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Energy and Climate Change Committee - Minutes of EvidenceHC 275
House of COMMONS
TAKEN BEFORE the
Energy and Climate Change Committee
THE Draft Energy Bill
Tuesday 26 June 2012
Rt Hon Edward Davey MP, Charles Hendry MP, Jonathan Brearley, Simon Virley and Kathryn Wood
Evidence heard in Public Questions 367-554
USE OF THE TRANSCRIPT
This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.
Taken before the Energy and Climate Change Committee
on Tuesday 26 June 2012
Mr Tim Yeo (Chair)
Dr Phillip Lee
Sir Robert Smith
Dr Alan Whitehead
Examination of Witnesses
Witnesses: Rt Hon Edward Davey MP, Secretary of State, Charles Hendry MP, Minister of State, Kathryn Wood, Bill Team Manager, Jonathan Brearley, Director, and Simon Virley, Director General, Energy Markets and Infrastructure, Department of Energy and Climate Change, gave evidence.
Q367 Chair: Welcome to the Committee for your first session, Secretary of State. We are very pleased to see you. You will be aware there is very considerable interest in our scrutiny of your draft Bill, although we regret we have only been given five weeks to do it. I appreciate that is not entirely your responsibility and we are doing our best. Your Minister is a regular witness and a welcome one, so we are glad to see him. We have met your officials as well.
Can I begin by saying we have appreciated the co-operation we have had from both the Minister and officials in the past, which has been helpful to us both privately and publicly? It stands in very sharp contrast to the attitude displayed by the Treasury, from whom we are having difficulty obtaining answers to what we regard as very important questions about the Bill when they are really understandably the people who should be giving the answers. I am told by them, and by implication, possibly explicitly, by you, that you are able to answer all those questions as well. We will explore some of them during the afternoon.
Could I begin by asking whether you feel that the Bill, in its present form, makes potential investors in the UK energy industry likely to bring forward or delay their investments?
Mr Davey: I think it will bring forward those investments. It is a radical, progrowth Bill, and it is designed to encourage investment in low-carbon electricity generation. We have certainly seen a lot of interest from investors who have not previously been interested in, for example, renewables in the United Kingdom.
Q368 Chair: It is acknowledged in the year since the White Paper was published that some of the proposals-including some quite central proposals for reforms-do not seem to be fully worked through. That certainly includes CfDs. Will that still not make people think there is an element of uncertainty?
Mr Davey: We have increasingly put a lot more information into the public domain. When we published the draft Bill in May with all the supporting documentation, we found a real welcome from industry about the details. They have of course been privy to a lot of our discussions prior to publication, so quite a lot of details did not come as a surprise. One of the things I am really grateful to you and your Committee for is that prelegislative scrutiny gives a chance not just for parliamentarians to engage further, but for stakeholders and industry to engage further, so we can explain ourselves more, in case there are any misunderstandings. We can hopefully bring even greater clarity where people are not quite sure where we are going. I think this is a useful process; I do believe a lot of people are welcoming the direction of travel. Reading some of the witnesses who have appeared before you, I get the impression-certainly from industry-that they like this direction of travel.
Q369 Chair: We will look at the merits of the issues, such as CfDs, in due course, but why do you think there has been a delay in finalising these proposals?
Mr Davey: I think we are on timetable, as set out in the White Paper. We are on timetable thanks to your willingness to do speedy prelegislative scrutiny. We want to respond to that, and we are very keen to hear what you have to say. We hope to publish our Bill in the autumn.
Q370 Chair: Do you accept that at the moment quite a number of the people looking at possible investment are saying there is still an awful lot of detail on how these reforms will work in practice that has not yet been published?
Mr Davey: Of course there is some more detail to be published-the final Bill, of course. We have a draft operational framework, which we will finalise in the autumn. We know how we are going to set strike prices, but we want to show what those draft strike prices will be in a year’s time and then finalise them at the end of next year. All that sort of information is what investors want. Let us be clear. This is not just a reform for next year or the year after; this is reform for decades to come. One of the points I am keen to get over to people focusing on this is about the phases of electricity market reform. When I was commenting on the draft document I was very keen to have a table-I think it is in page 19 of the documents in front of you-which sets out four stages of electricity market reform going to the late 2020s and beyond. That encapsulates the fact that this is a radical reform. Yes, I am sure investors and industry are hungry to have absolutely every detail, but we are undertaking such radical reform, and we are keeping pace with what we expected to be publishing. That has been welcomed.
Q371 Chair: What is your expectation about the speed with which this Bill is going to pass through its parliamentary stages?
Mr Davey: That will partly be down to business managers giving us the right slots and so on, but we expect it to be introduced later this year and to go through, I hope, getting a lot of agreement. I cannot say when Royal Assent will be given. It is a carryover Bill in the Queen’s Speech but we may be able to finish it during this session. I cannot absolutely predict that, of course.
Q372 Chair: Even though there are still calls for evidence out there about some of the measures?
Mr Davey: Indeed. We expect Royal Assent by the end of next year. Although there is work still ongoing, we think that can feed into this Bill process.
Q373 Chair: Royal Assent by the end of calendar 2013?
Mr Davey: Yes, at the latest.
Q374 Chair: I am not surprised that you say that, but given that a lot of the investment that we hope is going to follow the passage of the Bill is in infrastructure and assets, which need to be on stream quite quickly in this decade if we are going to get to where we said we want to be in 2020, are you worried about the tightness of this timetable?
Mr Davey: No, not particularly. You have to remember that first of all the Renewables Obligation Certificate process continues until 2017. There will be people, once we announce our response to the consultation, who will want to invest on the back of that. Within the Bill we also have the final-investment-decision enabling clauses, so if people want to invest ahead of Royal Assent there is a process we have put in the Bill to answer that very question. I think we will see everyone from offshore wind investors to CCS to new nuclear interested in the FID enabling if they are keen to go down the Contract for Difference route, and ahead of Royal Assent.
Q375 Chair: Given, as you acknowledge, that there are significant areas where further detail has to be published and secondary legislation and so on-perhaps a template CfD contract-is it your plan to publish those in draft form for further comment before they are brought before the House for approval?
Mr Davey: The secondary legislation?
Q376 Chair: Yes.
Mr Davey: Where we can, we would like to be able to do that, but because of the timetables that might not be possible. Clearly, we want to give the House as much time in all aspects of this legislation. The fact we have got prelegislative scrutiny assists that.
Charles Hendry: Much of that secondary legislation would be subject to consultation in its own right. Bringing forward the pace for consultation would therefore give people in and outside Parliament every opportunity to ensure it is in the structure they would think is most appropriate.
Mr Davey: Where we can, we will do the secondary legislation in parallel with the Bill. We want to try to speed up the process because we want to ensure investors get as much certainty as quickly as possible.
Q377 Chair: Given that the Bill has three broad aims-security, affordability, lower carbon-do you think in its present form it makes it more likely that we will be able to meet the fourth carbon budget?
Mr Davey: Yes. One of the whole objectives for doing this is to decarbonise electricity generation. I do not think we would have put a draft Bill like this before Parliament with the structure we have, Contracts for Difference and so on, if decarbonisation was not right at the top of our agenda. It is critical to the carbon budget; it is also critical beyond the fourth carbon budget report we published all the way to our 2050 obligations. It is a fundamental part of meeting our climate change obligations.
Q378 Chair: What does that do to affordability?
Mr Davey: Because, as you rightly said, we have three objectives-energy security, decarbonisation and doing this at the least cost-the design of this is to try to ensure we can bring that for that investment in low carbon and for energy security at the least possible cost. When you have the billions of pounds of investment we all know is needed in our energy infrastructure, that will inevitably need to be paid for, but we want to make sure that can be done without putting a heavy burden on business and consumers.
Q379 Albert Owen: First of all, can I clarify what the Chair was saying about the Treasury Ministers not coming before this Committee? You would have no objection as a Department if they were to come, would you?
Mr Davey: No, but I should say that as a Minister of the Crown I can speak on behalf of the entire Government. That is why I have intimated to the Chair that if there are questions you want to put to the Treasury I am happy to take them.
Q380 Albert Owen: It was not to catch you out; it is just that one of the answers we were given from Treasury Ministers was that it was not part of the protocol of prelegislation. Well, there isn’t really any protocol. I thought it would be advantageous, if there are some issues with the Treasury or another Department, that there would not be an objection from the lead Department. That is the question I am asking.
Mr Davey: No. There may be a protocol-I am not aware of it-but there would be no objection. Equally, I have no objection to fielding the questions that would go to the Treasury, because we work very closely.
Q381 Albert Owen: I will hold back on some other questions. We have tried to get the Treasury Ministers. That is the point we were making. A lot of the witnesses we have already spoken to have said this draft Bill is all mechanisms and no objectives, in many ways. Would you like to outline the Department’s objectives for this Bill?
Mr Davey: I do not want to repeat myself too much. In response to the Chairman-
Q382 Albert Owen: No, he listed them himself; I want to hear them from you.
Mr Davey: Yes, he did, he was absolutely accurate.
Q383 Albert Owen: There we are; perhaps you should swap places.
Mr Davey: I congratulate him for noticing our clear objectives. They are to get energy security, to keep the lights on; they are to decarbonise, to ensure we stop polluting; and they are to do that at the least cost, because affordability has to be a consideration.
Q384 Albert Owen: Why do you think some of the witnesses are saying what they are saying? You have read that they are saying it is all about mechanisms and it is complicated and these types of things: the objectives are not that clear.
Mr Davey: I just stated the objectives. They are absolutely what this Bill is about and I will not repeat them again.
Q385 Albert Owen: Why don’t you think they share that clarity?
Mr Davey: I don’t know, but in electricity market reform it is about substance. It is about delivering on those objectives. We have to make major reform. Let us remember, the current market is not working; it is not delivering investment in low-carbon technology. Many people believe it is biased towards gas. Therefore, if we are going to help bring on low-carbon investment, because of the high capital cost of low-carbon investment, we have to take these reforms. People are right: some of them are technical and some people find difficulty understanding them. Hopefully over this process we can help that by explaining them at meetings like this. But I think they are absolutely necessary. These are the nuts and bolts of climate change action.
Q386 Albert Owen: You have said that decarbonisation is one of the main objectives of the draft Bill. Why was it not therefore an explicit decarbonisation objective of 50 grams per kilowatt hour by 2030, as has been recommended by the Committee on Climate Change, if it is such an objective?
Mr Davey: Let me refer you to paragraph 34-I think it is page 20 in this document, which contains the draft Bill. We made it very clear-I made it very clear-that we are openminded about the role of targets. In this case it would be an intermediate target for electricity decarbonisation. We of course have an overall target, to reduce climate emissions; that is in the Climate Change Act and the carbon budgets and that is the outcome we all want. There are different methods towards that outcome. Clearly electricity decarbonisation is going to play a critical role in that. There are arguments both ways. I am openminded and interested to hear what the Committee says in its report.
The arguments against having an explicit intermediate target for something like electricity decarbonisation is you might get to the point where, to meet your carbon emission reduction targets, it would be more sensible to do something in another sector, say transport. You would thus be meeting your carbon emission reduction targets in a less efficient way. The argument for intermediate targets, just to be clear-I am genuinely openminded on this one-is that you could well corral and mobilise investment in low-carbon technologies. There are arguments both ways, and I would be interested to hear what colleagues say.
Q387 Albert Owen: You have clear objectives on decarbonising, we hear that, and you mentioned things that are slightly outside the Bill but are very important with regards to transport and other things. Specifically on this Bill and reform of the electricity market, the Government has already committed to reducing emissions through carbon budgets. Would the decarbonising target not give investors the confidence that they need, and give them more confidence?
Mr Davey: I hope the carbon budgets give people confidence. They are legal obligations. Everything we do in my Department is geared to delivering on those carbon emission reductions. We work across Whitehall, with the Treasury, the Department for Transport and others, so the whole Government is focused on delivering those carbon emission reductions. I can only repeat myself.
Q388 Albert Owen: I am repeating what our witnesses have been telling us as well; it is not my opinion against yours. They are saying that to get the confidence they need, they really need to have fixed targets. That seems to be slightly absent. You are saying you are openminded: they want firm targets.
Mr Davey: Let us remember, the whole of electricity market reform is geared to investors in low-carbon technology. If you are an investor in low-carbon technology or a generator wanting to use low-carbon technology we believe this is the legislation that you need and that you would want. That is critical to decarbonising. The analysis in the White Paper-the analysis we have done since modelling this-suggests that our proposals get us where we need to be. Whether or not there should be an intermediate target beneath the carbon emission reduction target is something that, I repeat, I am openminded about, but there are arguments against. You have given the argument for, which I accept-about mobilising investment-but I repeat there are arguments against. You could-intermediate targets often do this-end up wasting money getting to your main objective, which is carbon emission reduction.
Q389 Albert Owen: Still on this and targets for decarbonising, you say "get us to where we need to be". Again, in the Bill the target for decarbonisation seems to have slipped from "by 2030", as recommended by the Committee on Climate Change, to "by the 2030s". That is the sort of issue that investors and potential investors are raising with us, that there is this slippage and it is not quite clear. That is the reason I am raising this issue: they want greater clarity. Are we aiming for 2030, as recommended by the Committee on Climate Change, or is it the introduction of this Bill and the slippage that is going to go beyond that?
Mr Davey: Our core objectives are to meet our carbon budgets and the targets that are set out in there as we go to 2050. Those are our legal obligations. There are arguments to put forward additional targets on top of those to push forward action in one sector more than another. You could end up in a suboptimal world where you make it more difficult for yourself to reduce carbon emissions. It is a genuine debate, and I would be keen to hear what the investors have said in giving evidence to the Committee, and what the Committee concludes.
Q390 Albert Owen: The point I was making is what the Committee on Climate Change, which Parliament has set up, has said, more than just the investors, Secretary of State. In the Bill it has now slipped to the 2030s: which is it? Are we taking the recommendation from the Committee on Climate Change for 2030 as the cutoff date, or is there slippage to the 2030s?
Mr Davey: In some of our modelling we have shown we could get to 50 grams per kilowatt hour by 2030; we have shown that these measures could do that. The mid-range-I turn to Jonathan Brearley on this-is about 70 grams per kilowatt hour, but some of the modelling using this market reform would get us to 50 by 2030.
Jonathan Brearley: We model between 50 and 100 grams per kilowatt hour, which was the original CCC recommendation. What we are saying is we have tested this framework to ensure we could meet the CCC goals if we needed to go there.
Q391 Albert Owen: Why was that not put in the Bill? Why was it the 2030s? We are being picky but we are here to scrutinise.
Mr Davey: The 2030s is not in the Bill; it is in the accompanying documentation.
Q392 Albert Owen: Produced by yourselves, yes? Produced by your Department?
