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I welcome witnesses from the Office of the Gas and Electricity Markets, who are here to give us a briefing and take questions on project transmit, which relates to a matter that has concerned the committee for a considerable time. I invite you to introduce yourselves and make opening remarks.
Thank you. I am director of Scotland, Wales and regions for Ofgem and I act as the interface between Ofgem and the Scottish Parliament, the National Assembly for Wales and the Westminster Government. My colleague Stuart Cook is senior partner, smart grids and governance, and he is responsible for project transmit and all the network and infrastructure issues.
Does Stuart Cook want to add anything?
Charles Gallacher has introduced me, so I will just say that it is a pleasure to attend a second meeting of the committee. I was here a year or so ago when the committee was carrying out its energy inquiry. I will be delighted to take questions on what we are doing on transmit and where we are heading. If you would like me to provide an overview of the project I will be happy to do so.
Perhaps you could start by talking about where we are in the process and what the timescale is for completing the project.
I am happy to do that. The best way to think about transmit is as a project that comprises four elements, which we are progressing in parallel.
I appreciate that you are halfway through the operation that you are undertaking, so you might be unable to answer fully some of our questions—you can say if that restricts you. One of the committee’s key concerns has been that the transmission charging regime, which you mentioned, acts as a disincentive to the renewables sector because a large part of the renewables industry is furthest from the market and the charging regime operates in the opposite direction.
You are right to point to the Western Isles situation, which is complicated. It is clear that a combination of the connection arrangements and the charging arrangements has a bearing on the ability of developers in the Western Isles to progress their planning—that is certainly evidence. Evidence is also often quoted to me about Statkraft’s intention to invest in Orkney. We will try to work out whether information about both those situations tells a coherent picture about an issue.
The question that strikes me is why, if the current charging regime is based on being close to the market, people receive a subsidy for connecting in Cornwall but must pay to connect in Scotland.
That is a good example of how the regime operates and an interesting example to bring to my attention.
If the UK market that Ofgem serves were a nice circular ball there would be no problems, but our geography is long and narrow. How can it be fair to construct a model for a market that constrains people at one end from serving those who are at the other, or beyond and in Europe?
That is the question that we need to tease out as part of the review.
That has been happening since the 1980s.
The 1980s regime was established with the particular intention of protecting customers by minimising the risk of investment in the system when it could be put somewhere else more efficiently, and to ensure that there would be an incentive to locate closer to demand. You are asking a valid question about whether, when faced with a different agenda and a desire and strong commitment to connect renewables across the country, the prime driver is the right one for a charging methodology.
Yes, and we hope to find out from you whether you agree. Some people are for change to the charging mechanisms and some are against. Who are for it and who are against?
There is a geographical dimension to the fors and againsts—it would be wrong of me to suggest otherwise—but it is not universal; some of the cross-country renewables organisations sit more on the fence than might be thought. Those who are for the current arrangements tend to be those organisations whose centre of gravity is in the south, and those who are against tend to be those in the north.
Indeed. So it comes down to whether we are one market. If people who are part of the geographic market are constrained, the market cannot be fair. We do not have a level playing field.
What we need to do will have to be done carefully, because any change to the regime will have implications for lots of different people. We need to understand how changes would ripple through the system. For example, if we decided that it would make sense to reduce the strength of locational charges, generators in the north would pay less and those in the south would pay more. Some of the generators in the south would be renewables generators and some of those in the north would be thermal generators. Customers in the north, including those in Scotland, would end up paying more because the same charging regime that means that generators pay more in the north means that customers pay less.
You said that the flow of electricity goes primarily from the north to the south. That suggests that, if there is one market, there would be severe problems with the connections and transmissions if the flow needed to go north. That means that there is a double constraint on people in the north; it is dearer to produce the electricity and, while it is possible to export it and that is being strengthened, very little strengthening is being done the other way.
A lot of investment is going on at the moment—I think that that is what you are asking about. In the past three or four years, we have authorised £1 billion-worth of investment in Scotland to reinforce the transmission network up here, which I think goes to the heart of your observation. That is critical, and expediting that process is absolutely at the front of everything we are doing. We want to ensure that we are not a block to critical investment in transmission. That investment will make it easier for generators in the north of the country to export power down to the south.
I understand that and it is welcome; I am trying to point out that there must be constraints in the grid in England for exporting north.
That is true.
That has been the case since the 1980s. We have not had a level playing field in terms of the possibility of accepting electricity wherever it is produced, which is unfortunate given that this is a supposedly British market.
