Oral evidence - The Economics of UK Energy Policy

Mr Rupert Darwall, Dr David Clarke and Professor Michael Grubb.

Q40 The Chairman: Gentlemen, good afternoon. Welcome to the inquiry on energy policy. I am sure you have been following closely the witnesses we have had before us, and we have a number of questions arising from what we have heard to date. Perhaps I can start off with a rather more general question. The Government have three objectives: decarbonisation, security of supply and competitively priced energy. How well do you think the current energy policy is achieving those three objectives?

Mr Rupert Darwall: The short answer is that it is doing absolutely terribly. One word that is used the whole time in this debate is “secure”, which is a politically ambidextrous term first injected into this debate some time ago by Lord Mandelson when there was a question of coal closures. The argument then was that to have security of supply we needed to keep coal fields open. One needs to distinguish security, which I looked up in the dictionary—“The condition of being free from or not exposed to danger”—and safety from the concept of reliability, which is a different concept: “The quality of being reliable; in which reliance and confidence may be put”. I put it to you that, if you want a cheap, reliable energy supply, you would not have any renewables at all, or very little.

Dr David Clarke: It is very difficult to give a single uniform answer across all those three things without saying “not very well”. If we looked at individual elements, we might give a slightly different answer. On the security side, Rupert is absolutely right that there should be a distinction between security of supply and reliability of supply. If you look at that, you would say that is the paramount position. Broadly speaking, today—I stress today—the position looks reasonably okay; a year ahead, I might say something slightly different. If we look at the cost position, in the context of a low-carbon energy system, it does not look too ridiculous today, but there is some debate about what you might see going forward. If we look at the low-carbon objective, we are on track today for what we think we need to do in the context of UK energy targets to 2050, but there are major question marks over whether that is sustainable for the next period and through the fifth carbon budget. You have to be very careful about giving a one-size-fits-all answer across those three things without getting into the detail, but clearly they all link together. Overall, we would have to say the answer is that today, which I stress, it is just about okay.

The Chairman: Are you saying, “So far so good, but trouble ahead”?

Dr David Clarke: You can put those words in my mouth, yes, or at least the risk of trouble ahead.

The Chairman: Let us explore that as we turn to Professor Grubb.

Professor Michael Grubb: Energy policy is a large field and I will confine myself to electricity supply, and touch on end use. On electricity, particularly the energy market reform, I point to four fundamental characteristics. One is some use of a classical market instrument in the form of the carbon price floor, which is intended to generate the most efficient response from the market, subject to political feasibility. Then there is cost transparency through the auctions on both renewables and capacity. There is capital cost efficiency. We have seen the cost of capital on 15‑year contracts going down to not much more than three percentage points. That is among the most efficient in the world for financing capital-intensive investment. Finally, there are competitive pressures on cost reductions through the auctions.

I have submitted some supplementary evidence that contains data on the trends of renewable energy costs. They appear almost to have halved in the past few years, partly as a result of competitive pressures. That’s been achieved alongside, I am aware, five years of headlines about the lights going out, but they have not actually flickered, at least not from shortage of overall capacity. I certainly do not find things as bleak as Rupert.

On energy efficiency, I would be much less supportive. There have been some quite unfortunate developments around energy efficiency.

The Chairman: A number of witnesses said to us that the subsidies to assist the introduction of renewables have pushed up prices to the disadvantage of consumers, particularly those who are less well off. That has been seen as a failure in the system to date. Would you agree with that, Mr Darwall?

Mr Rupert Darwall: That is the finding of the Competition and Markets Authority. I do not think anyone disagrees that renewables are an extremely expensive way of decarbonising an economy. When the commitment was first taken on, it was acknowledged that it was more constraining than the carbon reduction targets; in other words, there are more efficient ways of reducing carbon dioxide emissions, but renewables have pride of place. That causes immense problems, because there is an overt subsidy to renewables, which Professor Grubb mentioned, but the big problem is the iceberg under the water in the form of the hidden costs of renewables. We still do not know how big that cost will be. To give an idea, the German CDU Environment Minister said in 2013 or 2014 that the cost of German energy transition would be up to €1 trillion. Those are not trivial sums of money.

Lord Turnbull: Can you tell us what form the hidden costs take?

Mr Rupert Darwall: The main one is the cost of intermittency, which means that because renewables—wind and solar—have a very different cost structure from conventional forms of generation, they have very high fixed costs and negligible marginal costs. That means that when the wind blows and the sun shines they flood the wholesale market with near zero-cost power, but the weather risk, the intermittency risk, because they have prior access, is transferred to the rest of the system. It is transferred to dispatchable generators, gas and coal-fired generators, which has made it increasingly difficult to get that capacity renewed. One of the big problems the Government still have not sorted out is how to get a new generation of gas-fired power stations in this country. The other aspect of the hidden subsidy is that because it is hidden we do not know the most efficient way of bringing on low-carbon capacity. For example, carbon capture and storage is disadvantaged, in that it does not benefit from the vast hidden subsidy represented by intermittency.

Q41 Lord Sharkey: In its report, the NAO mentioned that the levy control framework, which caps the renewable subsidy in 2020 at £7.6 billion, is on current form likely to be exceeded by £1 billion, so it will go up to nearly £9 billion in 2020. Why is that? Who has control over that measure?

Professor Michael Grubb: The first and simplest answer to the breaching of the levy control framework is that the response to the policies was stronger than expected. We now have more than 10 gigawatts of solar, when the cost projections were that we would get 1.5 gigawatts by about this time. If you get a massively bigger response than you expect, the volume of cost is bigger. It is now clear that in the electricity sector we will be delivering more renewables than the Government planned for or expected by 2020. That is why the levy control framework will almost certainly be breached.

To pick up this core economics point, Rupert said that everyone agrees that renewables were a very costly way of doing it. That would be everyone minus one at least. We know that most strategies involve decarbonising the power sector. We have made very little progress so far on CCS. We can discuss nuclear costs later. The key issue on renewables has been whether the strategy will generate cost reductions. That is why in my evidence I was at some pains to put together the best data I could find on the trends of costs and the most recent costs available. They have certainly come down very substantially. We can explore those numbers and what they mean.

