Electricity Market (EAC Report)

Viscount Younger of Leckie Excerpts

Monday 17th July 2017 Lords Chamber

[Viscount Younger of Leckie (Con)]

My Lords, I thank the noble Lord, Lord Hollick, for his work as chairman of the Economic Affairs Committee, a position he stepped down from at the end of the last Parliament. This report of the last inquiry of his tenure gives much food for thought. It also provides evidence, should it be needed, of the value that your Lordships bring by providing a long-term perspective on the policy decisions of successive Governments. I also congratulate my noble friend Lord Forsyth on his appointment in taking over as the new chairman.

Many questions have been raised during this interesting debate, particularly from the noble Lord, Lord Grantchester. On the assumption that I cannot answer every question, I will certainly write to all noble Lords who have participated in the debate.

In January this year, the Government published the industrial strategy Green Paper, which identified three major challenges for energy policy. The first is to ensure that the shift to a low carbon economy is effected in a way that minimises the cost to UK businesses, taxpayers and consumers. The second is for the Government, working with the energy industries and regulators, to deliver the changes to energy infrastructure required in the transition to a low-carbon economy. The third challenge is to make sure that the UK capitalises on its strengths in the energy industries to win a substantial share of global markets.

The forthcoming emissions reduction plan, or clean growth plan, as it is also known, will set out how government will reduce emissions through the 2020s. We intend to publish that plan when Parliament sits again after the Summer Recess. The noble Lord, Lord Hollick, pushed me on who might lead the energy review, and Dieter Helm was mentioned. I understand that this was the result of a leak in the Guardian last week. The announcement is yet to be made, and it is with the Secretary of State at the moment.

On the debate at hand, we understand the concerns that the committee expresses, and the Government agree at least in part with a number of the solutions proposed. However, some important differences remain. To start, I will focus on some points where we agree. The committee agrees with the Government about the previous objectives of UK energy policy—namely, that we need secure energy supplies that are reliable, affordable and clean. The committee also recognises that these objectives are shared by many countries around the globe.

At this point I will say a word about Paris. I am sure many noble Lords will share the Prime Minister’s disappointment that the US Government have decided to pull out of the Paris agreement. Even so, following the G20 summit she reiterated that,

“The UK’s … commitment to the Paris agreement and tackling global climate change is as strong as ever”.


However, decarbonisation is only one consideration. The Government made clear in their Green Paper on industrial strategy the importance of security of supply. They also emphasised affordability for households and businesses and the need to secure the industrial opportunities of energy innovation. However, my right honourable friend Greg Clark, in the other place, in his oral evidence to the committee, said that getting the right balance between all the objectives can be like trying to solve simultaneous equations. The right reverend Prelate the Bishop of Chester conceded that the supply of electricity is a complex matter. How right he is. On the subject of complexity, I will comment on Hinkley Point C later on in my remarks, as that was a central theme that came out of this debate.

The committee thinks that successive Governments have not struck the right balance, and says this has led to two problems: insecurity of supply and high energy costs. First, I will give a short reflection on some history—I note that the noble Lord, Lord Hollick, eloquently set the scene in greater detail on this.

The committee’s report looks back to the liberalisation of the energy market, driven forward by my noble friend Lord Lawson of Blaby. It is argued that this change, with other factors, led to significant reductions in energy prices in the UK. However, old generating capacity was wearing out and not being replaced, and the world became increasingly concerned about the emissions of greenhouse gases. This led Governments to intervene in the market in the early 21st century, to bring forward new low-carbon plant and to address capacity concerns. The committee accepts that intervention in the liberalised market was necessary to address these issues—I hope that my noble friend Lord Forsyth recognises this, given his strong criticisms in his speech which centred on too much intervention in the energy sector. However, the committee thinks that the way in which Governments intervened was unhelpful. To address this situation, the report proposes five reforms. I will briefly comment on each in turn.

