Electricity Market Reform

Barry Gardiner Excerpts

Thursday 3rd November 2011 Westminster Hall

[Barry Gardiner (Brent North) (Lab)]

My pleasure at speaking under you as Chair, Mr Havard, is exceeded only by my awe at having to follow my own Chairman of the Select Committee, the hon. Member for South Suffolk (Mr Yeo), who in his 16 or 17 minutes did not canter but gallop through the entire report in the most comprehensive fashion.

I often think of the Minister, for whom I have the greatest respect, as sitting in his Department twiddling a Rubik’s cube. The trouble is that someone has peeled one of the colours off this particular Rubik’s cube and put the wrong colour in its place. No matter how hard he tries to get the six sides all looking as they should, the task is pretty impossible. I do not underestimate the challenge faced by the Minister.

We need to replace 25% of our existing generating plant by 2020 merely to keep the lights on—that is one side of the Rubik’s cube. We are obliged by the European Union to have 30% of our electricity come from renewable sources by 2020—currently it is only 7%—and that is another side of the cube, as is energy consumption in the UK being set to double by 2050 if we continue with business as usual. We also need to tackle fuel poverty and to keep prices low, and that is a big side of the Rubik’s cube. We need to decarbonise our economy to combat climate change—yet another side. The sixth side is that we need to incentivise £200 billion of investment in new capacity and infrastructure in the space of only nine years. The puzzle is intractable indeed.

Take any two of those sides at random, such as the renewables obligation and low fuel prices. Professor Dieter Helm, in his evidence to the Committee, dismissed the Government’s projection of only minimal rises in customers’ bills by 2020. He told the Select Committee that to think that energy efficiency and other demand reduction measures could balance the increased costs of low-carbon supply to the extent that the effect on consumers’ bills would be only 2%,

“is again really stretching one’s imagination.”

Let us pick another two sides of the cube: what of delivering £200 billion-worth of infrastructure and of decarbonising our economy? Investment analyst Peter Atherton told the Committee that

“it is going to be extraordinarily difficult to get non-recourse debt into new nuclear in the UK. That basically means that it all has to be done on balance sheet.”

The Government’s strategy is market driven. It is predicated on getting the right incentives and believing that the market will then arrive at the correct solutions.

There are four pillars. Feed-in tariffs will incentivise at two levels. First, by encouraging microgeneration and paying people for the energy they feed into the grid through their solar panels and domestic wind turbines. No doubt we will come back to solar panels later. Secondly, by giving a long-term contract to large-scale low-carbon generators like offshore wind farms. This will guarantee a better price to them in comparison with carbon-intensive generators such as coal or gas-fired power stations. Those are the “FITs”.

Carbon price support is like a tax on carbon, as the Chairman of the Energy and Climate Change Committee said. It simply makes the cost of generating electricity from fossil fuels more expensive, and that means that carbon-free generation like wind becomes relatively more attractive the higher the Government set the carbon price.

Capacity payments, the third of the four pillars, are the price the Government are willing to pay to ensure that back-up is always available. The system needs flexible generation that can respond to the peaks of demand and any gaps in supply. They propose payments to generators that will give them increased certainty of revenues if they guarantee to be available when other supply is not—for instance, when the wind does not blow.

Emissions performance standards is the fourth of the pillars: the final tool in the Government’s incentives box. In reality, the EPS is more a disincentive, because it simply proposes a ban on any generator emitting more than a certain level of CO₂ per kWh. The Government want to set that limit at 600 grams of CO₂ per kWh. In practice, this would stop only unabated coal—the coal-fired power stations that did not have CCS fitted to reduce their emissions. It would still be enough to allow gas-fired stations. That is not good enough, given the Committee Chairman’s earlier remarks about adopting the Committee’s fourth carbon budget with targets of between 40 grams and 60 grams per kWh.

If the banking crisis should have told politicians anything, it is this: a strategy of “incentivise and then sit back” ignores the fact that markets need more than incentives. Markets need certainty, capacity and regulation. Peter Atherton put it nicely when he told the Committee:

“I warn you that it is not a question of making the rewards more and more, because the more you make the rewards, the less trust investors will have that those rewards are going to be sustainable.”

He went on:

“There are really five big risks: planning, construction, power price, operation and decommissioning.”

The mistake that the Government appear to be making is to think that by putting greater and greater incentives on power price, they can resolve all the problems that need to come within electricity market reform.