On the back-up point, there is huge misunderstanding. You have to understand what the roles and types of back‑ups are. If you are worried about how to provide power during winter periods when there is a cold dark windless night, you do not want to build a spanking new plant designed to run 100% of the time; you build something that is cheap to construct and expensive to run. The capital cost—again, I have put the data in my submission—may add around 10%. That is for new construction and not without resorting to a lot of existing infrastructure—CHP and existing physical generating plant. You would not expect the cost of back-up to add more than about 10% for renewables. The UK Energy Research Centre did a major review, and Aurora produced a report a couple of weeks ago. All broadly confirmed that estimate. The cost of balancing the system is certainly less than £10 per megawatt hour, and it is probably of the order of 10% or less of the investment cost of renewables.

The Chairman: Sticking with the data, we have had conflicting evidence about the costs of the subsidies and various energy sources into the grid. Is a central database kept? Does the keeper of the flame of that information, as it were, also pass opinion as to whether the three objectives we talked about at the beginning are being met? In other words, who is the umpire?

Professor Michael Grubb: There is no umpire. The best single source is probably the International Energy Agency, which tracks the costs, but, as I flagged, in the way we present the data the costs are incredibly divergent. A major reason for that is the perceived political and policy risk in different regions, which is probably even more important than differences in resource endowments. Even within Europe, comparing Germany with the UK, where we have had a weighted average cost of capital close to 3%, and Greece, at 20%, creates a massive difference in the installed cost. When we are dealing with capital-intensive sources, cost is quite sensitive to perceived investment risk of various sorts.

Q42 Lord Layard: Could we move on to the detail of the system of subsidies and support for renewables? Do you think that needs changing, and how?

Mr Rupert Darwall: The previous climate and energy Secretary, Amber Rudd, made a very important speech in November and I think it should be the cardinal point of policy going forward. She said, “In the same way generators should pay the cost of pollution, we also want intermittent generators to be responsible for the pressures they add to the system when the wind does not blow or the sun does not shine. Only when different technologies face their full costs can we achieve a more competitive market”. It seems to me that the goal is to make the subsidies transparent; that the technology creating cost—the cost-causing technology—bears the cost of that; and that you do not pick and choose between technologies. You subsidise the carbon dioxide abated, not the particular technology.

Dr David Clarke: That is absolutely right. The challenge at the moment is that most of the subsidies, if not all, are based on a single measure, normally the levelised cost of electricity if it is the power sector, and that gives a completely false viewpoint because it does not take account of intermittency. We need to look at it from the subsidy perspective and find a mechanism that allows us to step up a level and look at the true cost and, therefore, the true incentive we should be looking for. Pounds per tonne of CO2 abated seems like a sensible measure, as it goes to the top level of the tree.

Professor Michael Grubb: I agree in principle, but with one quite important caveat. I know Dieter Helm has suggested unified contract structures through the capacity market, including renewables—requiring renewables to pay for their own back-up, so to speak. The difficulty is that the back‑up is a system property. If each intermittent source has to pay for its own back‑up, we end up with a system with a vast amount of overcapacity and redundancy. It is like saying we should pay for all the capacity required for everybody to put on their electric kettle at the same time. It is an economically ridiculous proposition. We have to devise a way in which the plants face the costs they are adding to the system, but not chop it up so that each wind turbine has to pay individually for vastly excess capacity.

On your specific question about reforms, I would flag two particular ones with some urgency. The first is that the capacity mechanism was designed to try to support CCGTs, in which it is not succeeding particularly well, but it is certainly not succeeding regarding demand-side response. There are major structural reasons for that. Either the capacity mechanism needs to be fixed seriously with respect to the demand side or there needs to be a separate mechanism for distributed resource providers—storage, demand flexibility and so on. The other area is that if we look some distance ahead, by 2030 or beyond we may get to a point at which the various technologies receiving CFD supports are fulfilling all the demand needed. At that point we have to worry about how the system behaves, and there is a risk that the most subsidised source pushes the others out of the system. It is not desperately urgent, but I think that deserves attention.

Then there is the much more thorny issue that sources need to face the full-time and space variability of system costs. To the extent that we can do that through the wholesale market, it would be highly desirable. There are ways of getting closer to it, but that is not a trivial question.

Lord Sharkey: I think you are saying that there are mechanisms for assigning a proper time and space variability cost to intermittent sources.

Professor Michael Grubb: The dilemma we have to face is that the simplest way of getting that is to have a spot price, which we have, based on locational marginal pricing, or what an economist would call LMP. We do not have that. In roles I have had it is clear that the ability to introduce that is quite limited. It is a very complicated system; it is not one we have at present. It would be desirable if we moved towards that. Regionalisation of pricing would be desirable. Temporal distribution of wholesale costs, whereby prices are higher in winter than in summer, we already have through the spot market. The difficulty in part is that the spot market on its own is insufficient to support any investment, whether in renewables or others, so it is a partial reflection of those costs.

Lord Sharkey: But the scheme Mr Darwall was talking about relies on being able to assign those costs in an agreed way, does it not?

Professor Michael Grubb: Doing it fully is an urgent task to study, but I do not see it coming about in a hurry.

Mr Rupert Darwall: When the CEGB was broken up and privatised at the end of the 1980s, one of the most incredible achievements was the creation of the pool, the wholesale market. It took a lot of brain power to do that, and it worked. Sure, there is more complexity with intermittent renewables on the grid, but the idea that we have regressed and cannot do that now is a bit pessimistic. The problem with policy has been that when you set a target for 20% renewables, or whatever, the system says it is going to bury the costs and achieve the target at whatever cost. Ofgem and the Department decided to socialise the extra grid reinforcement costs of renewables, so they took absolutely the wrong direction. It is a question of rowing back on that, unpicking it and exposing the costs.

Dr David Clarke: We have to be very careful on this issue. Taking the two viewpoints you have just heard, it would be relatively easy to say that in the power sector we can probably work out how to answer this question, but the problem is that, looking ahead, the power sector is not the thing we have to worry about most. We have to worry about heat and how that comes in in the same way, because the system will become increasingly integrated. Today, they are to all intents and purposes completely separate, so the challenge very quickly becomes not just how we used to do it in the power sector and how we might do it, but how we allocate for low-carbon heating, when it might be electric; it might be a low-carbon gas; it could be a zero-carbon gas; it could be a heat network fuelled by all sorts of mechanisms; or it could be biomass. That is the challenge we have to wrestle with and recognise looking forward. When I said that the risks were increasing, or whatever phrase you want to use, the issue is how we handle heat in the future. Looking ahead, we have about 10 years to work out how to do it.

