Examination of Witnesses (Questions 700-719)|
TUESDAY 4 DECEMBER 2001
700. If there were gasand there is a
question mark over peak times and ensuring supply of gas to power
stationsyes, they may have the ability to meet the need
if they can generate it, but it is whether the gas will be there
to produce the electricity. Are you not worried about that?
(Mr Davies) I would look at that from the point of
view of price in the sense that, unless one is talking about sudden
interruptions in gas supplies, if gas supplies are short, the
economics of gas generation will change and it will not be the
preferred fuel to meet the needs of the power stations being built.
701. Or we see bills increase at peak times.
(Mr Davies) Yes, that is the common phenomenon.
Sir Robert Smith
702. In that answer you mentioned oil in the
range of fuels. Where is oil at the moment in terms of electricity
(Mr Holliday) In terms of its percentage of the total?
(Mr Holliday) Pretty small. There are some oil-fired
stations producing as we sit here today.
(Mr Scott) It is about four per cent.
704. Is there a potential to grow that?
(Mr Holliday) It is a function of economics. If you
put oil prices, electricity prices, the difference in technology,
in power station design and then all the environmental constraints
on oil versus coal versus gas, all in the mixing pot, the simple
answer is that you can create scenarios in which oil stations
could be built. It has not been happening for many, many years.
(Mr Davies) About 3,000MW of oil plant is in mothballs
at the present time, primarily on the Thames estuary. In addition
to building new oil plant, the economics could be there to bring
those plants out of mothballs.
705. When you are looking at the seven-year
plans and looking at the network investment, you have suggested
that there should be other methods of getting investment into
the network which should be encouraged. Do you believe that the
market is unable to provide the signals for suitable investment
in the transmission improvement?
(Mr Holliday) We have been investing very heavily.
We have invested £3 billion in the past decade, £360-odd
million in the last year, in excess of £300 million in the
course of this year. Our regulatory review period will invest
something of the order of £1.3 billion in a five-year time
frame. Investment is going in. The question is more about the
incentivisation to continue to invest at that sort of level. There
are two issues there. One is this continued question of RPI-X.
We agree, as well, that has delivered a huge amount of cost efficiency
in our industry over a decade or so. There is an issue of how
you continue to incentivise organisations to keep driving down
their cost base. Some new form needs to be created to ensure that.
The capital investment is as much an issue of cost of capital
and one of the things that the regulatory environment in this
country has continued to do in review after review is drive down
the allowable cost of capital. Considerable work has been carried
out looking at when you begin to hit a margin. The Civil Aviation
Authority in particular did a huge piece of work looking at the
efficiency and the social benefit of driving down another increment
on the cost of capital versus the cost of under-investing in networks
going forward. There is an ongoing debate with regulator and government
about where the limit of cost of capital is to ensure that companies
still have the investment incentive which is required in major
706. How are you finding that debate going in
terms of the regulator?
(Mr Holliday) Very constructive.
707. What is the scope for reducing transmission
related losses? This is something which keeps coming up.
(Mr Holliday) The transmission system, the high voltage
bit, is responsible for about two per cent of losses; two per
cent of the power which is transferred around is lost across the
transmission system. There is nine per cent lost in total in getting
from a generator through to an end consumer, the rest being associated
with the distribution wires part of the business.
(Mr Davies) If you look at the two per cent which
is lost on the transmission system, about one quarter of that
is due to transformer losses, losses on conductors when going
from one voltage to another and just energising the lines. About
three quarters of it is down to the distance travelled, the fact
that we have large power flows on the system from the north of
the country to the south of the country. The issue then comes
down to what can be done about those two components. In the case
of transmission losses and losses on the lines, we optimise our
investment in terms of looking at transformers which can be designed
for higher losses or lower losses. What we do is to optimise them
against the expected energy price as against the incremental capital
cost, so we are looking at an economic efficiency element. When
it comes to distance over which electricity is transported, the
main impetus we put into this is our structure of charges and
particularly the locational elements; a generator in the north,
just to take an extreme example, compared with a generator in
the south west of England. Let us take a 1,000MW generator which
is a fairly typical size of generator on our system. The generator
in the north will pay £17 million a year more in transmission
charges than the generator in the south west. That is a big incentive.