Mr Davey: Yes of course. Yes.
Jonathan Brearley: What we have said in the wider carbon plan and the wider work we have done on scenarios for 2050 is that it really depends where the balance of effort is in different sectors, in heat and in transport, as well as in the power sector. There are a lot of trade-offs. For example, if you need to electrify the economy you may want to tolerate a slightly higher grams per kilowatt hour to deliver against your overall aims of decarbonising the economy. Therefore what we are saying is that this framework will get us to where the CCC need us to be, but we need to do further work to test whether that does not end up costing us more money than doing it another way.
Q393 Albert Owen: That is very clear. On the other objectives, you have talked about decarbonisation in detail in answer to my questions, but why weren’t there any other specific objectives such as security of supply and affordability in the Bill?
Mr Davey: We could spend a lot of time legislating on our objectives, but we have had quite a lot of that set out both in Acts of Parliament like the Climate Change Act, which has set clear objectives, and in policy. This is, if you like, a workmanlike, businesslike Bill; this is about getting it done; this is about the means. We are very clear on the ends: the Chairman was very clear he knows what our ends are. This is about the means to get those ends. I could restate the policy objectives as well, but what we really need to do-because there has been quite a lot of debate and discussion about the ends-is get on with it and do it.
Q394 Albert Owen: We agree with that. That is why we are doing this work as quickly as possible. Again, our witnesses are not as confident as you are making yourself out to be. They are saying they expected something 18 months ago when the White Paper came out, and we had discussions and scrutiny of the principle of market reform, and yet things have changed and we are having to have these debates again now. That is one of the concerns I think you should take on board and I am sure it will be reflected in our report when we come to make it.
Mr Davey: Sorry, I am not sure which debates we are having again. Obviously I took over-
Q395 Albert Owen: You did.
Mr Davey: -the Department in February, so there may be some debates I am not aware of. Having read the White Paper and the work that has gone from there, we seem to be on track with the timetable set out in the White Paper.
Q396 Albert Owen: I will explain in a little more detail. We had witnesses this morning from the National Grid who are your system operators. They were saying, "We are going to have debates with DECC about very important issues that have not as of yet been clarified." They are saying that they are working models, they are part of a delivery plan with you and sitting down with you. There is a lot of work. You acknowledged earlier on-which you are slightly contradicting now-that has not been worked out.
Mr Davey: Let me bring in Charles Hendry in a second. Listen: you don’t publish a draft piece of legislation and have absolutely every detail-
Q397 Albert Owen: But I have scrutinised other legislation, as have you. After 18 months of a White Paper appearing, with respect, we have not had a draft coming to us in such a shabby form-these are my words, okay-after such a long period of time, and even with this Committee having an inquiry into it and the Government responding.
Mr Davey: I will bring in Charles, but I would obviously contest that this is in a shabby form; I think it is very good and well-written documentation. The points that it sounds to me National Grid were talking about were on the delivery plan. The delivery plan is not mentioned in the Bill because it does not need to be: it is a process of how you implement the legislation that is in the Bill. Without reading or being present to hear what National Grid said, they are right to say we need to engage with them over that sort of planning. That is completely in line with-
Q398 Albert Owen: I accept that every technical detail cannot be in the Bill, but the broad principles of the capacity mechanism and capacity market are what we were discussing this morning, and there is not much clarity even on that. We have been talking to potential investors who want that clarity now, and they are not getting it.
Mr Davey: I will bring in Charles in a second, but on that particular point, we made very clear-at my insistence-in these documents that if you are wanting to invest and you are not sure what the future capacity market is going to be because we have not given all the details yet, and you are worried that you might miss out on some payments, if you invest now you will be considered as a new investment in a future capacity market auction. So it deals with that criticism, which I have heard, listened to and responded to, that there was a possibility of investment hiatus. The real cause of the investment hiatus, if I may say, is the fact that the last Government were not pushing hard enough with a proper, clear energy strategy. We are. And there has been a recession, and growth has not been as quick as many people expected, which has caused concern on investment.
Q399 Albert Owen: Sorry, I am cutting across. This is not second reading or the debate. We can go past what previous Governments have done. That is a matter for debate; there was a recession under the last Government as well. What we are talking about here is this Government, and this Government making announcements, publishing White Papers and bringing draft Bills. We are scrutinising that. We need to concentrate on that. I don’t know if the Minister wants to come in.
Charles Hendry: Let me make a couple of points, if I may. First of all, I do not think it needs an Act of Parliament to say we want security of supply. It does not need an Act of Parliament to say we want affordable prices. Those are fundamental building blocks of energy policy and they run through everything we are trying to do. What we have sought to do in the course of the last two years, from pretty much a standing start, is to reinvent a new electricity market: the most dramatic changes to this market for 20 to 30 years. It is something other countries have not been doing, and therefore we are doing some very pioneering work. We were faced with the option of either waiting until every single detail of that was in place and then coming forward with the legislation or doing it in a more iterative process by saying, "These are the principles, then let us agree on the principles and move forward to the detail." People say they want the detail of the capacity mechanism; that is not going to be needed for some time yet. The capacity problem we face is at the end of this decade into the 2020s. We do not envisage that being a tool that needs to be used for a couple of years at least. Nevertheless we are putting the details in place gradually so that when it is needed it will be there. We are quite right to be moving forward in that way.
The other thing to emphasise is that we do have different objectives from the energy companies. Our objectives are to deliver the best deal and security of supply for consumers in a low-carbon way. If you are an energy company with a legal obligation to make the best return for your shareholders then your commitment to doing that in the cheapest way possible is not so absolute. So it is not surprising that when we look at their objectives, their current generation mix, their future investment plans and which technologies they may use, they are bound to have ones that reflect their corporate interests. But we have looked more broadly at the national interest to see how we deliver the security at a price consumers can pay.
Q400 Albert Owen: Final question to the Secretary of State: should the Committee on Climate Change have a role in assessing the impact of the strike price and achieving the climate change goals you have outlined?
Mr Davey: The Committee on Climate Change is quite rightly free to comment on all aspects of Government policy, and I am keen that they do. I do not think we need to add them into the Bill; they are more than capable of commenting and we encourage that.
Q401 Albert Owen: Whether it is in the Bill or not, should they be part of assessing the strike price? That is the very simple question. CCC themselves and others: should they be part of that?
Mr Davey: We have a process for going to the strike price, which will include consultation. They can respond to that consultation.
Q402 Albert Owen: You would not give them a formal role.
Mr Davey: No, I do not think we need to. They are set up as an independent body; they can respond to the consultation. I don’t think there is a need to bring them in. Arguably we could be criticised in doing that for somehow wanting to go on to their independence.
Q403 Albert Owen: You may be praised for giving equal weighting to the Committee on Climate Change’s objectives, and that that has been taken as seriously as the future investors or anybody else; they have been given a permanent role.
Mr Davey: They have a permanent role in the formation of energy and climate change policy through the Climate Change Act of 2008.
Q404 Albert Owen: So it is your intention to keep them as an adviser, rather than bringing them in?
Mr Davey: They are not just an adviser to Government; they are an adviser to the country, and to Parliament.
Q405 Chair: Just for clarification, one of the issues which National Grid said this morning was still open to debate was the counterparty, and whether it should be a single counterparty or the current proposal. We will come back to CfDs in a moment.
Could I just pick up on one of your answers about the current exclusion of an explicit decarbonisation objective from the Bill? The point you made of fixing the 50 gram per kilowatt hour target had some disadvantages. Even the Committee on Climate Change would accept that there are some disadvantages of putting that in the Bill. There does not seem to be quite the same objection to putting a commitment to achieving the carbon budgets in the Bill, because that allows flexibility as to whether we might make a bigger push on surface transport in the 2020s and therefore not need to go quite so far with electricity generation. The advantage of having a decarbonisation objective even broadly defined as meeting carbon budgets-particularly the fifth carbon budget, which will take us beyond 2030-is that it does make clear to the investment community that this is an absolute priority for the Government, such that its exclusion from this Bill might look a bit surprising given that we have made explicit decarbonisation objectives in other legislation.
Mr Davey: The problem with that proposal is that the legislation is already there. The carbon budgets from the Climate Change Act are already legislated for. A parliamentary counsel might have a slight worry at the fact that we want to repeat legislation that is already there. We are bound by that. I can repeat: part of the driver for this policy is to meet those legal obligations under the Climate Change Act.
Q406 Dr Lee: The message loud and clear from everyone we have had so far is that the document is too complex. Complexity equals risk, and the investors are all saying "I am not going to touch this; I am going to go and invest elsewhere". That essentially distils what we are getting. Is that complexity-if you accept it is complex-present because too many people have been involved in its genesis?
Mr Davey: First of all, I would want to question the assumption that what we are putting forward is not going to attract investors.
Q407 Dr Lee: Forgive me; that is all we have been getting.
Mr Davey: Obviously we have heard from investors who appreciate this proposal. For example, I was talking to a major energy infrastructure investor who has invested billions in other countries around the world. He has not come to the UK to invest because our Renewables Obligation process, he thinks, contains risks. Because we are going down the Contracts for Difference route he is now looking at investing in the UK market for the first time. Maybe it depends which investor you talk to, but I can be absolutely clear to the Committee: we have had some serious investors who have not previously invested in the UK market being attracted because of the reforms we are making.
I would say two things on your point about complexity. First of all, there is an awful lot of complexity in electricity markets now, and there has been going back. Talk to people who were around at electricity privatisation about how the pool operated and the rules for the pool; they were extremely complicated. The reforms made under the last Government were quite complicated and did not come before Parliament. They were mainly dealt with through the regulatory system. There is a lot of complexity in electricity markets; I think that complexity is inherent, to a certain extent. If you look at the Contracts for Difference, which people sometimes say is where the complexity is, first of all, we are not the first country to use Contracts for Difference. They have been shown to work in Denmark. Actually, the more you look at them the more intuitive they are and the greater sense they make. They are innovative, good for investment and good for keeping the cost down for consumers and taxpayers. Rather than adding to costs, which was what you were trying to suggest, I think they will reduce costs.
Q408 Dr Lee: In terms of objectives, you have those three; I am not going to repeat them. I would suggest we need to concentrate on one as our chosen primary goal. I get the sense that you are trying to please everybody and ending up not pleasing many people in the process. In terms of affordability, I do not quite understand how incentivising a private company with Government money to go into the markets to borrow money is a more efficient way than saying Government borrow the money, build it and sell it into the market. I would be interested to know why you think the way you have chosen to do it is a more efficient way of raising money, because at the moment the Bill seems to be an absolute bonanza for bankers and lawyers.
Mr Davey: I would disagree with that; if you are suggesting an alternative model of direct Government procurement, history suggests that is not always the most efficient way of doing it, both in this country and abroad. I am very keen to ensure we have the private sector leading this. We have a private electricity market, and, from talking to people in the industry and investors, they believe this can deliver in an efficient way. Indeed, to pick up Jonathan’s point, some of them do not like it because they believe it will reduce windfall profits the previous system gave them.
Q409 Dr Lee: Just finally, with regards to the Bill, is there some sort of overriding energy policy for the Government in which we look at our defence policy, our foreign policy, all in the round, and we say this policy fits in with our foreign policy, our defence policy, our access to food and all the other challenges this country will have over the coming decades? Or is this Bill being created in isolation by DECC, i.e. we have these lowcarbon targets, we want to diversify and decarbonise electricity? Or is it part of some big picture, some sort of big strategic vision Whitehall has?
Mr Davey: First of all, this is a proposal that has been consulted on not just externally but internally. A lot of Government Departments gave their views, helped create this and strongly support it.
Q410 Dr Lee: Does the Foreign Office?
Mr Davey: The Foreign Office has been one of the greatest champions in Whitehall for climate change reduction. It is fair to say that the Foreign Office does not spend as much time on these sorts of domestic reforms, but they do support the objectives.
Q411 Dr Lee: Forgive me; this is not a domestic issue, Secretary of State.
Mr Davey: Climate change is not a domestic issue, I completely agree with you, but this is a reform of the UK energy market we are talking about here, which I would suggest-
Q412 Dr Lee: With profound international implications.
Mr Davey: I hope it does have profound international implications, because we believe in quite a lot of these areas that we are world leading. We believe, because of the approach we have taken, lessons will be learnt by other countries. I would not want to be arrogant about this, but we believe because this is world leading it will set the standard. I think you will see more countries who wish to pursue the objectives we have. I believe you can pursue more than one objective at the same time. This could lead to some very profound and very beneficial effects around the world.
Charles Hendry: Can I go further? I do not think you can just focus on one objective. To do that, you have to make a decision that affordability or security of supply is less important than low carbon. That is not the position we are in; we need to pursue a range of different objectives. What we are intending to get to in the 2020s is: you get competition between the different technologies, and therefore the CfDs at that point essentially auction to bring in the lowcarbon technology that can deliver the capacity you need at the lowest price. That gets us back to the market principle, but therefore to go to a situation where the Government was procuring it you end up with political decisions being made where the market can decide on what will be the best way of making that happen.
Q413 John Robertson: Ministers, we are here to help you. I know sometimes it might appear that we are not. We want a Bill that is fit for purpose, and therefore we are trying to assist you when we deal with prelegislative scrutiny.
Mr Davey: I have no doubt about that.
Q414 John Robertson: Well, I don’t know: you have your opinion; I have a feeling you are there to put obstacles. Let me put a few things to what you have said. The Bill will encourage investment: that really sounds great. You have said you have talked to investors, and yet you said earlier you are looking forward to hearing from investors and to hear what they have to say. What we have heard is, basically, the Bill is too complicated; it is not fit for purpose, and other than the one of the big six who to be honest could have written the Bill given the way he made his contribution, four of them, while agreeing with the road you are going down, still have reserved rights, as we say, to put up some opinions; one of them said they thought the Bill was a waste of time. When you get to the smaller energy companies, they think you should go away and start again. Now, I don’t necessarily think you should go down that road, but I think it is important that you listen to these people. I don’t think you have spoken to them. We have talked to quite a number of investors, banking investors at that, and to be honest not one of them says at this present moment in time they would invest into energy in the UK. You might not believe me, but that is what they are telling me. If they are telling me that, I cannot believe they are not telling you the same thing. Where are we here? Are you really wanting to listen or have you not really made your mind up?
Mr Davey: We want to listen; that is why we have prelegislative scrutiny. This is a genuine, real process. We want to hear what your Committee says and listen to the evidence given to your Committee. Of course we have been speaking to investors and the industry. I have to say, I have a whole range of quotes here that have been given to your Committee from industry that are supportive of our approach.
