Energy and Climate Change Committee - Minutes of EvidenceHC 275

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Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 19 June 2012

Members present:

Mr Tim Yeo (Chair)

Dan Byles

Dr Phillip Lee

Albert Owen

John Robertson

Laura Sandys

Sir Robert Smith

Dr Alan Whitehead

________________

Examination of Witnesses

Witnesses: Asif Rehmanwala, Generation and Trading Director, Ecotricity, Ed Gill, Head of External Affairs, Good Energy, Andy Taylor, Energy Markets Group Director, InterGen, Gordon MacDougall, Chief Operating Officer, Renewable Energy Systems UK and Ireland Ltd, Dr Steve Riley, Chief Executive Officer and President, UK-Europe, International Power Plc, and Jonathan Smith, Head of Pricing and Risk Management, First Utility, gave evidence.

Q188Chair: Good afternoon. Welcome to this meeting of the Committee. Thank you for coming in. There is a lot of interest in our work on the Draft Energy Bill. Because we have been required to do it in considerably less than half the time that is normally allowed to a Select Committee doing pre-leg scrutiny of a Bill, I am afraid we are having to see larger groups in single sessions. You will have to forgive us if we are somewhat concise in our questioning and we appeal for concise answers. We only have one hour with you all and there is another panel following immediately afterwards. We will skip formal introductions if that is all right. You know who we are. We know who you are. Can I start with a question about the whole approach of Contracts for Difference? Do you think that they will meet the EMR objectives of achieving a lower carbon mix of generation in this country?

Gordon MacDougall: If I can go first, the answer is not necessarily. As currently presented, I do not think they will guarantee delivering that. One of the things we would want to correct is that it is often referred as a "CfD FiT" and it is not FiT. It is not a Feed-in Tariff. A Feed-in Tariff would typically apply where you have certainty of price and in this instance it is not a FiT. It is a Contract for Difference and a contract without a known counterparty. For those reasons, I think we would see it as having detrimental effects on the market as we stand today but having the possibility to work for certain types of technologies, particularly nuclear which is what I think it is being designed for.

Ed Gill: I think if you are defining low carbon generation as nuclear and offshore wind then yes. The FiT CfD as proposed has limitations in that respect to fit small and medium-size generators, which you are going to become more reliant on to secure new investment and also to reach those targets.

Asif Rehmanwala: There are no clear benefits in terms of low carbon generation, in terms of renewables, which will be a big percentage of the energy industry in the UK and, therefore, we can’t say that will happen because there are no clear benefits.

Dr Riley: I will take a slightly different view. There was a lot of consultation on what the mechanism should be to replace the RO if that was the direction we wanted to go in and the CfD FiT was landed upon as the one that would encourage more investment in low carbon technology. If you think across the full suite of those technologies, for the more difficult ones, like nuclear and CCS, the CfD FiT does seem appropriate because it gives some longer-term security around the income for investors and it may attract a different set of new entrants for onshore wind or offshore wind, for example. But, again, it should give investors, particularly those who rely on non-recourse project finance, a bankable contract against which they can raise finance. That does, of course, depend on who the counterparty is and what the exact details are for setting the strike price and the reference price. I think that is one of the issues that we are faced with at the moment-among the complexity in the EMR proposals, there is still a lot of detail that we don’t know and it is somewhat early to tell, until we have been through that process, whether this is in fact going to deliver the objectives.

Andy Taylor: I would agree with those sentiments. I think it has the potential to deliver what is required so we have that bankability of long-term investment. We certainly need the counterparty issues to be resolved but it has the potential structure to give that longer-term, 15 to 20 years, certainty to investment. There is a lot to be addressed such as strike price, transparency and liquidity in the market to support the market reference price. There are a number of major issues that still need to be resolved.

Asif Rehmanwala: Given all those issues that need to be resolved, I do not feel it would be any better than the RO.

Jonathan Smith: We think that the CfD FiT is overly complex. The Premium FiT would have been a better process, we believe. It would not damage the wholesale market price signal and price discovery mechanism like the CfD FiT will, in our view. We think it passes significant risks from generators on to suppliers.

Q189Chair: It has been suggested by SSE in particular, I think, that the option of a Premium FiT should be taken as part of the Bill.

Jonathan Smith: I would agree with that.

Ed Gill: We would agree with that. The Premium FiT brings advantages in terms of perhaps introducing genuine liquidity to the market rather than a more artificial form of liquidity that you would see through a CfD in 25% auctioning. That obviously has benefits in terms of price discovery and making sure that taxpayer subsidy is kept to the correct amount, but also, in terms of competition in the market as well, helping small suppliers, too.

Asif Rehmanwala: We have talked about bankability and investment certainty. Premium FiT would allow that more than a CfD.

Q190Chair: Would it be helpful to extend the RO?

Asif Rehmanwala: Yes, absolutely it would.

Ed Gill: The RO has advantages for the small-I say "small", still being anything above 5 megawatts obviously-and medium-sized generators insofar as it gives you something with bargaining power. It gives you a ROC certificate at the end of the day and that has a value which makes suppliers want to buy generators off you, which gives you something additional to sell. So there are advantages to keep the RO going from that point of view.

Gordon MacDougall: I think retaining a workable solution is an imperative absent of a robust solution being offered and the RO being retained or a Premium FiT would both be good alternative solutions. One thing in terms of maintaining the RO, which seems to be lost, is that the RO was more than just a certificate system. It was a physical obligation on the suppliers to source the right kind of energy and that has been lost in all of this. I think that is a much more significant departure than many people seem to recognise because one of the big problems with a CfD is there is not sufficient liquidity in the market for independent generators to trade and, as such, they require a PPA. Without the obligation on the supply companies, there is no incentive for them whatsoever to offer sensible PPAs to make these projects bankable.

Ed Gill: The other problem with a CfD as well is it is very prescriptive in its outcomes in terms of the operational framework that came out a few weeks ago. It was quite clear that the Government sees CfDs leading to a just a market where Variable Power Purchase Agreements or Market Tracking Power Purchase Agreements become the norm in order to track the day-ahead price, the reference price. Not everyone wants a Variable PPA. For the small and medium-sized generators, smaller generators in the market where there is low level liquidity, there is a real value for Fixed Power Purchase Agreements, which fundamentally are at odds with the day-ahead reference price.

Andy Taylor: Absolutely. I think not just renewables but gas generation and further gas generation investment requires some commitment from large retailers to effectively tender or source some of the generation from independents. That is where you get true competition. That is where you get innovation coming in as well. So if the RO is removed and that obligation is removed, I would certainly like to see 25% or more of the retail demand offered out there to independent generators like us.

Asif Rehmanwala: The key points there have been made in terms of the generation and the renewable side of it, but I would also like to add a point in terms of the risk to suppliers. There is massive, massive risk to suppliers in terms of the collateral that you would have to put up for a CfD, which is absolutely massive. One of the Big 6 has come out and said that this risk would affect their credit rating. If that is the case for one of the Big 6, then that is exacerbated even more for a small supplier. We think it is vital that a 250,000 customer threshold is put in if CfDs were taken forward; otherwise there will be barriers to growth for small suppliers and barriers to entry, too. That is absolutely fundamental in terms of growing competition in the market.

Jonathan Smith: If I can just add one more point. The CfD FiT is indicative of a lot of features in electricity market reform, in that it is overly complex, and we believe there is a far simpler set of reforms that could have been put together to fix the wholesale market deficiencies at its core and which would be far less invasive in the market.

Q191John Robertson: Does the levy cap introduce a risk that the pool of funding or number of CfDs allowed might run out before the end of this spending review period?

Gordon MacDougall: Yes. I think the Levy Control Framework is fundamentally incompatible with a CfD. Government can control the volume of contracts but what it can’t control is the price and, therefore, how do you balance that? What is the winning priority between long-term investment and short-term budget targets?

Asif Rehmanwala: To add to that, how can Government determine the correct level of deployment in a fair, cost-effective and transparent way? How can the Government do that?

Q192John Robertson: Let me throw it back to you then. What would you do?

Ed Gill: If you have a Premium FiT, a Levy Control Framework is probably going to be more effective rather than a CfD. With a CfD you have no control over volumes and the difference between strike price or reference price. With a P-FiT at the very least you know what the top amount is going to be. There are lessons there that have been learned from the current Feed-in Tariff and the situation with that. It is just a far more straightforward, simple mechanism. To return to Jonathan’s point, the CfD is so complicated and overly-complicated it is just another thing that makes it harder to keep track of and control the costs on consumers’ bills.

Q193John Robertson: Is there a risk that the early nuclear projects coming forward under the investment instrument might use up a great deal of the CfDs?

Andy Taylor: Yes, I think there is a risk of that. Given the information and transparency to date, we just suppose that. We are concerned about that. As with any further investment, there is a race behind the ball. The concern for us is that the investment instruments are almost something that will be entered into in haste and then we will be left with the ramifications of that further down the line. At this point in time there is a concern but, again, overall transparency needs to be put in place. How is the strike price for nuclear going to be determined? We don’t know that yet.

Asif Rehmanwala: I was going to say, in terms of nuclear taking up that fund, I think that could happen regardless of whether you go down the FiT route or the way CfDs will work. I do not think it matters either way. It is going to happen.

Ed Gill: The wider point here, of course, it keeping track of the cost of investment going on consumers’ bills. You are talking about an instrument that Government has continued to press ahead with and implement based on an impact assessment that assumes the Government is still the counterparty. The International Energy Agency came out, I think a month or so ago and said that improved liquidity is vital to ensure that the CfD works properly and also delivers proper value to the taxpayer at the end of the day. The proposals for liquidity are 25% at best, and the Government is saying it is not going to be the counterparty any more. The entire rationale for the CfD is that it provides taxpayer value for money. So the original rationale for introducing something that was in parallel run with the Premium FiT falls away quite quickly.

Q194John Robertson: Do you think there is a need for the Government to set out a level of deployment between each of the technologies so that it is set rather than wait and see who picks up the-

Andy Taylor: It would certainly help investors to have something in a broad framework. Undoubtedly there would have to be flexibility within that framework, particularly for investors who want to say, "Okay, what should we focus our pounds on in terms of developing? We are making a substantial financial commitment here. We need some kind of framework as to what the overall strategy going forward and the longer-term strategy needs to be".

Q195John Robertson: This is different from what we heard this morning when they basically said no to that. You are saying yes, so how should this be determined then?

Gordon MacDougall: I would agree that Government should not be setting volumes on any criteria other than cost. They have to focus on cost and deliverability of the sources of energy, not on picking a mix and then trying to dogmatically stick to that and deliver it no matter what the cost is.

Asif Rehmanwala: If the Government controls that then we will be in the same place as we have, for example, for the solar market.

Q196John Robertson: That has worked really well.

