lee: Do you think the renewables obligation’s lifespan should be extended?
Gordon Edge: Well, as I said before, we believe that the option at the moment should be kept on the table, in case all these-
Dr Lee: Do you think it should be?
Gordon Edge: Only if we can’t get the CfD to work, and we are still working with Government to try to get those details to work.
Shaun Kingsbury: I think we should push on and get the CfD to work. We believe it can work. We believe it has some advantages over the renewables obligation, which has worked to date, but would probably not drive the level of investment that we need to see here in the UK. So we want to be clear: we have challenges with it and we see some problems with it. We can park some of them already, but we want to push on and keep to the framework and make it work.
Q148 Dr Lee: I asked this question to the previous panel: would you rather just get the thing built and then have it sold to you in the private sector? The Government would say, "Right, we are going to do this." It is almost the best of two bad choices: "Do we go with the Contract for Difference or feed-in tariff or renewables obligation?" All of these are exercises in trying to put public money into the system to try to create an outcome. Why don’t we just decide what sort of outcomes we want and then sell them back to the market? Is that not a more straightforward mechanism than all of these complicated ones? You are going on about complexity all the time. Is that not just more, as I said, straightforward?
Shaun Kingsbury: I think one of the key areas of complexity for us is understanding the contractual framework. As long as we understand the contractual framework and we understand that our revenue is secure, there is an-
Q149 Dr Lee: But that is not my question. Of course I understand the contractual point-"Brilliant, employ lots of lawyers, make them lots of money". My point is that why not just make it simple and say, "Right, we are going to build all these new capacities" or, "We are going to build these wind farms" or "We are going to build a Severn barrage" or whatever it is, and then sell it as an ongoing concern back to the private sector?
Shaun Kingsbury: Weeding it out.
Dr Lee: Yes. Is that not more efficient in terms of borrowing money, a cheaper way of doing it, and is it not contractually more straightforward, because then you say, "Right, this is an ongoing concern, buy it or don’t buy it"? You can change the carbon price to make it more attractive.
Gordon Edge: I think you are not giving enough emphasis to the role of the developer in this in bringing forward the project to a point where you can build it. I think the only way that your proposal would work is essentially Government being in the market to buy projects from developers who brought them forward, and then you are into the same kind of difficulties of how do you incentivise people to develop when there may be only a certain number of purchases available. The development risk is the bit that I think is missed so much in this whole process, and it adds risk where it doesn’t need to be. So yes, there would be benefits to building off the Government balance sheet, but we also need to bear in mind we are talking about somewhere in excess of £100 billion, and it is a very significant amount of money.
Dr Lee: Yes, but in today’s world this is peanuts.
Gaynor Hartnell: I can see the merits of what you are suggesting in theory, but as for the Government taking that route in renewables, I would foresee them getting it very wrong. What we have at the moment is-
Q150 Dr Lee: What, do we have it right over photovoltaics?
Gaynor Hartnell: Well, I can come back to that, and I am happy to talk about that, but I think what we have at the moment is possibly one of the worst situations-I think this is what you are alluding to-which is Government not stepping in and doing it, but looking like it is being very specific about exactly what it does want to achieve. I think it is very important that this reform does let the market play out in terms of which renewable technologies it brings forward.
Ian Temperton: I would say no is the answer to your question. I think across the whole decarbonation agenda, on doing things cost-effectively, we and most people will believe that the rigours of the private sector will make sure that we spend less money decarbonising our energy system than we otherwise would, and that across the whole decarbonisation agenda, mobilising private capital is essential, because people don’t believe that Governments have the wherewithal to pay for it all themselves. So I think doing it in the private sector and making sure that the rigours of what investors bring to this is put on to those investment decisions is absolutely essential to making sure it is done efficiently.
Q151 Dr Lee: How much can you borrow? How much can you borrow on the public market as a private investor now? What is the interest rate? For something as risky and as complex as this, I would suggest it is quite a bit more than it would be if the Government borrowed it. Are you honestly telling me that there is 3% or 4%, which is probably the likely difference here, to be made by giving it to the private sector before selling it? Are you honestly saying that?
Ian Temperton: That is logically what I am saying, yes, indeed.