Let me take one issue, which the Chair referred to earlier, where there is some concern in industry. I am very happy to take that head on. That is with respect to the payment system. Maybe you want to ask me more questions, but I think it is appropriate to answer your question because we are aware that there are concerns. Some people believe the payment system and the debate around it is a real problem. Let me make it absolutely clear: we want to attract investment. We know we have to attract investment. If we have to look at the payment system again to ensure people are happy with that payment system, we will look at that again. However, I think the payment system we have in the Bill, where there are multiparty counterparties, works. It is quite similar to the Renewables Obligation system we have at the moment. Others have talked about having a single-party counterparty, and we are looking at that in detail. It clearly has some advantages. You are right, Mr Robertson, that there are some people worried about the payment system, and inevitably a payment system is quite critical to investors because they want to know that they are going to get-
Q415 John Robertson: To be fair, I never mentioned the payment system.
Mr Davey: No, but you were saying that people did not want to invest. The one argument I have heard where people are saying they are worried about investment is the payment system. I am saying to you that we are very aware of that and we are engaged with that.
John Robertson: We will get into that detail.
Charles Hendry: Can I come back on the point of your question here as well? Of course we need the big six and the independents, but they cannot do it on their own. We need over £100 billion of investment in the low-carbon sector in the course of the decade. That means bringing in new players and therefore finding a structure that is going to attract some of the private equity firms, sovereign wealth funds, to come in as partners in that development is an important part of this process too. I am certain absolutely from the discussions we have had with them that this is more likely to make them invest than they were before.
Q416 John Robertson: Minister, I have no doubt what you say is true to you, but if we are talking to the same people then we are getting different feedback from them. I suggest that you give us the names of the people you talk to and we give you the names of the people we talk to. I would not mind betting that a lot of them are the same people. If that is the case, are they too frightened to tell you the story? They certainly are not going to be frightened of us; they are more likely to tell us as it is. Maybe you seriously have to talk to the Chair and work these things out, because our information is completely different from what you are saying. I am not saying that is not what you were told; all I am saying is they probably told you what you wanted to hear.
Mr Davey: Let me be clear, I find when talking to industry or investors they are not shy about criticising our proposals, but I am telling you the main criticism I have heard is around the payments model. You were not specific, Mr Robertson, about the issues they were raising. If there is an issue they have been raising with you-
Q417 John Robertson: You are going to get them later on as we go into the questions.
Mr Davey: I look forward to them.
Chair: We are just about to do a bit more on the payments.
Q418 Sir Robert Smith: I had better remind the Committee of my entry in the Register of Members’ Interests to do with the oil and gas industry, and in particular shareholding in Shell. Can we look a bit more at the payment system? In the original impact assessment, you worked out that the CfD would reduce the cost of capital by £2.5 billion. That analysis was based at a time when you were giving a clear signal that the counterparty would be Government backed. How much of that £2.5 billion was because of the risk of capital because of the Government backing, and how much was because of the payment mechanism?
Mr Davey: I think I am right in saying this, and I might hand over to Jonathan Brearley in a second, but the modelling done to get that £2.5 billion was not taking into account the payment system. It is very difficult to model payment systems. What it was looking at was the difference between the costs of capital, primarily, of a premium Feed-in Tariff versus a Contract for Difference. Because you have greater earlier certainty and greater stability for your revenues if you are an investor, we believe that reduces the cost of capital. That is why Contracts for Difference is a better model for investors.
Q419 Sir Robert Smith: But at the time you were also saying that the price risk is borne by the Government balance sheet, which surely must make the cost of capital-
Mr Davey: Under Contracts for Difference the Government does take more risk, but let me just check on that modelling point with Mr Brearley.
Jonathan Brearley: It is true; in the impact assessment the drafting was a little bit unfortunate. But in the calculations we did-so when we say, "How do we compare a premium Feed-in Tariff versus the CfD?-what we did when we tested the modelling was we had one revenue stream based on the wholesale price, and therefore over time, particularly if you are making an investment decision today for something built seven years down the line, it has huge variability because the wholesale price is driven by the long term gas price. We would all agree that none of us can predict the long term gas price, whereas the CfD says, by and large, you will get a stable revenue stream. Therefore there is much less risk in a stable revenue stream than one that is dependent on this variation. Therefore we think that lowers the cost of capital. There was nothing in that assessment and the way we modelled it that tested different forms of contract structure or payment models.
Q420 Sir Robert Smith: So the debate on contract structure and payments is more to do now with how the market is reacting to that change of design, and the concerns being expressed to us with the multiparty model are the legal enforceability and the accounting impact. Quite a few of them see this as something that will appear on their balance sheets and therefore reduce their ability to borrow and invest.
Mr Davey: Whichever payment model you go to, there are accounting and balance sheet implications. You are right to say, as I was saying to Mr Robertson, that people have expressed concern about the multiparty counterparty model. We would argue, and our analysis suggests, it is quite similar to the Renewables Obligation model we have at the moment, because that puts obligations on multiparties, on all the suppliers.
Q421 Sir Robert Smith: Not the same volume.
Mr Davey: It is still about collecting the money, because they collect the money from the customers. Those contracts work now; the payments flow. Noone has questioned that in the past; noone has not invested in renewables through Renewable Obligation Certificates because of the payment system. However, although we think our payment system we published in the draft Bill has a lot of attractions to it, because it is a payment system, and we are talking about a payment system here, we want to make sure it works so that investors and industry are happy with it. We want to take those concerns. Yes, we have to protect the interests of consumers and taxpayers ultimately, but that means also getting in investment in this infrastructure. I would be interested to hear what your Committee says about the payment system. We are very much engaged in looking at that issue.
Q422 Sir Robert Smith: If we are going down the single-party model, do you see that as being a public body, or another private organisation?
Mr Davey: There are different options for that. That is part of what we are looking at, whether it should be a private or public body. There are of course different implications from different models. One thing I do want to make clear, because I know this has been a matter of debate, is some people believe you could have a singleparty model where the Government is backing the system. I don’t think we need to do that.
Q423 Sir Robert Smith: But the Government believed that when it started out on this process.
Mr Davey: I don’t believe that was the case, actually. It follows from what I have said when I was describing multiparty counterparty model: we have always said that it was the contracts between suppliers and the customers that assured the flow of money. In a singleparty counterparty model that also flows.
Q424 Sir Robert Smith: The impact assessment talked about the price risk being borne by the Government’s balance sheets.
Jonathan Brearley: I don’t think the description in the impact assessment was quite right, as I said. When you look at the description in the White Paper, what we always envisaged would happen was the payments would always flow from suppliers through to generators to make the CfD whole. I don’t think anyone really thought we would be talking about tax money or Treasury money being used to pay out these contracts.
Q425 Dr Whitehead: "A Contract for Difference, unlike a premium FIT, insulates generators and consumers from both short term volatility and the impacts of long term price trends because the price risk is borne by Central Government balance sheets." That is paragraph 100 of the impact assessment. That is not badly written, is it?
Mr Davey: I think Mr Brearley is saying it was badly written.
Q426 Chair: I think what he is trying to say is that investors were entitled to rely on this as an indication of what the Government’s plans were. The Treasury then had a second read of it and decided they did not like it very much.
Mr Davey: I do not believe that was the process. I have a feeling that Simon Virley may want to come in on this point.
Simon Virley: The point is we want to get something investable. We think we can find a way that provides a sound basis for investment. If you have an obligation backed by statute to raise money from consumers, that is a sound tax base, if you like, to raise that money and pass it through to generators of low-carbon investment. So we think there are workable models. As the Secretary of State has already made clear, the difference in terms of the impact assessment, in terms of the cost of capital reduction, is about the stability of the return you get under a CfD. We do not think the issue is about the exact design, although we recognise the concerns. The stability of the return is what lowered the cost of capital and gave rise to the saving you were referring to.
Q427 Chair: If you are a private company about to commit a couple of billion quid of investments, you are going to be concerned about the details. It may be that there is another workable model, but noone could conceivably argue that it is as investable as a model where the counterparty is the Government. Noone could argue that.
Mr Davey: Let me disagree with you, Chair. It is extremely common, and it has been the case for decades, that the fundability of investment in energy has been based on suppliers’ ability to get payments from customers, be they household or business customers. That is what happens under the Renewables Obligation Certificates now. There is nothing new in what we are putting forward. The Government does not back and underwrite Renewables Obligations Certificates now, so I would press you back very hard on this. I do not think the model that has actually been put forward by many in the industry for a singleparty counterparty model without Government backing is at all problematic.
Q428 Chair: What is new is that the impact assessment, published less than a year ago, apparently no longer holds good. Therefore, will you publish a fresh impact assessment with a new estimate of what the cost of capital would be, now that you have pulled one of the crucial bricks out of the wall?
Mr Davey: I don’t believe we have, and I will just again ask Jonathan Brearley to clarify this. My understanding is the impact assessment that was done and the figures that were provided in the White Paper were not based on Government backing to the counterparty payment model.
Jonathan Brearley: It is worth saying we will publish an impact assessment alongside the introduction of the Bill, and a number of assumptions change, but the underlying assumption that led us to that conclusion was, as the Secretary of State has said, based around the payment flows and not around the contract instructions. I would not imagine those numbers would change.
Q429 Sir Robert Smith: Could you give us that in detail now, because we are considering in the next couple of weeks what to-?
Jonathan Brearley: We are happy to share the impact assessment that was alongside the draft Bill and talk you through that, although clearly we will have to, over the summer, look at what changes are made and at how our assumptions around energy prices change. I am very happy to provide more detail, if it is helpful, on how we model those numbers and how we came to those conclusions.
Simon Virley: We have obviously put a considerable amount of detail in the draft Bill documentation, in terms of tables and bill impacts.
Q430 Sir Robert Smith: I just think if the line from the Department is that the previous impact assessment was badly written and misrepresented the White Paper, then-
Mr Davey: Well, let me be clear: there was a phrase read out by Mr Whitehead that I think we are saying could have been better written.
Q431 Chair: It meant one thing that you are saying you do not mean any more.
Mr Davey: The point I am saying is that the numbers from the impact assessment would not have been different if the wording had been, shall we say, more fortunate.
Q432 Sir Robert Smith: But you can understand how, in the mind of an investor who is taking maybe not a highly-detailed interest, they read that the Government is thinking along the lines of being the counterparty and being on their balance sheet, and then they find it is not; it just shows a shift.
Mr Davey: We have spoken to investors who have asked these questions. When we have given them the answers we have given you they have not walked away or blinked. They have actually supported our model. I have to push back very hard. There is a debate, and I acknowledge that; I was introducing into the debate of this Committee the debate between multiparty and single party. I think the point you are making is not at all central to many investors’ considerations.
Jonathan Brearley: It is worth noting that both the models we are proposing give more guarantees to investors than the Renewables Obligation does today and most other premium Feed-in Tariffs do.
Q433 Chair: I do think it would be interesting for us-because obviously the investors will say slightly different things-to know which investors say they prefer the multiparty model to the single-party model, which was the one they thought had been proposed last year. There are investors who will say yes, you could make this work, what you are proposing now, but we genuinely did not come across anybody who said, "We think it is much better than what was proposed before".
Mr Davey: There are three models that have been around in this discussion, for absolute clarity: there is the multiparty counterparty model; there is the single-party model, which is reliant on the payment flows between suppliers and their customers; and there is what I think some of the Committee and I believe some people who have given evidence to you are suggesting, another model where there is a single party where the Government is backing that contract.
Q434 Chair: Unfortunately, some of us were stupid enough to rely on what the Government had published in its own impact assessment.
Mr Davey: All I am saying is there are three models that people are talking about, and what I am saying very clearly to you is that we are looking at the single-party counterparty model, not the Government-backed one, and we think that certainly has some attractions to it.
Q435 Chair: Thank you for that clarification. What the Committee is saying to you is we have struggled to find any prospective investor who says they would prefer a multiparty counterparty to the Government being the counterparty. I do not think there has been a single investor who has said that to us.
Mr Davey: I do not know if I am allowed to ask you a question; hopefully this is a constructive process. Maybe that is the case, I will take your absolute word for that, but I would be interested to know whether people have made a distinction between the two different single-party counterparty models when they have been discussing that with you.
Chair: Yes, and clearly a single-party counterparty that is not the Government is not as good in terms of the investor as the Government being the counterparty.
Sir Robert Smith: It is probably an improvement on the multiparty model.
Q436 Chair: Exactly, so there is a sort of order here. What is also clear is that we all share a concern about the cost of capital. The higher the cost of capital, the higher electricity prices will be in the future. Of those three models, there is one that absolutely beyond any possible doubt delivers a lower cost of capital, and therefore lower electricity bills, in line with one of the three key objectives you have identified as being important to you and the purpose of the Bill. I don’t think this is DECC’s choice; we do not need to go into the details of your discussions with the Treasury; we have speculated about those from time to time, but I don’t think that we are blaming DECC particularly for choosing one of the two more expensive models. However, that is the choice you are being forced to make by the Treasury. You need not answer, unless you want to.
Mr Davey: I don’t feel I have been forced by the Treasury. What I am saying is a payment model that works on payments flowing from customers to suppliers and then on to generators is a very standard model for electricity markets. It is what happens now and it has not got in the way of investment.
Q437 Chair: Do you think that the Treasury now regrets the publication of the document last year, which at least raised the possibility of the Government being the counterparty.
Mr Davey: I have not spoken to them about that particular point.
Barry Gardiner: Secretary of State, I am going to be merciful and move on.
Mr Davey: Please continue.
Q438 Barry Gardiner: I want to talk to you about the levy cap. When is the liability booked against the levy cap?
Mr Davey: The liability is booked when they start generating.
Q439 Barry Gardiner: Not at final investment decision.
Mr Davey: As accounting specialists, Simon or Jonathan may want to come in here, but the Contract for Difference is signed at final investment decision, so there is earlier certainty so that people can go ahead with construction. But as I understand it, payments from the Contract for Difference do not happen until they start generating. Is that correct?
Jonathan Brearley: That’s correct.
Q440 Barry Gardiner: How do you assess your headroom?
Mr Davey: At the moment, we have a 20% headroom above the levy control framework cap, as you are aware. As we think about levy control frameworks going forward, which we will do in due course, we will have to make another estimate for that.
Q441 Barry Gardiner: Projects sometimes fail.
Mr Davey: Indeed, and sometimes more projects happen than you expect. That certainly was the case with Feed-in Tariffs.
Q442 Barry Gardiner: Indeed, and failing projects will be using up headroom and therefore will delay other projects from coming on stream, won’t they?
Mr Davey: If you are talking about the older model and NonFossil Fuel Obligations-
Barry Gardiner: No-
Mr Davey: Hold on, let me just explain my point. There was a problem with the old model under NonFossil Fuel Obligations, where people had won an auction and then did not proceed. There was no penalty in the system in that auction. Under our auctions, when we get to phase two of electricity market reform and will be having auctions of Contracts for Difference, if people win an auction and then do not proceed, there will be penalties.