First, the committee proposes that we should reconsider the relative priorities of the three objectives of energy policy. Its report is concerned that the legally binding decarbonisation target for 2050 trumps the other two objectives. In its opinion,

“Security of supply should be the first and most important consideration in energy policy”,


and it says that,

“affordability should not be neglected in the pursuit of decarbonisation”.

Keeping the lights on is an extremely important issue, and the committee is absolutely right to raise it. But the Government do not agree that security of supply has fallen down their list of priorities. When appearing in front of the committee, the Secretary of State for BEIS said that security of supply is the “sine qua non”.

The committee argues forcefully that the lack of a long-term energy strategy over previous decades saw the planned closure of energy-generating capacity without its adequate replacement being secured. However, the Government are addressing that through the successful launch and operation of capacity auctions, as well as contracts for difference, which have brought renewable capacity at a lower cost. Over the past decade, we have seen renewables grow to provide nearly a quarter of the UK’s electricity generation, but the system has remained consistently reliable. National Grid has the tools it needs to manage the system and meet the highest reliability standard in Europe.

The capacity market is already securing the country’s electricity from 2017-18 through to 2020-21. Many noble Lords this evening have acknowledged the value of the capacity market. The noble Lord, Lord Burns, thought that it did not deliver long-term solutions, but we disagree with him. The capacity market auction in December 2016 saw around 3.4 gigawatts of new capacity, of which 1.5 gigawatts was new gas—for example, a new CCGT plant in King’s Lynn and a new OCGT plant in Spalding help to emphasise that.

National Grid’s winter outlook consultation, published on 15 June, gave an initial forecast that next winter’s derated electricity margin range would be an increase on previous years. The noble Lord, Lord Darling, raised a point about capacity margins being rather narrow, particularly on a cold winter’s day. However, National Grid’s latest winter outlook consultation, with next winter’s margin assessed at between 7.2% and 9.9%, is much higher than the low point of 5.1% for 2015-16. We believe that this shows the effectiveness of the capacity market mechanism.

The noble Baroness, Lady Bowles, asked how new capacity will come through the capacity market. She may know this, but I reassure her that new capacity is already coming forward through the capacity market in a variety of gas generators and other types of new capacity, including innovative new smart technologies, such as demand-side response and storage. This bears out our belief that the capacity market is the appropriate mechanism to ensure security of supply for this country.

If the Government are taking security of supply seriously, do we need to give affordability a higher priority? Like the committee, the Government believe strongly that energy should be affordable for both households and businesses. We have cut the cost of our green policies. For example, measures that we have taken to reduce the cost of the feed-in tariff will save between £380 million and £430 million a year by 2020. We are also helping industry to offset the costs of climate change and energy policies, with a substantial relief package in place for eligible energy-intensive industries.

Domestic and industrial efficiency is important as well, both to reduce costs and to decarbonise. A recent report from the independent Committee on Climate Change shows that energy-efficiency policies have offset the cost of energy policies and resulted in lower energy bills. The Government have a number of schemes to encourage energy efficiency in industry and business. For example, the climate change agreements scheme allows energy-intensive businesses to pay reduced rates of the climate change levy tax in exchange for signing up to energy efficiency or carbon reduction targets. We are working to implement regulations that will require all residential properties let from April 2018 to meet a minimum energy efficiency standard, helping keep energy costs lower for tenants.

The second proposed reform—recommendation 12 in the report—is that the Government should allow time for the development of innovative and more cost-effective technologies that will provide security and help us decarbonise by varying the required pace of emissions reductions. My noble friend Lord Forsyth asked whether the Government will alter the pace of decarbonisation targets. He may know that the Climate Change Act allows flexibilities to meet a carbon budget, including using international carbon credits or banking overachievement from one carbon budget to the next. The Government will set out in the forthcoming clean growth plan how they will decarbonise the UK economy in the 2020s.