Gaynor Hartnell: It is very different from a few large nuclear projects, whereas with renewables, it is a distributed form of energy. You are talking many, many thousands of projects.
Q152 Dr Lee: Yes, but you talk about risk of development. This is all about risk. You guys are trying to run away from it and trying to offload it on to the Government-sorry, those of you who are investors. On where the risk lies, it is obviously going to lie with the Government, because the private sector does not want to take that risk. So why not be honest about it? Build the thing, and then sell it, having taken the risk of development.
Nick Gardiner: I did not hear the debate last time, but there are inevitably, in renewable energy, as we said before, many thousands of projects, so you have that issue to deal with, Government have that issue. Also, as Gordon said, you have a very long development time, so it is not just Government stepping in and building it. There are, in renewables, as I know, having financed it for a number of years now, any number of years as a lifecycle to get to that point where Government is going to step in and build it, so I don’t see that Government is best placed. Is that the most efficient use of Government, to be doing years of work in getting that through planning, getting that through the various consents and so on? It just doesn’t seem to be an optimal use of Government time.
Gordon Edge: I think the best way for Government to help out here would be to massively increase the capital available to the Green Investment Bank and lend at appropriately low rates to successful projects, where the private sector and developers have the skills to deliver those effectively. That would bring in the Government balance sheet in terms of financing for those projects, but I don’t think they need to own them.
Gaynor Hartnell: May I come back on the PV question?
Gaynor Hartnell: You were saying, "Well, Government has it wrong there". Government had the handling of feed-in tariffs and the reduction in tariff levels wrong for sure. It could have been done an awful lot better. Right now, they may be poised to get certain things wrong again, because the point was made in the previous session that the cost of PV has come down dramatically. The cost of larger-scale PV is now competitive with offshore wind-indeed, cheaper-and its trajectory is very steeply sloping down. Now, that in theory is a technology the Government should want to have a great deal of, because offshore wind is the Government’s marginal technology, and in theory it wants anything it can have that is cheaper, and to limit the things that are more expensive than that, so PV’s status has moved to becoming a technology that should have a significant role in the future.
Gordon Edge: The difficulty with this argument is that it avoids the industrial benefits that can flow from certain technologies over others. We will not win globally in PV, but we can win globally with offshore wind and wave and tidal in the future, so I don’t think this framework in the Bill recognises that there may be ways we can be winners as opposed to this idea that we just take whatever meets our carbon objectives cost-effectively. We need to have that sense of where we can do better than the rest of the world.
Dan Byles: What do you mean by that?
Gordon Edge: Establish an industry that exports, provides jobs and investment and economic benefit for the UK, and offshore wind, wave and tidal are definitely ones where we can do that, whereas there are other technologies where we won’t.
Q153 Laura Sandys: In summary, that is an industrial policy, not an energy policy, and so in some ways maybe they need different mechanisms. Taking it on from my colleague, Dr Lee, Climate Change Capital said, "The preferred contracting model approach will not work. It is over-complicated, has potentially unmanageable balance sheet implications for the supply industry and gives investors and projects with CfDs questionable legal recourse". Would you agree with that? In particular, when we are looking at trying to introduce and attract new entrants into the sector, is this a model that is open and increases that level of competition, or is it something that needs a huge legal department and a sort of massive balance sheet that is going to be able to sustain the pressures?
Shaun Kingsbury: Let me deal with one point, and then maybe some of my colleagues can deal with others. On the contractual side, that is an area where we have a lot of concerns. We like to see a counter-party on the other side of the Power Purchase Agreement. We will take development risk, we will take financing risk, we will take operational risk with these assets, but if we have to take counter-party risk, that makes us very uncomfortable with the revenue side, and as currently detailed in one of the two models, it is a synthetic counter-party. It is not something that we can easily get legal recourse to, and there are different views about whether the legality of it will stand up, but when you come to make that investment and deploy the millions of pounds necessary to build one of these large assets and you cannot see that counter-party, and it is not absolutely clear, then that is a decision we will probably defer. So that is one part of it. Maybe someone else can add-
Laura Sandys: Can I just come back to you?
Shaun Kingsbury: Yes, sure.
Q154 Laura Sandys: From what you see, and I know there is a lot of detail that hasn’t come through, are you going to be making an investment?