Q443 Barry Gardiner: Nonetheless, they will have prevented other projects from coming on stream, will they not, which was my point?
Mr Davey: We will not have the problem that we particularly saw with wind under the NonFossil Fuel Obligation, because we believe the penalty system will encourage people either to sell on or to proceed. They will have to take account of the penalties.
Q444 Barry Gardiner: If they proceed, then the project has not failed, has it? So they will not be paying the penalty. What you are saying is that you are trying to make sure that the projects do not fail because there is a penalty for failure, but you have already accepted that projects do fail. All I am trying to do is to follow through the logic of that position, which is to say that given that you are, as it were, booking space in the headroom that you have with the levy, and given that there is only a certain amount of headroom space, failing projects will be blocking space for other projects to come through. Is that not correct?
Mr Davey: One of the main reasons why projects failed under the auctions and the NonFossil Fuel Obligation was because the finance and the final investment plan were not in place. With the structure we are putting in place for Contracts for Difference they are signed at the final investment decision stage, so the likelihood of failure, which is often to do with finance and bankability, is much reduced. Of course there is always a possibility of failure, but if you are trying to learn lessons from the past, I think we have learnt them.
Q445 Barry Gardiner: What you are saying to me is that you are trying to minimise the risk of any project failure and that you will sign the contract at final investment decision but payments will obviously not be made until later on when generation capacity is on stream.
Mr Davey: Investors do not invest money to get towards a final investment decision wanting to fail, particularly if they know that there are penalties in the process. We are not doing the projects. There are lots of financial incentives for investors and companies to get it right.
Q446 Barry Gardiner: Does a levy cap introduce a risk that the pool of CfDs might run out before the end of the spending review period?
Mr Davey: No, I do not believe that will be the case.
Q447 Barry Gardiner: Why not?
Mr Davey: The Levy Control Framework, which I very much welcome, is about affordability, but it is derived from what we need in terms of decarbonisation. When we set the Levy Control Framework we are operating now, and when we look in the future, it is very important that all our objectives are taken account of. We have to decarbonise.
Q448 Barry Gardiner: What is the point of the levy cap if you do not think there is any chance of spending more than you needed anyway?
Mr Davey: I think it is very, very important to have the levy cap because it is very important that we consider affordability as we do our plans. We want to give a signal to investors, first of all, that we expect them to be competitive, that there is not a blank cheque. I am sure you would not, Mr Gardiner, want us to put a blank cheque; it is very important that there is a Levy Control Framework, but as-
Barry Gardiner: What I am trying to do is assess the risks that are being run.
Mr Davey: -we develop that Levy Control Framework we are putting in place our energy security and decarbonisation objectives.
Q449 Barry Gardiner: Yes, but you have put in place a levy cap. That cap has to be there in order to limit the number of CfDs that are available within the spending review period, is that not right?
Mr Davey: It depends on the price different CfDs go for in the auction.
Simon Virley: The levy cap is only set currently for the current spending review period 2014-2015. So even if we had some early projects coming under CfDs, that would only be a small element of the overall spend under the levy cap, which is dominated of course by the Renewables Obligation spend. We obviously are in discussions with the Treasury about what happens next in terms of the future arrangements, which will obviously have to reflect the fact that CfDs-
Q450 Barry Gardiner: But we have just heard from the Secretary of State that of course the levy cap is a very sensible way of proceeding-I am not saying that there should be a blank cheque-and therefore we are talking about it in principle not just in terms of this first phase.
Mr Davey: What I think Simon is showing there is we have a Levy Control Framework at the moment and it is working in bringing forward investment in the Renewables Obligation. So I think in many ways what you are suggesting is that we have been incredibly successful. We brought forward all this investment in renewables through our system and we had run out; we had hit our targets. A problem of success is a problem I would like to have.
Q451 Barry Gardiner: So you are saying that the cap is not a stringent one.
Mr Davey: The cap is a very important part of our planning, but as you have indicated, there is headroom. We have had to use some of that headroom in this spending review.
Q452 Barry Gardiner: Headroom is different, Secretary of State. Headroom is how much space you have left under the cap. What I am talking about is how tight the cap is, right?
Mr Davey: Headroom is over the cap.
Q453 Barry Gardiner: Well, you are 20% over, but headroom is from the projects that you have got also up to the limit of your cap. What I am trying to get at here is that there is no point in setting a cap unless that cap is imposing a constraint. Would you accept that?
Mr Davey: It imposes a real discipline and it sends a very clear signal.
Q454 Barry Gardiner: Indeed, and that discipline is about the number of CfDs that are available.
Mr Davey: We have legal obligations. Those legal obligations are to hit our renewable energies target and to meet our carbon budgets. Those are built in, as much as we possibly can because obviously we have a lot potentially over a long period, to the Levy Control Framework, so these things are integrated.
Jonathan Brearley: I think it is worth just saying two things. One is that the reason you have headroom is to manage the uncertainties you have described. So with the Renewables Obligation, that is why you have headroom: because some projects may not go forward in the way you expect and, indeed, some projects may overdeliver. Equally, when you get to a situation which, in a sense, we would love to have, which is renewables overdelivering versus the target, then you would have to have a discussion with Treasury about how you respond to that. This is all about bringing discipline into our processes and asking yourself some very simple questions: am I doing this most cost effectively? Am I getting the right sorts of project coming forward? It does not have to be the number of CfDs.
Q455 Barry Gardiner: Indeed, and I understand that. What I am trying to explore with you-but you are not wanting to engage in the debate, it seems-are the stresses that are implicit in the structure that you have created. I absolutely agree with you it might be nirvana to find that we had all these investors queuing up to get the CfDs. Pace all that the Committee has heard from investors, it might be a very nice place to be. Let us now engage in this thought experiment that I am trying to engage you on and say if we are there, if those CfDs are used up, what is the impact of that going to be on investors? Developers would have put a lot of time and money in getting projects off the ground to get to that final investment decision point and yet they know, because there is the cap, because there is a limit on the CfDs that may be available, that there is a potential risk that they get to the point of FID and they cannot get a contract.
Mr Davey: There are two points. First of all, because they are getting certainty in the process of investment much earlier than they get under the Renewables Obligation, at the point of final investment decision I think some of the problems that you are suggesting in your thought experiment will not occur.
Q456 Barry Gardiner: You yourself said, Secretary of State, that nobody is going to get to the point of final investment decision, no company is going to invest all that it has got to do to get to final investment decision, and then allow the project to fail, and you have tried to minimise and mitigate the effects of that. So FID is a huge investment for a company to get to that point: potentially millions, potentially billions of pounds. My point to you is that surely, if there is a risk that they make that investment and then find that they cannot get a CfD at that point, that is quite serious and it is going to affect their investment appetite.
Mr Davey: I will bring Charles in here in a second, but one of the things I think has not been discussed enough in this debate is the role of the delivery plan. The delivery plan that the systems operator will inform and the panel of technical experts will also comment on will set out the future expectations of needs for investment and infrastructure for the next five years. I think that sort of transparency will help investors and deal with the sorts of problems you are talking about. Maybe Charles and Simon want to add to that.
Charles Hendry: First of all, I think this is a significant improvement on where we are at the moment. If you are investing in renewables under the RO, you do not know what rate of renewable support you are going to get until you are ready to connect, and then whatever the prevailing rate is at the time is the level of support you are going to get. Under this, you make your final investment decision, which will be several years earlier, but then you are going to be given clarity about what that is going to be at that point.
Also, you need to look at the scale of these projects. This is not somebody building a conservatory and getting planning consent for it and thinking, "Shall I or shall I not build it?" This is something where people will have spent millions of pounds, of groundworks, of planning applications and all of the work that needs to be done before they can take a project forward. At that point they have made a very substantial commitment of their own that this is something that they want to see happen and the agreement on the strike price, the agreement on the CfD, is the final element which goes into their final investment decision. So this, I think, enables them to bring forward those decisions in a more timely way than they can do now.
Q457 Barry Gardiner: Do you not accept that there is an increased risk for an investor that they could put in that investment but get to the point where, because there is a levy cap that limits the number of CfDs that are available, there may not be a possibility of concluding a contract and therefore that that investment has been in vain? That adds a significant extra element to your investment decision right at the beginning of that process, not at the point where you are concluding it at FID, with that possibility that you make that investment up front but then there is not the space within the levy cap.
Mr Davey: What we are saying, Mr Gardiner, is the reverse is the case from the point you are trying to make: because of earlier certainty you are going to reduce the risk. I would also add, although it is not the case in this country, investors in other markets have seen, with feedin tariffs under the Renewables Obligationtype model, sometimes governments have not stood by them. So for global investors there is deemed to be an increased risk in those models, but in Contracts for Difference, because they are a contract, that risk is again reduced. So in terms of risk profile, if you were to compare Contracts for Difference with the Renewables Obligation, the risk profile is reduced under our proposals.
Q458 Barry Gardiner: We disagree on that one, but there we go. Would you accept that the person who is allocating contracts is going to have to make certain qualitative judgments about which projects will receive funding and, in effect, that is giving you as Secretary of State or the Department as the body in control of this really central planning powers that were not even available when we had a nationalised energy system?
Mr Davey: No, I do not accept that. Let us go back to the two first phases of electricity market reform. In the first phase, the way Contracts for Difference and the strike price will work is quite similar in many ways to the way Renewables Obligation Certificates work. Then in the second stage, after 2017, the prices are going to be set in the market. There is going to be a competition for who gets the Contracts for Difference.
Q459 Barry Gardiner: I was not talking about price, Secretary of State. What I was asking about was whether the person who is allocating the contracts will be making qualitative judgments about the projects that receive funding.
Mr Davey: No, I do not believe they will. I have talked about the delivery plan and certainly in the run up to 2020 the judgment we will have to make is which CfDs we auction for which technologies, but it will be technology decisions we are making, not project ones.
Q460 Barry Gardiner: You have put silos in place for each of the different strands, but within that there will be, one hopes and you certainly expect, as you have told the Committee, a plethora of projects coming forward. But you have now told the Committee that in making the allocation between those projects within the silo you do not believe that your Department or you will be taking a qualitative decision as between projects. Do you really want to stand by that?
Mr Davey: I absolutely do. Under the Renewables Obligation, which is administered pricesetting, we do not choose between projects. There are planning decisions at the local level, of course, but we do not choose between projects. We set the overall framework and for the first phase of electricity market reform when we are setting the Contracts for Difference they will be administered pricesetting, effectively, and they are completely analogous to the current ROCs. In phase two, the market is going to decide. So, no, I completely stand by what I said.
Barry Gardiner: Okay, good.
Q461 Dr Whitehead: Some people of course are going to get an enormous amount of assurance and certainty at a very early stage, much earlier than financial investment decision, about their Contract for Difference, aren’t they?
Mr Davey: There is the process, which I talked about earlier, for finalinvestmentdecision enabling with the investment instruments that are set out in the Bill, yes.
Q462 Dr Whitehead: So someone who has an investment instrument will have certainty about the fact that they will get CfDs in the fullness of time.
Mr Davey: It goes back to the point the Chairman was making about timing and wanting to make sure we were enabling investment to come forward. Whether it is somebody wanting to invest in nuclear or in offshore wind or in CCS, we want to make sure that they are able to proceed before Royal Assent and before the first Contracts for Difference are offered.
Q463 Dr Whitehead: Would you penalise them if they did not take their Contracts for Difference in the right year?
Mr Davey: It is likely that within the different terms of a Contract for Difference, if it was an investment instrument but quite near a Contract for Difference, we could put such a condition term in. We could do that, yes.
Q464 Dr Whitehead: Does that not suggest to you, however, that certain people would, effectively, bag CfDs in a particular year in advance of any other CfD decisions being made in the normal run of things?
Mr Davey: I am not sure if it is about bagging CfDs.
Q465 Dr Whitehead: No, I am just saying an effect would be that, wouldn’t it?
Mr Davey: I will bring in my colleagues-
Q466 Dr Whitehead: There would be no chunk of CfDs coming into the CfD pool at a certain point, having previously been assured that it will happen, because the investment instrument has been granted.
Mr Davey: If we can decide that we want to go ahead with an investment instrument we will be taking into account all our other objectives, whether it is the decarbonisation objectives or the Levy Control Framework.
Q467 Dr Whitehead: How can you do that if you do not know what the number of CfDs is going to be in a year when the investment decision arrives in that particular year having been made previously to those other decisions?
Mr Davey: All these investments are part of our strategy to incentivise low carbon investment. I know there was a point that was made in proceedings of your Committee where people were suggesting that, for example, if a nuclear project got an investment instrument that would somehow crowd out Contracts for Difference in the preceding years. I think that is highly unlikely, not least because, say a Contract for Difference was signed with a nuclear operator in 2013, 2014, the payments to that nuclear operator would not come until 2019 at the earliest. So the vast majority of Contracts for Difference in this decade are going to go for renewables.
Q468 Dr Whitehead: The point I was alluding to is whether it is 2017, 2018, 2019, 2020, in one particular year whoever had an investment instrument in their pocket, as it were-be they nuclear, large wind, CCS, whoever-would effectively cash in that CfD in that particular year in a way unpredictable against what else was being decided in that particular year.
Mr Davey: It would not be unpredictable because-
Q469 Dr Whitehead: Alternatively, it would be predictable to the extent that other people would not get a decision made in that particular year because someone else had bagged the CfDs.
Mr Davey: There will be a huge amount of transparency and, in this case, people would know years beforehand. Simon, do you want to add anything?
Simon Virley: Just to say the entire purpose of a CfD investment is to do exactly that: to bring forward these investment decisions for earlystage projects. So long as they meet the criteria and it is proved value for money and affordable, then we would welcome that. So if we can reach deals, whether it is nuclear, CCS or renewable deals under the CfD framework within the terms that we set out, then obviously that would be welcome.
Q470 Dr Whitehead: But we don’t know what the levy cap is going to be at the time when the CfDs arrive, having been already agreed in the previous cycle of the levy cap and, as you said yourself-forgive me-we do not know what the levy cap is going to be after 2015.
Simon Virley: But we have work underway with the Treasury to assess what that levy cap will have to look like and how it will operate under the new framework with CfDs rather than the Renewables Obligation.
Jonathan Brearley: Can I just say that any system is going to have to take account that some forms of energy take a lot longer to build than others and so, in essence, when you are asking someone to make an investment decision on something that they cannot get revenue from at all for seven or eight years you are going to have to provide them with a degree of certainty earlier than someone who can build in two or three years. What we are trying to do with this system is to manage those uncertainties, but just to make sure when we do that that we are using the consumers’ money in the best possible way, because this is a large amount of money that is being sent through the system.
