Examination of Witnesses (Questions 460-479)
MR CALLUM MCCARTHY, MR JOHN NEILSON, MR NICK SIMPSON AND MR JOHN SCOTT
TUESDAY 30 APRIL 2002
460. So you will consider his view to strengthen the guidance and think about it?
(Mr McCarthy) Whenever the guidance comes out we will have regard to it very carefully. That is our legal duty.
461. I just wondered if you had ever consulted with any outside bodies, either publicly or privately, on the scope for interpreting your duties perhaps in a more flexible way?
(Mr McCarthy) I sometimes say that Ofgem is an organisation where we consult before blowing our nose. We consult at a rate of about 100 consultation or decision documents a year. In all of those documents we set out a view on our legal duties and how they affect any decision and it is open to anybody to comment on the interpretation that we are putting on our legal duty. I would add that people frequently do that, including comments upon the way in which we interpret environmental duties.
462. So you get them whether you ask for them or not?
(Mr McCarthy) We actually do ask for them but we certainly get them.
463. You receive 100 consultation documents?
(Mr McCarthy) No, we publish about 100 consultation documents.
464. You as an organisation publish 100 consultation documents a year?
(Mr McCarthy) Consultation or decision documents, Chairman.
465. How many are consultation and how many are decision?
(Mr McCarthy) I do not know the answer to that; about 50-50.
466. A hundred a year?
(Mr McCarthy) Yes.
467. So one a week?
(Mr McCarthy) Two a week.
468. I mean half of them are consultation documents, so those are one a week.
(Mr Neilson) We understood.
469. You were very careful, Mr McCarthy, when replying to my colleague with regard to the draft guidance to say that when the guidance was in effect you would pay due regard to it, which suggested in my mind that there is this gap of a year that we have had since the guidance was first drafted where there has been no guidance placed on Ofgem and therefore on the things that this Committee is interested in, which would be the environment and sustainable development, there has been no guidance. That has included a very crucial period when you have been responding to some supposed difficulties and claimed difficulties of NETA and the embedded generation. What has been your guiding principle during that time if you have not had recognition, if you like, of that draft guidance, if that has just been a draft document to discuss? How have you been following the Government's environmental and sustainable principles in those intervening months?
(Mr McCarthy) The answer is that we have not had any guidance to which we can legally refer. The position you describe of not having guidance is in fact correct, but the decision to issue that guidance or not to issue that guidance is not a decision taken by Ofgem. If I look at it, we have been interpreting our legal duties against our primary objective of the protection of the interests of consumers, present and future, and we have been looking at a whole range of issues associated with NETA, with renewables, with embedded generation, and have worked very hard to try and deal with a series of problems during that period.
(Mr Neilson) And of course we have a series of secondary duties, one of which refers specifically to the environment, and all of those were commenced when the Authority was introduced.
470. The will of Parliament, certainly expressed during the debates on the Utilities Bill was, if I remember rightly, that there would be a package. There is primary legislation which gives the statutory duties upon you, but it was expected, I think, by Parliament that there would be a very important set of guidelines on the environment that would then influence the way that you were following them, because after all in Parliament we cannot set down in statute every single step that you as a regulator should take. We try and create the circumstances and then guidance is a very important tool for Government ministers to interpret the changing circumstances, reaction to the Energy Report, reaction to embedded generation, whatever it may be. That worries me, that we have had a whole year when that has not been in place. You have said that you are not responsible for it. Could you say a couple of words about the process? Are you in negotiation or are you just waiting for the DTI to tell you what the guidance is?
(Mr McCarthy) The DTI have consulted on the draft guidance. We gave them our views on the draft guidance. We did that some months ago and it has been a decision by the DTII assume it is a decision by the DTIthat no guidance has been issued. That is not a responsibility for Ofgem. We have done all that we can in terms of that.
471. I accept that, but would you not accept that it would have been better in responding to some of the environmental concerns that have come out of NETA if you had had that guidance to at least show that you had been following the Government guidance?
(Mr McCarthy) I think I would have preferred the environmental and social guidance to have been issued, yes.
472. You say you gave your view to the DTI about this guidance.
(Mr McCarthy) Yes.
473. What are those views?
(Mr McCarthy) There were a number of detailed points on the draft guidance.
474. Can you articulate them now for the benefit of the Committee so that we know what you said?
(Mr Neilson) The second consultation on the guidance was issued in May 2001 and people were asked to comment by August 2001. We really sought greater clarity on a few detailed areas. In particular there is a statement at the beginning of the guidance that important decisions to pursue social and environmental objectives that have significant financial implications should be taken by ministers through legislation or through their decisions and not by an unelected authority like Ofgem, and we thought the way that that was drafted could have been put more clearly and so we made some suggestions about that. I think that was the most important area of comment. We were not at all challenging the principle of that matter which we think is entirely inappropriate for an unelected body such as Ofgem.
475. Would it be fair to say that you have not taken any actions which have had an environmental emphasis because you have been concentrating, quite rightly, on your remit on the economic matters?