Shaun Kingsbury: At the moment, with the information we have available-and that may change as more comes out-it is not currently investable.
Q155 Laura Sandys: So it is not currently investable?
Shaun Kingsbury: It is not. We have not stopped our development activities, because we believe some of this will be worked out, but with the information that we have today, I could not take it to my investment committee.
Q156 Laura Sandys: Could the Committee ask you to be specific-in writing, maybe-about the aspects that are making that uninvestable, the actual details?
Shaun Kingsbury: Sure. It is already in our submission, but we can provide further detail if you think it is not clear.
Ian Temperton: I was just going to say, yes, I did write that and I still think it is right. I think the pendulum has to change, and there needs to be a Government counter-party. That is what was originally envisaged, and that is what we all thought was going to be the case.
Q157 Laura Sandys: But then do we not run into state aid rules issues?
Ian Temperton: I am the not the best state aid lawyer you have available to you, I hope, but maybe. I think that is one of the things that we are all concerned about. DECC has gone quite considerably out of its way to invent this payment model, which is different from anything any of us thought we were going to get when we first saw the proposals, and we are all quite fearful that the reason for that is that state aid and the Treasury balance sheet issues are what are driving them down this particular cul-de-sac. It would be a great shame.
Q158 Laura Sandys: So you have said this is not investable at the moment as well?
Ian Temperton: No, absolutely. I would agree with Shaun.
Laura Sandys: Absolutely?
Ian Temperton: Absolutely.
Gaynor Hartnell: I think there was an important point that Professor Newbery made this morning. This state aid question has been driven by nuclear, and it is great pity that renewables has been tied up in that.
Laura Sandys: Absolutely.
Q159 Sir Robert Smith: Can those of you who are working in the international market point us to another part of the world that has it right, and that we can copy?
Nick Gardiner: It would behove me to identify particular markets. I think that where you have seen the higher levels of investment, the feed-in tariff has been very successful in attracting investment into those markets, so it is markets where there is that level of simplicity, transparency and long-term confidence in Government. It has tended to be where you have strong and consistent Government support, and the more successful development of renewables has certainly been in those markets where you have feed-in tariffs.
Sir Robert Smith: I think they have been cost-effective for their consumers as well.
Nick Gardiner: Well, affordability, from a financing point of view, is incredibly important to us as well. It is not "build at any cost." If we don’t have confidence that this is affordable, then from a financing point of view that undermines why you would want to invest in anything in the first place. Absolutely, that is a critical element of financing, certainly from a bank financing point of view.
Ian Temperton: I don’t think anybody has it particularly better, frankly, particularly when you take the balance of investability with affordability. There is an awful lot of stuff that has gone into feed-in tariff regimes that has not been very affordable for consumers. I think the UK does have a reputation for being a bit over-complicated sometimes in its energy policy, but for generally being predictable, generally being open and generally signalling changes pretty well ahead of time, so we should stand behind what we say about some of the proposals at the moment. I don’t think we should throw the baby out with the bathwater on the attractiveness of the UK.
Q160 John Robertson: We have been told that awarding CfD at the point of final investment decision will increase the risk of a project developer not being certain that the project will be able to get a contract. How can we solve this? Or do you think it is not true?
Gaynor Hartnell: We can solve it. The Renewable Energy Association put forward what we called a kind of two-stage commitment process. What we think is important is that a project developer can essentially reserve a CfD at the point of winning planning permission; for example, they might have an option to take it up for, say, 18 months or a couple of years, by which time they take that project to the point of the making the final investment decision. Then the contract kicks in, and then they have a certain period of time in which to build it. It seems to us essential that that happens to de-risk the process. Obviously you can’t hold on to that allocation of a CfD or future allocation indefinitely, because you would have funding sterilised by, say, a project that was not going to reach fruition, so that is why we are suggesting, say, 18 months or two years to take it to the financial investment decision.
Q161 John Robertson: Would that not basically take up the CfDs available? We have seen it before; people have applied for planning permission all over the country to do wind farms and nobody builds anything. We have seen it with supermarkets; they buy up property to stop other people from building. Is that not the same thing that could happen?