Q471 John Robertson: I sometimes wonder if we are going to go down the road we did with wind farms-of people taking out licences to build wind farms that never happened, or the property being bought for supermarkets and the supermarkets never being built. Are we not heading down the same road with CfDs?
Mr Davey: I tried to answer that when Mr Gardiner raised that point, because you are right there were some of those problems with the NonFossil Fuel Obligation and the auctions we saw there. But we have learnt from that and that is why in our system of auctions there will be penalties, and also we have earlier closure in terms of final investment decisions.
Q472 John Robertson: Okay. What would happen if there was a choice to be made between sticking with the levy cap and meeting our 2020 carbon reduction target? Which would get priority?
Mr Davey: Let’s be clear: we have legal obligations. The renewable energy target is a legal obligation. Our carbon budgets are legal obligations. The Government has to meet those.
Charles Hendry: Can I also look at the other side of that equation, which is that most of the plant we are looking to build does not come into play until the very end of this decade into the 2020s. The earliest date for new nuclear plant is 2019, commercialscale carbon capture and storage is into the 2020s, a lot of the major renewables and offshore marine technologies will be in the 2020s and many of the earlier renewables up until 2017 can be funded under the RO in any case.
Q473 John Robertson: Yes, I understand what you are saying, but I just wanted to clarify which was, shall we say, the choice-whether it was going to be carbon reduction. It would appear to be that carbon reduction takes precedence.
Mr Davey: Let’s be clear: when we set the Levy Control Framework for this period, and no doubt even working for future cost control mechanisms to make sure we also hit our target of affordability, we bake in our legal obligations as well. I was trying to give a straight answer to your question, but I am also saying that we try to create the financial envelope and the financial discipline taking into account those legal obligations at the same time.
Q474 John Robertson: Okay. What about the 2020 renewables target; where does that come in terms of importance?
Mr Davey: I said a few minutes ago that that is a legal obligation that we must meet.
Q475 John Robertson: You might find it difficult to meet all your legal obligations at the same time. You may have to make a decision.
Mr Davey: The two legal obligations that I have been talking about, the carbon budgets and the renewable energy targets, are linked together very closely, and the carbon budgets were set on the understanding that we would be meeting our renewable energy target.
Simon Virley: It is worth just adding that of course we have the levy cap at the moment and we are on track to meet the first interim target under the EU Renewable Energy Directive, so the two things are consistent.
Q476 John Robertson: Let’s hope you don’t have to make that decision. Both RO and the CfD will be in operation between 2014 and 2017 and the levy cap will apply to both. How will you decide how the funding is distributed between the two schemes?
Mr Davey: Developers will largely have a choice between whether they go for a Renewables Obligation Certificate approach-
Q477 John Robertson: So you are not going to say X amount of money for one, X amount of money for the other, or all for one, none for the other?
Mr Davey: As I understand it, it all comes under the same envelope.
Q478 John Robertson: Okay. If the levy cap is fixed but the topup payments under CfD are volatile because of dependency on the wholesale price, is it possible for these two things to be compatible?
Mr Davey: That is our modelling and we believe it is. We believe it represents good value for the consumer, because if the wholesale price goes above the strike price there are payments back, which is one of the fairly unique aspects of a Contracts for Difference system, and that should give people reassurance.
Q479 John Robertson: Is the levy cap based on a fiveyear spending period? If it is, is it really compatible with investment decisions that need to take on maybe 20 or 30 years’ worth of investment?
Mr Davey: Let’s be clear: we have a levy cap until 2015. As Simon suggested, we need to think about the cost control mechanisms going forward and we will be doing that with the Treasury.
Q480 John Robertson: I remember the Secretary of State once standing up in Parliament and having a go at the then Labour Government for not having looked into the future about what they were going to do in relation to nuclear build with all the excess costs. Are you sure you have taken into consideration all the excess costs that may happen?
Mr Davey: Many of those we are legally obliged to and I am delighted we are. It may be, for example, decommissioning costs; we have to ensure that in any agreement the developer is making the necessary contributions to the fund, so that is one example of how the framework requires the system to look forward.
Q481 John Robertson: Have you considered how you might be able to give investors confidence that the funding will be available beyond 2015, given that the levy cap has not yet been set, or the date for that matter?
Mr Davey: This whole process we are going through is a detailed process-I think you will agree, even if you do not like aspects of it, Mr Robertson-and if people think we are doing this and then are going to pull stumps at 2015 they are wrong.
Q482 John Robertson: It is not a question of what I like or don’t like. It is a case of people telling us you can drive a horse and cart right through the whole thing and that it is just not fit for purpose. I have great concerns that we may go down the road of spending a lot of taxpayers’ money only to find that all these people were right.
Charles Hendry: Our starting point is that the current system is not fit for purpose. We have to get twice as much investment each year of this decade as in the last decade to keep the lights on. The old system was not bringing forward the new investment and it certainly was not bringing it forward in a low carbon way, so we have to reform the market to make that happen. I would not be overly concerned that there are some people out there who have a model which this is not the best one for, because if you have made a decision-let us take SSE-that you do not want to be part of nuclear because you are too small a player, then understandably you want a system which focuses all the resources on to renewables and nothing on to nuclear. Understandably, because that is their business model, those are the conclusions they are bound to come to. But what we have to do is take a much more holistic view and say that we have to get this investment. The only way we can protect the longer term interests of the consumers is to get a massive rebuilding of our electricity infrastructure and if we do not there will not be enough supply to meet demand and the prices will go through the roof.
Q483 John Robertson: I would say that you have not taken the holistic view. You have taken the view of large companies, only one of which does not agree with you or with the basic set-up, but you have taken no soundings from other companies below that. As a matter of fact, they went out of their way to tell us that they had not been consulted.
Mr Davey: I would be interested to know who it was-
John Robertson: It will all be in the evidence, so you can read it for yourself.
Mr Davey: The amount of consultation that the Department-
John Robertson: You have talked to groups where one person represents a group. You have not talked to individual companies.
Mr Davey: I am sorry, but we absolutely have. We have talked to a lot of companies of different sizes and there are a lot of interests to take on board, but ultimately the interests that we have to represent are the interests of the taxpayer and the consumer. We listen to industry; Charles has given an example where there is one large company who has criticised it and he has explained why that might be, but let’s take the issue of smaller companies. I have been concerned to make sure that the market is as competitive as possible. We have the work that Ofgem is doing to make sure there is greater liquidity, particularly in the forward markets, which is what independent generators need. We will be publishing a call for evidence about the operation of the market for Power Purchase Agreements and we would not be doing that if we were not concerned to make sure our proposals spoke to the need to have independent generators and smaller companies entering the market. We want that. Part of the whole purpose of this is to make sure we have as competitive a market as possible. As a former Minister for Competition, I believe in the power of competition very strongly and, whether it is this policy or other policies, one of my real personal objectives-and the Department and the Treasury share it––is to make sure competition is at the heart of what we do, because we know that is the best way of driving efficiency.
Q484 John Robertson: Does competition come before value for the taxpayer?
Mr Davey: Competition delivers value for the taxpayer.
Q485 Chair: Just in relation to one of your answers to Mr Robertson a minute or two ago, it is quite significant, and I think I interpreted the answer correctly. He asked about what happens if you have to choose between sticking within the levy cap and meeting our, as you point out, legally binding targets for renewables-carbon reductions and carbon budgets and so on. You are saying that if, to meet our legal obligations-perhaps to meet a carbon budget and all that-we have to breach the levy cap then we will breach the levy cap.
Mr Davey: We are not going to break the law. Clearly, we would need to be looking ahead before we got to that point to see if there are things we could do to make sure we did not breach the cap. We do not set these caps and these frameworks not to try to keep to them and abide by them, and we saw with the Feed-In Tariffs for microgeneration, particularly solar PV, that the system, the model, was breaching the controls that had been put in place and so action was taken. Hopefully, if we have a problem like that in the future, though I hope we will not, we would be able to take action more quickly because the system we are designing is trying to be more responsive. But if push comes to shove, if we have failed to do that for whatever reason, but we have this huge success because all this renewable energy and low carbon technology is coming forward, ultimately we need to make sure we meet our legal obligations. We would obviously be engaged with the Treasury closely about how we made sure that we did not load unnecessary burdens on the taxpayer and business.
Charles Hendry: The competitive pressure should also help to bring down the cost of the technologies. We have indicated that we would like to see 18 gigawatts of offshore wind, but that has to be based on the cost coming down from £130 to £100 per megawatt hour. If they can achieve that-and a task force has been set up to do it, they say it is achievable, they are now implementing their proposals; similarly for carbon capture and storage-we are in a position where in this country we can lead the cost reductions because of the scale at which they can be developed and deployed. This is the way we think in which we get the greatest amount of competitive pressure to bring down the costs, which helps us deliver that at the lowest cost.
Chair: I am sure we would subscribe to all that, but at least theoretically, given that we do not know what the levy cap will be beyond 2015 and the possibility that there might be a clash between achieving those goals that you have stated, which we support, and abiding by the levy cap, you might be forced to make a choice there. We would be much encouraged by your answers that complying with the legal obligations we have made will take precedence over staying within the levy cap.
Q486 Dr Whitehead: Were you always clear from the work leading up to the White Paper and beyond that CfDs and capacity payments were to have a state aid clearance issue attached to them?
Mr Davey: I think quite a lot of this will have a state aid clearance procedure, but we are designing the system for our objectives of decarbonisation and so on and we are designing it, despite some of the comments the Committee has made, to attract investment. Those are our key objectives for the design. We believe that our approach is strongly aligned with EU objectives. The EU wants us to invest in renewable energy. The EU is very keen on diversity; it is very keen on decarbonisation. We share those objectives, so designing a system that meets those objectives we think will find favour.
Q487 Dr Whitehead: Yes, but were you aware from the White Paper and beyond that there might be a state aid issue as far as CfDs and capacity payments were concerned?
Mr Davey: As far as I am aware we were, but I was not there at the time.
Simon Virley: Yes, indeed, we were and obviously the RO is approved state aid and the Commission wants to ensure that whatever measures we bring forward are consistent with the single energy market and competition across Europe.
Q488 Dr Whitehead: Knowing that, CfDs for renewables would not need to be notified because they had already been exempted, effectively.
Mr Davey: I am not sure if that is the case.
Simon Virley: No, that is not correct. You would have to resubmit any new scheme to the European Commission to make sure that they were satisfied that it was consistent with the treaty obligations.
Q489 Dr Whitehead: Yes, but the guidance document on state aid states that, as far as renewables are concerned, state aid is regarded as not an issue because they are relevant to the building of a lower carbon market within the EU. Is that not right?
Simon Virley: That is not quite right, because there is an issue about proportionality. There have been issues even under renewables where the Commission have challenged back and said that some of the tariffs, in their view, are disproportionate. So even where there is in principle support, there is still then the question of practical application.
Q490 Dr Whitehead: Yes, but you would accept that there would be in principle support. There is in principle support, indeed, as we know CfDs are in place in various other EU countries relating to renewables and have not had problems with state aid.
Simon Virley: There is in principle support. The point I am making is you still have to submit the details of the scheme and that is still subject to-
Q491 Dr Whitehead: But that appears to be entirely within the guidelines set out for state aid within the EU. Is that right?
Simon Virley: The framework of CfDs does operate, as you say, in other European countries, but the details of exactly what tariffs are being offered will still be vetted closely by the European Commission.
Q492 Dr Whitehead: Shall I read you out bits from the guide? Would that be helpful?
Simon Virley: If you so wish.
Q493 Dr Whitehead: My question is: is the clearance that clearly is now being required for CfDs unnecessarily involving renewable CfDs because it is rolled up with support for nuclear?
Mr Davey: I am not sure there is any evidence for that. There are many aspects of our electricity market reform proposals that would have to have EU clearance. We welcome that because we want to give investors certainty, and if there was any risk that they were not compliant with the EU state aid rules that would undermine that certainty. So I do not think we have any problem going through that process. I know we do not have any problem going through that process.
Q494 Dr Whitehead: I did not ask that. I said, as we have established, it appears that renewable CfDs, subject to notification, would be within the guidelines of EU state aid. CfDs are being discussed, so I understand, between your Department and the EU currently, particularly because the policy rolls up renewable CfDs and nuclear CfDs, which are outside the guidance.
Mr Davey: I am certainly not aware that we are having to go through a state aid clearance procedure simply because of nuclear. I think there are many aspects of our reform that would require us to go through state aid clearance.
Jonathan Brearley: We are obviously going to notify the Commission and they may take different views on different technologies as well as the mechanism, but I do not see the fact that we are notifying for nuclear necessarily holding up any decision on renewables. As Simon has said, whatever we do, we would have to go to the Commission and (a) ask them to look at the scheme and (b) make sure they believe that the scheme and its rates are proportionate.
Q495 Dr Whitehead: What elements of the capacity market would require clearance, since I gather that has been notified as well?
Simon Virley: Yes, the capacity market also requires clearance because the Commission again wants to ensure that any payments are proportionate and wants to ensure that there are no adverse implications for the single energy market across Europe. A number of countries obviously in Europe already have capacity mechanisms and some countries, like France, are taking forward work, as we are, to address security of supply issues that they face. So again, we do have to notify the capacity mechanism in a similar way.
Jonathan Brearley: Can I be clear? We are very much in favour of the state aid rules system. This country under successive governments has supported that. We want a single energy market. We want competitive market forces to operate in Europe and we are very happy to show we comply and we want them to make sure other member states have to comply. If we do not support these, if we do not make sure we comply, I have to say it would be against our country’s economic interests.
Q496 Dr Whitehead: With respect, though, there is a difference between notifying the EU that something appears to be within the guidelines and applying to the EU for state aid clearance, is there not? And both of these devices appear to be in the position of applying to the EU for state aid clearance.
Mr Davey: I was trying to suggest early on that it is really important that we can show investors that there is state aid clearance, because I think that will be one of the things that will give people more certainty in these reforms. We have had a discussion in this Committee today. We think these reforms are very good for investment. We believe everything we are doing, whether it is state aid or whether it is design of Contracts for Difference and so on, is all geared to try to give investors that stability and predictability that they seek.
Q497 Dr Whitehead: Was the reason the Treasury decided not to act as the counterparty for CfDs because they were concerned about the fact that that would be counted as state aid and therefore would need to be applied for?
Mr Davey: I am not aware of that.
Jonathan Brearley: I do not think it is necessarily critical in terms of the overall application that we make. There is a series of quite technical issues that the Commission will go through when considering our application and they will think both about whether it is aid or not and then, as you mentioned, whether it is approvable or not. There is a whole set of factors there that go far beyond whether Treasury is the counterparty and involve detailed design of how you run the contracting system, how that relates to different organisations and how you divert money.