It is true that there are constraints going north. It is also true that they do not bite as often as do the constraints going down south.
Indeed.
You mentioned the impact on customers. Your review is intended to consider whether the system is fit for purpose in terms of promoting the right kinds of generation, but there is also an imperative in terms of protecting low-income customers in particular. What options might be available to you that might allow a revision of the charging regime for generators with differing degrees of impact on customers? In other words, are there options that your academics are considering on the charging side that might do better than other options in terms of protecting the interests of customers?
That is an interesting question. The work of the academics is making an important contribution to the exercise but, as you would expect, we will not rely wholly on that work. I am not certain that the academic work is particularly considering demand options, but it is live in my mind. What is intended by the arrangements is that generation and demand should effectively be mirror images of each other, although we have questions about whether that mirroring is working exactly as it was intended to. The natural consequence of changing something on the generation side would, therefore, be a consequential opposite change on the demand side. Part of what we need to do is try to do exactly what you suggest: understand what that would do in terms of customer bills, particularly those of customers who are at the more vulnerable end of the community.
The committee is probably aware that Ofgem is in the middle of a major review of the retail market, which is due to be published by the end of this month. We launched the review in the autumn, when our on-going analysis showed that the latest price rise had caused the energy supply companies’ margins to go up by about 46 or 47 per cent. Our retail market review is a major piece of work that is concerned with whether customers are being treated fairly.
Stuart Cook, you mentioned that you had concerns that the reflectivity of supply and demand was not working in quite the way that the model suggests it ought to. Let me interpret that, and tell me if I have understood you correctly. Are you saying that it ought to be as possible to demonstrate that customers in Scotland are better off under the current system than are those in the south of England as it is to demonstrate that generators in Scotland are paying higher charges than they are in the south of England, but that it might not be possible to do that? Is your concern about whether the system is protecting customers to the extent that, in theory, it ought to be doing?
You can see that very difference when you look at the charges. To take an example that has already been cited by a committee member, I point out that a demand customer—in other words, someone who takes power off the system—in Cornwall pays five times as much for that right as someone in the north of Scotland. At the broadest level, the regime seems to be working as you would expect, with customers down south paying more to take the power off the system than those in the north. However, there are some differences. It would be legitimate to ask why, for example, charges are set on the generation side in 22 geographical areas but on the demand side in only 14. On other technical issues, we are testing the regime’s logic and whether it is operating appropriately.
I presume that your options for reform will reflect your greater understanding of those differences as you take your work forward.
Indeed.
If time permits, I will turn to another issue. In response to the convener, you said that the Western Isles connection was an interesting and complex case. I guess that that has some bearing on your questions on timely connections as well as charging. Can you explain for the committee’s benefit why that conclusion was reached and what it means for the issues that you are considering in your review?
I am delighted to do so.
The other area in which there is a lot of support for early progress is in relation to the export potential for new generation. I am thinking particularly of the bootlace developments on the west and east coasts of Great Britain. Do the issues that you have considered in relation to the Western Isles pose any risk to early progress on the bootlaces and delivering that potential extra opportunity to export Scottish electricity?
The bootlace that is most advanced in the companies’ thinking is the one on the western side. It is being taken forward by a joint venture between National Grid and Scottish Power. We have started looking at that set of proposals. We employ consultants to try to understand better what the companies are arguing is necessary. We have asked some questions, and when we get the answers we will be able to form a view as to whether that is a good investment.
It was put to me recently that while the transmission charging regime was absolutely appropriate when it was set up—and for some time afterwards—because the public policy context revolved around price and security of supply, the regime is no longer the right one, given the current public policy context, particularly with regard to the reduction of carbon emissions and the legislation behind that. Is that a fair comment?
That comment has been made, so in a sense it is fair that someone has made it.
Yes, sure, but is it fair from your point of view?
The truth of the matter is that that is what we need to understand. We know that, at the moment, the regime drives in the direction of minimising inefficient investment. What we need to understand is whether it impacts on renewable generation in the way that people say it does. As I said at the start, there is some evidence from specific cases that it seems to have had an implication. We need to understand whether, in the round, it acts against such generation. Part of that is about recognising that what we do in one part of the country will have an impact elsewhere. We need to understand whether, if we changed the way in which transmission charges operated, it would be better or worse for Great Britain as a whole. If we were satisfied that it would work in everybody’s interest, it would be the logical thing to do.
Obviously you are still getting reports from experts and so on. Is there broad acceptance by Ofgem that there is reduced or minimal locational choice for the siting of renewables?