Gordon Edge: I think the problem is you are not going to get to financial investment decision. You need to do a lot of investment to get to that point, and if you do not have the certainty that you are going to get the support, you will not make that investment. So earlier on in the process, as Gaynor said, when you have planning permission, when you have a signed connection agreement, it is a serious project. You have already invested significant amounts of money, particularly if it is something like a large offshore wind farm; it is tens of millions to get you to that point, so it is not a fly-by-night thing, in which you just speculatively go in and reserve CfD, but you do need a definite sense of where the milestones are; if you have not met them, it will be taken away. I think we do need that sense, at an earlier point in the process, of "I have my CfD. I can now negotiate with the turbine suppliers and the other contractors to agree prices and make it happen."
Q162 John Robertson: Would the levy cap introduce a risk of the pulling of a number of CfDs?
Gordon Edge: Yes is the short answer to that. We definitely see that as a greater risk now than we have seen in the past, particularly when the award is at this earlier point in the process, as opposed to the RO, where you get entry when you are finished-when you have completed the project. If there is this gateway earlier on, where people are going to be restricted in going through, I think that is a different risk.
Q163 John Robertson: So what could be done to prevent this sort of boom and bust situation?
Gaynor Hartnell: Well, I think there has to be flexibility about how the levy cap operates. The way things should work is that Government enters into a target-in the case of renewables, a legally binding target-and then it tries to meet that target as cost-effectively as it can. It should not enter into a target, then say, "We have this much money", and then say, "Well, how far can we go towards meeting that target with this amount of money we have set aside for it?" The decision-making process is in the wrong order there.
Q164 John Robertson: But does flexibility not increase cost in itself?
Gaynor Hartnell: Well, having a very tight control on the reins can increase the cost, because it increases the risk.
Ian Temperton: A Government ends up unfortunately making commercial judgments as to who gets these contracts and who doesn’t in a lot of these cases, because I think it is impossible just to allocate a final investment decision, for all the reasons that colleagues have said. I think if you look across various technologies, there are ways of having plans so that we don’t get massive amounts of over-supply. I think you can rely on the planning and the grid system to make sure we don’t get an enormous glut of onshore wind farms in the UK, personally, and I don’t think it would be at all harmful to tell the onshore industry that at a reasonable cost, they would always get a CfD, because I do not think that will cause a glut.
Q165 John Robertson: Do you think that nuclear coming along and maybe taking up a lot of the CfDs initially may cause a problem?
Gordon Edge: It depends how they are budgeted. If there are separate budgets for all the different technologies-
John Robertson: Okay, so do you think they should be separated for each technology?
Gordon Edge: I think at the least there should be a clear budget for renewables. As for whether there should be a budget for offshore wind or onshore wind, I think that is probably too much granularity, but there should certainly be a renewables budget.
Q166 John Robertson: The previous group didn’t like the idea of setting up distinct levels for each technology. Do you disagree with that? Do you think that the Government should say, "10% here, 20% there, 10% there", depending on the technology?
Gaynor Hartnell: I think the panel this morning were against the idea of the Government specifying a certain percentage of each type of renewable technology. The Government has already set an overall target for renewables, or agreed to the renewable energy directive target.
Q167 John Robertson: But do you think that splitting it up would cause a problem?
Shaun Kingsbury: I think it could cause a problem, and just to build on your point, I think you are exactly right when you specify both ends of the tariff bookcase, and if you say up-front to anyone with even an idea of a wind farm, "Please apply for a CfD", you may get 20 or 30 GW of applications. This is what happened, for example, in Turkey. If you wait until the very end, then people will not invest the capital to get there because of the risk, and, as Ian said, I don’t believe that if we make these available we will have a huge amount more than we expect today coming through, because of all the other constraints that we have. But if you go with either one of those two extremes, you are going to get the problems that you suggested.
Q168 John Robertson: On the volatility of the market, how do you think that will affect the forward planning? Do you think you can plan years in advance, or do you think it is going to be much more short term, in relation to which one you want to use?
Ian Temperton: One of the key issues is the supply chain, particularly with offshore. Uncharacteristically, I would be a bit more industrial-policy-like, and probably even think a little bit more about technology specifically, because individual projects competing will have implications, if we want a supply chain in the UK. Individual projects may be able to make those decisions, but if you want somebody to invest in the supply chain that might be amortised over a period of work-over 10 or 15 years or so-they need visibility of that work. So I would probably be in favour of a bit more of an industrial plan.