Q43 Lord Burns: Your point about everyone turning on their kettles at the same time brings to my mind the fact that demand already creates a great deal of variability. Some of it is predictable; some is not. If we are thinking of the concept of demand minus the intermittent supply, to what extent has that increased the variability and unexpected nature of it? It seems to me that this is a problem inherent in the system anyway, because of summer and winter, night and day and hour by hour. Rupert is making the point that there is a great cost attached to these intermittent sources, but I do not have a feeling of how great that is relative to the already existing variability we are dealing with and the problem that generation has.

Dr David Clarke: Sticking with the power sector, at the moment demand will be going up and down, in an extreme case, by about 30% over night and day. All the analysis from a whole range of groups, including mine at the ETI, the Royal Academy of Engineering, the UK Energy Research Centre and the Committee on Climate Change, concludes that we need about 15 gigawatts. Some people say it is a little less and some say it is a little bit more, but it is in the space of 15 gigawatts of baseload generation to maintain stability and reliability—to take the earlier point—in the system.

Lord Burns: That is without these intermittent sources.

Dr David Clarke: That is baseload that is always there. For the sake of argument, it is nuclear; it is on. We need that kind of background baseload. On top of that, UK demand is fluctuating—35, 45 gigawatts, depending on the time of year and so on; it is that kind of ratio, roughly. It is handleable, provided we have the baseload.

Lord Burns: I am trying to get an idea of the extent to which these intermittent sources are making the problem worse. Rupert is arguing that they do and that therefore a hidden subsidy is involved.

Professor Michael Grubb: To make one point about our earlier discussion, the pool was a good design. The offshore generators pay for their transmission connections, but transmission charges are more complicated. There has been some progress on locational transmission charges, but again it is probably not fully cost reflective.

On your question, the mathematician’s answer would be that you get two randomly varying sources and the total variability is the sum of the squares, which, roughly translated, means that at the moment most of the renewable fluctuations are fairly well drowned out by the load fluctuations, but that would not be the case once renewables were supplying 35% of electricity demand, which is what is projected for the 2020s. At that point, variability of the renewables starts to overtake, at least in certain important ways. That is the point at which we have to look at the various back‑up costs that I indicated, including the regulatory costs where we probably have more technological options coming in than just having 15 gigawatts of baseload that cannot move; but that is another thing.

Dr David Clarke: In time, and we do not have much time. That is the problem.

Q44 Lord Tugendhat: Can I ask a double-headed question? Do you think that the Government should have given the go-ahead to Hinkley Point? To add to that, if you had been in the position of the new Prime Minister when she came in, with all the water that has passed under the bridge, would you have given the go-ahead to Hinkley Point? Those are two questions in one.

Dr David Clarke: Yes, the reason being that there are a number of things around Hinkley Point. First, taking the points we talked about a second ago, we need baseload capacity in the future. I agree with Professor Grubb’s statement that there are options emerging other than big plant, but they will not emerge and be implemented in the UK desperately quickly. We are always assured by everybody, whether it is government or anybody in the commercial sector, that the number one requirement is reliability of supply: the lights go on when you press the switch, power comes out of the wall and it does not trip and damage computers, manufacturing systems or whatever. If we want reliability in the next 15 years, we need baseload capacity built, and we need to build it reasonably quickly. There is a piece about baseload.

The second reason is that in a low‑carbon world virtually every scenario, including all the work we have done, says that nuclear is an important part of a cost-effective system in a UK context. In that part, we can argue about whether Hinkley specifically is the right thing, or whether new nuclear specifically is the right thing, but from my point of view we need to get moving on a nuclear build programme to develop and maintain the skills base such that we can roll out subsequent plants. Irrespective of the exact plant design, whether it is a big plant or a small modular reactor, we need the skills base to do it. In particular, we need to get the skills base and capacity into the regulator. That is the crux. Irrespective of where in the world you get your machines from in the world, you need a UK regulator to carry out design approvals. Work we have just done in ETI shows that, if we start next year, we can have the first-of-a-kind small modular reactor on the stocks just in operation by 2030, but the rate-determining step in that is the regulatory process. It just highlights that, if you start rolling out multiple designs of nuclear plant over a period of time, you need capacity in your skills base and regulator to be able to do it. For all those reasons, before we come to the economics, Hinkley was the right decision to make. We have to move on nuclear.

Professor Michael Grubb: I venture to disagree with the first part of the answer. I was part of the UK Committee on Climate Change in 2008 and 2010 which recommended that the country should have a new generation of nuclear power, but one or two of you may have seen that I published a letter in the Financial Times in July saying that I felt that times and conditions had substantially changed. The cost increases for Hinkley are a major factor, but that is also set against the cost reductions in renewables. In my view, renewables are now clearly cheaper. Committing to a 35-year contract at that level was economically inappropriate; it was an uneconomic proposition.

However, I appreciate that other factors may have driven the final decision. There was a lot locked in. There could have been liabilities of over £1 billion to cancel. I am not saying that I know exactly whether they took the right or wrong decision in all the circumstances, but I do not think history will put that decision in a good light.

Mr Rupert Darwall: I agree with Professor Grubb about Hinkley. It was the wrong decision. First, when the chief financial officer of a French parastatal resigns because he thinks a megaproject will bomb, that is about the biggest red flag you can see, short of a market crash. That was what happened with the chief financial officer of EDF.

The second point is that, if the Government really want this, I submit that they should pay for it. They should not ask electricity consumers to pay for it. We are basically paying a lot of money to hire very expensive capital—we do not know how much it costs—from the Government of China. If the state wants it, put it on the state’s balance sheet. It is more efficient, because the cost of capital is lower; it is more equitable, because taxation is progressive and electricity bills are regressive; and it is accountable. We talked before about the levy control framework and all that sort of thing. The problem with this sector is that there is very weak accountability. Put it on the Government’s balance sheet.

Lord Tugendhat: Could I follow up with two questions? Would you like to give an estimate, between one and 10, as to whether it will come on stream at the right time, or by how much it will be delayed? We are not just putting a lot of money on a technology and on two partners, but given the level of uncertainty as to when this will actually come in because of what is happening to the other plants, what would you say is the probability that it will come in on time, or within a year or two of time, or that we will have to fill a great gap?