Ed Gill: There is a danger there, isn’t there, for it to become inherently more political if you have targets that are too specific, but on the other side, as we have talked about already, there is the benefit of having a renewables targets or a renewables obligation in shape or form that provides clarity and clarity of direction for the market. It is a balance somewhere between the two at the end of the day.

Andy Taylor: At the moment, predominantly the market is gas generation. We are effectively late to the conversation about the gas strategy of the UK going forward. We are starting to have those dialogues now, but fundamentally gas will have a role to play for many years to come. Unless we have that open dialogue about gas, nuclear and renewables, it leaves investors, particularly external investors, slightly confused as to what direction we are heading.

Dr Riley: Going back to your original question, I think it is a step too far for the Government to be saying how much of each technology there should be. I think it is fine for a policy objective across a broad range of carbon technologies to form part of the base going forward. There is a big difference between the two.

Q197John Robertson: If you do that how do you stop, as we have said earlier today, groups of people getting the CfDs and yet perhaps not doing the work? It is like applying for licences for wind power. There were thousands and thousands of them but nobody did the work; a supermarket for instance, was buying up land not to build a supermarket. How do you solve that problem?

Gordon MacDougall: I think that is an enormous issue and, again, you need to ensure that the contracts are awarded at a point where delivery is most certain. Back to your earlier point, it is a concern that nuclear, with such a long build period and such an uncertain cost, could dictate and use up so much of the funding. I think that is an area where Government has to work very hard to ensure that those projects that get built have the certainty of getting a contract, otherwise we won’t go through 10 years of development with the extensive costs behind that.

Q198John Robertson: Renewable UK and Climate Change Capital said that awarding CfDs at final investment decision stage will be too late in the process. Would you agree with that and, if so, how should it be resolved?

Gordon MacDougall: I think that is possibly the right time to be awarding the contract but you must have certainty of getting a contract when you get to that point. The danger would be, if you use up budget when projects are not going to be delivered, you are constraining the market and you under-deliver. So I think that is possibly the right point but you need certainty of getting something. You need transparency.

Q199John Robertson: How would you solve that then?

Gordon MacDougall: Again, that is one of the problems of the way the Levy Control Framework is being presented as potentially over a very short term. We much have a much longer term mechanism that recognises the long-term need and the long-term nature of renewable and other energy developments.

Q200Dr Whitehead: Can I just seek some clarity on the investment instruments. There are a number of clauses in the Bill that seek to set those up. My understanding of that is that under those investment instruments somebody, maybe nuclear or possibly large offshore wind projects with a long lead-in period, might seek comfort in terms of, as it were, securing their allocation of CfDs through those instruments in advance and, therefore, presumably, cashing that security at the point of which they deploy. Is it your understanding that most people would seek such instruments in order to try and get in first on CfD allocations? Would that be a strategy that one might adopt in order to secure CfD allocations over a period?

Asif Rehmanwala: If they feel there is a first mover advantage, absolutely they will do that.

Ed Gill: If the CfD is going to do its job, which is to attract investments, then they are going to do that at the end of the day. If it is going to be an attractive instrument then people are going to want to move in and people are going to want those things probably, yes.

Dr Riley: I don’t think that is a realistic scenario, to be honest. If we are thinking of the investment instruments ahead of the CfD mechanism being clearer to the investors, I would have thought that is, practically, going to be limited to very few projects. It is those with the really long development lead times such as your nuclear or CCS projects, for example, where there is another commercialisation programme for that technology in any case. I would have thought investors were going to think long and hard about boards getting comfort from the investments instruments with the knowledge that there is a CfD process just around the corner or a year or two down the line. I would have thought most would wait for the certainty of the CfD process to be clear-a longer term clear vision of what the UK market is really going to deliver for the investments rather than trying to do things on a project-by-project basis.

Asif Rehmanwala: In the absence of that, do you think people would be prepared to wait then?

Q201Dr Whitehead: If the organisation who have that comfort already and have, as it were, allocated CfDs but not, by definition, allocated CfDs in a particular year according to the Levy Control Framework because at the point of the investment instrument comfort presumably the exact year of deployment is not certain, I imagine at that point they could cash their CfDs in whenever they deployed. Presumably that could be a problem for other people trying to deploy in that year but taking decisions rather closer to the year of deployment. Bearing in mind that these arrangements are potentially lumpy, i.e. a large amount of CfDs might come on stream in any one particular year, because of the size of a particular investment and according to the Levy Control Framework the total is controlled in any one year.

Gordon MacDougall: I think you are right that it could give a very uncertain investment horizon for most other organisations who do not have the certainty or the knowledge that they have a CfD in any given year. It would make things very difficult for them and I guess it could open itself up for gaming and any other misuse of that instrument, which would be a concern.

Ed Gill: I think the wider problem that you are touching on is that there is a need for clarity and transparency in the process by which these mechanisms work. There needs to be a clear and transparent process, which is also defensible as well in terms of any political behaviour between Departments. For example, you have seen in the press recently about the RO. I think that is absolutely vital to give people confidence in the process. That leads back to the problem-how do you overcome that potential lack of transparency given that you are using a very, very complex instrument, which naturally leads to vagaries and opaqueness as a result?

Q202Dr Whitehead: Could I just briefly also clarify your particular point, Ed, concerning the volatility of CfD payments? Have you or has anybody done any work on the sort of range of payments one might reasonably expect to receive bearing in mind the variations on reference price over the period of time, what the strike price might look like and, therefore, what the sort of volatility range of CfDs in any one period might be and how, therefore, that might affect the possibility of the operation of a CfD cap, according to the Levy Control Framework, where that is an absolute numeric financial cap when the variability of the actual payments in a period of time looks at first sight to be rather large?

Ed Gill: We have not done any in-depth work on that particular matter but it is quite evident that there are concerns about having a large volume of cash linked to a day-ahead price going to your balance sheet. As a small supplier, that has impact in terms of credit and you also have to consider the collateral requirements that Steve mentioned. It is one of those areas that we think needs a lot more investigation. The most recent impact assessment that we have seen, and I think it is publicly available, is from July 2011, and there is no mention of small suppliers in there. There is no mention of the impact of the CfD on independent generators. That has only come about recently with the independent call for evidence. So it is a matter that certainly needs to be looked at a lot more, but I think the primary concern for us or the most basic concern is the large volume of cash for which we are responsible for handling. That is going to be of concern to us and to our creditors and that is going to therefore potentially impact on things like trading and that side of things.

Asif Rehmanwala: Yes, I agree. In terms of the volatility that you talk about, without having done the numbers, you have a volatility in terms of your operation as a vertically integrated energy company anyway and that will just be increased by the volatility that you will get between the strike price and the reference price and the timing difference between the end point in terms of paying generators and what sits on your balance sheet, as Ed said. So it is very difficult to quantify but it would be a large amount and that could be very untenable for small suppliers.

Jonathan Smith: I would echo those points. The CfD FiTs will increase the working capital requirements for small suppliers, which will hurt them more than the integrated utilities because the cost of working capital is much higher for smaller companies and the credit requirements to make a robust framework are new and over and above the requirements of the RO, which will hurt them a second time. It will introduce new market risks on the short-term CfD index price and the year-ahead index price that are going to be developed, which are a new market risk that will have to be hedged, which will come at a bigger cost to independent suppliers as well.

Q203Dr Lee: On the complex model of CfDs, do you think there was a particular form of energy generation that people had in their mind when they were drawing up this model?

Ed Gill: Yes, absolutely. I hate to bang on about it, but it is interesting looking back at the impact assessment that was released back in July and the underlying Cambridge Economics paper. It is quite explicit in what it says. It foresees the Government reaching its carbon emissions targets from nuclear and offshore wind.

Q204Dr Lee: So you are in agreement that that is what is going on. It is a complex model, which is seemingly not being received that well for small and medium enterprises and certainly has not been received well by the investors that we have spoken to. Would it be better, do you think, if nuclear was taken out of this whole process and treated separately in a more strategic way by Government for maybe geopolitical reasons, so that we could then concentrate on a system that encouraged small and medium renewable businesses?

Asif Rehmanwala: We completely agree with that. If nuclear can be supported in that respect, then the market can continue in terms of its competition, which is fundamental.

Ed Gill: That creation of clarity would be welcome, I think, but there is a need to be clear on what cost and what funding nuclear would be receiving and that nuclear would be accountable for that, just as renewables are as well.

Gordon MacDougall: I categorically agree with that. I think the most difficult objective that has been set for EMR is to try and fit everything into one mechanism. They are very different forms of generation. They have very different features and they do not fit well together. The idea of trying to do it all as one to maybe avoid certain other issues and make that simpler has created a whole host of other problems and a whole host of other complexities. So I fully agree.

Jonathan Smith: There is a danger in some of this for me in that we have been in a consultation process for quite a long time around energy market reform and an Energy Bill and we seem now to be consulting on some of the elements that are in there and at the same time we are talking about fundamentally changing what we have been consulting on for the last two years. As a potential investor in the UK, it has given me the impression of even more uncertainty rather than of closing things off and giving me the opportunity to tell my shareholders that there is greater clarity coming in the UK and we can start to make some investments on the back of a framework that has been widely consulted on. I take the point behind the question but there does come a point in this where, having been out for fairly wide consultation and come up with a range of instruments to try and move the market forward, we need to try and deliver on some of those.

Andy Taylor: Certainly you can see some attractions in terms of the market for separating nuclear, but investors will say, "There is a ring-fenced treatment. What is next? Is offshore wind going to get ring-fenced at some point?" Again, it would introduce a further uncertainty. Certainly there are lots of challenges ahead to get this Bill through and make this Bill into something that is effective, but I would much rather have transparency of strike price for nuclear, costs of nuclear, timescales for introduction into market and what that means for other generation sources. I would rather have some awareness of that rather than assuming that something else is going on separately behind the scenes.

Q205Albert Owen: How do you think that could be done? Would it mean two sections to a Bill, two separate Bills or what? You talk about transparency but we still have to legislate at the end of the day for the reform. So two different mechanisms? I am not really clear.

Andy Taylor: It might be attractive to take nuclear out of the equation, but I would rather have it included in the treatment of CfD FiT, so they had that transparency. I am not looking for two different-

Q206Dr Lee: My point is that the CfD exists because of nuclear. That is my point. It would not be the model that you would choose if it wasn’t for nuclear. If it wasn’t for the fact that we were trying to perhaps be a bit economic with the language in terms of subsidy and state aid and everything else, it would not exist, would it?

Gordon MacDougall: I would agree with that. My view is the renewables obligation that we had for purely renewable energy was working well and delivering and was a solid mechanism. All the other concerns that people raise around cost or otherwise relate to the tools that were embedded within the RO to deal with that. There is banding. There are various other ways that that could have been dealt with. I would agree that that is the case. I also sympathise with Steve’s point around the certainty and not having this 18-month process we have already been down, and not knowing what direction of travel we are going down. However, after 18 months, I would say that we are consulting on something that is quite well understood, and I take the view that after 18 months we are sitting here going, "What is this and how are we going to deal with it?" There are equally as many unanswered questions as questions answered 18 months in.

