Energy Bill

Lord Davies of Stamford Excerpts

Tuesday 18th June 2013 Lords Chamber

[Lord Davies of Stamford]

My Lords, I always listen to the noble Baroness, Lady Parminter, on these subjects with great interest and respect. She has great command of the subject. I think what she said about interconnection was a very valuable contribution to the debate.

I do not think that anyone who has read the report of the noble Lord, Lord Stern, published a few years ago, or least of all who, like me, has seen the dramatic retreat of glaciers in the Alps and the Himalayas evidenced in photographs taken only 50 years ago, can be in any doubt at all about the reality of climate change and the challenges we face.

I see the purpose of this Bill to provide the country with a diversified and secure basis for future energy supplies on the one hand and to achieve our international obligations on decarbonisation on the other. I totally support both objectives and I certainly will be voting for the Bill on Second Reading in the very unlikely event that there is a vote.

However, there are at least four respects in which I very much disagree with the Government’s approach to energy, and I rather think that the noble Baroness, Lady Parminter, has persuaded me to add a fifth to my list: the need for greater investment in interconnection. First, this Bill does not require the Minister to produce a decarbonisation target. In this respect, I totally agree with the right reverend Prelate the Bishop of Hereford and others who have said that this Bill should be prescriptive and not permissive on this point. Secondly, I am very disappointed that the Bill says nothing about demand reduction. I have yet to hear the Government set out their strategy quite clearly on that. Certainly I cannot find such a strategy in this Bill and we definitely need it.

My third problem with the Government’s energy policy is that we have made a probably excessive commitment to wind power, certainly to offshore wind power. It seems to me that the Government, under pressure from their Back-Benchers, are using the planning system to stop more developments of onshore wind power and are pushing it all offshore. However, offshore is an extremely expensive form of energy and it does not make any sense at all. The usual comparisons are that the cost of nuclear energy is somewhere between 6p and 10p per kilowatt-hour and offshore wind power is somewhere between 11p and 16p, which is about twice as great. However, you are not comparing two comparable things. Wind energy is not base load. It is not even a reliable peak load that you can turn on and off as you require, which you can with a combined-cycle, natural-gas-fired, thermal power station. It is extremely expensive for something that is not that valuable. I think we have gone perhaps too far in that direction.

My real quarrel with the Government is about nuclear power. What they propose is not in any way adequate. I would not go quite so far as the right reverend Prelate the Bishop of Hereford who wants to see 80% of our electricity generated by nuclear fission. That is, as he rightly said, the case in France. That is going quite far and would deprive us of the potential quite considerable advantage of benefiting from shale oil fracking to produce gas in the future. It looks as though gas prices are going to come down quite dramatically as a result of that. We have large reserves in this country and it would be a pity to give up that bonanza.

What is more, for the reasons I have just mentioned, there are advantages in flexibility in having in your portfolio a considerable degree of capacity from combined-cycle natural gas generation as well as nuclear. It is very alarming that the proportion of our electricity produced by nuclear fission has now fallen to below 20%. It was 25% a few years ago. If the proportion does not go up to 80%, as the right reverend Prelate would like, I would certainly want to see it above 25% very rapidly and it should be 30% or 40%.

If I asked the Government why we do not build 20 new 1.6 gigawatt nuclear stations rather than 10—they have not got round to signing a contract for one yet—they would probably give two answers. I have never asked them so I am probably putting words into their mouths. First, they would say that it would be inordinately expensive and, secondly, that there is very limited appetite in the private sector for this type of risk. This has been demonstrated by the difficulty they have had in getting people to bid for their business in this context already. The two German potential partners, E.ON and RWE, have walked away.

The Government have produced this situation by their own errors. They have adopted the wrong model for nuclear generation—one that is based on misallocation of risk and which consequently is unnecessarily and excessively expensive and deters potential private sector investors. The risk of design, construction and operation should be borne by private sector investors and contractors. It is vital that the same partner is responsible for all three so that design and construction are informed at every stage by the need for maximally safe and efficient operation. That is clearly a role for a contractor, but the Government are quite wrong to think that it is better for the private sector contractor to manage the commercial risks involved.