That argument has been put, but there are mixed views on it. Some of the evidence that came forward suggested that it was quite difficult for thermal plants to locate in particular locations. For example, a lot of the new nuclear fleet is restricted to locations where existing nuclear plant is located; there is very little flexibility. Some people have made the case that it is difficult for renewables to locate; others have said that that applies equally on the thermal side and therefore the picture has not really changed.
Without stating whether you think that this is a good idea, will you say whether it would be technically possible to have a system that still involved a locational element, but in which the strength of that locational element was reduced, so that the fact that the carbon reduction public policy context has changed was taken on board? Would it be technically possible to have a system in which there was still a locational element, but the impact of that element was reduced to try to change the playing field?
There are many options, and transmission charging is operated in many different ways around the world. Academics and our advisers are helping us to understand work on that. Generators elsewhere pay more or less of the total pot of charging. In this country, they pay 23 per cent towards the total contribution, but in other countries they pay less. In some places, there is less of a locational signal for the shared assets—the use of the system as a whole—but there are more locational signals for the assets that people have to buy that are uniquely associated with them. The charging regime can be formulated in different ways, and there are some ways within that spectrum in which the locational signals are weaker. The short answer to your question is that it is technically possible to envisage a world in which there are still locational signals but they are not quite as sharp.
I will ask my final question purely out of interest, as I have heard two contradictory responses to it. Did the Scottish Government submit a formal response to the consultation?
That is a very good question. I know that the committee did so. We received 60 responses in total. From my papers, I can see that the Scottish Government did not send in a formal response, but its views are clearly on record in any case, and we have taken them into account. We have received letters and correspondence from members of the Government in the past.
I know that the Government’s views are known, but there were specific questions in the consultation, and I simply wanted to clarify whether, as a matter of fact, it submitted a formal response.
My record here says that it did not. However, it is still open for it to do so if it wants to, and we would obviously take its response into account.
If you take an atlas of Europe, and centre on London a circle of 200 miles radius, you will see that two issues arise. One is that the circle extends well into northern France and the south of Belgium and includes heavily built-up power-requiring areas, such as Brussels. To the north, the line goes north of the vale of Trent and the bulk of Britain’s non-nuclear thermal generation. What life expectancy do you give the big and incredibly carbon-inefficient thermal generators in the vale of Trent—the Drax and Knottingley generators and so on? When will they run out of service?
That is an interesting question, but to be honest I do not have a personal view on it. It is a matter for those generators and their commercial cases. It is clear that what the Government is proposing in the energy market reforms will impact on their decisions, and the extent to which an environment is being encouraged that is less conducive to thermal will bear on them. However, I am afraid that I cannot tell you how long they will remain in existence.
But surely European constraints will also bear on that. They will condemn Longannet and Cockenzie, say, within around 20 years. How much do European policies, European charging practices and, of course, the fact that European utilities now own a substantial amount of the British generation market bear on your calculations?
They are central to our thinking. We are keen to ensure that any changes that are made on the transmission charging side are for the long term. We do not want to put in place a modified arrangement in Great Britain only to find that, shortly afterwards, something happens in continental Europe that affects the way in which charges operate. We are trying to understand the European legislation that we have to comply with and the direction of travel, so that we can make certain that we are heading in a direction that is consistent with European policy or, if we decide not to be consistent, so that we understand the consequences and associated risks and how long the regime is likely to remain in place. You make the really important point that we cannot live in isolation from the European context, so we have to make certain that the arrangements are consistent with that context.
I will add a little advert, which is that we are running a seminar in our London office tomorrow on that very subject. We have 250 people coming. An invitation has gone to the Scottish Government, and Christopher Harvie would be more than welcome to come if he wanted to do so.
I can dream on, given the whips and the budget decision.
That is another fascinating issue. We have three teams of academics working on that. We are drawing on experts from Professor Jim McDonald’s team at the University of Strathclyde, who are helping us to understand some of the international issues. We have also commissioned work from an organisation called Cambridge Economic Policy Associates, which is specifically looking at case studies from throughout Europe. I do not know whether any of them is in Germany, although Germany is in the scope of the countries that are being looked at. That document will be published at the end of the month.
How much do you calculate at the moment, in locational calculations about production that is centred on the big markets, based on the carbon output of your generating capacity?
Sorry, but I did not follow that.