Dr Riley: In terms of whether the Feed-in Tariffs or the CfDs are appropriate for the technologies, in other markets, Germany for example, Feed-in Tariffs work for onshore wind. I am not sure it is entirely driven by nuclear and offshore wind.

Q207Dan Byles: I would just like to explore the role of Power Purchase Agreements. Will PPAs still be required in this brave new world of ours?

Asif Rehmanwala: Yes, I can’t see it working without PPAs. There are specific concerns in terms of PPAs in that suppliers might not have the incentive to sign up PPAs in the way that they are now and that will create a massive risk for the generators.

Ed Gill: To come back to my earlier point, I think a concern is that the CfD is quite prescriptive in what PPAs will be signed and the Department seems quite open in saying so. For us as a small supplier, in the absence of any real and meaningful liquidity in the wholesale markets, signing Fixed Power Purchase Agreements is a very good way of fixing our costs, which help us deliver stable bills for our customers at the end of the day. If a CfD removes, in particular through the use of a day-ahead price, that particular instrument then that makes life more difficult for us as a small supplier in some ways, but also it makes life more difficult for independent generators because if we have to strike a deal through a Variable PPA we have to manage that variation and that is a cost that we will then have to pass back in terms of a market discount to that independent generator.

Q208Dan Byles: A fixed price PPA, from your point of view, would be better than a PPA linked to the day-ahead market?

Ed Gill: Yes. You can probably just modify the CfD if you use a long-term reference price. Anything from a year ahead or more would be better than the day-ahead price in our view. Ideally something like a three-year-ahead reference price would strike a good balance between, say, a Premium FiT and FiT CfD. That is one idea that we think has merit and should be considered.

Asif Rehmanwala: It has been talked about and the PPA would not hit the reference price generators. If that was the case then they will not be getting their strike price.

Dan Byles: Yes, that is something that people have raised with us.

Asif Rehmanwala: Yes. So that will be a key concern to a generator.

Ed Gill: Sorry, just briefly linking back to my opening remarks about whether a CfD enough to hit our renewable targets, if you are looking at seeing more small and medium-sized generation coming on stream to hit those targets but if those small and medium-sized generators are going to get the market discount, which is not going to be made up to the correct amount by the strike price because the reference price is wrong, that has an impact.

Andy Taylor: If you want independence in the market, and I think you do because of the competition that they bring, then for project finance we are going to need long-term PPAs, 20-year PPAs, and that is for gas and that is for renewables. We need to those PPAs in place. You are not going to get project finance without them.

Q209Dan Byles: Is that likely to skew things more towards the larger companies though than smaller companies?

Gordon MacDougall: Under the new mechanism, yes. The need to put PPAs is not because it is a CfD we working with. It is because there is an underlying lack of liquidity in the market as we stand today. Twenty years post-privatisation in liberalised markets, we still have 91% of the supply within the Big 6 and 72% of the generation within the Big 6. So their vertical integration in that market, control and power, is why we need PPAs. It is not a liquid market.

Ed Gill: It comes all the way back to investment in generation for small players becoming more and more difficult, which I don’t think is a route we want to go down.

Q210Dan Byles: Would a buyer of last resort mechanism be appropriate?

Gordon MacDougall: Yes, I think that would be very helpful. It would be a very good insurance policy against the market not being sufficiently liquid and not functioning well.

Ed Gill: It is an idea that I think has been considered, and returning to the impact assessment and the underlying analysis, it actually said that if there isn’t sufficient liquidity in the market, the Government should introduce a buyer of last resort. As a result, there is a slight risk of levelling down PPAs to whatever amount they might offer. I think we would probably prefer just to move away from day-ahead reference price. It seems a simple, more straightforward way to modify the CfD.

Q211Dan Byles: How good a handle do you think DECC have of the subtleties in your discussions with them?

Ed Gill: Again, obviously we got the call for evidence now and they are aware that there is an issue. I think the ball is in their court, obviously.

Jonathan Smith: I think the PPAs will be needed for the same reasons that everyone has cited-liquidity is so poor in the wholesale market. The CfDs are going to be very gainable unless the liquidity is at least doubled and it does not seem that there are enough mandatory measures being pushed forward to encourage the doubling of liquidity that is required. Much more work needs to be done to improve liquidity and the mandatory auctions proposed by Ofgem won’t get us there.

Andy Taylor: We have the retail market review going on at the moment looking at options for liquidity. They need to go hand in hand. There needs to be an answer there, not just to suppliers’ concerns but generators’ concerns as well. I think the retail market review mandating portions of large utilities, supply tendered in the market, would help a lot. We are all very much aware of the lack of liquidity since NETA started and also the vertical integration since that point, but if you are going to have independence you need to get an answer to these things.

Q212Dan Byles: Would there be a particular impact on independent gas generators?

Andy Taylor: Yes. Again, as I said, without a long-term PPA there is no bankability. Nobody is going to invest on a traded market that at the moment is concentrated on a day-ahead auction. As a gas generator, we don’t know what our returns are going to be until tomorrow happens. So that is just not a bankable solution. Effectively that squeezes independence out of this whole market.

Gordon MacDougall: I think that was one of the original mismatches of expectations. I think at the time of the original consultation Ofgem were doing a liquidity review and that was designed to bring immediate liquidity to the market. I think Ofgem were looking at something entirely separate and it was not about generation liquidity. It was about retail liquidity and these are very different. So the liquidity in the wholesale markets has not moved forward and there is nothing to fix that.

Ed Gill: I think you have touched on quite an important point there and there is very much a feeling that the Department have come to this problem of, "Okay, we have X amount of plant closing down in X number of years. We need to encourage investment and generation and we will think about the retail side of it afterwards". However, they are inextricably linked. Now, there is always going to be a tendency to do that when you have a market dominated by six large vertically integrated players where you do not necessarily think of the two things separately but also interlinked-if you see what I mean, not wishing to contradict myself. There is the feeling that that is the case and it has not been a case of saying, "Okay, how is this going to impact on the retail side and indeed is this a good opportunity to improve liquidity in a genuine way and have 100% liquidity rather than just messing around with 25%?"

Q213Dr Whitehead: Who do you think will provide PPAs in a post-2017 market?

Gordon MacDougall: Without some form of obligation on the utilities-and I think that is a very effective tool to motivate people to do it-I think that is one of our biggest concerns right now. As we stand there is no prospect of a healthy PPA market and any competition. Again, the discounts that would be applied would be excessive, which would have two impacts-either the strike price would have to be higher and increase the cost to customers or it would basically just have a serious impact on the commercial competitiveness of independence, which we believe would be very detrimental to the UK’s energy needs. We need independence. I think it is will be recognised that utilities alone can’t bring the investment needed but without that access to the market there is a big threat to the ability-

Andy Taylor: You definitely need some compulsion. We have 2½ gigawatts of capacity of high efficiency gas with 1½ gigawatts of that available for sale to any retailer and yet the Big 6 continue to self-supply and build their own with the capital cost there. So I think it is essential to have some compulsion.

Q214Dr Whitehead: To the Big 6, who will be the suppliers of-

Andy Taylor: Yes, the large retailers. Some compulsion. As I say, 25% is the discussion and perhaps you might need more than that going beyond 2017.

Asif Rehmanwala: In terms of your question, Alan, I think there could be an even bigger detriment to the renewable market, especially-going back to the discussion we had earlier-fundamentally they not being a target as part of CfDs compared with RO. There is no target and there is no requirement to have a PPA with a renewable generator. If the renewable is intermittent what is the incentive for a PPA with a renewable generator? It is quite linked in that respect.

Jonathan Smith: I would make the point that if the liquidity intervention that was being proposed was a self-supply restriction, you would have six very large independent suppliers that would need to source power and they would compete for the PPAs on a market-based mechanism. It would solve the liquidity problem as well.

Q215Laura Sandys: Some of the mechanisms that we are dealing with here seem to be a way that DECC is trying to sidestep problems around state aid. Certainly SSE and RWE believe that this is underlying some of the issues, the reluctance of the Government being the counterparty. To what extent do you agree with that? Also, do you feel that DECC is over-stating this and creating a structure that is anticipating problems where there might not be as many problems and do you think that DECC has engaged enough with Europe on this issue before developing a system that in many ways is expecting the worst rather than possibly a little bit more flexibility?

Gordon MacDougall: State aid is a very complex set of rules. It is not clear, I think, without almost testing them to see whether it would qualify and I think that is a difficulty. It could be challenged. I would look at it and say, "If you go down a CfD option with a nuclear plant would you be able to say with a straight face that there is no Government support towards nuclear?" If we take that we are primarily involved in renewable development, onshore wind, and we have many people who like to detract and invent scurrilous comments around the support mechanisms we have, would I then be in a position to say there is no support mechanism or we do not have support; we have a Contract for Difference"? I think that would be the test and I think that does make it very difficult.

Asif Rehmanwala: I agree with that. In terms of technology lifecycle, nuclear is a mature technology.

Q216Albert Owen: Can I move on to capacity mechanisms and just ask a very broad question. The Government says it wants to ensure security of supply. Is there a real risk of the lights going out in the next decade or at the end of this decade, in your opinion?

Dr Riley: There is certainly oversupply in the market now. National Grid will publish their analysis; I think DECC will have their own. Each of the companies here will do their own analysis of when new build is going to enter the system and when plant will fall away. On our analysis, the reserve margin starts to get tight around 2017. I think on Grid’s analysis, it is around 2020. There will be different assumptions in there about the return of some of the mothballed plant and growth projections. "Risk of the lights going out" is probably a bit strong but there will be the need for new capacity before the end of this decade certainly.

Andy Taylor: Our view is similar to IP, 2016-17, particularly given the running hours and LCPD restriction in the coal plants. We should probably just put the mechanism in place so it is there as the insurance policy it is intended to be. Our view is you could have the auction in place. You define the products as early as possible, because some of those products might take seven years to deliver. If you are requiring development of a new fast-response CCGT, that is the criteria, that is the characteristic of the supply you want, then that could take seven years to develop. Start the auction process early and have the insurance policy available, rather than trying to guess exactly when that period of capacity shortfall is likely to be.

Jonathan Smith: We would argue something a little bit different. We think that if the wholesale market price is deep and liquid and vigorously competitive, you would have a price discovery mechanism and you would have supply that the price signal in the market would tell you when the time was right to invest in new peaking plant. If we have time before this capacity shortfall, why don’t we try and fix the hub of the wholesale market so that that price discovery mechanism can try and function? We should try and do that before giving up and putting a policy in place for insurance right now. I think there is time to try and fix the market first.