I have taken the extremes of the system but if you take the South
Coast or the Thames estuary as against the North Midlands or Humberside
or something like that, there are smaller differentials but they
are quite significant. So we give large incentives for the location
of generation which impacts both on losses and on the investment
cost in our system.
708. Presumably a low loss transformer costs
more than a high loss.
(Mr Davies) Indeed; yes. What we are required to do
and what we do do is to look at the trade-off between the energy
cost of that and the incremental investment cost.
709. Looking back in history over electricity
transmission, has there been much movement on losses, or is it
(Mr Davies) It has come down a bit. In terms of transmission
losses it has come down from a figure a few years ago of 2.3 to
2.4 per cent and the precise figures now are about 1.8 or 1.9
per cent. So there is a trend downwards and partly that is a movement
towards lower generation and improved investment.
(Mr Holliday) Technology and replacement with cables
and conductors which have better characteristics. It is small
710. Renewable generators complain about the
cost of connecting to the infrastructure. Can you give an outline
of what connection involves and where the costs arise?
(Mr Holliday) We do play our part in helping everyone
connect to the transmission system who requires to connect. The
issue on renewables is the size of their generation capacity.
You normally find that it is not economic to connect anything
less than 300MW to the high voltage transmission system. By definition
they tend to find the economics are driving them to connect more
locally into the distribution system.
711. I can think of one particular example which
was a photovoltaic system just up the road in my constituency
and they had tremendous difficulty in getting onto the system.
What are you doing to alleviate that problem?
(Mr Holliday) That is a very good example of what
I have just been describing. Perhaps Charles can just enlarge
on what a generator of that size would do to try to connect into
a distribution system.
(Mr Davies) A typical size for a photovoltaic system
would be something of the order of 4 or 5KW or that sort of size.
Clearly it is not going to connect to the transmission system,
it is going to connect to the distribution system. There are several
issues associated with both technical standards and connection
charging principles which the distribution network operators are
considering and which are being looked at by the Embedded Generation
Working Group. What I am really sayingI am sorry it may
sound slightly lameis that it is an issue for the distribution
network operator not for us. What I can say is that when you have
large renewable developments above the 300MW level, and potentially
the Severn barrage might be one of those, or, large offshore wind
farms, particularly if you take two or three of them together
and bring them ashore, could easily get up over 300MW. Our approach
to charging is very different from that of the distribution network
companies. Our approach is what is called the `shallow' approach
where we only charge the immediate connection charge to the generator
concerned and the deeper investments in the system are recovered
through this locational tariff I was talking about a minute ago.
In the case of the distribution network operator, they tend to
charge on a `deep' basis, in other words all reinforcement costs
through their system. This is an issue which is at the forefront
of the agenda of the Embedded Generation Working Group, in which
I am actively involved and which had its first meeting last week,
are to look at those principles, to see how they ought to be changed,
to put it bluntly.
712. Do you have a view on the submarine cable
which was announced a couple of weeks ago in terms of the effectiveness
of bringing renewables onto the infrastructure?
(Mr Holliday) We do not know a great deal about that.
We have been in conversation with a number of companies who bid
for the original 18 offshore licences which were leased by the
Crown Estates, talking about how we can help them facilitate a
tie-in to the transmission system, help them understand what the
hurdles would be in terms of economics and size. At this stage
we are not in conversation with anyone associated with the Western
Isles, so it is hard to answer anything without doing a desktop
exercise first of all. We look forward to seeing that in the very
713. One of the concerns we had about this was
that it was put to us that if you are putting cables over inhospitable
rock surfaces, they have a tendency to shred. We just wondered
whether there was perhaps a degree of optimism about certain aspects
of this. I am not asking youwell I amto sell your
soul here, but you are obviously experienced, you have been looking
at the Netherlands and connecting
(Mr Holliday) And we are building one in Australia
as well, so yes, we do have some experience. The reason why I
am going to avoid the question is that I do not know the route
and we do not understand the geology of the sea floor. In our
planned link between England and Norway we found that as the cable
actually went in through a fiord there was a huge amount of volcanic
rock which was going to cause it tremendous problems so the route
was planned to avoid that completely. If there is geology in this
area then you can get around it, but the question is going to
be what the exact route is, what it looks like, what is the extra
distance required, etcetera. Without knowing all the details we
cannot make a comment.