Innovation will be a crucial part of bringing down the cost of clean technologies and maximising benefits for the UK. As well as the £500 million for low-carbon innovation announced at the spending review, last November the Prime Minister announced £4.7 billion of additional R&D funding, some of which will support our clean growth objectives.

The third proposed reform is that a neutral, fully competitive supply auction should be held for the supply of electricity. The noble Lords, Lord Darling and Lord Burns, and the right reverend Prelate the Bishop of Chester asked what the Government were doing about prices. I reassure the House that the Government are focused on reducing costs for consumers, and that is why we have announced a cost of energy review. We have reduced subsidies for renewals, and, for example, action has been taken to reduce the feed-in tariff, representing a saving of £5 on the average household electricity bill. The Committee on Climate Change has said that energy efficiency measures have more than offset the cost of energy policies.

The right reverend Prelate the Bishop of Chester and the noble Lord, Lord Burns, asked whether I lamented the lack of transparency in bills—I think that was the gist of the question. The Government recognise the importance for consumers of having regular, reliable data on the impact of policies on bills. The department will publish its latest estimates of the impacts on domestic bills in the near future.

There was a discussion on switching, involving the noble Lord, Lord Burns, and others, but I do not entirely agree with the comments made by the noble Baroness, Lady Bowles. Switching is an important mechanism to allow consumers greater choice and prices to come down. I agree that some fine-tuning is needed, because I understand the concept of somebody switching and then—funnily enough—the prices seem to change a short time after the switch. There are some issues that need to be addressed. This House has taken through a number of consumer initiatives in recent years, but I hope that a review of that side will continue.

The principle of using competitive processes to cut energy costs is one the Government and the committee agree upon. I understand the attractions of a technology-neutral approach to auctions, if the judicious use of research and development funding could level the playing field for innovative technologies. But this proposal would represent a big upheaval for the industry and for investors. We would need a strong reason to take such action, since we often hear that change creates investor uncertainty.

We have already discussed security of supply. The Government believe we have the right tools available to address the issue. The current “contracts for difference” system is driving down the costs of low-carbon generation. The 2015 allocation round saw cost reductions of around 20%, compared with the levels of support under the renewables obligation. The current and future rounds are expected to deliver even lower prices. The arguments that the committee made in relation to this proposed reform are thought-provoking. However, while we agree with the committee that the Government should facilitate the operation of a competitive market that cost-effectively delivers secure supplies of power and carbon reduction, we do not see that the case has yet been made to replace the current arrangements with something new and untried.

I recognise the passionate views that many noble Lords expressed about the Hinkley Point project, and I will do my best to answer their questions. However, I am sure the House will realise that that is a debate in itself, so I will not be able to answer them all. We are putting in place robust technical advice, monitoring, assurance and governance arrangements to track the progress of Hinkley, and are working closely with EDF to secure the benefit of such projects. The nuclear power sector has a most important role in decarbonising our society. The House will be aware that EDF is the lead investor in the Hinkley project and responsible for its funding and construction programme. We remain committed to providing secure, clean and affordable energy for the UK, and will consider advice and funding models for future nuclear projects, including Moorside.

The noble Lords, Lord Darling and Lord Kerr of Kinlochard, and my noble friend Lord Howell, among others, raised concerns about Hinkley and asked about a so-called plan B. If Hinkley is delayed the capacity market would be the primary mechanism to procure alternative capacity if it is required.

I have made some overarching comments about having robust arrangements in place for Hinkley but I would like to go further. My noble friend Lord Howell alluded to information being available to explain further secure arrangements for Hinkley. We believe there are good reasons to be confident about Hinkley’s delivery timescales but, as I said, the Government will ensure that the project is closely monitored and the capacity market provides a mechanism to make good any delays in Hinkley delivering its capacity, just as it does with other capacity risks.