Dr David Clarke: From an engineering perspective, the answer is that it is probably better than a seven. Does that worry me as an engineer? It ought to be better. Does it worry me as a taxpayer in the UK? I am not paying the bill, so it does not. You can argue about whether it is a good or bad deal, but I think it was a deal done to manage risk and in that context it is what it is.

Lord Sharkey: In what sense are you as the taxpayer not paying the bill?

Dr David Clarke: The whole point Rupert raised was that, in the structure of the deal, the money is coming from private sector systems.

Lord Sharkey: What about the consequences for electricity bills?

Dr David Clarke: That is later. If it comes in late or not at all, it does not get paid.

Lord Turnbull: What about the cost of replacing it, which we may not have planned for?

Dr David Clarke: For capacity, to go back to what I said earlier, we have to build plant irrespective of Hinkley Point or any particular machine. We need of the order of 10 to 15 gigawatts of strong baseload by the end of the next decade, which means we have to build a lot more than just Hinkley Point. We need to build gas plant with carbon capture and storage, and we need to get moving on that. To my mind, it is almost irrelevant to look at any one project. We have to look at the package we need to deliver for the UK, and it is a lot more than just that.

Lord Sharkey: That is especially true if one project has a rating of seven.

The Chairman: Is there any advance on seven?

Mr Rupert Darwall: It seems to me that the project was born under an evil star.

The Chairman: What you are saying is that we have to take out an insurance policy, which will be very expensive.

Dr David Clarke: It is not going to be very expensive. I do not think you should view this as an insurance policy. There is an energy system that the UK needs for the future, and right now if we do not do anything it will not exist. The lights will not come on; the heating will not come on in winter; and we will have all sorts of issues around fuel poverty, health and economic problems, so the answer is that we need to build, within reason, a new energy system for the UK, and we have about 15 years to do it. We have to deal with the whole package. It is not a little problem, I admit.

Lord Tugendhat: I am not arguing against the decision, although you might think I am; I am trying to get an understanding of it. If I understand what you are saying and your colleagues think, it is that we are locked into this very high-cost project. That is point one. Point two is that there is a sufficient degree of uncertainty about when it will come on stream, and, indeed, if it will come on stream, that the corollary of going ahead with the project is that we also have to spend a great deal of money on an insurance policy to make sure that we are not left high and dry in the event of its not coming in when we want it to. We are having a double hit.

Dr David Clarke: I go back to what I said a second ago. If we build just this, we have failed. It is not an insurance policy in case this does not work; it is part of a very big solution. If it does not work, what would be my immediate alternative? I would want a 3 gigawatt gas plant with carbon capture and storage based on the North Sea, either on Teesside or Humberside, and it could be going in about the same time. That would be a solution.

Professor Michael Grubb: I think the original question was really about nuclear engineering and EDF project management, so I do not consider myself qualified to answer it, but if David’s view is that there might be a 30% chance of its not delivering, my view is that if we knew now, we would not have a security problem; we would have plenty of time to address that. If we discover in the early 2020s that it is not going to deliver, maybe we will have a problem, so the 30% would worry me.

Q45 Lord Livermore: I want to ask about future technology. First, do you believe that current government policy takes sufficient account of new technology and changing market conditions? Secondly, do you believe the Government are currently investing enough in R&D?

Professor Michael Grubb: I would like to see the Government investing more in R&D, but I think that the design we have, particularly the use of competitive auctions, is proving a good way of keeping up with the pace of technologies in the established areas. Storage requires particular attention as regards policy design and market design. There tends to be a caricature about existing technology not being very good and new technologies being wonderful. One thing I have observed in my career is that the most popular technologies are always the ones you have never tried to deploy at scale yet.

I was very struck by Dieter Helm’s evidence to this Committee. He said, “I make a very strong distinction between future renewables, which have enormous potential, and devoting so many billions of resources to the current renewables, which in their current state cannot make much difference to global warming and climate change”. I just do not understand that statement. I do not think the laws of physics are likely to change. It is a physical fact that renewable resources are dominated by solar and wind. Wind turbines are now operating very close to the limit of their theoretical potential, so improvements are going to come through cost reductions rather than by magically increasing the amount you get per swept area. Solar may improve a little more. It is a sort of caricature. What technologies is Dieter referring to? I would love to know, but I do not have a clue. It seems to me that it is in storage and in material science. There we may get good progress, for example, maybe in modular nuclear, but to my mind the real significance is that within the last five years, arguably even the last three, we have reached the point where renewables will do precisely what Dieter claims they cannot.

Mr Rupert Darwall: Professor Grubb mentioned costs coming down. The whole concept of levelised cost is not the right one. It is a very misleading one in this sector, for reasons given by Professor Joskow in a very important paper in 2008. What matters in electricity in this sector is value. When demand is required, you have to produce it; it has to be produced at a particular moment in time, and the variability of price in the wholesale market is huge. We have to look at value, not cost. Whatever the fantastic improvements of wind and solar, they respond to the weather; they do not respond to demand. It is a form of agriculture. When the sun shines and the wind blows, you get more of the stuff. It is not an industrial form of generation where you put in more inputs and you know precisely what outputs you will get. That is the fundamental problem with relying on wind and solar.

Responsiveness to technology is a problem when there is a government-run system. It becomes very unresponsive. It gets swept by the technology du jour, if you like. If you want a responsive system, you have a market. A market would respond to changes in input prices, particularly the falling price of gas and, before that, coal. Because we are locked into a top-down system where the state progressively decides the more and more of the generating mix, we miss out on changes in market prices.

Dr David Clarke: From an engineering perspective, which is my job, the answer to your question is probably slightly more nuanced. You ask whether there is enough R&D and what are the future technologies. There are lots of technology developments going on around the world, many of which will be more or less applicable in the UK context, whether in wind, solar, appliance efficiency improvements, home energy management systems, small modular reactors, better vehicle efficiency or low-carbon heating systems. Myriad developments are going on.

There are a number of points to recognise. One is that all those things will be available somewhere in the world. We then have to look very carefully at which ones are applicable in the UK context, because not all of them will be. We did a piece of work on solar. We took an extreme view of the world where solar is free—by magic, there it is and it generates. The conclusion we came to was that we could implement a UK system heavily based on solar. We cannot have just solar; at the very least we need storage alongside and so on. We worked out that even with 15 gigawatts of core baseload, and with offshore wind in the mix, we would probably have about 80 gigawatts of solar in the UK. If we want to run low-carbon heating from solar as well, it jumps to about 140 gigawatts of capacity. To manage the storage issues, we would all—every man, woman and child in Britain—need a 40-foot shipping container full of batteries. That is the scale of the challenge. All these things will be available, but some are more or less applicable in the UK context. That is the second thing.