Say you have about 5 million tonnes of coal going in and 10 million tonnes of CO2 coming out of your conventional thermal stations. Does that issue, as well as the very low efficiency of thermal stations—about 34 per cent if you are lucky—play a major role in calculating your matrices for the efficient supply of power?
Under the current arrangements, it is very much the market that decides what the mix of generation plants will be. Clearly, the mix will be influenced by what the Government says in its energy market review. The Government might have done that type of analysis involving the matrices that you describe and the carbon imprint.
Would that still apply to decisions that relate to existing power supply from thermal stations?
To the extent to which it is within our remit, we will look at all those considerations.
One of the issues that we highlighted in our submission was whether the current regime encourages large, inefficient power stations at the expense of localised combined heat and power schemes, for example. Is there anything in the transmission charging regime that could be used to encourage more efficient use of energy, so that we do not have power stations sending 70 per cent of their energy up the chimney as waste heat, for example?
The answer to that is definitely yes. One of the proposals that National Grid had on the table before we launched project transmit related to the discount that small generators get for connecting to the distribution network as opposed to the transmission network. They tend to be the smaller generators that you described. We said that we would consider that discount arrangement, which provides many incentives for such generators, as part of project transmit as well, so we will definitely examine the way in which charges can provide incentives for them.
I am pleased to hear that, but the other side of that is to ask whether there is a way of using the system as a disincentive to encourage large power stations that just pump their heat out the chimney to consider how they could use that heat more efficiently.
I understand the question that you ask. The difficult thing for us is that we have to ensure that the regime is non-discriminatory. There must be an objective reason in law for putting in place a set of provisions that affects a particular class of generators. We would need to satisfy ourselves that it was right to make it more difficult for one class of generators and easier for another. You might judge that that is a sensible thing to do.
I suggest that the efficient use of energy would be a reasonable ground. It would not be discriminatory. You could say that all generators had to be efficient in their use of energy.
I shall raise two issues. One is specific to the transmission charging regime and the other is more general, but they both relate to the scale of investment that will be required.
We have not talked much about the balancing side of the equation, but it is right to bring it to the table.
Can you say a general word about that at a high level?
As of 11 February there will be a new connect-and-manage regime. As part of that, the balancing charges are to be socialised across different generators rather than targeted on individual ones. We need to factor that into our thinking because a view has been expressed; we need to respect that perspective when we form our own views. We are not constraining the solution by saying that we definitely need a model that minimises across the balancing and asset sides; we are looking for the different and most efficient ways of handling those elements in the UK, given the decisions that have been taken.
I suppose I am asking whether the endgame on transmission charges is likely to be a big net consumer of investment. We will talk later about the other demands that are being made. Are the costs associated with changing transmission charging likely to exceed the general rise in generation capacity? Have either Ofgem or the Government set any parameters around how significant the scale of investment will be? Obviously the balance between the different operators and generators that are participating in the system will change.
I can give you a feel for the scale, then I will explain a bit about the process by which we get to that.
I was going to come to that as my next question about the scale of grid investment required. I am sorry to interrupt.
The total investment is £200 billion across the board on the network and generation sides. We estimated a figure in excess of £30 billion on the network side in transmission and distribution. We made that estimate last year and we are now reviewing the submissions that the companies have made as part of the periodic price control resetting. It is likely that that number will be revised upwards rather than downwards in the companies’ view. However, we have not completed that analysis so it is best to rely on last year’s figure. So, of the £200 billion, around £30 billion is network related.
And the remaining £170 billion is related to generation?
Exactly. We do not place a cap on it—by which I mean we do not deliberate on it and decide that the maximum amount is £30 billion and the companies cannot spend more than that; we ask them to come to us with a case and we take case by case. In future, we will need to have the flexibility to handle new situations so that if something arises that the companies are not expecting and they have to make an unanticipated investment, we can be flexible enough so that they are not delayed from investing.
I invite you to say a word about the scale of the grid investment that is involved. Lewis Macdonald mentioned the two bootstraps. I have in my head a figure of around £4.8 billion that has been committed, £2.7 billion of which is coming to Scotland. Can you give us some sense of how the £30 billion is committed and how it relates to Scotland? There is a bundle of issues around the transmission charging regime, but there are also huge issues around the grid upgrade and networks and how that all integrates with your retail market review, the energy market review and the significant amount of lobbying that is now going on of the committee by the energy companies about the scale of investment that is required and expected from them and the time horizon over which payback will come. I want you to say a word about the scale of grid investment that is likely to be required during the next five to 10 years and how much of that pertains to Scotland, the bootstraps and the interconnectors.