The EMR set out three high-level objectives: decarbonisation of the electricity sector, energy security and affordability. I wish to focus for a moment on affordability, because it is becoming—certainly for my colleagues—one of the biggest issues that we find on the doorstep. One in every four households in the UK is now classed as fuel-poor. A fuel-poor household is defined as one where the expenditure required to maintain adequate warmth exceeds 10% of household income. It is a measure of the number of households needing to make impossible decisions on expenditure just to meet their basic human needs.

If we look across Europe, there is no pan-European definition of fuel poverty. In other countries, fuel poverty might fall within general poverty alleviation programmes, or it may simply not be recognised as a major problem. Cross-country comparisons therefore are difficult and they need to employ indicators such as the winter variation in mortality levels or the number of people in arrears with their utility bill payments.

The Labour Government brought in winter fuel payments for the elderly to tackle fuel poverty, and no doubt my colleagues will point to figures that show that excess winter deaths plummeted from almost 50,000 in 1999-2000 to 25,000 in 2009-10. The truth is that while Labour can claim real success by acting to increase household income, if we look at the figures over an extended period, it becomes evident that the net effect of our winter payments strategy was only to hold winter deaths broadly static when otherwise they might have increased. If one goes back to 1993-94, one sees that excess winter deaths were again 28,630. In 1994-95, the figure was 29,720. It rose to a peak in 1999-2000, but in 2007-08 it came down to 27,480. That shows the danger of focusing on just one aspect of a problem.

Winter mortality in other European countries reveals some surprising trends. The countries with the highest winter death rate are Portugal and Spain. That is counter-intuitive, but easy to explain when one considers the low level of home insulation. What emerges clearly from such comparisons is that there is a strong correlation between thermal standards in housing and excess winter deaths. That excess winter mortality is almost twice as high in England as in Finland or Germany cannot be directly attributed to weather. However, precisely because of its cold climate, Finland already has very demanding thermal insulation requirements.

By contrast, the coalition Government have just introduced their warm home discount scheme where energy suppliers will be obliged to give rebates of £250 million in 2011-12, rising to £310 million in 2014-15, to vulnerable customers. It is astonishing that the UK continues to focus on financial solutions to what is essentially a technical problem of building standards. On the Minister’s overview of the industry, I urge him not to repeat the mistake of which I have already accused him once this afternoon by adopting a single focus solution to a problem. I fear that is what happens.

The Government have also failed to control the soaring costs of energy charged by the big six utility companies. Again, the Chairman of the Committee made strong reference to this in his remarks, because it is a major focus of our report. Household bills have increased on average by 71% in just five years. The latest attempts by Government to reform the electricity market once again let those companies off the hook by failing to break up the vertical integration of the companies.

Vertical integration allows a utility company to generate the electricity under one arm of the company, which it sells through an intermediary—often offshore—which they also own, and then on-sells to another arm of the corporation, which supplies it to us as the consumer. The result is a total lack of transparency in the true cost of electricity. All the big six operate similar structures, which prevent real competition and stop new entrants coming into the market.

When the Committee Chairman mentioned the big six and the break-up of the vertical integration of the market, he alluded to the announcement by Scottish and Southern. It is important to try to appreciate why what sounded like a major announcement from Scottish and Southern to auction all its electricity to household suppliers on a wholesale market is perhaps not the concession or big move that might have at first been perceived. One small supplier that it was supposed to help said that the move was “cosmetic” and will do little to help small suppliers gain market share. That is because the Scottish and Southern Energy Group is freeing up only short-term energy and not the long-term market on which small suppliers rely.

The big six gas and electricity firms buy and sell energy on the wholesale market, but energy is traded in two ways—first on the day-ahead price, which is where SSE said it will auction all its energy, and secondly, by smaller energy firms that trade with a longer view, buying up enough energy for up to two years so that they can guarantee a price for customers. The markets are complex and subject to many external factors that can affect price. First Utility, a small company, says that it buys less than 1% of its wholesale energy on the day-ahead market, and claims that smaller, newer suppliers buy wholesale energy on a much longer-term basis. That is why the move from SSE that the Chairman of the Committee mentioned will not free up the market and help liquidity in the way suggested.

Lack of skills is a problem in driving the investment that we need in industry. It is one thing to get £200 billion of investment, but providing the skills to deliver that is a much greater challenge. The Minister must respond clearly and tell the Chamber how he proposes to make skills available to meet the demand should such investment be obtained.

[Mr Dai Havard (in the Chair)]

Order. I would like to start the winding-up speeches at about five past five and other hon. Members wish to speak. I appreciate that it is a complex report and that huge areas need to be discussed, but I appeal to the hon. Gentleman’s internal discipline.

