Examination of Witnesses (Questions 120
WEDNESDAY 6 FEBRUARY 2002
120. Are they always in-house or are you providing
some services to independent generators?
(Dr Senior) We have independent wind farms. We also
put within our consolidation service the demand-side management.
Clearly there are benefits in very short timescales of having
demand-side management, large industrials that can shed load quickly,
together with people with a very uncertain generation. So by putting
those things together you can start to take the natural offsets
and you can also start to manage that position as a whole. So
there are a number of sites that are not Innogy sites within that
consolidation service, and they are seeing the benefits, too.
121. Is not the reality that in, say, five or
10 years' time there will be a massive shake-out of the market,
and a lot of the small independent generators will have been bought
up by the larger players? Is that not realistically the only kind
of consolidation that is going to take place?
(Dr Count) I think that is a very credible scenario.
This is a large investment business, a heavy investment business
and clearly participants have to judge the market risks. Clearly
scale effects do make that the best way and will lead to lower
consumer prices as a result of that. I think, as Brian says, that
does not mean there is not a place for the small niche player
who may have to hand their risk management to others and consequently
take a lower return but at a lower risk, which is not unreasonable
for the market. What should not happen is that small players are
allowed to have premium prices at the expense of the consumer.
There is an ultimate destiny that consolidation will happen whether
through ownership or risk management. That is what is happening
and clearly risk should be managed with those people who can manage
it at the lowest cost.
122. You think there might be some future for
small independent generators?
(Dr Count) There is always room for small independent
generators but they cannot take the returns and pass the risks
across and still expect those rates of return that a player that
takes the risk would have. So it is a matter of the conditioning
of the market, I think.
123. What sort of rates of return are you getting
(Dr Count) I think the assets today are getting a
very low rate of return in the market price, but I think it is
reasonable to expect on a global basis generating assets to command
about seven to eight per cent real, post-tax return in the market-place.
124. That is not bad.
(Dr Count) That is not a bad return. Leverage can,
of course, give good equity return. I think the global spread
is somewhere between six and eight per cent real, depending on
the element of market risk. Clearly, if you hand market risk across
then you are taking very much lower risk and you would expect
a slightly lower post-tax return. It is still a reasonable return.
125. To reiterate one point you made earlier,
when we are talking about investment and potential return, from
what you were saying the greatest barrier, even looking at the
seven to eight per cent potential return, beyond any other technological
barrier, is political risk?
(Dr Count) We ourselves expect to be a heavy investor
in the wind projects under the renewables certificates. What will
tax most of our minds in our board room will be will that scheme
be withdrawn and replaced with a new scheme and hence we end up
with stranded assets? We would like some sort of grandfathering
rights to avoid stranded assets. If it moved to an Emissions Trading
Scheme which eroded the value, then that is a big risk. In a long-term
investment that requires a long-term return, that is the biggest
126. Can you tell me what grandfathering rights
(Dr Count) It is a quite a common process. I have
experienced it particularly in other European countries. If you
change the rules in five years' time because the technology may
be developed, new technologies have come and let's suppose instead
of threepence a unit, you think it only requires tuppence a unit,
those schemes that went ahead on the basis of threepence should
maintain that throughout their life and new schemes should only
best stimulated with tuppence.
127. You will look to government for that?
(Dr Count) I think that has to be legislative. That
is a government issue.
128. You have not had that so far?
(Dr Count) No, that is not in the legislation.
129. What is your experience of how political
risk has been handled so far?
(Dr Count) I think we would say on the whole quite
well and there has been a smooth transfer from the Non-Fossil
Fuel Obligation through to the Renewables Obligation that is going
to start in April. However, there is still risk and we know, ultimately,
that policies can be changed and that there is always consumer
pressure. If an asset is producing power above a market rate there
is always pressure to squeeze the equity holder.
130. Moving on to the Renewables Obligation,
one of the problems we have is electricity from an intermittent
source. I think it is quite exciting to hear about opportunities
for storage to manage that risk. In terms of this particular risk,
are you able to put a value on it in terms of pence per kilowatt
(Dr Senior) The specific value of uncertain generation
or the impact on value of uncertain generation really depends
on the extent to which it is a stand-alone scheme. If it is completely
stand-alone and there are no offsets and no consolidation with
other generators, then it could be around half a pence or more
per kilowatt hour. If it is consolidated then we believe that
can come down by about 50 per cent.
131. So there are some clear benefits of consolidation
in order to spread the risk?
(Dr Senior) Yes.
(Dr Count) Correct. Just on the statistics, the irrefutable
fact is that unreliable power sources in a market will be priced
lower than a reliable power source because we all value switching
the light on and having the light come on.
132. That was a useful answer because we have
seen varying figures and you have explained for us why there is
that variation in the values there. On the ROCs the benefit tends
to come, we believe, to the suppliers rather than directly to
the people generating. We touched on this problem before, but
in terms of this particular context, looking at the position of
the small renewable generators, if the suppliers can avoid passing
back the full value of what they are getting to the generator,
does that place the generator at further risk?
(Dr Count) We would not agree that the suppliers take
the benefit. We think that is a fair share. I would make a number
of points. The first thing is the suppliers will have obligations
to buy this premium-priced power. In my judgment I do not believe
all of that will be passed through to the consumer because I think
a vast majority of that will be competed away in supply competition.