The third thing goes to your R&D point; you asked whether enough R&D is being funded. You have to look at research, development and then demonstration and commercialisation. There is a lot of funding for research. Whether it is in the UK or elsewhere in the world does not really matter, because at the research stage things tend to be fairly generic. We then step into the development stage where we move towards industrialisation. Suddenly, the private sector will look at it as a risk proposition versus other opportunities for investment. I used to run R&D for Rolls-Royce, so that was my business. Once we get into that space the question very quickly becomes whether it is applicable to a UK market or another market and so on. There is a drop-off in terms of willingness to invest for all those reasons and because there are other opportunities.

When you get to first-of-a-kind commercialisation you are in real trouble. It is the valley of death, as it will always be called. For almost any technology, even something small that goes into a house, the up-front capital cost to develop it might not be very much—it might be a few million—but the risk of implementing it starts to escalate very quickly if suddenly there is a problem; for example, if there are 10 million of the things in people’s houses causing problems. There is a piece for even small-scale technologies about the risk of commercialisation, and in the big-scale technologies the first of a kind costs hundreds of millions. Very few companies will put that on the line unless they can see a global market where they can exploit that capability and get a return.

The answer to your point is that research is more or less good; the development piece is tough but handleable with focus; and the kind of policy positions we have seen from the UK Government have been reasonably supportive in the right areas. Once you get into the commercialisation space it is really difficult, almost impossible. Carbon capture and storage in the UK is a very good example. We have had multiple attempts, and they have all fallen over. We have to find a mechanism with CCS. Looking around the world, the technology is more or less established as a bag of opportunities. We have to find a way of implementing that in the UK with a model that delivers early commercial return; otherwise, the private sector will not get involved. Right now, the private sector does not trust the UK Government around CCS—whether government funding is committed. First-of-a-kind commercialisation is a particular challenge. I do not mind the scale of it, whether it is small devices, and there are millions of them, or a one-off, first-of-a-kind big plant. That is the engineering and investment problem.

Q46 Lord Layard: To follow that up, obviously there is incremental R&D but there is R&D that involves a bigger leap and is a more disruptive technology, which may eventually solve the problems we face with climate change. I would very much like to know what you think about the organisation of the publicly funded part, which is the part that is justified, in the sense that it can take on risks that the private sector will not take on and, therefore, is more into the business of the big leap-type progress rather than small increments. Are we organised well at all in Britain for doing these things? The problem is that in one sense a substantial proportion of blue sky research is bound to fail. On the other hand, somebody has to co‑ordinate how the money gets spent. Britain is one of the leading scientific countries in the world, and if we get in first with one of these disruptive technologies we will benefit a lot. Do you feel there is the leadership in our system of governance for research funding that will deliver what we need?

Professor Michael Grubb: David may be better placed at the R&D end per se. I would not be alone as an analyst in saying that Britain seems to have a problem with the effective commercialisation of its intellectual brilliance. Personally, I trace that slightly to the sense that we have always struggled with the economics of innovation. Economics does not have terribly good theories of innovation. In energy, reasons have been articulated as to why it is a particularly long, costly and risky road from idea to fully deployed commercialised viable industry. The Government have to be engaged in that if they are to make commercial success from the inventions, but maybe partly for cultural reasons the UK has been much more reluctant to do that. It has had notable successes. In the 1970s, the offshore oil industry started with some quite far-sighted initial capital outlay from government, and when it was starting to get to the really expensive stage it was partly rescued by the oil shocks. In offshore wind, we are looking at a very similar kind of gamble, where there is a very high-cost phase that has to be gone through. The evidence is that we have got through it, but it was not cheap. Let us be clear about that.

I am not sure that I am entirely answering the question, but classically Britain has struggled in precisely what analysts in this field call the technology valley of death. It is relatively cheap to do R&D and it is nice to deploy fully commercialised technologies, but the bit in the middle is expensive and risky, and there are varied attitudes and willingness to see that through, because it will involve some failures.

Dr David Clarke: That is the whole point. You get to the valley of death, and in simplistic terms it is very difficult for a private sector commercial investor to see a case for investing unless there is a guaranteed market somewhere, whether it is in this country or elsewhere. You will always wrestle with the challenge of getting through that valley, and that is the critical piece where government support comes in. The reality is that government clearly need to be able to justify investment at that scale, because it will not be peanuts; it could be potentially hundreds of millions, certainly many tens of millions, to capitalise private sector investment. If the Government are to invest in that, they need to be able to justify it. You need to be able to argue the benefit case at a much higher level than just £X per megawatt hour and saying, “I must have a contract in advance for a CFD; otherwise, I will not do it”.

We very quickly get to how to analyse the energy system and work out the real value of a particular technology, whether it is nuclear, CCS or a home energy management system in 20 million homes to help efficiency. We have to be able to analyse at that level how it plays out across power, heat and industrial infrastructure. What is the benefit? At that point, hopefully, there will be a mechanism that gives government the transparency and justification to put a lot of funds into a risky venture.

Q47 Lord Kerr of Kinlochard: I want to ask two engineering questions, probably of Dr Clarke. I am not an engineer so do not worry, but I should declare an interest as a director of a power company.

First, how worried should we be about capacity margin? Supposing we get an anticyclone in January with a cold snap and low wind, how large is the risk that the lights go out this winter or the following winter, and how big is the premium we are paying companies against that risk to shut down and invest in disaggregated polluting diesel capacity? The second question is also linked to capacity margin. Do we have a black start problem? I read with interest a paper a year ago from the RAE. It does not talk about that issue. Suppose we get a storm, an accident or a cyberattack and the system goes down. When there is less coal and capacity in the system and we are not building the CCGTs that we should be building, how long is it going to take the system to get back up again? Interconnectors, as I understand it, have no particular value in that context. It is a two-part question: lights going out and black start. Is it a problem?

Dr David Clarke: I class the lights going out as unlikely. Clearly, it is not impossible on a local scale, but the measures National Grid has put in place and the developments around capacity market over the past 12 months and so on will aid the solution to that problem. The capacity margin piece, for the near term, looks acceptable.

Lord Kerr of Kinlochard: Is that partly because we are paying companies to agree to shut down?