[Barry Gardiner]

I apologise, Mr Havard; I thought that we were working to a slightly different time scale than that outlined, so I will rapidly bring my remarks to a close. I must, however, focus on this week’s events and the change in regulation. I do not suggest that the Government are wrong to change the tariff structure and bring it in line with the levy, but they should do it at the end of March next year when the review was originally planned. By bringing the move forward by a meagre four months, the Government have reinforced a perception in the markets and business that they cannot be trusted to deliver a stable regulatory framework. The Minister shakes his head but he knows that to be true. He also knows that he will be subject to judicial review. Some companies are losing up to 45,000 workers, and many will “JR” the Government’s decision because there is a consultation period that extends 11 days beyond the deadline at which the change of tariffs will come into effect. That is dishonest and the Government are wrong to go down that route.

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[Dr Alan Whitehead (Southampton, Test) (Lab)]

I will limit my remarks to one or two points. One disadvantage of having such a knowledgeable, far-sighted and competent Committee Chair is that after he has spoken there are few sensible contributions left to make. I will, therefore, confine my remarks to one or two less sensible points, which I hope will add something to the debate.

In the Green Paper, and certainly in the subsequent White Paper published after the Committee’s report, one must look a long way to find comments on electricity market reform. Although the White Paper addresses a range of topics, such as capacity, the carbon floor price and energy performance standards, its central oddity is that it leaves the electricity markets as they were designed 10 years ago under NETA—the new electricity trading arrangements. It leaves the electricity markets in pretty much the same place, with the same assumptions and mechanisms. However, it countenances a very different landscape as far as electricity trading is concerned.

When NETA was set up, there was a substantial number of wholesalers selling and retailers buying. That is no longer remotely the case—not by conspiracy, but through the accretion of suppliers, generators and retailers into the big six. By accident, what has come about is, in effect, a cartel—we have to say that—that essentially hedges, using the strategies that my hon. Friend the Member for Brent North (Barry Gardiner) mentioned: it buys on the futures market and sells to itself, using the same market mechanisms, and therefore pretty much bypasses most of the things that NETA was originally set up to do.

When NETA was set up 10 years ago, it was carbon-blind. Its purpose was to secure, among other things, the cheapest price between wholesale and retail. In the early stages, it looked as though it was substantially succeeding in doing that, until other factors took over. However, there was the emergence of what one might call the other things that are central to the electricity market reform White Paper. To some extent, they were mechanisms that mediated that central electricity market. The renewables obligation, for example, was a mechanism attached to the original NETA/BETTA system to bring renewables to market; to underpin emerging technologies; and, in an echo of the recent debate on feed-in tariffs for solar photovoltaics, to recognise that over time the obligations may change as the technologies come to market. Nevertheless, the aim was to underpin those technologies in the first place.

Now, as hon. Members have said, we need to decarbonise our electricity market rapidly and invest substantially, not just in replacing capacity but in providing additional capacity, because of the nature of the capacity that we are bringing on board as far as the low-carbon market is concerned. We are talking about perhaps £200 billion in investment. All but two of the big six companies have pretty much borrowed up to the limit of their balance sheets, so we need important mechanisms to secure not just the good running of the market, but low-carbon investment on the basis of good value for customers. I do not underestimate at all the breadth of the challenge implied by the electricity market reforms.

There are various things in the reform. The central electricity market remaining must have a substantial question mark against it, with regard to whether it is fit for purpose as one of the central mechanisms driving all the demands forward. I think—evidence was submitted to the Select Committee on this—that a single purchaser pool of some description is a necessary way of dealing with the issues of cartelisation and the lack of transparency in the wholesale market that has emerged. There must also be a question mark against the contract for difference as set out in the White Paper.

[Barry Gardiner]

I absolutely agree with what my hon. Friend is saying. Will he say something about liquidity and the ability of smaller companies to enter the market with regard to the changes that he is discussing?

[Dr Whitehead]

My hon. Friend has just stressed that point. Given that I have about one minute left, expatiating on liquidity to any great extent is probably beyond my abilities. However, he is absolutely right to raise the question of liquidity in the market and the fact that as a result of the lack of liquidity, small companies are pretty much shut out from gaining a foothold in the market. Whatever is done about the big six, that is a very important issue.