Ed Gill: We come at the capacity mechanism from a slightly unusual angle in that we obviously only ontract with 100% renewable projects. I think one of the things that we have seen through the power portfolio that we manage is look at what are we doing before we get to the stage where we need the capacity mechanism in terms of technology, diversity and all the things that we are starting to see as the interplay between different renewable technologies coming through quite strongly. As you have seen more solar come on grid in the last year or so, you have seen how it works quite well with wind and hydro. They complement each other quite well. I think the broader point to make, which comes back to the earlier point I was saying, is there is a need to make sure that whatever we are doing, the CfD or the FiT or whatever we use, encourages a degree of geographical spread into the location of generation sites but also technological diversity as well. If you have that, then that can help reduce the need for things like gas-fired back-up and the need for a capacity mechanism, too. It is about taking a more decentralised approach at the end of the day as a way of encouraging investment in renewables.

Asif Rehmanwala: Yes, there was a capacity mechanism under the pool, as we know, before current trading arrangements. There was an argument that generators made supernatural profits under that capacity mechanism and there is a question mark as to whether this capacity mechanism now will lead to that or could there be investment in the market to ensure that there are not any brown-outs, as you suggested, without the capacity mechanism. The question is, will some of the bigger players be able to invest without the capacity mechanism and I think the answer is yes.

Gordon MacDougall: I would agree with Jonathan that at the moment there is time to fix the underlying market and then probably in the future we would need to the capacity mechanism.

Q217Albert Owen: Is it your understanding from the draft Bill and the documents that have been produced with it that the auctions will be technology specific? Is that your understanding?

Andy Taylor: Certainly my awareness was that it was open, with the characteristics of supply still to be defined. There are going to be peak periods. There is going to be intermittent coverage insurance. So you need a technology choice that they can deliver that. That is open. I don’t think it says explicitly which fuel it has to be or is it peaking capacity compared with base load. I don’t think that has been defined.

Dr Riley: My understanding again was that capacity mechanism was intended to be a market-wide capacity mechanism on the basis that, in capacity terms, with the exception of demand-side management perhaps, all the attributes of capacity are the same from the different generating technologies. So there is no need to differentiate between them. Back to your earlier question around would investment come with that capacity mechanism, I don’t think that is as clear cut as has been suggested. I think the capacity mechanism is needed in a world where there is a high degree of intermittency on the system and lower load factors; so a higher proportion of fixed costs for the infrastructure compared to variable costs. Then it is not unreasonable for some of the costs to be recovered through a capacity mechanism or a fixed payment.

Q218Albert Owen: Do you think the capacity mechanism will influence interconnection?

Jonathan Smith: Absolutely. The capacity mechanism will reduce the price at which a generator would otherwise turn on to generate. So it reduces the wholesale power price in this country. It is a local policy and interconnected EU energy market, so that will create an arbitrage opportunity for players to try and capture the difference between the price between the UK and the higher price in Europe. You could view it as UK consumers ultimately subsidising EU power prices.

Q219Dr Whitehead: Certainly in the context of interconnection and things such as storage demand side response, the capacity mechanism could have a role to play and, bearing in mind that officials from DECC are, we understand, looking at how demand side measures might be incorporated into the Bill, is that an area where demand side measures might work?

Asif Rehmanwala: I think it could work. I don’t think it is, by any stretch of the imagination, defined very well at the moment. As far as I understand it, it works for dispatchable plant and storage and demand time response is not dispatchable. So they need to come up with a mechanism about what that would look like and how it would work before really knowing what the benefits of that would be. So capacity mechanism generally is for dispatchable plant.

Ed Gill: I think there is a point in that, if this is the most fundamental reform of the electricity market since it was privatised 20 years ago, then where is the wider strategic view of things like demand side response, smart grid, smart metering? We would argue there needs to be a lot more in there about how we ensure that barriers to more distributed generation are removed as well. All of those things are not even on the radar of the EMR at the moment and they should be.

Q220Dr Whitehead: Is there an inherent problem in having a de-capacity mechanism, you might say, in terms of longer-term demand reduction? Arguably, demand side response, if repeated often enough, looks a bit like demand side reduction.

Gordon MacDougall: You have to be careful how you make that work. Efficiency and lowering demand is very good but demand is usually there to serve a purpose and you want to ensure that your industry and everything else is continuing to flourish. What you would want to see is that demand being met by the lowest cost of low carbon energy.

Q221Sir Robert Smith: As this is a new Session, I should remind the Committee of my entry in the Register of Members’ Interests to do with the oil and gas industry, in particular a shareholding in Shell. One thing we did hear on the capacity mechanism was that the very fact it might come in is undermining investment at the moment as people think, "Well, let’s wait and see what the capacity market has to offer before I make my investment". Is that a sentiment any of you would share?

Dr Riley: I think it is the general sentiment around the whole of the energy market reform process; the longer it takes, it is just causing that hiatus in investment until there is more clarity on what the various mechanisms are going to be going forward.

Andy Taylor: We have been in the market for 15 years. We have seen various different changes and reviews and there is always uncertainty. I think capacity mechanism is one part of that but the fact that the price signals are not there on the market going forward means it is not a liquid market, which is the key reason for limited independent investment to date.

Q222Sir Robert Smith: Looking again at the Contracts for Difference and its treatment, how serious is the concern that it could be treated as a derivative and, therefore, affect companies’ balance sheets? Is that still a serious concern?

Ed Gill: If the Government is not going to be the counterparty then it is a concern that needs to be looked at and given a lot of careful consideration, but that does not seem to have been considered by the Department and I think that links perhaps to the wider point I was making to Dan about the fact that the whole EMR approach has come from a very one-dimensional view and it needs to be more of a two or three-dimensional view. It is a matter that needs more investigation certainly.

Asif Rehmanwala: If it is a financial instrument, then there is a question market about whether it is subject to FSA regulation as well and, again, for some of the smaller players how realistic is that if that would be the case?

Dr Riley: Even for the larger players it is a concern. I think it is a real concern.

Q223Sir Robert Smith: Do you see a definitive solution?

Dr Riley: Not at this point, no.

Asif Rehmanwala: Exemption.

Q224Sir Robert Smith: Exemption for the smaller ones. Would that not affect the confidence in the market if you start to exempt people?

Asif Rehmanwala: We don’t think so. I mean there has been exemption on a number of other social obligations for up to 250,000 customers-Green Deal, Warm Front, Home Discount, CERT, ECO and a whole host of others. So we don’t see any reason why that would not be the case for CfDs.

Ed Gill: We would probably welcome consideration of an exemption. I think it is probably worth considering, but I think the wider problem here is have we reached a stage where instruments are being designed but we are having to exempt small suppliers. It is not an ideal situation.

Q225Sir Robert Smith: You think the counterparty being sorted out by some sort of underpinning then also solves the problem?

Ed Gill: If the Government was the counterparty rather than suppliers then I think that would help resolve the issue, but I am not sure how feasible that is.

Q226Sir Robert Smith: I think that goes back to the state aid.

Ed Gill: Yes.

Q227Sir Robert Smith: The other concern is the posting of collateral. Does the fact that DECC are looking at shorter arrears periods going to make the posting of collateral less of a burden?

Asif Rehmanwala: It will make it less of a burden, yes. Will it take the burden away? No.

Ed Gill: We agree with that view.

Jonathan Smith: It could lead to suppliers needing to pay for the CfD or the capacity mechanism, collateral requirements and the payments ahead of time versus when they receive their customer cashflows in. So it increases working capital costs. One thing with the short payment cycle that has not been touched on is that in the domestic market the settlement system is a 14-month one for non-half-hourly meters. So a few days up to a month after delivery of power most meters have not been read. Nothing that I have seen has addressed that problem and whether there is going to be a reconciliation process to return cashflows if they are overpaid due to incorrect estimates of how much is being deemed to be delivered to meters.

Ed Gill: We probably share both those views.

Q228Sir Robert Smith: Do you see any other solution?

Ed Gill: One that makes basic sense is to move to an alternate to the CfD, but obviously we have already made that point.

Jonathan Smith: The Premium Feed-in Tariff would not be classified as a derivative.

Sir Robert Smith: It wouldn’t be?

Jonathan Smith: I would imagine so.

Q229Dr Whitehead: Bearing in mind what we have said this afternoon about the need for some form of continuing obligation and we have also gone into the problems of collateral and repayments and reference prices, isn’t the solution beginning to rather look like the idea that the renewable obligation continues?

Ed Gill: We think so.

Dr Whitehead: You might not call it a renewable obligation, but it will look a bit like a renewable obligation.

Ed Gill: I think it would probably be preferable. There are, of course, the politics around that in turns of the cost of the RO and, if we are looking towards greater ambition for renewables, how compatible those two things are. The RO has some real benefits over the CfD, aside from the complexity points, for small and medium-sized generators in terms of the benefit of ROC as an asset at the end of the day.

Asif Rehmanwala: And the fact that it has worked for so many years.

Gordon MacDougall: I think there are a number of features of the renewable obligation it would be nice to see returned. The fact that there is an obligation and the fact that the obligation was set to help steer the country towards its legally binding targets is very good. These kinds of features would be welcome.

Q230Sir Robert Smith: What about the consumer, though?

Gordon MacDougall: Again, I think the renewable obligation is important, with all the levers available to Government, because it ensures that energy is delivered at the lowest cost. We are currently going through a banding review, which hopefully continues to be evidence-based and produces a banding that is appropriate and gets the lowest cost for the consumer.

Chair: Unfortunately, in the interests of time, we have to move on to our next panel. Thank you all very much for coming in.

Examination of Witnesses

Witnesses: Rhian Kelly, Director of Business Environment, CBI, Richard Hall, Head of Energy Regulation, Consumer Focus, Paul Steedman, Senior Campaigner, Friends of the Earth, Dustin Benton, Senior Policy Adviser, Green Alliance, and Nick Molho, Head of Energy Policy, Climate Change Team, WWF UK, gave evidence.

Q231Chair: Good afternoon and welcome to the Committee. Can I apologise in advance for the fact that because we are required to complete this scrutiny process in only 5 weeks, when 12 weeks is normally allowed, our sessions have had to be rather compressed and we are very severely time constrained. We need to wrap this up just after 6.00pm, so our questions may be a bit concise and I would appeal for equally concise answers where possible. Could I start by asking you whether you think the Bill is necessary or whether we could have arrived at where we want to be in terms of secure, clean and affordable energy simply by making incremental changes to our existing arrangements?

Paul Steedman: I think clearly we do need some significant reform from where we are and, therefore, the existence of a Bill to make some changes probably is the right thing, but is this the right Bill in terms of the measures that are before us? Probably not. We think there need to be some very significant changes, which will potentially produce some more simplicity rather than more complexity and give us a better chance of hitting the objectives. Not least, we think that the Bill is struggling tremendously because of the absence of any clear target or goal that sets out what it is for.