So, in our view, we will not see price increases at the domestic
end; we will see price competition continuing to develop, and
that is an extra cost. The second issue is that if you do not
give that back to the suppliers, what incentive has the supplier
got to take the renewables certificates? They will just buy out.
There is no real incentive and we want to see things happen. If
you go to the production end, the producer does have the renewables
certificates and that certificate could be worth more than three
pence in a tradeable market if there is a shortage of production
because the suppliers will be incentivised not to buy out because
they get this "green smear" back, so ultimately I think
the producer is getting a fair return threepence per kilowatt
hour over and above market price and the supplier is incentivised
to take that. The benefit they get through the smear is only partially
offsetting, in my view, the cost they will have to absorb, and
supply competition will keep prices down. So I believe the balance
133. Looking at investment in the Obligation
and financial institutions and the sort of returns they are looking
to see, obviously we all want to see more investment in renewables
and we need the financial institutions to really play a strong
part in this. How confident are you about the financial institutions
seeing this as a sound investment, and something they want to
get into? What is your view about that?
(Dr Count) I think it comes down to a fair return
for the risks taken by the investor. Clearly markets are global.
One could argue even sitting in a pan-European market or a United
Kingdom market that we are certainly in the financial world in
a global market and ultimately companies and investors and financiers
have the option of investing either in the United Kingdom or in
another country. Ultimately if the returns are better elsewhere,
capital and equity will flow that way. If returns here are below
what is sensible on the world stage, then the capital will flow
134. Which is worrying because looking at your
analysis you are very much involved with wind energy but also
a lot of the other low carbon energies and high capital risks
and so on. How do we go forward with some of those other technologies
then? Obviously we do not want to be totally reliant on wind,
we want to bring on other technologies too.
(Dr Count) I suppose my response there is that there
is a time for technologies to come into the market. If at today's
level there is a range of technologies that can provide the consumer
with the best solution, then we should use those technologies
and develop them. If over time we want to increase the value of
carbon reduction or the technologies themselves get developed
by the developers to bring them into the market, then their time
will come. There is an argument why do you have to bring all technologies
to the market in one go? I think I come back to the storage. We
have not asked the market to produce any incentives to invest
some tens of millions in our storage technology. The global plant
suppliers in gas turbines have brought their technologies to market
and ultimately there is a place for that. I would simply question
do we have to have every technology competing at one time if some
of those technologies are further away from development? I think
there is an old saying that a technology brought to market too
early costs people a lot of people.
135. Do you feel you are getting the right amount
of support from universities and academic research in this area?
I am struck by the huge amount of money that is pouring into this
area in North America, sucking in international PhDs, etcetera,
across a whole spectrum of renewable sources. It seems to be here
that we are not putting that investment in. Is that correct?
(Dr Count) You are on one of my second loves. I think
we under-utilise our research institutions. On the Regenesys technology
we do have a lot of relationships with the universities, but I
think there is a whole difference of culture between the United
States and the MIT model being the classic model, and the United
Kingdom model. I think that is a very wide issue. We would like
to see much more working together. We are almost saying that it
is more important to get a commercial technology to market rather
than some learned academic paper that is giving the intellectual
capital away to somebody else. On the wider point, no; on the
specific point of Regenesys we have initiated a lot of university
136. On the wider point, do you feel that the
relationship between power producers and universities is satisfactory?
(Dr Count) No, I think it could improve considerably.
I do not think it is power producers, I think it is just industry
137. Is that a cultural thing or a financial?
(Dr Count) I think it is a cultural thing. There are
many issues but I think culture is an important thing. We have
got to take away the culture that doing a learned research exercise
is more valuable at that level than working for business or working
with business, where there is still the belief that independence
is somehow lost, and I think that is a culture we have got to
get over. I would only make the point that half our research position
on Regenesys now is in the United States because that is a better
environment for top-level electro-chemical research.
138. That is quite an interesting point because
I was quite concerned that while you are involving in some technologies
fairly heavily, to a certain extent government is almost picking
winners. From what you are saying you are looking for a product
which is reasonably mature in its development. If there is research
still to be done I am getting the feeling that you would like
to know it is a bit further on before you start making investment
(Dr Count) We have taken a technology through but
that is a heritage. I would counsel against government picking
winners. Create the market incentives and R&D expenditure
will go in and technologies will be brought to market because
it makes real sense.
139. With the Renewables Obligation, is it not
actually more or less saying here is the winner because it really
favours wind above any of the other renewables?
(Dr Count) I think I would argue that it does favour
wind more heavily. I think one could argue from our perspectiveand
we are neutral in this but I find it very interestingif
the issue is to save carbon then we are incentivising offshore
wind and that is almost, in our judgment, round about five to
six times more expensive to save a tonne of carbon dioxide than
co- generation which is not receiving any real incentive package.
What has happened is that nobody is investing in co-generation
and people are investing in wind. I do not mind what the objective
is but we would much prefer to see a value of carbon put into
the market to stimulate research and technology, and to allow
the most competitive technology to come through. If biomass is
not competitive then we should not worry about that if another
technology is more competitive. Ultimately biomass may become
more competitive in a few years' time when people have invested