In the case of the people who are going to use up a lot of the levy control framework gap-the nuclears and the big offshore wind farms-Government kind of knows where they live, and it shouldn’t be impossible to plan for what they are going to need and what they are going to use up of the budget.
Q169 Dr Whitehead: Perhaps you could help me clarify some of these issues around how all that may happen. We don’t know the total envelope of the levy cap that may apply to all these decisions, in as much as it will be over the next spending round, not this one. Secondly, since the relationship of the strike price and the reference price is uncertain, whereas a levy cap would be certain, it is not clear to me how those two fall into the same cup, and thirdly, since we do have investment instruments at the heart of the Bill that appear to be methods by which one can book one’s CfD at an early stage, it appears logical that absolutely everybody would want to go for investment instruments in order to book their CfD place, but without the knowledge of what the levy cap is going to allow for early booking. Presumably an elementary gaining point would be that you want to try to book your place as certainly as possible, but by doing that, you may completely overflow the pot for anybody else, and logically therefore investment instruments would overturn the whole relationship between CfDs and the levy cap. Do I have that wrong, or is it a potential problem?
Shaun Kingsbury: It is a potential problem, yes.
Gordon Edge: In fact, it is even more complicated than that, in that the levy control framework will also be including all the RO projects. There is an uncertainty-because there is a choice between the CfD and the ROs-which one the developers will go for, and they have different implications for how much of the levy control pot will be used. So there are multiple uncertainties, and I don’t think DECC or Treasury have worked out in their own minds how they are going to account for that problem, as you say, of the differential, the uplift being an uncertain amount, and against a hard levy control pot.
Gaynor Hartnell: Can I just say one thing about booking a CfD? This isn’t a casual thing. You have to go and get planning permission and achieve it and a connection agreement. That is the investment possibly of hundreds of thousands of pounds, so it won’t be that easy. It is not as easy as, say, just bidding in for a NFFO contract, to go back to the previous Government’s policy, where all you needed to do was to have some time to fill in a form.
Q170 Dr Whitehead: But is it your understanding, Gaynor, that as far as investment instruments are concerned, essentially that looks like a promissory note, saying, "When you get your scheme under way, you will get CfDs when you want them"? Those have then already been pre-promised, so how does that fit in with the question of how you otherwise might get CfDs in terms of the planning process?
Gaynor Hartnell: It just means that you know that you have some of the risk in the project development stage taken away. You have invested a certain amount of money, sure, to get to the planning permission stage, but you haven’t gone all the way. If you go all the way and reach that point when you are about to make the final financial investment decision, say, "that is too much money". People will not be interested in pursuing this if they have no idea whether they will be able to get a CfD. If the demand is such that there is greater demand than availability, which is a concern at the moment, there is no transparent process by which one project developer will be chosen to receive a CfD and another won’t. They will be batched in six-month rounds, as Gordon was suggesting, without anybody knowing what the process will be. It is very unsatisfactory.
Gordon Edge: There also won’t be transparency on what the strike price will be for the investment instrument, so it will be negotiated it maybe considerably greater than the administered price. There are lots of options for over-allocating the pot in ways that some people might find unfair.
Ian Temperton: On another control point, you are completely right, and it strikes me that the reason the levy control framework exists is because of the money that we all have to pay through central Government, and that is used as tax payment-tax through the populace, which is what Treasury cares about. That is why they have levy control frameworks-so that they can stop Departments taking away the tax-paying capacity of the populace through some other means that they are not in control of, and that seems fair enough. It does strike me that what the Treasury ought to care about is the total cost being paid for the electricity, which is what is set on a project-specific basis by the CfD, so I agree with you that it is not how it works today. It sort of strikes me that the principle of it is that people should only have to pay so much for essentials so they have some money left to pay taxes to the Treasury.
Shaun Kingsbury: If I just reply to this whole discussion, it is again evidence of the complexity and risk, and relatively speaking the complexity seems to be getting bigger, and the risk is therefore higher, potentially making the UK market less attractive, which we don’t want.
Q171 Laura Sandys: Just a one-word answer: do you think that DECC has the capacity to manage this complexity and to be the so-called arbiter of these contracts? How are they going to work through all of these processes?