You have heard from other witnesses already about the need for being super clear about the purpose of this Bill and, in our view-and I think I can speak for Green Alliance and WWF as well on this one-that should be about almost entirely decarbonising the electricity system by 2030. That is clearly what the Committee on Climate Change suggested is needed and is needed to hit our carbon goals in a cost-effective way. We think that should be on the face of the Bill, 50 grams per kilowatt hour by 2030. In terms of the vast range of other things that are in there, I can briefly skim across a summary of the other measures. The CfD mechanism is clearly overly complex, and is not going to work for smaller renewable players.

We think a support mechanism for renewables in particular needs to have a number of qualities. It needs to be simple. It needs to have Government backing. It needs to be transparent and at the moment CfD is not going to do any of those things. On the issue of whether demand side plays into this, that is an area where clearly there is reform significantly needed because at the moment the demand side does not play a significant role and it must do. At the moment it is deeply disappointing that DECC’s projections and the whole basis of this Bill seem to assume a doubling of demand when in fact that is not necessary. Germany, for example, has set a target of reducing electricity demand by a quarter over the period 2050. That seems deeply unambitious from our side of things in terms of the Government assuming demand will double. Clearly there can be a number of measures that will deal with that in terms of the way that demand side can play in the capacity mechanism, the idea that there should be an equivalent mechanism from the Feed-in Tariff side of the picture. In a word, yes, we need very significant reform. Are these reforms it? Probably not.

Rhian Kelly: From CBI’s perspective, we do support the general direction of the Bill. We believe it will help ultimately to deliver a more diverse energy supply, which will be low-carbon, secure and affordable. We have consistently said since about 2009 that we thought the existing system would not deliver that and that incremental reform therefore is not the answer so therefore we are in full support of electricity market reform. We are worrying though that what we have on the face of the Bill at the moment will not attract the necessary investment and there is a real challenge then between driving this forwards as quickly as possible to get investor confidence but making sure that we, at the same time, pin down the necessary details.

We think, in a sense, therefore this session and others is a good opportunity to discuss some of those details, keep up the momentum, but make sure that we put in place the right level of detail.

On Contracts for Difference, we think it is essential to get the design right to reduce the cost of capital. We are very worried that the current Contract for Difference design will not do that. On capacity mechanism, although we have never uniformly accepted the case for it, we know Government is going to ahead with it and so we need to get on with this as soon as possible in order to avoid an investment hiatus. Both of those, if you get them right, we think will reduce the cost of capital and therefore help us deliver the scale of investment to secure a diverse energy supply.

A final point I would say is that when we design this new reform we need to make sure that we manage the costs to those sections of the business community that use a lot of energy, so energy intensive industries. We need to make sure that for the most at risk energy intensive industries, their competitiveness is not further undermined by any additional cost that would be brought on by these reforms.

Dustin Benton: I would just add that we have a Bill with some mechanisms but we do not know what the Bill is intending to do. We are talking about diversity and we are talking about decarbonisation but we have no sense of what that means. The mechanisms in the Bill, depending on how they are used, could get us down to the sort of low carbon diverse energy system we would like or it could end up in a system that is very gas dependent and very risky, so that is why I think we need a pathway down to around 50 grams of CO2 by 2030. It is technology neutral, it enables competition towards 2030, it is sensible. In terms of addressing the price risk, I think the way we do that is through energy efficiency and to bring that to the Bill and that is why we have called for an efficiency Feed-in Tariff, which would give an incentive to anyone in the market to save energy and make some money because right now all the incentives are sell more energy, make more money.

Q232Chair: We will come on to those points in a moment. If we are going to accept, and I think probably a lot of the Committee will be inclined to do so, the need to include a decarbonisation target in the Bill of some sort, and we have taken evidence from David Kennedy this morning, do you think it would also make sense to have a role for the Climate Change Committee in overseeing the decarbonisation of the electricity market generally?

Nick Molho: I think certainly, given their involvement in the carbon budgets in the first place, that would be very sensible and I would see that role mainly around overseeing the delivery plan and especially the volumes of low carbon contracts going forward to make sure those are consistent with a decarbonisation of the power sector by 2030.

Paul Steedman: I think if they don’t, there is a significant risk to the overall ambition of the Climate Change Act and a low carbon budget. It is imperative that, particularly given the risk that the system operator may have some conflicts of interest in their role in bringing forward draft delivery plans and then implementing the system that there is an independent voice, which the Committee on Climate Change clearly is, saying whether or not delivery plans are likely to be consistent with carbon budgets. So absolutely, yes.

Rhian Kelly: From the perspective of the CBI, I do not think we need to have an additional target on the face of the Bill. I think we might want to have a reference objective but I do not think it is necessary to set the target in the place in the Bill. I think we already have targets through the Climate Change Act, through the carbon budget. We have the scrutiny of the Climate Change Committee and they will continue to do that scrutiny. I think we are at risk of missing the point by putting a target in the Bill. The point of the Bill is to attract the necessary levels of investment and that is what we ought to be making sure this Bill delivers.

Q233Chair: Just on that point, raising the target was not defined as 50 grams per kilowatt hour, for example, but merely compliance with carbon budgets. Would that make more sense from your point of view?

Rhian Kelly: The assumption anyway is that this is a part of delivering the long-term carbon budget and this will have to form part of the trajectory if we are going to be achieving a low-carbon transition that is secure, affordable and decarbonised. We can put it in the Bill but the working assumption is that this is a piece of the framework to get us there.

Nick Molho: I think on that point, having at the very least a reference to meeting the aims of the fourth carbon budget in particular, in the Bill, is absolutely critical because if it was just a question of delivering the 80% emission reduction objective by 2050 then you could argue we already have the structure in place because we have the Climate Change Act. But that clearly has not brought in the levels of investment that we are looking for. What investors are looking for is a clear short-term picture up to 2030 as to the volumes of CfDs that would be awarded, so I think at the very least a reference to the fourth carbon budget is absolutely critical.

Q234Laura Sandys: I think, Paul, you mentioned something about demand-side resources. There seem to be some mixed messages around demand-side reduction and demand-side response. I just wonder whether you would like to expand on that, and how you think we could be looking at demand reduction through the EMR. I know that some of you have looked and proposed issues that would be an energy-efficiency FiT. I wonder whether you had also looked at, in many ways not that mechanism, but a different mechanism such as a form of set-aside, which is a different mechanism from a different part of the economy or different Department that has possibly more in relation to what we are trying to look at. I welcome your views.

Dustin Benton: Just to clarify the "set-aside" is that like an obligation? Would that work by obligating energy companies to say-

Q235Laura Sandys: Not necessarily, but a payment mechanism. I mean in many ways it appears very difficult to put in a mechanism to not generate when it is a mechanism for generation, but there are parallels, such as set-aside, which is about passive non-production. I throw that to you.

Dustin Benton: I do not know enough about the set-aside proposal to say anything intelligent about that, but what I can say is that I think an efficiency Feed-in Tariff fits into the Bill and fits into the energy market quite well. That is because you can think of energy efficiency as delivering long-term demand reduction, as operating a bit like a base load power station does, so you get a megawatt of electricity that goes along and feeds into their system in the same way as if you reduce a megawatt hour of electricity that feeds in all the time. So the Contract for Difference mechanism, which I think seems to have been designed for nuclear, seems to mirror that quite well. If you were to enable demand reduction to be paid for in the same way that nuclear was, albeit at a much lower price, you could use that mechanism quite effectively and I think getting some sums in here is a useful way of identifying how big of a deal that is. There is a refrigerator replacement programme that has been running in the United States and it costs £33 per megawatt hour of electricity saved. The cheapest low-carbon form of power we can find right now is onshore wind at about £83 per megawatt hour. What we need the Bill to be able to do is procure that £33 megawatt hour of saved energy over the £83 megawatt hour of new low-carbon energy. That is what a Feed-in Tariff mechanism would do.

So the system operator would set out a set of strike prices, a set of Feed-in Tariffs for different generation technologies and it would produce one for efficiency providers, for demand-side aggregators and say, "If you can save a megawatt hour of energy, you make this amount of money and then instead of buying that megawatt hour from a low carbon supplier you get it from that, and it is much cheaper". That can help address the affordability, it also means we have to build less stuff overall, so it helps with the financing.

Richard Hall: I think that would also assist in making sure we get maximum value out of our smart metering programme insofar as quite a significant proportion of the benefits of smart are perceived as being empowering consumers to change their consumption habits and providing some kind of financial recompense for that is going to be clearly, I think, quite significant in driving in behavioural change.

Paul Steedman: In terms of the funding, although the carbon floor price does not form part of this Bill it clearly is part of the wider EMR package and it seems clear to us that particularly as Warm Front and other direct state funding programmes for energy efficiency are wound down and withdrawn, the money from the carbon floor price, and indeed from auctioning the receipts of EU ETS permits could well be directed towards energy efficiency work. It seems to us a sensible source of funding for cutting demand both on the electricity and on the heating side.

Nick Molho: Just to add to that, the benefit of having something like an energy efficiency FiT in the Bill is not just to save on the amount of any low-carbon infrastructure you need to build, you also are reducing the amount of transmission and distribution infra-structure that needs to be built, and those are the type of infrastructure projects that often encounter various problems going through the planning system. Those benefits should also be taken into account.

Richard Hall: If I could highlight an additional thing here. I think this kind of approach could try to perhaps get over some of the issues we have around a reduction in the number of houses in which we are expecting to see insulation measures in the coming years. At the current moment in time, although CERT is a scheme which has its critics, according to the DECC statistics there are still over 100,000 homes per month seeing insulation measures coming in, whereas the Government projections for Green Deal are 100,000 homes per year and for ECO about 260,000 homes per year. At the moment, we are likely to see a downsizing, a downshifting of the number of homes seeing insulation measures and seeing efficiency measures. Using perhaps the proceeds of carbon taxation to try to take up some of that slack and invest in making our housing stock more energy efficient and helping the most vulnerable we think is probably quite a prudent idea.

Rhian Kelly: I absolutely think that energy efficiency is an important part of the decarbonisation story and we should be doing everything possible to make it happen. I mean in a sense it is a no-brainer, it is the low-hanging fruit so we ought to get on and do it, but I am not quite sure it is the right place to link it to this particular Bill. I think we already have in place a number of mechanisms that are aimed at energy efficiency and, in particular, in the business community, the energy efficiency landscape is pretty complicated and overlapping. So I am not totally convinced that adding something to this Bill on top of what we already have is the answer to the problem.

I think again what we need to be focusing all through this Bill is making sure we get the scale of investment into energy supply and at the same time we ought to be making sure that the carbon production commitment, the climate change levy, the climate change agreement, Green Deal for business, add up in their own right to ensure that we also are taking energy efficiency action alongside managing our supply.