Finally, I want to emphasise two things. First, the contract for difference as currently proposed conflates mature technology, the overall costs of which will not change, with emerging technology, where costs may well change. That is to say, it rewards, and particularly in the future will reward, old nuclear technology, as well as new nuclear power stations, for their output. That seems—the Committee alluded to this—a considerable concern, given the pronouncements that continue to be made that the Government are in favour of new nuclear but with no public subsidy. It is necessary at this stage to say either that there will be no public subsidy—that nuclear will not be rewarded for being a mature technology in the way that emerging technologies are, but will take its chance in the market—or that we need to do something about public subsidies for nuclear, for reasons that may be perfectly honourable to consider, and we must be up front and deal with that. Electricity market reform continues to fudge that essential choice that we have to make.

Secondly, we have to enter into capacity payments with a clear understanding of demand-side analysis, which is substantially missing from the proposals in the electricity market reform White Paper. We need to consider capacity payments for energy efficiency and reduction in output, and in relation to things such as interconnectors and electricity storage, which will be an essential part of a balanced, very low carbon economy that takes serious account of the demand side as well as the supply side.

Trying to deal with the entire landscape of electricity market reform in eight minutes flat was a difficult challenge. I hope that I have contributed a few thoughts to the debate, and I look forward to the Minister’s response to a number of issues that hon. Members and I have raised.

--- Later in debate ---

[Charles Hendry]

I know that you, Mr Havard, are capable of so many miracles and magical things that we thought that nothing was beyond your capabilities.

The hon. Member for Brent North (Barry Gardiner) made an interesting comparison to a Rubik’s cube, but I think of the issue as more of a complicated jigsaw. With a Rubik’s cube one makes a move and moves everything else out of place, whereas with a jigsaw, one gradually puts in place the elements that build up the whole picture. One has to do that in a structured and sensible way, because some parts are more complicated than others. Nevertheless, we are keen to take forward the challenge.

What we are about here is securing £110 billion of investment over this decade. The £200 billion includes investment in gas infrastructure, the wires and the pipes, but it is still an enormous investment. It is twice the rate of investment every year of this decade than has happened in the past decade. We need to recognise that the old market structure did not bring forward the necessary investment—it sweated assets to try to keep costs down—and could not price in the cost of carbon, which is one of the big issues that we have had to address. Therefore, I do not see market reform as being about subsidising nuclear, but about how we make all forms of low carbon feasible, affordable and economically attractive.

The Chair of the Select Committee on Energy and Climate Change, my hon. Friend the Member for South Suffolk (Mr Yeo), asked a number of questions when introducing the debate—it was like a bullet train going through the energy terrain. A comprehensive range of issues and questions were raised. He asked how much investment we have seen in the past year. Just in the renewables sector, in six weeks between 1 September and early October, we saw £800 million of new investment, offering nearly 2,000 new jobs, and we expect that to pick up. However, he has had to accept that much of the investment is lumpy—a nuclear power station needs £5 billion or £6 billion of investment, and an offshore wind farm needs billions of pounds of investment. Therefore, there will not be a straightforward progression to 2020, but we will have big steps up over time. We are quite clear that without the measures we are putting in place, it will not be achievable.

My hon. Friend also asked why we had not gone for a target such as 50 grams per kilowatt-hour for the electricity sector by 2030. We will set out our formal response to the Energy and Climate Change Committee later in the year. We recognise, through the work that we have done, that there are a number of ways to reach our 2050 requirement, which is that we need to have reduced our carbon emissions by 80%. There is not just one way to do that, and we need to look at what is the best way. At the end of the day, we need to do it in a way that is cheapest for consumers. A common theme in this brief debate has been to ask how we deliver that in a way that will protect consumers, both industrial consumers and people in their own homes.

We have covered a number of measures regarding market reform, and I want to address each of them briefly. We have adopted a system of feed-in tariffs with contracts for difference, because we believe that that is the best way of getting the best deal for consumers and giving the greatest certainty to investors. By clawing back when the wholesale price is high and paying more when it is low, the system is more predictable, and it is easier to bring in investors from outside.

One of the things that Mr Atherton from Citi, who has been referred to, has not fully taken account of is that we are trying to take the system closer to a regulated rate of return. Many institutional investors, such as sovereign wealth funds around the world, are now looking at the opportunities to invest in the UK energy sector precisely because of the structure that is being put in place and the fact that we think that the CFD mechanism delivers the policy more securely than any other mechanism.

My hon. Friend the Member for South Suffolk asked us not to tinker with the policy as it progresses. The history of previous Energy Ministers suggests that I will most certainly be long gone by the time anyone gets a chance to tinker, but if I am still in the position at the time, I guarantee to him that the whole system is designed to stop tinkering. It is not just an agreement or Government policy, but a long-term contract that tells investors over 20, 30 and more years how much they will be paid for each unit of electricity generated by a certain technology. That means that we need to build a system that is as close to automatic as possible in order to recognise how the costs are coming down, so that new entrants coming in beyond a certain point understand how they will be remunerated in the process. The policy will also deliver investment, particularly in renewable energy, at a cost lower than that of the existing renewable obligation. As the policy supports all low-carbon technologies, it will make a greater contribution to our decarbonisation targets than is otherwise possible.