Shaun Kingsbury: Two words: I don’t know. That is three, sorry. We don’t know yet. We have been working with them closely, trying to add detail.
Laura Sandys: You are obviously going to be employing lots of lawyers; there is going to be a whole load of professional expertise there on your side. Do you believe that the Department has the capacity to interface with all the questions that you are going to be asking and possibly any legal recourse?
Shaun Kingsbury: All I can say is they have been engaging directly with us. They have been listening to what we have been saying, and it has been a good process in terms of exchange of ideas.
Nick Gardiner: It is a difficult question to ask, and I agree with you, sure.
Q172 Laura Sandys: But do you think that DECC needs to change its role?
Nick Gardiner: Its role is changing. I have been engaging with DECC now for a number of years, and certainly the level of engagement has improved, in terms of the amount of time we get in front of DECC, and the complexity of what they are talking about. To give a very succinct answer to your question, "Are DECC at a level where they could do that now?" I suspect they are not, but it is difficult to be unequivocal about it. I suspect that given all the complexities-as you say, not least from the legal side-which it would entail, you would look for that, and you would have to think, but certainly the level of engagement from DECC that we have had to date has been very, very good, and they are increasingly engaging with us on the financing side.
Q173 Chair: On a related point, given that the issues like the cap are clearly Treasury-driven rather than DECC-driven, do you feel you have satisfactory interaction with the Treasury?
Gaynor Hartnell: I am not sure that they really appreciate the impact they are having, and it is a counter-productive impact, in terms of increasing risk and reducing investor confidence. All these things are not going to help targets to be achieved in a cost-effective manner.
Nick Gardiner: A similar answer to a previous question, I think: certainly we are beginning to have engagement now with the Treasury, and they are beginning to join the dots between the Treasury, DECC and others. So is it to a satisfactory level? I would suggest not. Is there a level of engagement? Yes, there is.
Shaun Kingsbury: This control issue has emerged as a risk over the last few years. I am not sure people who were developing projects several years ago were really thinking of it as a risk. It is an emerging risk. It is one that is, after conversations like this, moving towards the top of the list, so I think engagement directly with Treasury on that, and making sure they understand that and the effect it has, is probably something we should do more of.
Gordon Edge: I think the Treasury is never the most open Department to engagement and lobbying, but I think what I would worry about with the Treasury is a narrow focus, and I really disagree with your point, Laura, about divorcing industrial and energy policy here. We have to have an energy policy and industrial policy that go in tandem. If you do not have-
Laura Sandys: Yes, I totally agree with you, but I am just saying that they are different issues when you were responding.
Gordon Edge: I think it is clear that we need to emphasise that these need to be integrated, and I am not sure that Treasury is quite there yet.
Q174 Sir Robert Smith: Just on this counter-party problem, how much of a real problem is it? The analysis from DECC talked about the savings of cost of capital, on the feed-in tariff and the Contract for Difference. How much of that saving was because of the actual nature of the contract between them, and how much was about the fact that Government were a counter-party to the final analysis?
Gaynor Hartnell: I think that impact analysis was conducted on that basis, and if that is not the basis anymore, then one has to question whether that degree of saving will be achieved.
Shaun Kingsbury: We really need to see a counter-party that we can form a legally binding contract with on the revenue, and if we think we have it, but it is not clear, it is a real problem.
Nick Gardiner: Two boxes that banks have to tick for that is legal enforceability and creditworthiness.
Q175 Sir Robert Smith: On the creditworthiness, given that it is all the suppliers, isn’t there really quite a reasonable creditworthiness?
Nick Gardiner: But you need the two to go hand in hand, so from a creditworthiness point of view I would agree with you, but I think there are question marks around the legal enforceability. We would need to be, on a finance side, very comfortable about both of those, and they do very much go hand in hand.
Q176 Sir Robert Smith: And can you see a legally enforceable solution?
