Memorandum by the Association of Electricity
1. The Association has a membership of some
100 organisations, including generating companies of almost every
size, from family businesses to major PLCs. Between them, the
members embrace virtually every generating technology used commercially
in the UK and scales of production ranging from plant of less
than one megawatt to those of thousands of megawatts.
2. The Association has no brief to favour
any particular generating fuel or technology. It does have, however,
a keen interest in the market in which its members make and sell
electricity and in the influence of the legislative and regulatory
framework on the electricity industry. The legislative and regulatory
framework affects security of supply, not least because it has
an influence on generators' earnings and on the climate for investment
in new power plant.
3. The Association provided a written submission
to the Energy Review Team of the Cabinet Office Performance and
Innovation Unit (PIU), in September 2001 and has taken part in
discussions with the PIU.
4. As part of its consideration of security
of supply issues, the Committee expressed an interest in the possibility
of conflict between security of supply and environmental policy.
It also asked about the role of renewables and combined heat and
power (CHP) schemes.
5. The Association recognises the challenges
presented by the different requirements of energy policy. Competitive
energy prices, security (and diversity) of supply and controls
on emissions, including reduction of carbon emissions, are all
understandable objectives, but they lead to well known conflicts.
When the main driver of energy policy is competitive prices, then
measures to deliver environmental objectives or to induce diversity
beyond that which normal business decisions would have provided,
will usually add to costs and reveal policy conflicts.
6. If present policies for the supply of
renewable energy succeed, they would assist with the Government's
diversity objective by providing ten per cent of electricity from
renewable sources. The Association's policy<mr14>, for almost
five years, has been to support the idea that, by 2010, ten per
cent of UK electricity should come from renewable sources. It
also proposed in 1996-97 that consideration should be given to
the introduction of a "percentage obligation" on suppliers,
requiring them to purchase a proportion of their electricity from
renewables. It supports in principle the Government's proposed
Renewables Obligation (and its equivalent for Scotland), albeit
it has some concerns on matters of detail.
7. The Committee will be aware that many
renewable energy and combined heat and power schemes that are
operating in the open market (ie not supported by Government-sponsored
obligations) have experienced serious commercial difficulties
since the introduction of the New Electricity Trading Arrangements
(NETA) on 27 March 2001. As many organisations, including this
association, predicted, NETA has proved damaging for many CHP
schemesthe very opposite to the expectations expressed
by successive Energy Ministers since the proposals to change the
trading arrangements were announced in 1997. The Ofgem study<mr15>
of NETA's effects on small players confirmed that there are problems,
but the Association believes that Ofgem under-estimated their
impact. The Association welcomes the Government's recent response
to Ofgem's report, which is a consultation<mr16> on proposals
to address the problems.
8. The Energy Minister announced at the
launch of the PIU Review that competitive markets remained important
and the PIU Scoping Note in June confirmed "Competitive markets
will continue to be central to energy policy." The Association
therefore takes that to be the context in which security of supply,
including diversity, has to be considered.
9. Electricity customers in the UK are used
to high standards of security of supply and any significant reduction
in such standards would quickly become a matter for public policy
debate. Those standards are not simply a question of having adequate
fuel supplies and generating capacity. They are also affected
by the quality of the transmission and distribution networks and
by the ability to trade across borders.
10. In the state industry, before 1990,
a recognised plant margin was established to meet defined security
standards. In the market after 1990 there have been no such standards,
but various licence requirements have sought to encourage levels
of security. Generating capacity has not proved to be a problem,
however, and plant closures have been more than matched by investment
in new plant. This investment has been driven by normal commercial
expectations and fostered by a growing understanding of the way
that electricity markets function.
<mo14> Renewable Energy: Building on Success.
Association of Electricity Producers 1997.<mo15> Report
to the DTI on the Review of the Initial Impact of NETA on Smaller
Generators. Ofgem. August 2001.<mo16> Government response
to Ofgem's reports "The New Electricity Trading ArrangementsReview
of the First Three Months" and "Report to the DTI on
the Review of the Initial Impact of NETA on Smaller Generators".
DTI. November 2001.
11. At the same time, there has been a great
increase in diversity, in terms of the types of generating plant
being operated and the fuels that they use. Such diversity is
usually viewed favourably as it reduces over-dependence on particular
fuels and is sometimes evidence of technologies competing for
sales in the wholesale market. The diversity of recent years is
a "happy outcome" which has occurred through the operation
of the market and has not been induced, except in the case of
a comparatively small amount of renewable energy, which has been
encouraged through Government sponsored support arrangements.
12. There is reason to believe that diversity
could be reduced considerably if the expected development of new
gas-fired plant and the closure of Magnox plant proceeds as currently
forecast. In its response to the Government's Review of Energy
Sources in 1998, the Association indicated that trends suggested
that generating plant in England and Wales would be 55 per cent
dependent on gas by 2003 and perhaps 70 per cent dependent by
2010, depending on certain assumptions. Today, industry forecasters
suggest that the UK will be a net importer of gas in a few years.