The Government have already retreated and accept now that the counterparty for contracts for differences must be a single counterparty backed by the state. Previously they were saying that the generators could just deal with the suppliers in an open market. They got that completely wrong. They have realised now that they have to take back that risk for the Government, so they have already accepted the logic of my argument. However, there are many other respects in which commercial risks are better handled by the Government. For example, anything to do with network risk, the failure of the system, and difficulties with suppliers or distributors or anything of that sort is probably better handled by the Government as they have the means to intervene.

If there were a shortage of uranium in the world—very unlikely at present but we are talking 60 or 70 years ahead—the Government are much better able than a private sector contractor to deal with that. We have our own sources of uranium. I speak as the former Minister responsible for the Atomic Weapons Research Establishment. We have international agreements and so forth. There are many respects in which the state is better able to handle those risks than a private sector body.

Some risks have already been mentioned. The noble Baroness, Lady Parminter, referred to one of them, which the taxpayer or the energy consumer cannot walk away from anyway. For example, there are the risks of an accident costing beyond £1 billion and the risks of decommissioning. It is all very well to say that a contractor has to make provisions. Under the contracts that have now been negotiated he will have to provide for the costs of decommissioning, but who knows what they are going to be in 60 or 70 years time, or what the value of the fund accumulated in EDF Energy or any other contractor will be by that time. Again, in practice the state will be standing behind those risks and reinsuring them. There will be a contingent liability on the state.

What does all this mean? If you construct a model on that basis, you are passing to the private sector risks that it can less efficiently manage than you can yourself. Therefore they are going to cost more by definition. You are passing to the private sector risks, some of which remain with you anyway, so you are paying double for them. It is not a very intelligent policy. The private sector contractor will factor in those risks in his costing, which will be very expensive. What is more, because of the lack of competition in this business he will expect a very high profit and get away with a very high return, so the cost of capital is going to be extremely high.

With the long lead time in constructing nuclear power stations, the cost of capital will be a major factor, if not the most important factor, in the total cost. The Government have created the problem of the extreme cost of this business. I will give a simple example so that noble Lords can do their own calculation. The impact assessment predicts a cost of capital of 10% for nuclear power stations. I think that might be a little less than the likely level. The cost of equity is vastly more than that, I would have thought twice that at least. What the weighted average cost of capital will end up being I do not know. Take the 10%—do not take any figures that I might suggest—that is used in the impact assessment. That 10% is four times the Government’s cost of capital—2.5% is the 10-year gilt rate at the moment. The Government are paying four times more than they need. I think that is bad Government. It is a great mistake and they have gone for the wrong model.

I am sure that if you put that to the Government or to the Treasury, they will say that they could not have the state owning the stations and raising the finance from the gilt market because that would mean an increase in our total debt ratio, our debt to GDP ratio, and cause us problems in the markets. That is very naïve. First, it means that we are paying a very considerable price in economic terms for purely presentational advantage; and, secondly, that argument depends on the markets being so stupid that they cannot look through the presentation for the reality and do not actually know what is happening.

Of course, the markets are perfectly capable of doing that. The markets will factor in the contingent liabilities of the state for the environmental risk that I mentioned. They will factor in the contingent liability that the Government are now incurring in standing behind the counterparty for contracts of difference. That is obviously a contingent liability in itself. That is not a sensible answer; it is also a reflection of not very intelligent government.

I fear to say that we have sold the pass on that. Of course, we cannot go back to any other model for the construction of those vital nuclear power stations, but we should be aware that by going down this road we have deprived ourselves of a lot of investment that we might have had to build much greater nuclear capacity. That is a great mistake and we should look very critically at what the Government come up with in energy policy because, up till now, they have shown something very much less than the competence one would like to see.