Dr David Clarke: Yes.

Lord Kerr of Kinlochard: How much are we paying?

Dr David Clarke: I do not know the answer to the pricing piece. One of these gentlemen might be able to answer that. On your point about black start, there are measures in place to manage that situation if it arose. It feels unlikely at this stage that it would, but it is difficult to say never about these things, particularly in a world of maliciousness, as you imply, in relation to cybersecurity and so on, but it is not something that keeps me awake at night.

Lord Kerr of Kinlochard: Presumably, the risk is rising as we phase out quick-start generating capacity.

Dr David Clarke: You mentioned diesels. There is an awful lot of small-scale power generation on the system that forms part of the black start capability to kick things off. The very big plants have on-site capacity to help with that position. There are small plants to get the bigger plant running.

Professor Michael Grubb: To what extent is capacity margin a concern? I would say moderately, but no panic. As David said, we can paint scenarios in which there is some trouble, but I do not think it would extend to domestic lights going out. The system has a lot more reserve options than the headlines tend to make out, and I suspect we could bore you at great length about what those are. As to what they cost, it is quite hard to put easy numbers to them. The cost of the capacity mechanism at the last couple of auctions was just under £20 per kilowatt per year, which in some senses is a relatively and surprisingly small number; it is smaller than expected. It still amounts to an overall transfer payment of about £1 billion, because all the generators are paid the same amount for capacity.

On payments for demand-side response of various sorts, at the end of the day it is a commercial decision. If a company feels that it does not need to use its factory 100% of the time to produce products, and it can make money out of rescheduling when it produces, on the whole it tends to be extremely pleased to do that. I would be reluctant to cite numbers, but clearly a few tens of millions have been paid for such contracts overall and, compared with the overall costs of actually building stuff, that is a pretty good deal.

My overall remark is that if we design policy in a sufficiently smart way—the competitive auctions under EMR are probably close enough for the present—back-up is pretty cheap, but we need continual review and further smartening of policy over time.

Q48 Baroness Wheatcroft: If possible, I would like to learn a little more from you about small modular reactors. Dr Clarke said that we might manage to have a small modular reactor working by 2030. I understand that there may be problems with commercialisation. Given that there are already small modular reactors in universities and so on, why could it not be done faster? If the problem is commercialisation, why is 2030 a possibility and not 2025?

Dr David Clarke: I can give two brief answers. One is that if it is in a university it will be classed as an ultra-small modular reactor, which will probably have little use in the commercial world. The machines people are talking about in the main are somewhere in the 100 to 400 megawatt bracket, and paralleling multiple machines on a site gives you a bigger capacity if you want to do that. That is the scale of unit we are talking about. The reactor would probably fit into a couple of shipping containers, with a bit of ancillary equipment. There is quite a balance of plant—turbine generating sets and so on—that sits around it, so the whole unit would not fit into this room, for instance, by the time it was finished. They are relatively small but not minuscule; they are not tiny things, but they are an awful lot smaller than a Hinkley Point-type reactor.

Baroness Wheatcroft: Could they be smaller?

Dr David Clarke: You get to a point where you run into the law of diminishing returns on economics that says that, if you go very, very small, you have all the issues around the plant that sits around it and you get below a threshold. People are looking at 50 megawatt units. I am not aware of anybody looking seriously at anything smaller than that in a commercial sense.

Baroness Wheatcroft: And why 2030?

Dr David Clarke: That is driven by a number of things. There are a number of reactors in either near-prototype or design from around the world. The major rate-determining step is regulatory approval in the UK for any of those designs. You have to go through that for any nuclear plant, no matter what it is. Clearly, you then have to build the thing and get site approval as part of the regulatory process, and get it up and running on site, but the fundamental you need to start next year is the first stages in the regulatory approval.

Baroness Wheatcroft: If that regulatory approval were forthcoming, how important a contribution do you think the smaller modular reactors could make?

Dr David Clarke: We have looked at this. By the time we get to nth of a kind, as it would be called—a commercial unit rather than first of a kind—the stage where we are manufacturing the core of these things in a production environment in a factory, not pouring concrete on site and so on, they start to become cost-competitive with the bulk of the generating fleet in a low-carbon world, which puts it at a level of about £80 per megawatt hour. If we take the broader system view and use the waste heat from those machines, it starts to come below those levels. We should not talk about LCOEs—although I am doing it, it is meaningless—but they pull it down below that. The real opportunity is to use waste heat, because that starts to make a difference in the economics of the machines.

Lord Turnbull: How many of these might there be?

Dr David Clarke: In the UK or globally?

Lord Turnbull: The UK.

Dr David Clarke: Tens, and that is not enough to build a factory. If you build a factory, which is the only way to get the manufacturing economics right, you are serving a global market.

Baroness Wheatcroft: Given what has been said about Hinkley Point, seven out of 10 is better than four out of 10 but it still leaves room for nervousness. What could we and should we be doing to get new gas-fired generation?

Dr David Clarke: My view is that we need to be in a position where we can implement a big plant with CCS, which means that there is a mechanism for offering a contract for difference, for instance, for low-carbon generation, and then private sector investment will start to come through and that will help to move it. My crucial mindset is that we have to look at this with CCS so that it becomes a low-carbon plant in the future.

Baroness Wheatcroft: Mr Darwall, do you go along with that?

Mr Rupert Darwall: The fundamental problem is that the effect on the wholesale market of subsidising zero marginal cost renewables is to destroy investment—“destroy” is a strong word; it makes it very difficult to assemble an investment case for new dispatchable capacity. Until renewables pay the cost of the intermittency they are imposing on the system, we will continue to have that problem.

Professor Michael Grubb: It is a critical question. Sooner or later, we need to look at changing the contract structure on renewables and on nuclear and potentially try not to make them based on metered output, so that there is not the same impact on the wholesale market. That is not a dominant problem in the UK. At the moment, in the UK the problem is that we want the private sector to build CCGTs and it sees the Government subsidising coal plant because they are frightened of headlines about the lights going out. That is the problem. You have to break open that chicken-and-egg problem. We will not get the gas plants until we think the coal plants are really coming off the system, and the Government are scared to take the coal plants off the system when so much fear is generated about the lights going out. We have also had an era of very high energy prices, partly because of gas prices. Fortunately, they have come way back down again, which should give us more room to manoeuvre.