Q498 Dr Whitehead: So if we have a single counterparty or a virtual counterparty or a joint counterparty, that would still be pretty much involved in an application for state aid as far as CfDs are concerned.
Jonathan Brearley: I do not think under any mechanism of this sort you would not be able to apply to the Commission-and by "apply" I mean notifying the Commission of what you are doing and asking them to make a judgment.
Q499 Dr Whitehead: Apply or notify?
Jonathan Brearley: I consider them both to be the same thing. In essence, we would have to go to the Commission and say, "This is what we are doing. Do you consider this (a) to be aid and (b), if you consider it to be aid, do you consider it to be approvable?" That is therefore what we are intending to do.
Q500 Dr Whitehead: How long do you think that process will take?
Jonathan Brearley: In some sense that will depend on the discussions we have with the Commission, but we have talked to all investors who are looking to invest early and we are confident that between the process we run with the Commission and their investment decisions we will be able to make the timetable work. It is very hard to predict, as you know, how long the Commission will take, because obviously they need to make a judgment about the level of detail they want to investigate the issue and therefore how long they want to take over it. It is not really for us to prejudge their timetable.
Q501 Dr Whitehead: So we don’t know?
Jonathan Brearley: We have an idea, but no, I don’t think it is up to us to try to control how much time the Commission takes.
Mr Davey: In my last job in BIS we had a number of cases we had to take to the European Commission for state aid clearance. You could never be sure about the time they were going to take. You obviously tried to do whatever you could to speed them up, because you often had deadlines, but this is not unusual.
Q502 Dr Whitehead: What might be unusual in this case is that we are seeking to give people, as we have said, comfort for investment decisions and trying to make sure that they know as early as possible whether they are going to have CfDs and what have you. Presumably, timing could be quite important in that respect, except of course that investment instruments are according to date not within state aid. Is that right?
Mr Davey: I am not sure if that is the case; we have certainly not said that. Investment instruments like capacity markets are up for state aid clearance. You state, Dr Whitehead, that there are deadlines for investors and so on that we need to meet, and you are right. I hope I have made it clear we want to press ahead with this. We are not trying to drag our feet despite sometimes being criticised on that basis, but on state aid clearance timetables there is always a deadline that you need to meet for very, very good purposes. I remember in the Postal Services Bill we needed to get state aid clearance for what we were doing to the Royal Mail Pension Plan and there was a very significant deadline there. We had to work very hard to make sure the Commission understood that and were able to meet it. When there are deadlines in this area we would take similar action to make sure we worked with the Commission, because they are our partners in getting this cleared, but we would obviously make it clear what our preferred timetable was.
Q503 Dr Whitehead: Can I be absolutely clear? You have indicated, the Department has indicated, certainly that there are no ongoing discussions with the Commission about investment instruments being liable for state aid, and certainly the Department has implied that that appears not to be, therefore, something that would be applicable for state aid. I am grateful for clarification, but it certainly would be in exactly the same way as CfDs would be.
Jonathan Brearley: I think, given that when you offer an investment instrument you are offering some comfort over a CfD, then yes, it would follow the same rules as any other state aid would.
Q504 Dr Whitehead: So investment instruments will also be liable to the timetable, which we are not sure about, as far as state aid is concerned.
Jonathan Brearley: Yes, but I think you have to remember that those people making any of those early big investments will obviously be sophisticated enough to factor into their calculation any state aid risk at the time they make their final investment decision. What we have said very clearly to anybody coming forward is while the state aid process is going on any agreement needs to be subject to decisions in that process.
Mr Davey: There is no special exemption from the state aid process. They cannot have one; we are not seeking to give them one.
Q505 Dr Whitehead: So if they do not give you state approval what happens?
Mr Davey: Of course we believe we are designing these to be compliant.
Q506 Dr Whitehead: Yes, but presumably an application means an application could not succeed. Does that down EMR or are there plan Bs, other alternatives?
Mr Davey: No, it would not down EMR, but you are seeking, to me, to get into the realm of speculation. Our approach all along is to try to make sure we are using all the devices, whether it is market competition, negotiation, to ensure that the taxpayer and the consumer pay as little as possible, I believe that, because that is our focus, I think people in the Commission will look at what we are trying to do and, I hope, find it compliant. But I don’t want to give a running commentary on those negotiations, nor should I.
Q507 Dr Whitehead: So we hope they will work?
Mr Davey: We believe they will.
Q508 Sir Robert Smith: Do you see Contracts for Difference delivering on the renewables without the obligation that has been there up until now to use renewables?
Mr Davey: Yes we do. We think Contracts for Difference are an excellent device for renewable investors. Let’s face it, where they were introduced-the example people point to is in Denmark-they were used primarily for renewables, and we have tested the model in the UK context and they work well for different types of renewables, whether it is intermittent wind or elsewhere. So we believe these are a device which is very suitable for investment in all forms of low carbon technology.
Q509 Sir Robert Smith: When you were looking at the White Paper you did not then envisage that Power Purchase Agreements would be needed, but I think you now recognise that they could well be part of the mix. What has changed?
Mr Davey: We do not legislate for Power Purchase Agreements; at least we have not in the past, as I understand it. They are long-term contracts between the developer of independent generation and a counterparty who will purchase their power, and that this contract is important to securing finance. There has been concern currently, before we get to our reforms, that people are finding it difficult to get Power Purchase Agreements. That is one of the reasons why we said we would publish this document, that we would be issuing a call for evidence to try to understand those problems in the Power Purchase Agreements market. We will be issuing that call for evidence in the next few weeks and during that process we will try to understand the current problems, the current system and see if there are any concerns for PPAs going forward under the Contract for Difference regime. I think that is a very clear signal to those investors who use these instruments that we want to take on board their concerns.
Q510 Sir Robert Smith: Do you share the concern that, without them then, the smaller independents would be driven out of the market and there would be more vertical integration?
Mr Davey: We want there to be many players. We want a competitive market. I spoke earlier about the work Ofgem is doing; very, very important to make sure there is more liquidity in the UK forward markets. It is why we are doing the call for evidence. But be clear, I am going to say in quite a strong way we need to see the market working so that these players can get involved and, if necessary, if we find that we need to legislate, we will.
Q511 Sir Robert Smith: Do you think a buyer of last resort will be needed in the mechanism to underpin-
Mr Davey: You are slightly ahead of the game. We are going to do the call for evidence. We will do the work. All I am saying today is, if we feel we need to take legislative action, we would not hesitate if that is what was required.
Simon Virley: The issues that exist on PPAs exist now and are somewhat separable from the question of which instrument you use going forward. There are issues with the PPA market as it currently exists. We do think that by providing a stable stream of revenues obviously the PPA market will develop in a different way under a CfD regime and what the call for evidence is doing is saying are there other barriers that we need to remove to address any problems that might exist going forward.
Q512 Sir Robert Smith: The smaller scale, the community projects: do you think the CfDs are maybe too complex for community projects to take on and another mechanism might be necessary?
Mr Davey: Depending on the size, some of the smallest projects will get FeedIn Tariffs under the microgeneration regime, so the smaller community projects, I think below five megawatts, would not be in the Contract for Difference regime.
Jonathan Brearley: As today, in a sense, when you have, in essence, a ROC traded on the wholesale price you would expect intermediaries and aggregators to help communities build projects and essentially give them a different kind of revenue stream. However, the efficiencies that are created by CfDs and the value of having a consistent framework means that we think it is important that we have the same framework for different types of generation and, as we have today, we would expect intermediaries and suppliers to be able to help small schemes get away.
Q513 Chair: You will be aware this Committee is quite concerned with demandside measures. Would you like to tell us how demand reduction is featuring in your EMR proposals?
Mr Davey: I strongly agree with the Committee that demandside is a really, really important part of the whole energy policy debate, the whole decarbonisation debate. Of course, there are two types of demandside measures: demand response, particularly when there are peak issues, and demand reduction. Already in our proposals we see a role for demand response, particularly in the capacity market and we are doing a lot of work on that and will be setting forward more of our thinking on that. I think that is a really important part of the proposals. On demand reduction, where you are permanently reducing demand, I think there is a lot of work we should be doing and are doing on that. Indeed, again in the documentation, I think it is on page 21, we talk about the work we are doing.
Let us be clear, though, on demandside reduction there are a number of approaches you can take to this that governments have taken in the past and the question is which works the most effectively. There is everything from product standards to home insulation, the Green Deal sort of work we are doing, the work you can do with businesses, whether it is through policies like the CRC, whether it is through even capital projects to help people invest in energy efficiency. Or you can try to bake it in to your energy market. I know a lot of people are keen to see it baked in. One organisation is talking about FeedIn Tariffs for energy efficiency, Contracts for Difference for energy efficiency. I think at this stage we need to look at all the different options to try to get demand reduction and we are going to be working very hard on that. Simon’s team is leading it. Simon, I don’t know if you want to say a little bit more about the work that is going on at the moment in this area.
Simon Virley: We are doing work to assess the potential for electricity demand reduction and then to assess what is the best way to unlock that. As the Secretary of State has indicated, you could come at this through a number of different routes of which market mechanisms within EMR is but one route. There are other ways to get at it, so obviously we will be looking at what is the best value for money way of unlocking that potential.
Q514 Chair: The work that you are doing: page 21 in fact refers to a report which may appear this summer.
Mr Davey: Yes. We have not got a specific date for publishing it, but all I can say to you, Chair, is there is a lot of work going on.
Q515 Chair: Are you considering a FIT for energy efficiency?
Mr Davey: As I said in my remarks, I know that is one idea putting around it, but I think if I said we are considering it that would probably set the hares going. Let us do the work. We are going to do it in a strategic way. All I want to emphasise is the commitment, both my personal commitment and the commitment of the Department and the Government, to do as much as we possibly can on energy efficiency and, particularly, business energy efficiency. Coming to the Department new, I have been very impressed by a lot of the energy efficiency policies that the Department and my predecessor developed, but I do think there is some more work we can do on business energy efficiency and resource efficiency. That is one of the reasons why I am committed to doing this work, to link it into the Bill if that proves to be the right route to go down.
Q516 Chair: You will be aware that some of the witnesses that we have heard from have drawn attention to the relatively weak element in the Bill dealing with demand at present. On demandside response, you say you want to see this play a fair and equivalent role alongside generation and we would certainly agree with that. How do you expect to be able to ensure that happens?
Mr Davey: Some of the work that is ongoing is examining the issues. One of the issues we have to consider is one imagines that the capacity auction will be auctioning availability of capacity for four or five years in advance. Demandside response might be quite difficult to plan that far ahead, so we might need to look at, for example, a secondary auction model, but this is very much work underway. I have put a lot of emphasis on it myself and we will be sharing some of that with your Committee. I am sorry we have not got it all worked out today for you, but we do believe this is a really important part of the reforms.
Jonathan Brearley: I think it is worth just adding that when we make that design there are some technical issues there, as the Secretary of State has said, around the timing of contracts, but the principle in the capacity auctions will be fair and equal treatment of demandside versus generation.
Q517 Chair: We had some exchanges with National Grid this morning. One of the concerns I think several members felt was that the core business of National Grid is transmission and supply, and the more capacity there is the more profit their shareholders make. If, as the system operator, they have quite an influential role in a number of areas, doesn’t that make it rather harder for us to be confident that demandside response and perhaps also storage will be given sufficient priority in the future?
Mr Davey: I am going to let my colleagues respond to that, but my initial response to you would be I think National Grid have an interest in the development of smart grids and I think it is smart grids that are increasingly going to support demandside, demand-response policies. So I think you might see the model you described, the business model of National Grid, changing.
Simon Virley: Obviously one of the objectives that we would be setting for the system operator would be to deliver the reforms in the cheapest possible way and obviously within that framework then if demandside measures could provide cheap and available capacity then obviously that would take precedence in any auction.
Jonathan Brearley: The issue of conflicts of interest is something that we are alive to, National Grid are alive to and we should bear in mind that they already carry out a series of system services and manage a series of conflicts within their business just like other networks’ businesses do, for example British Telecom. We are running a review now to take evidence as to the scale of that and then to think about the sorts of responses you might make, and provisions to do so are part of the Bill.
Q518 Dr Lee: A question on demand: it goes back to my point about whether there is joined-up government across Departments. This afternoon the Chancellor has announced scrapping of the fuel duty. How does that fit in with reducing demand? The winter fuel allowance: how does perpetuating that at £2 billion to £2.5 billion a year feature within enhancing energy efficiency?
Mr Davey: Well, we do need, you are right, to look at a lot of these policies across Government and I believe we do. It is the Government’s legal obligation to meet our climate change targets and to meet our carbon budgets and we work with other Departments to deliver that. Clearly our main policies are on the energy side, decarbonising electricity generation. You tempt me to comment on issues that are the purview of the Secretary of State for Transport and the Secretary of State for Work and Pensions and I tend to find if I do that I get myself into trouble. So, tempting though it would be to have a long discussion about that, I probably shouldn’t.
Q519 Dr Lee: Forgive me, £2.5 billion of the Exchequer is going into measures that are not enhancing energy efficiency, are not changing the behaviour of individuals in terms of how they travel from A to B. God forbid I would say this; there is a sense the Treasury has a different agenda across all of this. Their interference with regards to this Bill seems to be there and they will not come to us to give us evidence, and that also suggests that they do not really want to be publicly speaking about it. I guess what I am trying to say is that, with all the best intentions, if the Treasury are not on board, to what extent can you make an impact upon demand in Britain for energy?
Jonathan Brearley: I am afraid I do not agree with your underlying assumption. I do not believe the Treasury aren’t on board. We are collectively bound by carbon budgets, for example, and despite what you read in some places and some commentary I have found working with the Chancellor actually very productive, and I always point people to things he says. If you read what he said in his Budget speech, he was very positive about investment in renewables, for example.
You are focused on demand, and I understand that, but to give you an example about how we work across Government, the Green Deal, for example, is involving close work with the DCLG and they are very much signed up to helping us reduce demand through the Green Deal.
Q520 Dr Lee: I do not seek to personalise it; I think the Treasury fears liability. The way we are talking about singleparty/multiparty; this is about the Treasury not wanting to be liable for whatever excess costs. Going back to the original point, it will affect how much you borrow money at if the Government is not the last resort, the person who is backing it. I am actually on your side here, Secretary of State. I am just saying that there is a fear I have that, actually, when push comes to shove, "The Sun says reduce fuel duty; we’ll go with The Sun," not as in solar, because it is politically expedient to do so. The problem with this whole area is that, at the moment, it is not politically expedient to go green. It is a pity but it does seem so.