(Mr McCarthy) No, Chairman. I think that is an inference from what we said that I would not want to be taken because a lot of the things that we have done have been designed to recognise our existing environmental duties. If I take, for example, the work that we have done, which has been significant work, on embedded generation, that is something which is deliberately designed to facilitate the Government's objective of extensive use of renewables. For distributed generation, we need to recognise that there is at the moment a pattern which has been established for a different model of generation and to investigate very significant changes that have to be made if we are to move from one model to another. We have been pressing ahead with that work and are quite able to do that irrespective of the fact that the guidance has not yet been issued.
(Mr Neilson) In August 2001 we published a very detailed Environmental Action Plan, which followed consultation, which was precisely a statement of how we understood our responsibilities in relation to the environment ought to be exercised, so not only had we had a consultation about what the right approach to those statutory duties was; we also set in place a very specific work programme with commitments about work that Ofgem should be doing.
476. But these are work programmes and plans. What I was asking about was decisions affecting the price or the market in some way.
(Mr McCarthy) No. We have made a series of decisions. For example, on the question that was raised about the effects of NETA on smaller generators, which include both renewables and CHP, we have taken a series of decisions which have had the effect of significantly changing the principal problem that people have identified as being specific to NETA as it affects those smaller generators. Those are real decisions.
477. I would like to explore the area of NETA as a potential barrier to the development of renewable energy, which we all know is something that Government policy seeks to promote. The PIU report specifically identified NETA as one of the three principal barriers to the development of renewables. Giving a bit of the background, your most recent assessment of NETA was that it has reduced electricity costs by round about 17 per cent as opposed to the 25 per cent or so that you were estimating last summer. One argument is that this fall is largely due to an excess in generated capacity, so even without NETA a lot of this fall would have taken place anyway. What do you say to that?
(Mr McCarthy) I would say first of all that the fall in wholesale electricity prices over the last four years, since the proposal to introduce NETA, has been around 40 per cent. If I look at the reasons for the reduction in price, they come about I think because of three things. One is the fact that the oligopoly in generation which existed at the time of privatisation and persisted for a long time has been broken. The second is that there is genuine competition at all levels in the supply business, and the third is the introduction of NETA. The fact is that for a decade after privatisation you had an uncompetitive generating sector, which was manifestly the case and which led to high prices and to a very large amount of investment in new generation, which leads to the fact that we have in excess of 30 per cent spare capacity in generation. We have now established a genuine market for wholesale electricity which has had the effect that you would expect in a market with 30 per cent over-capacity, namely, significant reduction in prices. I am quite clear that that would not have happened without the introduction of NETA.
478. That is a very long and, if I may say so, detailed answer and you have focussed on price but, interestingly, you never mentioned the environment once. In 1998 the Energy Minister, Mr Battle, specifically said in a DTI press release that he wanted to ensure that NETA provided encouragement for CHP and renewables. Why have you not done anything to encourage that?
(Mr McCarthy) Could I just make two points by preparation? One is that I gave a detailed reply on pricing because you asked me a question about price. Secondly, it is worth looking at the quotation from Mr Battle in October 1998. He did indeed mention as one of the objectives the effect on CHP. He started off by saying that we need a market which will push prices down, not one which pulls them up, and I think it is important to take the specific reference that is often quoted in relation to CHP in the John Battle statement in its full context. It is not true to say that we have failed to take action in relation to small generators in relation to renewables and CHP. We have taken a series of actions which have been under the category of encouraging aggregation which is deliberately designed to help smaller generators. We have taken a series of actions which have had the result of reducing the system buy system sell spread, which is the principal thing that the smaller generators object to about NETA, which in the first year of NETA fell from about £70/MWh to around £14/MWh, and there are other things in the pipeline which give every reason to believe that it will fall further, principally the change that is going to be introduced in July which reduces the period between gate closure and real time, which at the moment is three and a half hours, to one hour. The answer is, we have taken a series of steps which have significantly improved the problems that people identified specifically about NETA.
479. That is obviously from your perspective but we have taken evidence from some of the representatives of trade bodies in these different groups, and I think it is fair to say, and my colleagues will correct me if I am overstating the case, that their argument was that these measures thus far have made very little difference. You may wish to argue that you have done things but the people they materially affect are telling us that it has not made much difference at all. How long do you think it is going to take before we see any material effect with the things you were doing in the spring of 2001?
(Mr McCarthy) I think that the changes that have already taken place are having a material effect. It is very important to recognise that both renewables and CHP are categories of the general class of generator. I remember that when NETA was going through the representatives of the CHP trade association in particular argued, in a way which was understandable, that they did not like NETA because it was going to result in lower generating prices, and indeed it did result and has resulted in lower generating prices for everybody. If I look at CHP the central problem of CHP is that they are squeezed between higher gas costs and lower generating prices. I am delighted that the Government has taken action in the Budget to assist CHP which was something which I think was highly necessary. In relation to renewables, the renewables obligation, plus the receipts from the present wholesale electricity generating prices, gives renewables really rather attractive prices at present, as I think Mr Wilson's evidence to you confirmed.