The House will know that there are three other nuclear projects based on the same reactor technology as Hinkley Point C and currently subject to delays. However, there are good reasons to be more optimistic about the prospects for delivery of Hinkley Point C on schedule—that is, by 2025 and not 2027. Hinkley Point C is a different proposition. Lessons have been learned and many of the causes of delay to the earlier projects do not apply to Hinkley Point C. For example, much of the delay at Flamanville is due to changes in regulation and design during the construction phase, whereas Hinkley Point C has already gone through the UK regulator’s generic design assessment, which helps to minimise this risk.

There are also provisions within the contracts for difference that incentivise delivery. EDF will receive payment under the contract only once the plant begins generating. If commissioning takes longer than four years—that is, beyond 2029—the delay will start to eat into EDF’s 35-year contracts for difference. There is a long-stop date of 2033, after which the Government can choose to terminate contracts for difference. However, I say again that robust technical advice, monitoring and assurance in the governance arrangements are being put in place to give an early warning of any problems that may arise during the construction. I hope that helps. One could say more but we are short of time in this debate.

The fourth proposed reform is to establish a new independent body with a wide-ranging remit to monitor and advise on energy policy. The body would also have oversight of the technology-neutral auctions just mentioned. The committee’s rationale is in part based on the recommendation by the Competition and Markets Authority that Ofgem should have a formal route for commenting on government policy. The Government will be setting out our response to the CMA recommendations in due course. However, I know that the CMA does not recommend the establishment of a new body. The Government welcome advice from regulators and other bodies, including this committee, and always take their views into account. However, we are not convinced that a new energy commission is necessary to provide further advice.

The noble Lord, Lord Hollick, stated that we need a proper regulation of prices and a strong regulator in Ofgem. I can reassure him that Ofgem is already able, under its current powers, to comment on government policy, and Ofgem responded to the CMA that it will use those powers when appropriate. Given that we do not believe a new system of technology-neutral auctions is necessary, nor do we believe a new body is needed to provide oversight. There is no agreement there.

The fifth and final proposed reform is that there should be more and better co-ordinated funding for research and development. The committee proposed that funding should be directed to enable new technologies to deploy on a commercial scale and that a new national energy research centre should be established, and that proposal was raised this evening. We understand the committee’s argument in this regard. The UK’s research and innovation system is world-leading. The Government are funding a number of programmes in energy R&D. Organisations such as the catapults, including the energy systems and offshore renewable energy catapults, are working closely with industry to make a real difference to developing critical innovations in the energy sector.

However, we are in the process of making it even better. On 1 April 2018 we are establishing a single strategic research and innovation funding body called UKRI—UK Research and Innovation. As I said in winding up on the Second Reading of the Higher Education and Research Bill, we should be proud of the UK’s standing as a world leader in R&I. I believe R&I will provide the cohesive and cross-disciplinary leadership needed to maximise international collaboration through the research system.

Beyond the co-ordination of strategic oversight, the committee wanted more money spent on R&D. To remind your Lordships, in the 2016 Autumn Statement we announcement the investment of an extra £4.7 billion a year in R&D by 2021. An example of a new initiative created through this uplift is the Industrial Strategy Challenge Fund, a new challenge-led fund to support collaborations between business and the UK’s science base. The first wave of this fund’s investment will be spent across six key challenge areas, including £246 million for clean energy in 2017-18. This will include a Faraday challenge to develop world-leading batteries that are designed and manufactured in the UK to exploit the industrial opportunity of vehicle electrification. I know Faraday was raised by a number of speakers and I hope that answers some questions.

I realise that time is running out. I conclude by paying tribute once again to the work undertaken by the committee and its advisers. We have read the report thoroughly and taken careful note of it. A number of areas, such as the importance of security of supply and the value of better co-ordinated research and development, show that there is much common ground between the committee and the Government. We are committed to tackling climate change, but I assure the House that we are taking steps to bring down costs, to capitalise on industrial opportunities and, as I said, the sine qua non of continuing to secure our energy supplies.