Ian Temperton: A Government-backed entity that signed the contracts would be nice. There is also an accountability point, I think, because I think it is important that people don’t think that this is technical accounting and legal issues that hopefully the lawyers will get comfortable with. There is an accountability piece to this, which is we are expecting the utilities to set their tariffs for their customers under this regime on the basis that they forecast what they have to pay in difference payments to their competitors. Having viewed all the evidence from last week, it did not look to me like some of the utilities were desperately impressed with that idea. People who invest in these projects are going to have to look through this and say, "Do we think this payment structure is going to work in the face of what is always going to be a lot of regulatory rough and tumble in the energy sector?" So I think having a Government entity that makes an estimate as to what those different payments needs to be and requests that the supplier gather those as a levy from their energy consumers looks a lot more transparent and a lot more robust. Then people would get a lot more comfortable with it.
Q177 Sir Robert Smith: If the state aid rules prove insurmountable, is there a second-best solution?
Gordon Edge: Well, the solution then would be to remove renewables and nuclear and take them apart, because the state aid problem applies to nuclear, not to the renewables.
Q178 Sir Robert Smith: Right, and do you think if you could isolate nuclear, there could be, given the chunkiness-
Shaun Kingsbury: We are a renewable energy investor, so we tend to focus on that.
Q179 Sir Robert Smith: So if the renewables could be sorted, you would be happy?
Ian Temperton: I am sure DECC would say, if they were here, "The Government doesn’t explicitly stand behind the renewables obligation and we all invest in the renewables obligation", so while it is not that simple, there is a mechanism for the flow of the cash flows through the industry that we have become used to, that we think is robust and that passes the sniff test of credit committees and investment committees and boards of directors. So if it was a counter-party with a pretty absolute right to levy the energy consumer, then subject to how those rights are enshrined, everybody might get comfortable with that.
Q180 Dr Whitehead: The White Paper, when it came out, envisaged that the Power Purchase Agreements would effectively no longer be needed once CfDs came in. Do you think that is right?
Gaynor Hartnell: I have heard some larger project developers speculate that they may not need Power Purchase Agreements, but I think they may be changing their mind, or they may be concerned about the implications of the year-ahead reference price for non-intermittent generators, so I think the majority of project developers will certainly need a Power Purchase Agreement, those that are not directly trading, who aren’t signatories to the balancing and settlement codes.
Shaun Kingsbury: There is another issue, which is even if you have a CfD, it is getting your power to market and making sure you get the reference price, because if you get less than the reference price, your economics are going to be impacted significantly, so the questions are: how do you move the power; who is the counter-party; will people buy intermittent power from you; what price will they discount it; and what will the basis risk be against that reference price? Those are all challenges that could be taken away if you had a counter-party on a PPA and you signed a transaction with them.
Q181 Dr Whitehead: So is it your general conclusion, panel, that it may well be the case that in the absence of a continuing obligation after 2017, Power Purchase Agreements, particularly for intermittent generation, are fairly basic to what goes on?
Ian Temperton: People wanting third-party finance will need Power Purchase Agreements. They will need to give their financiers a surety that their product is going to get into the market.
Shaun Kingsbury: That is a strong preference.
Nick Gardiner: Absolutely. From a financing point of view, banks would require PPAs, yes.
Q182 Dr Whitehead: Who would provide those PPAs under those circumstances?
Shaun Kingsbury: I think you have two options: the Government-backed entity, which could enter into the CfD for purchasing the power, or a counter-party that you would sign a bilateral agreement with-one of the big six, for example.
Gaynor Hartnell: I think our concerns are that the Power Purchase Agreement may not deliver for the project developer or the generator the power at the reference price and therefore the combination of the PPA plus the CfD might not deliver the strike price, and that is one of the premises of the whole idea of CfDs-that that be achieved.
Q183 Dr Whitehead: Wouldn’t it be the case that if you did have a PPA offered, say by one of the big six, then almost inevitably that would be offered at a substantial discount?
Gaynor Hartnell: Yes, I think we are agreeing there, Alan, so there is a discount. The combination of the two things doesn’t achieve the strike price that the Government is expecting or anticipating you need.
Q184 Dr Whitehead: Yes, so presumably unless you had a PPA issued as an issue of last resort from the Government, then it would probably be in the hands of-difficult to see who else might issue them-large integrated suppliers and generators.