Dustin Benton: I think that energy Feed-in Tariff is an opportunity for a business because it provides a means of getting paid to reduce your energy demands. All of the mechanisms that-

Q236Laura Sandys: Can I just ask you, is that the responsibility of Government, but actually the consumer to pay for that, because the price of energy should be driving those efficiencies through the system, not necessarily an ongoing subsidy. When you start to then look at, let’s say technologies, as technologies drop in value, in price, let’s say solar, you will end up with a smaller subsidy as time goes on. How do you manage that tapering when it comes to energy efficiency?

Dustin Benton: That is a good question and one you need to figure out as you go along. What I would say is that there is a short-term issue and that is that we-it has been economically rational to save energy for the last 40 years and we are not doing it. We do not act the way economic models suggest we do. So getting in an incentive, which is a great way of providing a mechanism to pay energy services companies that can use private sector-

Laura Sandys: So you have a psychological problem rather than a-

Dustin Benton: There is a psychological problem but you can make money out of it. Take a look at CERT and CESP, it is a cost to the Big Six so naturally you look at it and think, "Well, I have to do it, so I will". You do not think, "There is a major market opportunity for me. If I do that well I can make a lot of money" and that is what a Feed-in Tariff gives it the ability to do. It also brings in new entrants because you can get people to come in who are not already in the energy market who will be able to take up opportunities. I mean it is a big area of opportunity. Greg Barker announced a couple of weeks ago that DECC has done a study that says you can save 38% of electricity demand by 2030. There is a major opportunity there; we are just not taking it up.

Q237John Robertson: Do you agree with the Government on the choice of CfD and do you think it is the most appropriate for intermittent generators?

Nick Molho: I think as it stands, we are very concerned by the suitability of these contracts four intermittent generators on the basis that they are not simple, they introduce an offtake risk, they are not Government-backed and there is considerable uncertainty as to the predictability that they will give to generators in terms of both long-term volume and price certainty. Those are key issues that need to be addressed to improve investment certainty and to accelerate the deployment and the cost reductions of renewable technologies.

Paul Steedman: I think we should be clear who it is that CfDs are working for. They are working on behalf of the nuclear industry and they probably work for large, vertically integrated companies. For everyone else, they add such a degree of complexity, as we have heard from witnesses all day, it beggars belief that that is the mechanism that is being introduced. In terms of the vision that I think lots of us share about a market that is much more liquid, that has a way higher number of players in it, and I think that includes people and organisations who are not necessarily traditional power companies with big bits of kit that might include, as it does in Germany and other places, local authorities, it might include consumer co-operatives, it might include non-traditional investors in this sector.

For those kinds of non-traditional players who we think can play an important role and provide additional sources of investment as well, potentially taking lower levels of return than big PLCs will require, CfDs just do not work. There are many more simple instruments that would do that job. The characteristics that I guess are clearly required, simplicity, Government backing, and for us the fixed Feed-in Tariff model that Catherine Mitchell referred to earlier today, which has been demonstrated well in other countries, not least Germany, offers a good example of a mechanism that delivers a price certainty, simplicity and straightforward Government backing.

Q238John Robertson: That was the question I was going to ask you about, so you would say that the proposal disadvantage small skilled generators?

Dustin Benton: Clearly it does, and I think that this is part of the problem with the one size fits all mechanism. There are two attractions to CfDs. Firstly, if they were contracts with the Government, which they do not appear to be, then they seem like they are very low risk. The benefit of that is that you can then get in very low risk, low return investors, to take on projects once they have been built, and it brings some finance into the sector, which frankly the Big Six and the smaller players just cannot get together.

That is an attraction but that is not necessarily what we would be delivering through the existing proposals. But absolutely it does not address the small scale concerns. If you are a local community group who wants to put in a few wind turbines or a few solar panels, CfDs are too difficult.

Q239John Robertson: Mr Hall, Consumer Focus, what about the consumer in all this?

Richard Hall: I think we have always held that a sensibly designed CfD scheme could work in consumers’ interests. We do not think this is a very sensible designed CfD scheme. Picking up on Dustin’s point, the initial impact assessments and the way that this policy was sold was based on the Government being the counterparty. I think that has clear implications in terms of keeping down the cost of capital. For example, at the moment the rolling yield on Government 10-year gilts is 1.64%. If you look at GB pound bonds issued by E.ON for 10 years, they are 6.4%, so the Government can borrow at quarter of the price that the private sector can. So the cost benefit assumptions in the DECC impact assessment appear to be quite deeply flawed.

There are further issues that concern us. One is around counterparty risk, so if a supplier who is now effectively the counterparty to a CfD goes bust, who picks up those liabilities? I have a nasty suspicion we are going to look at a regime that involves those liabilities being essentially socialised over other suppliers, and that creates its own sort of systemic issues where, as a previous witness highlighted, about two thirds of our generation, the bulk of our supply, comes from the same companies. So we are effectively asking these companies to self-guarantee. You are saying that the person who stands behind your contract if it goes wrong is you, and that does not strike me as a particularly credible mechanism.

I guess a final point, sorry, I know we are short on time, in terms of-

John Robertson: You have obviously been saving this up.

Richard Hall: Yes, today’s rant. In terms of the value for money here, picking up on a point, which I think Paul made, it is not entirely clear what the terms of reference for this Act are. What are we trying to achieve here? For us, one of the things that manifests itself in it is there seems to be a poor targeting of costs. We are trying to simultaneously stimulate every single type of renewable energy plus nuclear plus a separate capacity mechanism to make sure the gas-fired generation does not feel left out. This kind of sort of tapas approach of failing to choose an option on the menu, so trying to choose one of everything looks highly unlikely to offer consumers value for money.

Q240John Robertson: The SSE has advocated keeping the option of a premium FiT open in the forthcoming Bill. What do you think about this idea and are there any benefits of it?

Rhian Kelly: The CBI have been very clear on balance and support Contract for Difference. I think one of the striking things about everything you said is the key to getting that right and making sure that they are bankable and making sure they reduce the cost of capital, so we would prefer to have a Contract for Difference and keep the momentum on the existing Bill rather than rip it up and start again.

Nick Molho: Given the concerns that we have with the CfD in its current form, I think it would be (a) sensible for DECC to review the suitability of it for different forms of low carbon generation and in the meantime widening the enabling power in section 1(1) to allow to introduce a FiT other than a Fit CfD should that turn out to be the most suitable option, either for all forms of renewable technologies or some classes of renewable technologies. It is just a minor amendment in section 1(1) that is required to allow that.

Q241John Robertson: Mr Steedman, Friends of the Earth propose a fixed FiT model; what are the benefits of that?

Paul Steedman: It has the benefit that just like the CfD, you have some degree of price certainty, but the issues around off-take risk, which is still basically left open, which is particularly problematic for smaller independent generators under the CfD model, are handled because you have a guaranteed buyer. That seems to us particularly important for smaller players who may struggle and, as we have heard earlier today, to make the reference price and therefore make their money. So it is much more investable against. It is simpler as well. It is much more straightforward. Investors are much more familiar with it.

Q242John Robertson: Simplicity seems to be a word that is creeping up a lot in these inquiries. Does the RO life need to be extended to 2017?

Paul Steedman: Clearly our preference would be to get this reform right and get it right quickly. That is the imperative thing in order to have certainty about the new regime, in order to ensure that costs are managed as fairly as possible for the consumers and to provide the greatest level of certainty for investors. If it proves necessary to extend it then, sure, I think we would probably rather that we get this right and get it right now.

Nick Molho: I think it could provide a short-term fix if that was required. But I think ultimately having the clear long-term certainty that the Bill is supposed to provide implemented as soon as possible is where we want to go.

Richard Hall: It will be interesting to experience once the Act goes live because we envisage this period of essentially I think 2014 to 2017 when there will be an overlap where essentially you have a choice of which to go into. If we see widespread opting into the RO rather than the CfD FiTs then I would suggest at that stage as a matter of emergency, you can treat that as the market saying, "We will not touch this with a barge pole, we need to extend the RO. "

Q243Dr Whitehead: Two thoughts, it does appear that in the first instance the cut-off date of 31 March 2017 for the RO is predicated on the fact that nuclear power would be coming on-stream in 2018 and therefore the instruments needed to be unified. Since nuclear power is not coming on-stream in 2018 and the RO indeed in the Bill is continuing for 10 years with headroom intact but no new entrants and then effectively collapses to a Premium FiT after 10 years, are there mechanisms possibly within the Bill that you might consider could precisely perform the sort of function that Richard mentioned in terms of the possible emergency that might arise should people opt in the way that they might do in the period running up to 2017?

Dustin Benton: It is possible but I think the key thing is to make sure that we do not end up overpaying and part of that is through energy efficiency, but part of it is also saying what happens if the situation arises in the latter part of this decade where electricity is very expensive for other reasons. If you have a Premium FiT mechanism then the potential issue is that it is very expensive for the consumer and I am concerned about that as an environmentalist because the lesson of the last three years is that when prices rise people do not go and save energy as the rational response. They get angry at politicians and then the political consensus for the Energy Bill disappears. I think we need to be clear that we are not going to overpay. The best way of doing that would be through a mechanism like a fixed Feed-in Tariff or a CfD that worked. As for a Premium FiT or a renewables obligation, I prefer that to nothing but it would be a second option.

Nick Molho: With respect to the Premium FiT you can address this latter concern by introducing a cost cap mechanism - to a Premium FiT to ensure that if the wholesale electricity price goes above a particular level, then the subsidy is reduced accordingly to avoid over-rewarding generators. I think that is something that could help mitigate the concern.

In any case, going back to the original question on extending the RO, I think if it proves necessary to do extend to clarity on that needs to happen asap just as clarity as to when the new arrangements will kick in needs to be clarified as soon as possible.

Q244Dr Whitehead: Early clarity rather than the emergency switch?

Nick Molho: I think early clarity is essential if you want to avoid a long-term hiatus.

Richard Hall: My understanding is that it is intended that there would be, if you like, a technical advisory panel who would give the Secretary of State advice on essentially what kinds of options it had on the strike prices, so if you want to bring forward certain volumes these kind of strike prices will give one volume, these will give another volume. It may be an idea to get that technical power reporting into this body. Can I suggest almost an Office for Budget Responsibility-type function for setting the prices for these instruments, so that essentially there is public scrutiny of the credibility of the recommendations coming forward, and if it looks like those are resulting in a mix that is not attractive to the market, which is not being delivered, action can be taken to remedy that.

Rhian Kelly: I think the importance here is making sure we design the Contract for Difference properly in the first place, so we are not then pushed into the position where we have to take drastic emergency measures. I think that is particularly important because what investors want to see is a confidence and a longevity in the system, so if we are then building in any emergency measures that they are not going to get that. I think the important thing is we get the design of the Contract for Difference right now so that everybody can see what is going to happen out to the future and there does not then need to be, as I said, emergency measures put in place just in case, because that would just increase uncertainty.