Mr Davey: I think the evidence shows that it is the right thing to go green. In a period when this Government wants to generate growth, as I said in my earlier remarks in terms of the Queen’s Speech, this Bill has more to contribute to growth than probably any other Bill. We are talking about an investment that we believe will be brought forward by this Bill; we are talking about a quarter of a million jobs. You caricature the Treasury, but I think we should all be worried about liabilities and consumer and business bills for energy. I have been very clear; I think the Levy Control Framework is the right thing; working with the Treasury in close partnership is the right thing, because we want to do this in the least cost way. I think we will take the public with us if we do that; we will take business with us if we do that. Certainly in my first few months as Secretary of State, I have made it very clear that I am worried about consumer bills. I did not say earlier, but I would not talk about business energy efficiency, wanting to do more than that, if I was not worried about the costs on business. We should all be worried about that, but I do not believe worrying about the costs on business and consumers is contrary to a green agenda. I actually think the two go together. While there are people who say those are against each other, I think they go together.
Q521 Dr Lee: I do not think we are disagreeing. The point I am trying to make is that the shortterm view is that it does not go together. The longterm view is it does. I do not need to be persuaded of that. That is why I sit on this Committee; it is why I stood to sit on this Committee. Politically at the moment, the shortterm view is where we are getting growth from. I think people look and say, "Okay, if we give £500 million away on fuel duty that will go back into the economy and stimulate growth." That is the judgment that the Treasury has made this afternoon, "and also we’ll take some voters with us because they will get cheaper petrol at the pumps," but that does not fit into a longterm green agenda and you know it does not. We all know it does not. That is the frustration I find with this: you are balancing, not you personally, shortterm political expediency with longerterm views.
Mr Davey: We have a coalition agreement to see environmental taxes increase. It is important that that coalition agreement is met. We need to ensure that, across Government, we meet that coalition agreement.
Q522 Chair: Does your happy partnership with the Treasury, keeping it completely depersonalised, extend to the discussions taking place about the cut in RO for onshore wind?
Mr Davey: Again, you are tempting me ahead of an announcement.
Chair: If you want to get rid of the temptation, give in to it.
Mr Davey: You know, from your experience, that we are discussing the consultation findings before we make the response to that. I want to make the response as soon as possible. I know people are impatient for it and hope to get it out before the summer recess. We will get it out before the summer recess. I have made it very clear on more than one occasion that I believe we need to go where the evidence takes us. It is really important; it speaks to the point being made by Dr Lee. We need to do that. That is important, because investors and business want to make sure that this country is a country where decisions are made in terms of the evidence and the longterm interest, and not because of political pressures. On these issues and others, we need to send that signal very clearly.
Charles Hendry: It might also, Chairman, be useful to put it into context. The RO Banding Review is not just about one element; it is about 29 different mechanisms. We have had 4,000 responses to the consultation compared to 200 from the last consultation on the RO Banding Review. There is a very significant amount of detail in a whole range of different areas.
Q523 Chair: Of those 4,000 responses, one that seems to have reached the public prints rather more prominently than others is the alleged view of the Treasury about a bigger cut in RO for onshore wind.
Mr Davey: Your most important word in that sentence was ‘alleged’.
Q524 Chair: Fine. Given that we are talking about evidence and rational responses, it is my experience that businesses, particularly those making longterm decisions, are very focused on the evidence and the need to make a rationale response to the evidence. Why do you think investors have decided not to invest in Kent now?
Mr Davey: I saw their press release, which set out why they felt they could not proceed with it at this point. It was to do with the fact that, as I understand it, they have not won the orders that they had hoped for.
Charles Hendry: They have also announced that they are closing their facility in China, so this is not simply something that is happening in the United Kingdom. They have not so far got orders for their new turbine. When they have no wider portfolio of products to fall back on, then this becomes an area of concern for them. They were at pains to point out that this was not a criticism of the UK market. We remain very firmly of the view that this is the place to develop offshore wind
Mr Davey: There are a lot of companies that want to come and be part of a really extensive supply chain here.
Q525 Dr Whitehead: Could I turn briefly to the capacity mechanism and capacity markets? The plan is to assess what capacity is needed four years ahead. The National Grid estimates for demand for 201213 are 10% below their estimates for 2006. It will not be an easy job, will it, to make a fouryearahead estimate of capacity in order to undertake the process of putting capacity payments into process?
Mr Davey: I think a fouryear period seems a lot easier than some of the time periods we have to deal with elsewhere. You are right to say that things can change and the big thing that has changed in recent years is the economic recession and the financial crisis. That clearly has affected things. Actually, it is suggested that the capacity constraints that people feared for the middle of this decade are much, much less likely to happen, as Charles was saying earlier. I think our central forecast, at the moment-obviously we want to do more detailed work on it-is that we do not expect capacity constraints until the end of this decade or potentially even early next decade.
Jonathan Brearley: It is worth just understanding why we came up with four years. You have to balance the uncertainties going forward with the need to set the framework early enough so that people can invest and build. Four years gives someone a reasonable chance of building different kinds of plant to meet any potential capacity gap.
Charles Hendry: It can be done more quickly. It does not have to be a new build plant. There is a whole range of other ways: we have got mothballed plant, which can be brought back into use extremely quickly if there was an unexpected growth in demand; we have got a plant that may not go through, an old coal plant, which may, under the LCPD or the IED, decide to go for a modest number of operating hours after 2020; there is the use of interconnectors. There is a whole range in which one can meet the imbalance between supply and demand. Many of those would not take four years to put in place.
Dr Whitehead: Indeed, you have deftly anticipated my next question.
Charles Hendry: I always seem to.
Q526 Dr Whitehead: It is only to be expected, I know. It is a question of whether we should be looking at the type of capacity, as well as the fact that we make an estimate of total capacity, and how we might do that, in terms of the various options that may be available to us, within the capacity market arrangements that we have presently put down on paper.
Charles Hendry: The principle of the capacity market is it will find the cheapest way of filling the gap. It is quite possible the demandside response could be part of that process, as a way of taking demand out of the system. Equally, the National Grid themselves are doing some of the pioneering work on looking at interconnectors. I have been talking to Iceland, Norway and others about taking forward those technologies. This is not a onedimensional approach; this is a way of finding the cheapest way, by auction, of filling a gap.
Q527 Dr Whitehead: I was going to congratulate you on signing up with Norway on the early stages of an interconnector to and from Norway, which I think is a very positive move, as far as security of supply is concerned in particular, but how compatible are such moves, particularly, say, a substantial increase in interconnection, with what we basically have in mind as far as capacity components are concerned?
Charles Hendry: We have also done a memorandum of understanding with Iceland, and so we are looking at a range of different potential partners. It is extremely compatible, because we have countries that have an enormous amount of lowcarbon electricity generation that they cannot use in their own domestic grids. Therefore, finding a way of harnessing the resources where they are strongest is, I think, a good way of meeting our lowcarbon objectives. It is a good way of doing it at a more affordable price for consumers. Part of the challenge now is how we develop a more interconnected energy world. In energy terms, we are no longer an island. I would not tell that to some of my colleagues perhaps.
Dr Whitehead: We are European in fact.
Charles Hendry: In energy terms, we are now so closely interconnected, and that is something that is simply going to go forward. I think this is a very exciting part of the way forward.
Q528 Dr Whitehead: Is there not an issue that, having said all this about capacity payments, however we work them out in the capacity market, we are getting into a situation-and certainly some people have suggested this to us-that having heard about the outline of the capacity market and capacity payments, but not knowing yet the detail, they are therefore unlikely to invest until such time as they do. There therefore may be an investment hiatus, because people are waiting to see what the capacity market looks like. Isn’t there a strong case now for, having said it, getting on with it very urgently in order to prevent that from happening?
Charles Hendry: On the interconnectors, we have just completed a call for evidence about the case for energy trading and electricity trading, seeing how that might tie into the mix, because certainly the Irish Government is keen to explore that further as well. We see no capacity challenge in the course of the next few years. The demand destruction that we have seen over recent years has taken that down, as you were saying, Dr Whitehead, to levels that were lower than expected. Even if one sees that starting to rise up again, then we have seen some additional investment in new plant. We can see what is coming out of commission, so there is no complacency whatsoever about the need to replace that. Our estimate of the capacity gap when it starts to become a bit narrow-i.e. we would like a 5% capacity margin-when it drops below that, it would be around the turn of the decade into the early 2020s. That would be our working assumption at the moment.
Mr Davey: The investment hiatus point you make, I touched on this earlier. We have said very clearly in the overview document that is accompanying the draft Bill that, if someone wants to invest now, they should do, even though they know a capacity market auction might happen. We are saying to them that new capacity coming on now after this has been published would count as new capacity in any future capacity auction. We have tried to give a very clear signal that there need not be this investment hiatus in relation to the capacity market. I do not know whether Simon or Jonathan want to add to that.
Simon Virley: We will be publishing further details of the capacity mechanism in the autumn, so people will have further details on which to plan when they have seen that
Q529 Dr Whitehead: I assume that maybe some further workings will come out at the time when you publish the details. You suggest in principle that the market will have a limited impact on bills and, if anything, may reduce bills in the longer term. Could you add a little about how that will happen? How will it reduce bills?
Jonathan Brearley: When you have a system that is under stress, so when you have a market that is very tight, you end up with very spiky prices at the point when you have that tightness. What the capacity market does is it produces a little bit extra capacity that we need, whether from that demandside response or indeed conventional generation. That smoothes out the pricing and, therefore, over time, we think it could possibly save consumers money. Our view overall is that we think the capacity mechanism impact on bills is fairly marginal either way, but you can see, in worlds where you have huge system stress, having a capacity mechanism there to avoid it could save consumers money.
Q530 Dr Whitehead: I am sure you will agree, however, that the question of tightness and looseness in the market can be subject to gaming.
Jonathan Brearley: Our point is, if you have a market where suddenly supply is not adequate to meet demand, then yes you absolutely have opportunities for gaming. In a world where you have a capacity market, it is much harder for someone to use market power to drive up prices.
Q531 Dr Whitehead: Are you intending to put forward any measures to ensure that gaming does not take place?
Jonathan Brearley: When we design the auctions, it will be done in such a way to maximise competition and to minimise any possibilities for gaming.
Q532 Dr Lee: Just following on from that, how resilient is this interconnected world that we envisage to unilateral decisions like Germany saying no nuclear, the Iranian regime collapsing or those sorts of incidents? You can foresee the possibility of some of them. How resilient are we in those circumstances?
Mr Davey: One of the aims of this, as I explained, is to improve our nuclear security, to make ourselves more resilient and to have more diversity. One of the advantages of the lowcarbon transition, with renewables, new nuclear, and carbon capture and storage, is it makes you more resilient. This is very much in the direction that it seems you want to go.
Q533 Dr Lee: Moving on to the Emissions Performance Standard, Friends of the Earth has said to us that the only thing that this Bill gives us as a certainty is a new "dash for gas". How can the Government ensure that the measures in the draft Bill will not cause such a scenario?
Mr Davey: This is not a dash for gas. Let’s be clear about the Emissions Performance Standard. This is an important part of the framework, but it is very much a backstop. We have many, many tools that are in this reform to drive decarbonisation, whether it is the Contracts for Difference, whether it is the carbon price floor. All those are there, but the EPS is playing a role; it is playing a role already very clearly with coal. There were some concerns being raised when we said what we did about grandfathering the EPS for 2045 that this was somehow a dash for gas. I do not believe that is the case; I know it is not the case. We do need to have some more gas coming forward, and that is why we are going to have a gas strategy in the autumn. We think that was important, both for energy security and climate change objectives. We see coal being replaced by gas. Also, and people pay no attention to this but I believe they should, we are free to review the Emissions Performance Standard for future investments. There is a process of a three yearly review. We are reviewing the current 450 grams per kilowatt hour in 2015.
Q534 Dr Lee: Why 2045? Why 30 years? It is quite a long time; is that because, in discussions, they were saying that is the only way we will get them to invest? Is that an investment requirement?
Charles Hendry: Essentially it is the operating life of a plant. If people are going to be investing in the hundreds of millions it takes to build a new gas plant today, then they need to understand what return they are going to be getting on that process. One of the challenges we face here is there is quite a lot of consented gas plant, which is simply not being built. As much as anything that is the fact that the spread prices are pretty low at the moment, and therefore people are burning coal rather than gas. If we want that new plant to come forward, then there has to be an understanding of when they might be required to retrofit CCS technology, bearing in mind that CCS technology has not yet been perfected. The view was that that, if we need gas to fill the challenge that we have in the shorter term, then we have to give a longterm picture for the investors.
Q535 Dr Lee: Shale gas is the buzz phrase at the moment. It is the gamechanger if you believe The Spectator, etc. How do we prevent gas becoming the base load and a significant part of energy generation, instead of being what we probably all envisage it being, which is a peak deliverer of energy?
Charles Hendry: We do need some more largescale gas plants coming through into this process. If you look at the challenge we face, where we have a quarter, a fifth, of our current electricity generation plant closing down in the course of the next decade, we need some significant investment in that timescale. Nuclear cannot do it in the course of the next five years. CCS cannot do it. Some of the major renewables cannot do it. Therefore, we need some gas to be coming forward into the mix, into the process. This is looking at a balance. Some of this will be baseload generation. Gas does have the great advantage of dispatchability. Nuclear cannot be switched up and down; renewables cannot be switched up and down, apart from biomass. Therefore, to have a generation technology that can be increased when you need more demand has a flexibility that is an added benefit.
Jonathan Brearley: It is worth adding that we will have the Carbon Price Floor, which will be introducing carbon price into the system, which will change the relative economics of different clients.
Q536 Dr Lee: Do you think that the Government might not be left with any option other than to have a high carbon price to control the proportion of gas generation?
Jonathan Brearley: You need to bear in mind that, alongside that, we are bringing a lot of low marginal cost plant through CfDs. Once they are built, their marginal costs are very small and it is likely that they would be on the system first, simply because their marginal cost is very low. One would expect that, as CfDs roll out more highcapital lowmarginalcost plants, when they are on the system they will bid into the system first. Therefore, gas’s role over time will change but, as the Minister has said, we think that gas will still have a role to play in all parts of the market, for some time to come.
Q537 Dr Lee: This length of grandfathering of 30 years, how is that consistent with reducing emissions by 80% from 1990 through to 2050?
Charles Hendry: It comes back to the point the Secretary of State was making that this is something that is reviewed. It is not therefore saying that every single gas plant that is built over the next 1520 years is guaranteed to have a 30year exemption, or even out to 2045. This is a case that there is a threeyear rolling programme; when we feel that we have a volume of gas on there that would threaten our ability to meet those carbon requirements, we can actually then change for future plants the emission standards.
Q538 Dr Lee: One final question in terms of base load: the way in which you describe some forms of energy-nuclear, renewables, marine, etc-once you have committed, they are on. By definition, it is base load, is it not? Is there not an argument here that base load perhaps should be treated slightly differently in terms of the Government’s subsidy, in that you say, "Right, okay. We’re going to commit to a 30% or 40% base load, and it is going to be broken down into an interconnector from Norway, via hydro-nuclear and the Severn Barrage," which is my own personal favourite? I wonder if that is not the better way of doing things. Thereby, you factor in, you actually fix in the system, a base load that you know is going to be there. Comments?