Chairman: We asked the Minister and he was surprised
that anyone should ask a question about this. We are still awaiting
his answer. In our search for truth we came to you, but we shall
wait with interest.
714. You referred in your memorandum to the
issues surrounding balancing the supply and demand, plant and
demand balance. In effect, if I paraphrase, you could see how
problems might arise under the new electricity trading arrangements
as compared to the old pool arrangements but they had not yet
arisen. Tell me if I got that wrong. If problems did arise, would
you see them being able to be managed with the new electricity
trading arrangements or by some change in the structure of those?
(Mr Holliday) Do you have a problem in mind?
715. If for example the surplus, the margin
of plant over current demand fell below whatever you would regard
as an acceptable level, 20 per cent or something. If it fell below
that level would you see the responses coming in terms of perhaps
facing purchase requirements inside the electricity trading arrangements?
(Mr Holliday) I shall let Jeff describe some of the
details of what is happening here at the moment. I have to say
NETA has been hugely successful for us. It was a tremendous change
for an industry to switch on a whole new way of working at midnight
one night and find the suppliers and generators and National Grid
and distribution companies, everyone, just continued seamlessly.
It has been putting some very strong commercial signals into the
market. Those commercial signals are benefiting consumers and
I know Ofgem will talk about a 20 per cent reduction in power
prices since the introduction but nonetheless it is working very,
very well. Our daily experiences are causing us as National Grid
to take some commercial decisions to find the cheapest way which
benefits consumers ultimately in balancing the energy balance
in the system. That has created some new marketplaces where previously
there were people who supplied certain services in fast response.
As that has had a price in the market, more people are coming
in to provide that service which lowers the price ultimately.
Jeff, do you want to talk about the issue here of demand and margin?
(Mr Scott) From our perspective in terms of operating
the system and the transfer from the pool to NETA, NETA is working
very well and certainly in line with the expectations from those
involved in the group putting together the new market rules. The
expectation was that a large proportion of energy would be forward
contracted, that we would be dealing with a relatively small proportion
in the balancing mechanism which is the residual mechanism we
used to balance the residual supply and demand. Current percentages
are about 95 per cent being traded forward of the total energy
in the market; we are dealing with less than five per cent in
the balancing mechanism. That has been fairly consistent since
NETA was introduced, which suggests to us that fundamental design
is working from an operational perspective. In terms of the margin,
as far as connected capacity is concerned, we are currently in
the fortunate position that we have a connected capacity margin
of about 30 per cent above demand. On the day, I and my colleagues
in the system operator, deal with the pack of cards we are given
in terms of matching supply and demand. With that sort of connected
capacity margin, one would not expect a problem in terms of matching
supply and demand on the day; certainly there are no signs that
NETA is not bringing forward capacity into the balancing mechanism
through the forward trading markets and with a good range of bids
and offers .
716. May I just make sure I understand that?
Would I be right in deducing that the large proportion you described,
which is being contracted forward, gives you some degree of assurance
and a continuing check on the extent to which you are able to
retain that margin against over-demand?
(Mr Scott) It gives us comfort that we are able on
a day-to-day basis to achieve the residual balance between supply
and demand. In terms of looking further ahead, we have the Seven-Year
Statement which we prepare, which constantly looks at the forecast
demand position going forward and looks at the available generation
both already connected to the system and in the pipeline, looking
for connection to the system. The key question, when you have
a margin of 30 per cent or so as we have at the moment in terms
of connected capacity, is the extent to which people might start
to withdraw generation from that portfolio. The market drivers
there are associated with whether the price is right in the market
for generation to continue to make itself available. Indications
so far are that it is making itself available.