Q245Dr Whitehead: We have heard a lot of evidence about the extent to which there appear to be difficulties in designing the actual CfD to work in any way like the theoretical CfD was supposed to. Is there a point at which you may say, well, investor certainty is better served by either going with a CfD that does not look like the original CfD at all or going with something else?

Rhian Kelly: I think two things; we thought that you had to have formed a system so we think the system as it is now will not deliver. But secondly the opportunity we have here is to make sure we get the design right, so we need to look at what is on the table. But there are other ideas out there and we need to make sure that when we get to the actual Bill that is going through Parliament, rather than a draft Bill, that that is the mechanism that everybody agrees will deliver the investment.

Dustin Benton: I would like to say CfDs are not an unknown quantity. We have CfDs in the financial world, Britain is very good at that. I do not think that CfDs are themselves the most difficult thing. It is that, for whatever reason, we have not yet taken the choice to enable the CfD to work. So on the counterparty issue I think that is a classic example of we have not taken the obvious decision, which I imagine, although I have not reviewed all of the evidence what everyone has said to you, that everyone has been saying, "Get the counterparty to be the Government, have that be clear". It is a de minimis requirement for the CfD to work. It is not so much that that is complex. It is very simple. It is just we have not yet done it.

Q246Dr Whitehead: There must be a reason.

Dustin Benton: I could not possibly comment.

Dr Whitehead: The Treasury could, does it?

Dustin Benton: Perhaps they could. Is this is the State aid question?

Dr Whitehead: Yes.

Dustin Benton: Yes, I think there is a credible risk that if a CfD is considered to be a subsidy for nuclear that the Commission may say, "Well, that is not acceptable and we will not go with that". My solution would be to say, "Let’s not have one mechanism for all different technologies". I mean the worst situation would be everything getting stalled. All of the other low carbon stuff that we need gets stalled because we are having an argument about it here. In a way that is sort of at risk of putting something that is potentially irrelevant in front of all of the other stuff we need. Solar costs are coming down enormously quickly, onshore wind costs are coming down very quickly. We have an industry that believes it can bring down offshore wind costs quickly, but if that gets blocked by a fight about nuclear there would be an enormous waste of everyone’s time and a huge missed opportunity.

Paul Steedman: This goes right to the heart of the problem. When the Committee last looked at EMR it identified rightly that the whole thing was being skewed around the needs of a one-size-fits-all regime in order to benefit nuclear, in order to be able to preserve the coalition fantasy that there will be no subsidy for new nuclear. We are still in that space and that means again that we end up with this horrifically complex instrument, rather than, for example, a simple Fixed Feed-in Tariff for renewables. Increasingly people, from Peter Atherton at Citigroup through to Dave Toke at the University of Birmingham, are saying that the kind of strike prices that are going to be needed to get any new nuclear away are of the order of £150 to £160 per megawatt hour and way in excess of that offshore wind or most of the other renewable technologies that we are talking about. So nuclear is becoming entirely uneconomic on its own terms and yet this whole Bill has been mired in complexity in order to try and funnel money towards new nuclear. It is a crazy situation. We could have a much simpler support mechanism, a much simpler Bill and meet our carbon targets through renewables, if that is what we focus on, providing support for demand reduction, demand side response and renewable energy.

Chair: We have another five group of questions that I want to get through. We have 25 minutes to do it so can I urge you, if you have made a point in answer to another question, do not feel the need to repeat the same point.

Q247Dan Byles: Before we get to a CfD mechanism where the prices are set by the competitive process, we understand they are going to be set through the administrative or negotiation process, which has raised a number of concerns, particularly around the transparency of that process. Do you share those concerns?

Richard Hall: Yes, I certainly strongly share those concerns, in particular around the issue of investment instruments. We have heard from previous sessions that the Hinkley Point C investment, which EDF and Centrica are contemplating, is seeking investment instruments. Press speculation suggests the materiality of the two reactors there is probably of the order of £14 billion, which for context is larger than the London Olympics.

In its draft form, the Bill envisages that the Secretary of State would essentially lay information relating to any investment instruments they were considering before the House but includes something of a carve-out where it says something along the lines of, "Subject to respecting commercial confidentiality and commercial concerns". My experience in dealing with statutory or contractual instruments, which include those kinds of carve-outs is that that tends to end up being a euphemism for "nothing useful will be made publically available".

It therefore becomes vital that we have a means to establish whether any of those strike prices coming forward offer the public value for money. I certainly do not know what would be a competitive strike price for nuclear when compared to other technologies. So I think we would be reliant on having a process that is sufficiently open and the core commercial details of those contracts are made public so that if other developers can deliver the same level of low carbon generation more cheaply, whether through the same technology or whether through alternative technologies, they can jump up and down and scream at you as an MP to say, "Actually this is a bad deal. We can give you a better deal".

Q248Dan Byles: Are you reassured by Vincent de Rivaz from EDF who has said that "the strike price will not be defined in a cosy way through hidden decisions; it will be the result of negotiations and the result of the negotiation will be absolutely open and transparent"? Does that not reassure you?

Richard Hall: Not particularly. I mean, ultimately there appears to be a maximum of three potential consortia for new nuclear if you assume that a buyer is found for Horizon, which is quite a big if. In a bilateral negotiation where there is only one player in the room and that player can say, "Take it or leave it; these are our terms", I have very little confidence that that is an efficient way of deriving a price.

Q249Dan Byles: Do you think there should be a role for Parliament in this, in scrutinising the strike prices or the investment instruments, and/or a role for Ofgem perhaps? Does anybody else have a view on that?

Nick Molho: Absolutely. I think that is important and, just to complement Richard’s points, I absolutely agree with him about the investment instruments. The only point that I would make, however, when you are looking at new and emerging technology such as offshore wind and wave or tidal, is that I think that is absolutely right that, for those technologies, you do not move immediately to a competitive auction system because those technologies need the time to grow in maturity and reduce in costs before they are able to compete on a level playing field. So by rushing a move to a competitive auction process you would be undermining their long-term cost effectiveness.

Q250Dan Byles: Leaving aside nuclear, what they have laid out in the Bill as being the interim process is in your view sensible for other mature technologies?

Nick Molho: I think the principle is. I think in terms of 2017, which is the date listed in the operational framework for CfDs as the date from which competitive auctions could be introduced for renewable, whether that is the exact date from which you could introduce competitive auctions, really needs to be reviewed on the basis of empirical evidence. That might be

Dan Byles: So that might need to be pushed back?

Nick Molho: Yes. In any case the principle of first of all having an administrative price setting before you move to a competitive auction is certainly a sensible one.

Paul Steedman: Certainly the idea of doing it in a technology-specific way is absolutely right because if we move straight away to technology-neutral price setting through an auction mechanism, or some other format, all we do is we take a snapshot of where different technologies are in terms of costs at any given moment in time and the experience from any number of technologies, not least oil and gas, is that it is through deployment and through the learning of deployment and the economies of scale we get from deployment that we drive costs down. One of the reasons that solar has been plummeting in cost quite so rapidly is because we have been seeing considerable deployment of those economies.

In terms of the consumer interest, the consumer interest may not be best served in the first instance by going to a technology-neutral auction where you expect immature technologies to compete against mature technologies when that clearly is not a level playing field. Clearly over time, as technologies mature, absolutely that is what everyone wants to see but as to the question of when that date comes, we will just have to wait and see as technologies mature.

Nick Molho: Just to complement that, I think you can see that very clearly in the offshore wind reduction report that was published by the Crown Estate last week and which is the most detailed body of evidence we have as to how the cost of offshore wind can go down. In three out of four scenarios, the analysis shows that the cost of offshore wind can reduce by about one third by 2020 and significantly more beyond that date. The only scenario where this does not happen is the slow growth scenario where the lack of long-term volume certainty given to the sector combined with slow build rates reduces the rate at which costs can be reduced.

Dan Byles: The irony is that in order to get the reduced costs we need to commit or sink a lot of higher cost in offshore wind between now and then.

Nick Molho: I would say that clarity as to minimum volumes of delivery is absolutely key if you want to see a greater investment in R&D, in standardisation of products, in economies of scale and in domestic supply chains, because these are all the key factors that would fundamentally reduce the costs of renewable technologies. You do need a minimum amount of volume clarity.

Paul Steedman: The technology costs for nuclear, as I said, look like they may be higher than for offshore wind. Offshore wind costs are falling; nuclear’s mature technology not likely to go anywhere.

Q251Dr Whitehead: Consumer Focus said in evidence to us that you did not like the carbon floor price. You must have discussed that obviously in the context of EMR, even though it is not in the Bill, in terms of its potential effects on consumers, but if it were to be retained you would want to essentially see it hypothecated. Is that right? How might it be hypothecated for the benefit of consumers if your initial objection is-

Richard Hall: The analysis we have been doing and the consumer polling we have been doing suggests, perhaps somewhat unsurprisingly, that consumers do not particularly like taxes. Not exactly a revelation for this Committee I am sure. However, their objection to carbon taxes does ameliorate somewhat if they can see some evidence that the proceeds of those taxes are being used to assist them. Setting aside our lack of happiness with the carbon floor price, we are keen to see if we can find ways to usefully use those funds both to mitigate consumers’ exposure to any potential increase in costs from supply side measures and also to ensure that we get consumer buy-in here. I mentioned earlier that the Government’s projections are that the Green Deal and ECO will hit a very significantly fewer number of homes than CERT currently does.

The Energy Bill Revolution, which is an initiative which I think the majority of us at this table are signed up to, is proposing to use the proceeds of carbon taxation to try to lift households out of fuel poverty. The analysis which they have conducted suggests that using the proceeds of the Energy Bill of carbon taxation could lift about 87% of homes out of fuel poverty by 2027. The contrary position, if there is not a significant uplift in the amount we spend on insulating our homes, is that our fuel poverty situation is likely to get worse. The DECC figures currently suggest that about 4.75 million households are in fuel poverty in Great Britain. That was the 2010 figure. We have seen forecasts that predict that could be as high as 9.1 million households by 2016. If we are going to get a grip of fuel poverty issues and if we are going to come up with an Energy Act that is sustainable in a political sense, I think we need to have measures in there which will allow us to reduce consumers’ exposure to bills and to make their homes more efficient.

Q252Dr Whitehead: Do members of the panel think that there are any similar kinds of principles involved with how the effect of CfDs need to be looked at in terms of effect on consumers. Which?, for example, suggested that the effect of CfDs may need to be effectively levied on bills on a unit basis rather than a bill basis. Is that a sensible idea in your view or do you think that the way CfDs may work will not have the sort of effect that some people are suggesting?

Paul Steedman: I think, whatever the instruments are that ultimately are used to support low carbon technologies and renewables, hopefully from our point of view, whoever pays for them it needs to be fair and so if they have to come off bills, levying them in a more progressive manner, which probably does relate to a per unit per consumption basis so that the more you use the more you are contributing, is probably the right way to go, absolutely. There is no hard evidence either way, I think, about whether through bill payments or whether through taxation is the most progressive way of paying for these measures, but it is clear that however they are paid for, they should be paid for in a way that is fair to the people on the lowest incomes.