Charles Hendry: Clearly there is a range of different ways of providing base load. The market reform proposals will provide support for technologies like that. The capacity mechanism, where we started on this, is actually something that needs to represent flexibility. There is no point nuclear bidding for a capacity mechanism in support, because it cannot up its output. It only makes sense to run nuclear plant for a full 24 hours a day. A different part of this landscape will work for different areas. Add into that as well gas with CCS, and the work that we are taking forward in CCS and the tremendous amount of interest we are seeing in the new competition for that. We want gas with CCS to be a longterm lowcarbon source of generation as well.
Q539 Dr Lee: I guess my point-and this is the final question-is whether there is any merit in taking nuclear merit out of this whole thing, i.e. you say there may be decommissioning costs, but there is a hint in the Bill that it muddies the waters for all the other renewables. I wonder whether maybe you take nuclear out and say, "Right, we’ve got to deal with it differently." It seems as if, from what we are hearing, the investors are not terribly enthusiastic about going nuclear at the moment. It seems as if you are almost going to be forced into doing that and treating it in a different way. Why not take it out? There is this sense that CfDs have been constructed to hide subsidy for political reasons.
Charles Hendry: I think CfDs are still a better way for renewable investment, particularly for renewables in many ways, because you look at the tremendous price fluctuations and output fluctuations that we get. If one can smooth that over through a Contract for Difference, it gives a much more predictable rate of return that is beneficial. It also means, from a consumer’s perspective, that first of all it brings down the cost of capital. Secondly, it gets away from simply paying a topup to whatever the wholesale price is. When the wholesale price is high, the Renewable Obligation pays a topup on top of that. That is not a good deal for consumers. We are moving to a system that will actually make it easier to balance and will deliver it in a more affordable way. The final point of that is that the objective here should be a market structure delivered through CfDs. In the 2020s, we want to be seeing nuclear competing with coal and gas, with carbon capture alongside renewables, for which is going to be the cheapest way of delivering lowcarbon electricity. One can only do that if you have a standardised approach between them.
Mr Davey: The point I would bring to your attention is that all lowcarbon technologies, whether renewables, nuclear or CCS, have a cost structure with high upfront capital costs. CfDs are designed to reduce the cost of capital, so they are suitable across the suite of lowcarbon technologies.
Q540 Sir Robert Smith: Can I just pursue that a bit further? When it comes to nuclear, the Government is going to be negotiating directly with project developers. How is it equipping itself to get the best value for money, and what criteria will be used to try to ensure that there is the best value for money?
Mr Davey: Well, my predecessor set out how we would go about implementing the coalition agreement on no public subsidy for new nuclear in his statement to the House in October 2010. That is, I guess, our most public description of that. What I do not want to do, and you would not expect me to do, is to be involved in a negotiation. We cannot, through a process, give weekly reports on how those negotiations are going. We will be held to account for the outcome of those negotiations and there will be real transparency about the agreement that is reached.
Q541 Sir Robert Smith: How will that transparency manifest itself? Will there be transparency in the outcome or, having had the negotiations where you do not want to show your hand, will there then be transparency about what took place in the negotiations, once the deal is struck?
Mr Davey: The outcome is the key thing. People will want to know what the strike price is; they will want to know the various terms of the Contract for Difference. They will want to know whether that is value for money and how it squares up against the statement that my predecessor made in October 2010.
Q542 Sir Robert Smith: Without being party to the information on which the decision is made, how can people make that assessment?
Mr Davey: I have said that we will be publishing an awful lot about this, with all the key elements. There is always going to be something that is in commercial confidence, which we will not be allowed to share but, in terms of the price, the duration of the contract and those sorts of things, they will be in the public domain.
Q543 Sir Robert Smith: Will the panel of technical experts maybe have a role in scrutinising the process to give assurance about its transparency?
Mr Davey: We do not currently believe they should have a role.
Jonathan Brearley: There is a timing issue there about when the panel of technical experts would be in place. As the Secretary of State has said, you are ultimately talking about these first enabling projects, which are a range of different technologies, being something that is subject to a commercial negotiation. Therefore, some of the information that is shared there, such as the underlying cost information, is something that companies will want to keep confidential, just like an offshore wind developer today does not need to share their costs with us directly; they simply take the rates they are given under the RO.
Q544 Sir Robert Smith: Some of the investors that have been talking to us have suggested that the Contract for Difference is not enough to give them certainty, because the ratio of upfront capital to longterm return is such that, with the risks of a construction problem or something like that upsetting their investment, they were looking for some kind of cover on the construction risk.
Mr Davey: I think you are trying to draw us into negotiations. I am sorry; I am not sure if we can really respond to that directly.
Q545 Chair: Just on nuclear, when Vincent de Rivaz from EDF was here last week, he said that he wanted this Bill to be passed with Royal Assent by the first quarter of next year. I think that we would accept your view that that is a pretty challenging timetable; in other words, it won’t be achieved. Where are we going to be if, round about then, he says, "I am frightfully sorry; I don’t think we are going to be going ahead with our nuclear investment in the UK"?
Mr Davey: We have obviously spoken to EDF about how we saw the parliamentary process going, since before I became Secretary of State. The timetable has not changed. I remember one of my first meetings was with him to talk about how we were seeing the parliamentary timetable. We have kept to the words I gave him at that meeting. There has been pretty clear sight for the timetables. EDF is very much aware of them. I very much doubt it will be the parliamentary process that would be the problem for EDF. There might be other reasons; I hope there are not.
Charles Hendry: We clearly would like that investment. We think it is a very important part of the energy landscape, but there are two other consortia as well. Horizon is currently for sale, where we are seeing significant interest from people who want to take that forward. I am certainly optimistic that we will deliver a new owner there. There is a third, NuGen, up in the northwest at Sellafield, looking at a project there with a different consortium. There are other players in this process as well. It is a really important part of the process that there is not just one company that we are relying on, or one consortium.
Q546 Chair: Two large companies decided to withdraw from the process three months ago, and we have not yet identified a firm replacement for those. It seems certainly within the realms of debate that, because of the very high upfront costs for nuclear and the very long period before any return is generated, it may be quite hard to design a CfD, with a strike price, the lengths of the contracts and so on, that really makes it possible for a purely privatesector company-I am not sure that EDF qualifies as that description, but purports to be. Certainly, we have never financed entirely privately in this country a nuclear power station. We are seeking to do something that has not been done before. Just supposing that the measures put forward in good faith in the Bill do not deliver that. Does the Government envisage the possibility of some other form of support for nuclear? I know we have this form of words in the coalition agreement but, in practice, a lot of us believe that a nuclear element in the UK energy mix is essential, and therefore, we should be prepared to pay for it. If it were removed, as Dr Lee suggested, would that not rather simplify the way in which we support other lowcarbon technologies?
Mr Davey: First of all, I think it is very good we are having an approach that requires private investors and people who want to invest in nuclear to be extremely rigorous, robust and disciplined on their costs. One could run an argument, I would have thought, over history, that the nuclear industry has not been robust enough and has not been under pressure enough to make sure it comes up with competitive pricing. I think the approach is the right one to make sure that we both get these investments, but also get them not just linked to the coalition agreement, but at a price which business and consumers in this country can afford. I absolutely believe it is the right approach. We have made it very clear-I have made it very clear- that we want to see all lowcarbon technologies coming forward. That has to be right. Dangerous climate change is extremely problematic. We need to be tackling it with all options on the table, but there can be no blank cheque. Let’s be clear: this is not about simply one nuclear power station at Hinkley Point C; it is potentially about a fleet of nuclear power stations. That is what is in our plan and what we hope to happen through the processes that we have put in place.
Charles Hendry: Chairman, I would urge you to be optimistic about this as well, not blindly optimistic but sensibly optimistic. If you go back five years, nuclear was off the table in this country. It was only the 2007 White Paper that said nuclear should be part of the mix. In that time, we have now moved to being, without doubt, the most exciting country in Europe for new nuclear and one of the most exciting countries in the world. Many global players are looking at how they can be part of the process here. The work that was done by the last Government, continued here, on removing the regulatory barriers and now moving to market reform, is one of the reasons why this has become an attractive place to investment. At the moment, I think we are in a very strong position to encourage people to look at the opportunities that are here.
Chair: I can assure you I often have difficulty containing my excitement about this. Indeed, I have a constituency interest as one of the power stations will be in the neighbouring constituency to my own. I am a tremendous enthusiast for that, but my excitement sometimes is tempered by facts and circumstances. Although I agree with you that we are certainly in a better position than we were five years ago for nuclear, it still seems to me that some other factors have, rather unhelpfully, moved in the opposite direction at the same time. Therefore, I am concerned to make sure that we do not pass a Bill that makes it harder to ensure that nuclear is part of our energy mix in the future. We have one very final question.
Q547 Albert Owen: Just on nuclear, I am very enthusiastic and have been for a long time for a fleet of new nuclear, but doesn’t it worry you that EDF came before this Committee and said they want everything finished by spring of next year, because they want to make a final investment decision? That is what they said openly to us. When you are telling us today, Secretary of State, that the Bill might not meet Royal Assent until the end of 2013, don’t we need to be doing things a little bit quicker to encourage not just EDF but the likes of EDF, and their partners, Centrica, who are looking to make these final investment decisions?
Mr Davey: As I said to the Chairman a few minutes ago, the parliamentary timetable that we are going through is not news to EDF.
Q548 Albert Owen: Sorry, but what is news to us is the head of EDF sitting where you are now telling us he wanted it completed by the spring of next year, and his partner, Centrica, said they want to make their final investment decisions. That is concerning for us who support nuclear and always have supported nuclear.
Mr Davey: We have, in the Bill, the final investment decision enabling procedures, which we think, whether it is new nuclear, CCS or a renewable investor who wants to go before Royal Assent, gives them something to use. We have listened to those investors who want to go early, including new nuclear, and responded in the Bill. I think they have welcomed that.
Q549 Albert Owen: That is not what he said to us. Just one final thing: you mentioned the coalition agreement. I do not want to get partypolitical, but you raised it.
Mr Davey: The Chair did.
Q550 Albert Owen: No, you did raise it first. If you check the record, you did make reference to it. My point is what concerned me is, when we had the debate- and my position has always been clear on this-the deputy leader of your party actually said he does not think new nuclear will go ahead, because the coalition agreement says that there would be no public subsidy. He believes that these Contracts for Difference are a public subsidy. How do you react to that? It is very important that, on the floor of the House, the deputy leader of your party is making those comments.
Mr Davey: I have worked with Simon over many years, and I think he has been a real champion for the environment. I know about his concerns over nuclear power.
Albert Owen: And some of us who are pronuclear as well.
Mr Davey: He has not exactly made a secret about those. On your specific point about whether Contracts for Difference are some sort of subsidy, I do not believe it is the case. I would disagree with Simon on that point.
Charles Hendry: If you look at the vote in Parliament on the regulatory justification, it was 520 to 20. That is an incredibly strong signal. I do not want to make a partypolitical point, but it would have been a slightly bigger margin if three members of the Shadow Cabinet had not inadvertently voted the wrong way.
Albert Owen: You know where I was on that.
Charles Hendry: Yes.
Albert Owen: Just for the record, you do know where I was on that.
Charles Hendry: I know where most of the Labour Party was and it was very positive.
Q551 Dr Whitehead: This is, I promise you, absolutely the last question-well no, sorry, the penultimate question from me. Have you carried out any analysis of the effect on cost of EMR on fuel poverty, bearing in mind there will be a number of levies, protolevies and expenditures rolled up in EMR? How that will affect fuel poverty and plans as far as combating it is concerned?
Mr Davey: In the White Paper, we did some analysis. That needs to be updated, and when we publish the final Bill and the impact assessment, we will update those figures. Some analysis has been done but it does need to be updated. Bear in mind two things: Electricity Market Reform is about making these changes at the least possible cost to consumers. Therefore, that is obviously in the interest of tackling fuel poverty. Also, we tackle fuel poverty with many other instruments as well. I personally, the Department and the Government are committed to tackling fuel poverty.
Q552 Dr Whitehead: The suggestion that we have received from a number of consumer groups is that it is likely, indeed as levies tend to at the moment, that the impact of EMR may well be on the basis of the overall bill, as opposed to unit cost. That is, it will be regressive, inasmuch as a lump sum will be placed per bill to cope with the costs, for example of CfDs, etc. Would you favour putting in the Bill a suggestion that any such levies and costs ought to be placed on a unitcost basis, rather than a bill basis, i.e. the more electricity you use, the more you pay?
Mr Davey: Are you talking about changing the tariff system?
Dr Whitehead: No, changing how levies and associated costs fall on electricity bills or gas bills.
Mr Davey: Well, I am not sure if we are going to be able to change the accepted way that they operate. As I said, we have some very clear plans to tackle fuel poverty and we envisage making sure that, through this process, we keep those levy costs down as much as possible. That is part of our plans.
Q553 Dr Whitehead: My point is that, at the moment, levy costs fall on a flat rate per household, whereas you could introduce for future levies a unitcost base, which would not, therefore, be a flat rate per household. For example, on fuelpoverty homes a flat rate is much more punitive than it is for homes not in fuel poverty.
Mr Davey: As I understand our policy, the objective is to minimise the cost. By minimising the cost, because the cost of energy is proportionally more to a poorer household, you are in many ways helping the poorer households the most.
Jonathan Brearley: What we do with our levies is we allocate those out to suppliers, who then recover the money from consumers. I think we do envisage-or certainly a serious possibility for us is-doing that by unit of electricity rather than by number of customers, which I think would then address your concern. What we do not do is then regulate what suppliers do with that afterwards.
Dr Whitehead: Yes, that was the answer I was hoping you would give,
Jonathan Brearley: It is possible, but we will need to look at that as part of finalising the details of the CfDs.
Q554 Chair: Well, such is the enthusiasm of this Committee for scrutiny that we have been in session for more than five hours today, but we very much appreciate the time you have given us this afternoon. We have overrun a bit, and it has been very helpful indeed. There certainly will be some quite strong points we want to make, but I think the objectives are ones that we all share. We are genuine in our efforts to try to make this Bill better, more workable and more effective.
Mr Davey: Can I, on behalf of the Department, thank you for the work you are doing as a Committee? I think this prelegislative scrutiny process is really important, and this Bill particularly lends itself to that. I am grateful you are doing it at such speed; five hours in a day is some going. I know you only have five weeks to do it. We are very grateful for your doing it and we look forward to reading your report.
Chair: Thank you.