Furthermore, such imported gas may come from distant sources and
some observers suggest that those supplies would be less reliable,
either for the technical reasons of managing long supply lines,
or for reasons of political stability, or both. Importing fuel,
however, is a situation faced by many other countries and in the
case of oil, it was normal for the UK for most of the 20th century,
even in wartime.
13. Where forecasts of fuel sources for
power generation are concerned, some caution needs to be exercised.
Whether plant with planning consent is actually built depends
on a number of factors, including fuel input prices and electricity
wholesale prices. The Committee will no doubt take note of the
recent announcement by one of the UK's well known generating companies
that, during 2002, it will close a generating unit at one of its
gas-fired stations and re-open a previously moth-balled unit at
one of its coal-fired stations.
14. There are signals that demand for electricity
(or, more accurately, the benefits that it provides) is likely
to rise. Customers want the product and are increasingly dependent
upon it. In view of this, it is reasonable to assume that the
companies whose business it is to provide electricity will meet
that demand. They will have the usual business incentives to secure
reliably at the most competitive price the fuel that they need
for production of electricity. Increasingly, this may have to
be imported and it could be subject to price shocks which would
be reflected in prices to UK customers. The extent to which, through
public policy, such shocks can be anticipated and absorbed and
indeed, whether they should be, is a key part of this debate.
The generating industry and its customers need to be fully aware
of the Government's attitude to this issue.
15. To obtain imported fuel reliably and
competitively, the UK's power companies will become increasingly
reliant on the effective operation of networks and markets in
the rest of Europe and beyond. This applies equally to companies
wishing to import electricity itself, as well as gas for electricity
production and clearly the Government and the electricity industry's
pressure for effective liberalisation of European energy markets
should be maintained.
16. It has been suggested that the energy
crisis in California gave added impetus to proposals for a review
of UK policies, not least because the Californian problems had
been depicted as resulting from energy liberalisation and market
deficiencies. The conclusions which some people reached, however,
appear to be at odds with what actually happened in California.
The difficulties, principally the failure to provide capacity
to meet growing demand, were more to do with the market not being
designed to accommodate the dynamic interaction between customer
demand and power production, than with any failure of the market
itself. The Association notes that the influence of heavy-handed
regulation, including environmental regulation, appears to have
proved costly in California.
17. Markets, however, do not always deliver
neat and tidy outcomes and the more open and competitive they
are, the greater the risk of periods of over-supply or shortage.
This could be true in the case of electricity generating capacity
in the UK. There are, however, several areas where public policy
can reduce the risks surrounding security of supply. These are
set out below:
The Government and Ofgem must allow
the electricity market to provide the signals associated with
any normal market place, which indicate among other things a requirement
for investment in new capacity.
In the wholesale trading regime which
operated from 1990 to 2001, there was an explicit capacity signal,
albeit constructed on an administered judgement of "probability".
The Committee will be aware that this is absent from NETA. The
Association is not suggesting that the same process necessarily
needs to form part of NETA, simply that the issue is important
enough to be worthy of monitoring and perhaps some study.
The Government and its regulatory
agencies, in particular Ofgem, can also have an impact on investment
in the industry. A stable, predictable and transparent regulatory
regime is more attractive to investors than one where intervention
in the market is rather more random in its timing or scope of
application. The attempts by Ofgem to introduce an unnecessary
"Market Abuse Licence Condition" show that the regulatory
body is prepared to use discretionary powers of its own to cut
across trading rules, established codes and competition legislation.
If introduced in the manner that Ofgem has proposed, the Conditions
would add to regulatory risk and increase the cost of, or even
Ofgem's own comments to the Cabinet Office PIU
Energy Review are worth noting:
"Recent events in California provide a clear
warning of the dangers to security of supply that can result from
inappropriate regulatory or political interference."
Development of new power projects
is subject to various planning consents according to the size
of the project. The difficulties associated with securing local
consent for renewable energy projects are well known. If the renewable
energy target is to be achieved, then it may be necessary to bring
about changes to the land use planning process, to give energy
projects special status in the structure and local plans system,
perhaps similar to that given to the minerals industry. Consideration
might also be given to steps which enable local communities to
secure direct benefits from energy projects, perhaps through the
business rating system. This issues applies to equally other forms
of generation project and to transmission and distribution networks
The UK's electricity network monopolies
provide high common quality standards for electricity as well
as allowing high reliability of product delivery. The benefits
of this to suppliers and customers are obvious and they enable
generation projects to be developed with confidence. That the
monopoly businesses should be regulated effectively is critical.
Simply driving down costs through RPI-x controls will probably
not be sufficient and a more imaginative approach may be needed.
Among other things, regulation needs to take account of the effect
on both transmission and distribution of the probably growth in
generation connected to the distribution networks. In 1998, the
Association produced, in response to Government policies encouraging
smaller-scale generation, a policy document<mr116> on embedded
generation. Among other things, it suggested that distribution
networks, where new renewable energy and combined heat and power
projects were likely to be connected, might need to become more
"active" rather than largely passive distributors of
centrally-produced power. The Association welcomes the proposal
by DTI and Ofgem to carry out further work on embedded generation
6 November 2001
<mo116> Review of Embedded Generation Issues.
Association of Electricity Producers. Juy 1998.