717. The implication of your evidence to us
has been that the nature of the new trading arrangements is likely
to make people question generating capacity that they hold, but
which they cannot sell. So by extension they will be continuously
looking to reduce their own surplus margins of capacity.
(Mr Scott) We have seen no evidence of substantial
decommissioning of plant or applications for closure.
(Mr Holliday) That is true. You have a marketplace
now in which a supplier and a generator do not want to be involved
in the balancing market. They want to trade bilaterally. Therefore
there should be a balance in the market. If I need to go and buy
some electricity to supply, I do not want to leave it until the
last minute marketplace to do that because potentially I get penalised
for doing that. I form a longer-term relationship with a generator.
Our role is the balance of the margin because things will always
move around and demand is lower or higher than expected and a
generator breaks down, etcetera. Under the old world there used
to be a capacity payment for people to sit and just have the generation
available to them. There could be some costs in going forward
which we shall have to pay, which will then be shared out amongst
the participants thereafter to make sure that the surplus capacity
which we require as a safety margin is available. At the moment
that margin is provided by the way people are operating their
(Mr Davies) There is a bit in our submission to you
which says that the margin is quite comfortable at the present
time: the question is whether the market will continue to deliver
that reserve margin looking five or six years out. For the reasons
that Jeff particularly has explained, that margin will not disappear
because of closures. There is the issue of demand growth and closures
particularly of the nuclear stations which is a slightly different
matter from closures of coal-fired plant or whatever, or even
gas-fired plant over that period. What we just referred to briefly
there was that this margin needs to be kept under review and we
indeed will keep it under review in the Seven-Year Statement and
will draw it to the attention of Ofgem and the DTI if we do see
issues arising. They might need to look at the capacity margin
system and capacity payments at that time, but there is no need
to do so now.
718. A couple of points in relation to what
you had to say about real time balancing as well. In effect it
seemed to be a very straightforward explanation of the factors
involved, but the conclusion is that experience to date says this
can be managed. Of course underlying that sentence is an expression
of risk which you constantly have to be looking for. Where would
you say, amongst those various factors, the greatest risks lie?
Where are you conscious that if at present you do not anticipate
those risks upsetting your ability to achieve real time balance
nevertheless you have to watch them most carefully?
(Mr Scott) The risks we identified there or the issues
we take into account in balancing are in some sense intuitive
issues. I do not expect that you read through the list and thought
there was anything untoward in that list. What gives me the most
sleepless nights is the question you are asking in a sense. I
guess there are two factors. One is that we need to have sufficient
generation capability with firm fuel supplies. If you take gas,
which is relatively topical in that context because of the increase
of gas on the system, then we have about 30 per cent of total
plant gas fired, of that about one quarter is on interruptible
contracts, so three quarters of it is on a firm supply. Of the
25 per cent of gas which is on interruptible contracts about two
thirds has a back-up capability. If you look at gas, which is
the growing area of "concern" because of the potential
interactions between the two markets, then only about two to three
per cent of the total connected capacity is at risk of complete
loss from the system due to commercial interruption. That gives
me a fair amount of comfort that I can rely on the new gas-fired
generation which is on the system. The other issue is the flexibility
of the plant on the system. If all of the plants on the system
were nuclear, 100 per cent, then I would have a problem in managing
the flexibility and variation between supply and demand, but we
do have a very good plant mix on the system as we described earlier.
There is a wide range of flexible plant and we do not see any
great difficulty in managing the system in terms of flexibility
719. Nor indeed in relation to the presently
anticipated changes in intermittent supply from renewables.
(Mr Scott) No. In some sense all generation sources
to a greater or lesser extent have the capability to be intermittent.
Generators can fall off and do with reasonable regularity. That
can occur at any time and we have to deal with that. We provide
a range of balancing services or we contract for a range of balancing
services and those balancing services provide us with the ability
to deal with variations in generation on the demand side.