I suggest a two-pronged approach. One is at least to maintain the carbon floor price and preferably reinstate the escalator. That would send a very strong signal about the positive economics of gas plants vis‑à-vis coal, and in the long term it would get that industry more seriously interested in CCS, although, as David said, that would not be enough on its own; we would need the other components of CCS development. The other thing that could be considered would be to move the incentive on coal, take the supports out of the capacity mechanism and put them, potentially, into a strategic reserve. In other words, the definition of a strategic reserve is that you pay a plant to be available in times of real need but not to participate in the market. That is the German strategic reserve. It is not the most efficient and beautifully designed system, but it does the job of saying there is space for gas to generate. It is much lower carbon than coal and, therefore, you are safe to go ahead and build gas, and then you can take the coal right off when you are comfortable about the overall adequacy of capacity. I would not artificially try to jack up the capacity mechanism to prices that make it economic to build CCGTs on their own, because they should be justified on the basis of the moderately low-carbon power they will generate vis-à-vis coal.

Q49 Baroness Bowles of Berkhamsted: Earlier, you touched on the fact that maybe power and heat might merge to some extent, but how much has been done on looking at the whole energy system? Have the Government done enough, including on heating and transport? What should their objectives be for a more global energy policy?

Professor Michael Grubb: It is insufficient. There is very little sign of real joined‑up policy-making across the different sectors. There is emergent thinking about it. One illustration is that we have all been worried about peak electricity demand. Peak gas demand in this country is six times bigger in energy terms, yet the capacity of combined heat and power plants is about 10% of our installed electricity capacity. If we could focus just on getting closer to, say, 7%, 8% or 10% of the heat demand also being attached to a generator, in one stroke we would solve concerns about the adequacy of electricity capacity. I do not think enough attention has been paid to CHP or the various aspects of the heat challenge and its relationship to power. Similarly, on transport, in some scenarios electric vehicles might in total double electricity demand. That is a fairly high estimate, but all of that comes with batteries. Do we really have the institutions and thinking in place to know exactly what that system is like and how best to utilise it? No, I do not think we do yet.

Dr David Clarke: There is an enormous amount to do on how we implement low-carbon heating systems in such a way that consumers feel they are getting real benefit from them. In the work we have done on heating in the home and what people actually expect from it, we see that it is more complicated than lights and sockets and expecting electricity to come out. People expect to be comfortable, and it is quite tricky to work out what that means in reality, particularly when they make decisions to leave doors or windows open. It is a hugely difficult challenge to manage heating, and to implement different heating systems that people think they will benefit from effectively. Part of the challenge is that we currently have a gas system that provides most of the heating in the UK. Generally, it works very well, with domestic gas boilers in the main, and it can cope with extreme sudden demand shocks without any problem at all. On Saturday 18 December 2010 at 8.30 in the morning there was a cold snap. Everybody got up and gas boilers came on. In effect, the demand rise was 132 gigawatts in an hour. The gas grid just dealt with it. Moving into a low-carbon world, we have to think about solutions that can manage that. It does not mean that the system has to be able to respond to that, but it has to make people comfortable, whether that is pre-heating houses overnight or whatever. We need intelligent systems that can manage that in future, whether they are electrically powered, low-carbon gas powered, hydrogen powered or whatever.

In government policy, we have gone through hiccups around heat. At points we started putting in money, but I do not think we have really seen the benefits yet. The real challenge for the current Administration looking forward is how we can start to do not necessarily mass market trials and tests of new solutions, but certainly testing of solutions on a large scale involving hundreds and thousands of houses to get a grip on how it is going to work in practice. Leeds is looking at the possibility of putting hydrogen in the grid, for instance; to keep using the gas distribution grid but with a lower-carbon system than today by putting a percentage of hydrogen into it. Fine. We need to test it. If we are serious, we need to work out how that could be done and how we are going to deliver the hydrogen. That takes us back to CCS in some ways, but fundamentally we need to test it and to test people’s acceptance of some of these things, because this is not like big power stations; we are now going into 28 million houses in Britain and doing something to them. Whether consumers do it themselves by choice or whether they are told to do it, in the way that natural gas was introduced in the 1970s, we do not know yet, but either way it is going to be difficult.

Baroness Bowles of Berkhamsted: You want to keep using the gas pipeline rather than switching to other technologies, such as geothermal or anything like that.

Dr David Clarke: From an engineering perspective and from a systems perspective, all the work we have done in ETI says that the logical and economic solution for the UK around future energy—power, heat, transport and infrastructure—is the heating system. Depending on where you are, it might run on fossil gas; it might run on low-carbon gas, which could be biogas or hydrogen; it might be electric; it might be district heating networks using waste heat from power stations; or it might be a district heating network on a dedicated CHP plant—all of the above. It will vary wherever you are, based on local economics, but that is part of the issue of what is going to work in particular areas. We have to work it out from economic and consumer acceptance perspectives. It will vary around the country.

Q50 Baroness Wheatcroft: Leading on from that, there are communities in Germany where every house is now serviced by geothermal, at least for new build. Is that something we should be looking at more effectively in this country? For instance, where a new estate or a new town is coming along, it gives relatively cheap energy, and indeed often costless energy in the future.

Dr David Clarke: The answer is maybe. I go back to my previous answer. You have to look at the specific site. That is the problem. You cannot say, “Oh yes, it will be fine”. The question is, where and under what circumstances? With heat, we very quickly get into detailed planning. On a particular site, depending on whether it is deep or shallow geothermal, we get issues. Deep geothermal will not be of great benefit in a lot of areas of the UK, because there is not sufficient temperature in the rock, although there is in certain areas, as we have seen. Geography plays a part straightaway. Local economics plays a part. What is affordable? Who is going to finance it? Is there a nearby electricity distribution grid that is very strong? If there is, it might be a cheaper option. I do not think there is one answer. It is site-specific and it depends on local economics and social issues. It is easy to say new build, but for the vast majority of properties in the UK it will be a problem of retrofitting, or knocking them down and starting again.

Q51 Lord Burns: One of the issues we have been interested in throughout the inquiry is the balance between the roles of public policy and private investors in the energy market. You touched on that earlier. When Dieter Helm came before us, he said that what we had now was something close to a nationalised industry. One issue we have been probing is whether there is any room to change the balance and get back to a position where there is a greater role for markets, or whether the decarbonisation objective rules that out. Are we stuck with it? I know we have options for certain things, but is this going to continue to be for the longer term essentially a state-controlled activity?