Dustin Benton: We may not have detailed evidence on how progressive things are but we do know what works. The Hills Review highlights that energy efficiency works. It is the cheapest way of addressing fuel poverty and so if we do want to address the problem of people paying higher bills over time, we need to target energy efficiency at those who are least well-off. So, you could do that through the Energy Bill Revolution, carbon floor price mechanisms, you could do it through energy efficiency feed-in tariffs. In the United States they have special feed-in-it is an obligation but the market system is quite different because there is a single provider so you can do it in a slightly different way, but there is an obligation for low income customers to be served first so they get the energy efficiency that is needed so that their bills go down and then you go out to other players and that is a way of addressing the problem.

Rhian Kelly: I was just going to come in in terms of the business users. We are worried that the CfDs and the overall package will add additional costs to particularly energy-intensive industries and the most at risk in terms of the fact that they compete internationally both in the EU where they do not have some of these unilateral costs and beyond the EU, we think there will need to be further support for the most at risk and that, when designing the CfD in more detail, we will need to build that into the way in which we design it so it is possible to find a way to insulate some of the most at risk energy-intensive industries from the additional costs.

Paul Steedman: The additional point I wanted to make was just in relation to not just who pays but who benefits and it seems to us that mechanisms like CfDs, because they are complex and therefore exclude non-traditional players like local authorities, like large scale community co-operatives and so on, make it less likely that those on the lowest incomes can directly benefit from low carbon electricity, installed perhaps through panels in social housing, through local authority investment in low carbon generation within the city, from which people might benefit from lower bills directly. A simpler mechanism like, for example, a Fixed Feed-in Tariff would probably enable more people, particularly on low incomes, to access the benefits of low carbon.

Q253Chair: Just going back to an earlier answer from you, Mr Hall, the Treasury are dressing up, I think, some of their interference in this area, including the imposition of a cap, as a means of protecting the consumers. In practice, do you think it may have the perverse effect of undermining the efforts that are being made to minimise the costs of meeting carbon targets?

Richard Hall: I think certainly if investors lack confidence that the goalposts will not be moved with relative frequency, they may well seek a higher return on their investment if they are going to consider zero carbon assets in the UK, or they may defer investment until the situation becomes clearer. If investment is deferred then I suspect that if we do things later in slightly more of a panic than we already are that it is likely to have an increase in costs on customers.

Chair: Do you want to be more explicit, though? You say if there is a risk of moving the goalposts, is that risk effectively imposed by the existence of the cap?

Paul Steedman: Yes. I volunteer, yes, absolutely it is.

Q254Chair: So this makes investment in this industry in the UK less attractive than it otherwise would be?

Nick Molho: That together with the risk of the cap changing regularly absolutely undermines the long-term volume certainty of the number of contracts that would be awarded and therefore all that increases investor risks and therefore the overall cost of capital. I think that is an area where getting evidence from the Treasury and not just from DECC would be highly useful, together with a clear understanding as to why the Treasury does not want to push for a more ambitious green investment bank.

Chair: I am making very strenuous efforts to persuade the Treasury.

Nick Molho: I am sure you are and I am supporting you in those efforts.

Q255Chair: What does the CBI think about all this?

Rhian Kelly: We agree with some of what has been said really, that what we must ensure is that we do not increase the cost of capital. So if moving the cap around is going to do that then that is not going to be good from an investor perspective and then ultimately the cost of this and the way in which it may or may not fall on consumers, businesses and households.

Q256Chair: Just going back to your previous answer about the at-risk energy-intensive industries, who are very effective at lobbying in their own interests-I think sometimes making the most of their arguments- I think the CBI have suggested there should be an analysis making comparisons with other European countries about what they are doing for their energy-intensive industries. Are there any other factors that you think should be considered?

Rhian Kelly: We have always said that it is the most at risk and it needs to be an evidence-based process. We have also said that we need to be thinking about the energy costs both here in the UK but comparing it with the EU costs, and on paper they do not look too dissimilar. One of the challenges though is that when you go to the countries, when you start talking to the industries and the companies set up there, the exemptions that they get are far greater than the exemptions that are applied in the UK. What we need to make sure is that we do not just do that analysis based on pure energy costs, but we do it on the basis also of the exemptions that are applied in other countries and then that is when we can make a decision here about how we might apply exemptions and to whom we might apply it.

Q257Chair: Does that mean other countries are better at getting around the state aid rules than we are?

Rhian Kelly: I would not put it in quite that way.

Chair: How would you put it?

Rhian Kelly: I would say that they are experienced in this and they have been doing this for some time and we are now on catch up and with the carbon floor price, it brought the whole thing to the boil and we need to make sure that we do not recreate that situation through the main Contracts for Difference; that we are already building it into a scheme because the last thing we want is to have agreed the Contracts For Difference and then be in a situation where we have to, as we did last year, scramble to find a solution for exempting the most at-risk energy-intensive industries.

Q258Chair: So Britain is a late starter in the European game of bending the rules?

Rhian Kelly: Again, your words, not mine.

Dustin Benton: I should just say, we cannot see a hand-out as being a solution to this problem. I am genuinely concerned that we do not push particularly electricity-intensive manufacturing out of the UK, but the solution is not simply to give them money off their bills. The solution is to help them to take the big investments, and they are often very big investments, in energy efficiency which can systemically reduce their costs and this should be relatively easy through a financing mechanism. I mean, a lot of these companies have big pots of cash that they are sitting on right now but are not willing to spend it because it seems like it might be risky or they can’t get over their internal hurdle rates. Understanding what the characteristics are to enable them to invest in less energy-intensive processes to do the same things will give us the opportunity to have that manufacturing at a lower cost without having to exempt them.

Q259Dr Whitehead: We are running out of time but I just very briefly wanted to touch on Emissions Performance Standards. Now, they have been introduced in the Bill as 450 grams per kilowatt hour. Meanwhile, grandfathering of all new gas plants has been indicated up to 2045 at existing levels when they are introduced. How do you think that squares with possible targets in the Bill that we talked about earlier and do you think maybe that there might be scope for looking again at what EPS limits might look like over the next years?

Nick Molho: Absolutely. If you look at the Bill as a whole, we currently do not have a particular decarbonisation target in the Bill, we have a feed-in tariff proposal which is unlikely to provide the right level of support for renewable technologies, we have a capacity mechanism that might be incentivising gas new-build and we have an EPS that does not affect gas at all and is grandfathered until 2045. So, it is hard to see where the stick in all this package of measures is to ensure that we do reach a level of decarbonisation of around 50 grams by 2030.

I would add to that just a couple of points. The first one being that the argument has been made that the carbon floor prices is there to prevent excessive build rates of unabated gas but, as Simon Skillings very rightly pointed out this morning, the carbon floor price would have to be pretty high to prevent those investments. Almost more importantly, the carbon floor price is the one element in this whole package that is subject to the greatest amount of political risk, as it is very much akin to a taxation measure. The EPS in its current form is clearly unsatisfactory and the case needs to be reopened. We suggested in our written evidence that the Emissions Performance Standard and the capacity mechanism should be looked at together as an integrated package of measures rather than two separate policies. From our perspective, having an EPS that has shorter grandfathering provisions and seeks to go down towards the 50 grams by 2030 limit would work if it was complemented with a capacity mechanism which, in the specific example of gas plants, recognised that the EPS would be tightening over time and therefore provided sufficient levels of revenues and sufficient predictability on these revenues to incentivise investments in peaking gas plants that would be operating at low load factor. It is a fundamental question of looking at both elements together rather than as separate pieces of policy.

Paul Steedman: It is certainly the case that, as it is currently positioned and particularly in the context where the likelihood of the amounts of new nuclear that the Government expects to come forward are just not going to come forward, what will fill that energy gap is going to be a new dash for gas. That is what is on the table in front of us at the moment. In terms of our ability to then meet carbon budgets that will severely compromise, probably just throw out entirely, our ability to do that. That is added to the loopholes that are present within the Bill in terms of new coal plant which hopefully will be able to demonstrate CCS and indeed the extraordinary provision that the Secretary of State can effectively override entirely the provision on EPS in relation to security of supply. It seems to us, for a measure that is supposed to give a clear steer in terms of certainty, the way the Bill has been constructed does entirely the opposite or at least the only thing it gives certainty to is a new dash for gas.

Rhian Kelly: Bearing in mind the time, I make two very quick points, one of which is that the DECC scenarios, and I believe the scenarios from the Climate Change Committee, would suggest that it is compatible to have some unabated gas in the system up and beyond 2045, a limited amount, and that is still compatible with the 2050 target. Secondly, one of the reasons inside the capacity mechanism we are suggesting that you ought to also allow existing plant to bid in is that we think that will mean that you will not get as many stranded assets and carbon lock-in and may limit, or may allow, existing plant to continue to run and therefore limit new build of gas.

Richard Hall: I think my position is very similar to David Kennedy’s this morning in that I am relatively relaxed about the grandfathering out to 2045 because I think there will still be a need for unabated gas for balancing the system out into the 2030s. In terms of the anxiety that this might mean that we bust our carbon mix, the mitigating facts against that are the projected carbon price which the carbon price floor in tandem with ETS is expected to get us to. I think DECC is projecting £70 per tonne by 2030 on a steadily increasing trajectory. So, although there would be an absence of a statutory preclusion on these older slightly dirtier plants from running, realistically, unless we are in a situation where the market price has spiked because of genuine security supply, I think they would probably end up being out of the money. I think the combination of a steady rise in carbon price is likely to mean that these plants would simply be used for balancing the system and not running as base load.

Dustin Benton: The big problem is we are reintroducing risk. Ian Marchant said it best, "This is a known unknown". The message that is being sent by saying, "We are going to sign up to the fourth carbon budget and decarbonise the power sector out to 2030", is a very different message that is being sent from saying, "Build the gas plant now and you can run it at base loading by 2045". Those two messages at a very high level just look like they are conflicted. The Government needs to show a plausible story, which I agree could be shown but it needs to say, "This is the rough pathway that we are going towards and the EPS and our de-carbonisation objectives are going to be compatible".

Nick Molho: It just goes back to the point I was trying to make at the beginning, which is that if you look at the capacity mechanism and the emissions performance standard together, you will be able to deliver an outcome that protects the environmental integrity of the Bill in helping to drive down emissions while ensuring that you are providing sufficient investment certainty to attract the required investment in peaking gas plants and obviously demand side response storage and interconnection which should also be part of the capacity mechanism package. It is about an integrated approach rather than having two separate and disconnected strands of policy.

Chair: Thank you all very much for coming in and for making a very useful contribution to our consideration of the Bill.

Prepared 20th July 2012