The discussions, particularly my hon. Friend’s remarks, also focused on the emissions performance standard. My intention with such a standard will be to give a long-term signal for what we believe is acceptable and to start to set out how that degression might take place when it is considered. Above all, it has to be a driver for investment. It is easy to set it in place in a way that kills off investment decisions. How we have done it, which is to say that it will not be reconsidered before 2015 and that investments happening before that will have perhaps 20 years of assured production on a certain emissions level, will strike the right balance.

I was intrigued by the comments my hon. Friend the Member for South Suffolk made in the earlier part of the debate. He sees the role for shale gas as having been underestimated. He said that we should be having much more shale gas and gas in general in the mix, with perhaps less energy from renewables, offset by the structure that he was calling for in the second part of the debate, which would be subject to an emissions performance standard. We will not get the investment that he wants to see in new gas generation if there is a much tighter emissions performance standard biting at an earlier stage on gas generation.

We have also said that the capacity mechanism should be part of this process, because we recognise that we need to know exactly how we will keep the lights on at all times of the year, as well as ensuring that there is back-up capacity and, critically, building in that demand-side response, to see whether we can find cleverer ways of dealing with this than building new power stations that will only be used for a small part of the year. If we can find ways of taking demand out of the system during times of particular demand, it will be a big gain for the consumer and save £1 billion on new plant. Clearly, whether that is a new plant or an old plant going for a few hours a day will depend on how that capacity mechanism is structured. We are determined, however, that that demand-side response element should be part of the structure as well.

The final element of the package is the carbon floor price. The carbon floor price is important for giving investors confidence. Currently, if one looks at the history of the European emissions trading scheme, it has been impossible to guess where it will be in a few months’ time, let alone in nine years’ time. The people who are making investment decisions that will not come to fruition until the end of the decade need greater clarity. Putting in place a carbon floor price is all part of that process.

The trajectory that we have taken is to show them that we are serious. If we had said, “Yes, there will be a carbon floor price, and it will be introduced by the next Government after the next election, at a level to be established,” nobody would have taken that seriously. The way in which that has been done shows a much greater commitment to giving the industry the clarity that is necessary. A measure of success in this will be whether we can bring new entrants into the market. Improved liquidity will be one of the benchmarks by which we can test whether market reform is working. Undoubtedly, we want to see more liquidity and more players. That is primarily the responsibility of Ofgem, and we know that Ofgem will look at this further if that proves to be necessary. The Government have said that they will act, if necessary, to address those structural barriers.

My final point is on fuel poverty and feed-in tariffs. One cannot, on the one hand, talk about concern for those suffering from higher fuel bills and, on the other, baulk at every measure that is designed to take pressure off their bills. The cost of solar technology has come down by around half since 2008. Degression was always built into it, from the very first brochure, signed off by the right hon. Member for Doncaster North (Edward Miliband), who is now the leader of the Labour party. He said that degression should be part of that process. As the prices have gone down much faster than anyone anticipated, it was right to do that. We know that a domestic installation can be done in a few weeks and had we not acted quickly—if it had been announced that it will come into place in the spring—there would have been a complete explosion in demand and installations, which would have completely destroyed the budget that has been set for this and led to the complete collapse of the industry, because anything after that would have been much more draconian.

[Barry Gardiner]

rose—

[Charles Hendry]

I fear that this is not an integral part of the debate on market reform and, while I want to respond to the hon. Member for Brent North, we owe it to the Chair of the Select Committee to give him time to come back.

I do not think that, on the one hand, someone can argue on fuel poverty that they want to take pressure off consumers while, on the other hand, opposing the decisions we take to help consumers, such as the billions of pounds taken off the feed-in tariff costs out to 2020. It is not possible to do both.

[Barry Gardiner]

Will the Minister give way?

[Charles Hendry]

I am not going to give way, because I want to give time to the Select Committee Chair. I have spoken for less time than the hon. Member for Brent North, so I hope that he will understand if I do not give way. I am grateful for the advice and input of the Select Committee, and I hope that we can put in place a structure that recognises the scale of the challenge, the need to decarbonise and the need to rebuild our energy infrastructure, while doing it at the lowest cost to consumers.