That is a really interesting point. Your memory for numbers is obviously better than mine. It is worth focusing on some of the figures. The current asset base of the companies is approaching £8 billion—the figure is about £7.5 billion, I think. About £15 billion of investment is required for the offshore regime, which involves connecting the grid out to the generators in the sea.
That is very helpful. How do you get from the £15 billion that is required for the offshore regime and the £5-plus billion for the onshore regime to the £30 billion figure, which you have indicated is likely to rise? What is the other significant element of that?
That is distribution investment in England and Wales. There are distribution and transmission, and there is offshore investment. The £5 billion is for GB transmission; the £15 billion is for offshore; the rest is all the onshore distribution network investment.
A brief note to lay out that landscape would be helpful. Returning to my original point, the question is whether significant net investment for transmission requirements is likely to arise from project transmit. Do you expect the project to require significant net investment in addition to the investment on the new grid, for want of a better description, or the anticipated grid upgrading?
It is too early to answer that question. Depending on the conclusions of project transmit, we might expect that there will be implications for where generators are located and the speed at which they are installed. Some of the things that we will do on the connection side will I hope enable generators to connect quickly. All those things will have implications on transmission investment.
I do not think we need to go into that level of detail at this stage, but it would be helpful to have a sense—even just visually—of what we have been discussing regarding the scale of the investment that is likely to be required, with some idea of the time horizons over which you expect the various efforts to interact and nest in. There is a little bit of confusion about the matter. It would be useful to discuss with the operators what has been committed, what the timescale is and what the likely requirements are—although that is speculative—and it would be helpful to get a little more information about that landscape.
We can certainly provide that. It sounds as though it would be best to do it in picture form.
Visually—exactly.
I am sure that we will manage to do that.
I have a question about wind energy that follows on from something Charles Gallacher highlighted. He spoke about a 46 per cent increase in profits in the energy retail sector. Stuart Cook just spoke about the investment element. You said that you might have to consider approaching the energy companies and asking them to come up with some investment a bit more quickly.
You raise a major concern of ours. The numbers are enormous and somebody will have to pay for them, as you say. As we are in the middle of a review, I cannot discuss the detail, but that issue will be a part of the review.
Stuart McMillan asked about investment. The amount of more than £30 billion would be spent on assets that last for many years, so the impact on people’s annual bills would be reduced, as the costs would be spread over several years.
I have just one question. In its report of 23 February 2010, the House of Commons Energy and Climate Change Committee said:
That is an issue. We have asked National Grid to consider it and we are looking at it, too. Different generators have different patterns of operation. I will give an example of two extremes. A generator that relies on nuclear technology tends to run more or less continuously, as that is more economic and efficient. It will rarely go off the system, other than for safety reasons or plant maintenance. In contrast, a wind generator goes on to and off the system according to whether the wind blows.
It will be important to keep us up to date with those deliberations. Transmission charges seem to discriminate against renewable energy, which is a huge issue for Scotland.
I would be delighted to return to the committee, as I am sure would Charles Gallacher.
I would be happy to do that.
Stuart Cook mentioned the introduction of electricity market reform, which members debated last month and asked Chris Huhne about. The removal and replacement of renewables obligation certificates will have huge implications for investment decisions—particularly in the north of Scotland, I suspect. How will project transmit dovetail with the final EMR proposals and avoid the risk of going in one direction while EMR goes in another?
We are alive to that risk. Some models for taking forward charging neatly avoid the complexities of aligning with EMR, but others are enmeshed in EMR. It is important that we understand the direction in which the Government wants to go and the implications for some of our decisions. We are working closely with the Department of Energy and Climate Change to understand how its thinking is developing and to share our thinking on project transmit, so that the two reviews work together seamlessly.
What is the timing for that?
I understand that the EMR proposals will be available in the spring. That works quite well—we should have views on where EMR is likely to land at about the time when we form our views about the charging regime, so bringing together the two reviews should be possible.
I thank Stuart Cook and Charles Gallacher for giving us a useful briefing on project transmit’s progress. I am sure that our committee will recommend that our successor committee, whatever it may be, keep a close eye on the project. I hope that the witnesses will be as willing to meet that committee in due course as they were to address us today.
It is always a pleasure to appear before the committee.
Thank you very much.
Because of the recess, our next meeting will be two weeks from now, on Wednesday 23 February. Given that the only agenda item will be consideration of a draft report on our enterprise network inquiry, I am pleased to say that I will recommend to our clerks a slightly later start than normal.