Gordon Edge: It is possible to imagine new aggregators coming into the market-potentially financial institutions and other companies with large balance sheets who want to take that kind of trading portfolio risk. The trouble is that was meant to happen under NETA and never did. We ended up with large, vertically integrated companies, and so even if we did feel confident that these companies would come along, there would be a timing issue as well. It will take some time for those kinds of entities to come forward and start trading at the kind of volume that would be required. So we see there is very much at the very least a transitional problem from where we are now, where the big six have been given an incentive through the renewables obligation to contract, to a position where under CfD, they have no obligation and incentive to do so, and therefore may not provide PPAs at a price that is bankable. I think that is the main thing. I think we worry more about the terms on offer, rather than about them necessarily being on offer at all.
Gaynor Hartnell: There is one other possible route to market: you directly contract with, say, an onsite user of electricity. It may be through a private wires agreement or just a direct contract, and it is not clear to us that the EMR envisages that you would get a Contract for Difference on that basis if you are not contracting with the supplier. That is a worry, because that could be a significant source of good sites for renewable energy project development and also good capital for investing in the project.
Q185 Dr Whitehead: But if you couldn’t get a bankable price, or had only a marginal bankable price from the PPA that you have to have in order to continue without an obligation, wouldn’t that eventually put you out of business?
Gaynor Hartnell: I am not sure I quite heard the question, but if you have a large industrial user of electricity, so they are creditworthy, they have physical assets and they want to buy the power and they contract with you, that is another route to market, but I am not sure that it is one that is envisaged in these electricity market reform proposals.
Dr Whitehead: No, what I had in mind is this: let us say you are an independent generator post-2017, and you are seeking to sell your power. In order to do that, you have to have a PPA, but that PPA is likely to be barely bankable because of the discount that will be offered. Does that mean that you as an independent generator are in trouble as far as either your entry into the market or your continuation in the market is concerned?
Gordon Edge: The short answer is yes. I think this was one issue that DECC didn’t take seriously enough early enough-that there was a risk in offtake. They just saw this nirvana where everyone just sold through a liquid day-ahead market and they could achieve the reference price and it is topped up with CfD and everybody is fine. That may happen sometime in the future, but we have a real problem getting to that point from where we are now, so PPAs will be essential. Again, it is back to the bankers’ point: if they don’t have a PPA, they will not lend, so we very much welcome that DECC have recognised it and will be doing a call for evidence around this issue, but again, they have very little time to be bringing forward a workable solution if they do conclude that there is something that they can and should do.
Nick Gardiner: Just to develop that point just slightly further, in terms of would that be bankable, banks will look at what could be going on offer and will structure our finance accordingly, so almost certainly there will be less debt that would go into those types of projects, so hence there will be a higher equity requirement. Does that make the project sustainable from our point of view? It would certainly prejudice the economics of the project.
Shaun Kingsbury: In markets where there is more liquidity-for example, Scandinavia-you are looking at this concept of 2% or 3% versus the reference price, so significantly less discount that you would see, for example, in the UK market.
Q186 Dr Whitehead: But if you were about to be integrated, generator and supplier, you would not worry about a PPA, presumably, because you would be able to offset against your own background-
Shaun Kingsbury: Correct. It is the small independent generators that suffer most of the problem as a result.
Q187 Dr Whitehead: Do you see that as an insoluble problem for the future markets post-2017, particularly for the independent generator, or is that something that can be patched?
Gordon Edge: There are a number of possible solutions. A buyer of last resort has been kind of mentioned here. You might, through licence conditions, impose upon the big six a requirement to offer terms of some description. There are other options of incentivising them to buy low-carbon power. None of the options I have seen or thought of are perfect, but there are options to deal with it.
Dr Whitehead: Do you see any obvious-
Shaun Kingsbury: No, I think it needs a piece of work with DECC internally, to do with improving liquidity. It is a liquidity issue, because if we have enough buyers and sellers, the market will work more efficiently and so the discount that you might see for intermittent power would be much less. We have seen it in other markets.
Ian Temperton: The independents will tell you the problems now as well. It is worth noting that. You have them this afternoon, I think. I think they will tell you that the availability of PPAs at the moment is pretty poor, and so one of the problems-we are only at the call for evidence stage on the issue-is that quite a lot of them are saying they are suffering in the here and now.
Chair: All right. I think we have probably reached the end of our time. Thank you very much indeed for coming in. We are very grateful to you and have obtained some useful evidence.