Mr Rupert Darwall: The problem is that we have the worst of both worlds. We have state control and private ownership, and that is inherently inefficient. The state defines the energy mix it wants; it makes numerous interventions and keeps having to make changes to the policy framework because there are unintended consequences of a particular policy and another policy has to come in, so it creates a raft of uncertainty. There is the private sector cost of capital; there is the political risk premium on top of that; there are the transactional costs of large numbers of lawyers, consultants and so forth. It comes to a point where you say, “Why not just have the Central Electricity Generating Board?” If the state wants to have control, it should have ownership and it would be a lot more efficient. As somebody who believes in markets and so forth, I do not think that is the right way to go, but basically it is a choice between the market and the state, and at the moment we are in this awful no man’s land where we are paying more than we need to, and it is highly inefficient. The Government say they want things but cannot obtain them; they have to bribe the private sector to do things that it really does not want to do, so we have to pay more. In my view, it is an incredibly unstable and unsustainable framework.

Professor Michael Grubb: I did my PhD in the days of the CEGB. On transparency, clarity and use of competitive pressures and private capital, there is absolutely no comparison. We did not have a clue. We had a central board, which basically believed that the only energy sources in existence were nuclear and coal. That was the end of the electricity issue.

I was interested in Dieter’s evidence. In my evidence, I cited his 2004 book about why electricity has always been a political industry, to some degree. There are loads of characteristics, which I tried to flag in my evidence. Decarbonisation is just one among many factors that make it very hard for Governments to get out. In fact, you could argue that it is impossible. One might say that the closest the UK got to it was with the neater and better systems, when Ofgem wrote its report in 2009 saying, “Nobody is going to invest in anything, and the lights will go out under this system”, to be crude. That is a slight caricature, but—

Lord Burns: Which way should we be moving now?

Professor Michael Grubb: We need to move forward, not back. I am sorry—that sounds like an easy caricature, but there is a lot of truth in it. What does it mean? Clearly, the move from administered contracts to competitive auctions was a very positive one. In our earlier discussion, we alluded to some of the additional things that could be done—by having greater rollover time for the space-varying signals in the wholesale market, for example. Potentially, we could try to delink the long-term contracts from the metered output, which would avoid some of the adverse impacts. We could also increase the role of the carbon price floor. Ultimately, you would like to try to migrate away from technology-specific contracts for auctions to a more technology-neutral mode of decarbonising. That can happen only if you have a credible and believable rising carbon price. In a nutshell, that is the direction in which I would try to go.

To be clear, people get very mixed up by throwing around the word “markets”. They seem to mean lots of different things. At one extreme, it is a completely technology-neutral spot market in electrons for everything. On the other hand, it is just talking about using private sector and competitive forces, which we are getting a lot better at, as far as I can see.

The Chairman: The last question is from Lord Turnbull.

Q52 Lord Turnbull: Earlier there were suggestions about bringing building of power stations on to the balance sheet. Dr Clarke, I think, went on to say that that would be by taxation. I do not think that bringing something on to the balance sheet necessarily implies taxation. You can bring something on to the balance sheet and still charge an economic price for it. You can make a judgment on whether Hinkley would have been better had it been put together with the cost of capital to the Government, rather than to commercial operators. Am I right in assuming that you were not really—

Mr Rupert Darwall: Yes. It is secured on the government balance sheet, so effectively it is secured on future tax revenues.

Lord Turnbull: But that is in its construction phase.

Mr Rupert Darwall: Yes.

Lord Turnbull: This is a lot later.

Mr Rupert Darwall: With Hinkley Point, a public sector comparator would be an intelligently designed procurement contract, so that you pay for the thing only when it works and it works properly. Then you pay EDF for it. The public sector can do those contracts—not with aircraft carriers, but it is able do those kinds of deals. It would be very interesting to see what a public sector comparator for Hinkley looked like.

Lord Turnbull: There is another question that was not clarified. Dr Clarke, you talked about gas with CCS. It is already difficult to get gas built now, without loading CCS on to it. What would be the additional cost of adding CCS, given that for the moment we do not have a UK government project or pilot of any kind?

Dr David Clarke: For absolute clarity, the comments about Hinkley Point were Mr Darwall’s comments, not mine. I deliberately did not comment on the economics or structure of the deal.

On CCS, the reality is that you have to view the CCS elements of a major project—the transport and the storage—as an infrastructure project. If you take that mindset and say, “I am building a piece of strategic infrastructure”, from an operational viewpoint, you will then say, “How do I maximise the value of that infrastructure?” I have not got to the power station yet. From the point of view of that infrastructure, you would want to make it so that it could serve multiple customers in a region, to get the maximum value out of the unit. The inference from that is that you would probably want to go to somewhere like Humberside or Teesside, as you have multiple opportunities there to pick up emissions from industrial emissions sites, not just power stations. You have steel, chemicals and food stocks, which emit quite a lot of CO2.

The reason I stress that is that the answer to your question is not a simple one. The incremental cost of implementing CCS depends on how you implement that piece of infrastructure, how you fund it from a capital perspective—going back to exactly the conversation that we have just been having about what percentage you apply on that—and what the value chain is for using it in the long term. The big advantage of power stations is that they are—or can be, if it is a baseload operation—a more or less guaranteed source of CO2 for a very long period, so you can see a commercial construct where you can execute something.

Lord Turnbull: You seem to be describing a niche project or projects on the east coast. How does CCS work at Didcot, for example?

Dr David Clarke: If I were implementing CCS, I would not even look at Didcot. I would not look at anywhere that is more than 20 miles from the coast.

Lord Turnbull: But we still have to get enough gas-fired power. Would it not be better just to build gas-fired power and take the fact that it is half the CO2 value of coal?

Dr David Clarke: Building gas is a sensible thing to do, from the point of view of getting a lower CO2 emission than coal—absolutely. That is a tick in the box, from a gas perspective. But you are then faced with the challenge of how long the plant will exist and whether it can be run throughout its life economically with a CO2 emission coming from it that is going into the atmosphere. Depending on your policies around CO2 pricing, the answer is yes or no. That is why I said that you have to treat CCS as a strategic infrastructure project and to look at the complete value chain that goes with it.

If you say, “I want to put CCS on Didcot power station, Ratcliffe-on-Soar power station or anywhere else in the Midland corridor”, the answer is, “Do not”. It is that simple. You look at areas such as the east coast, north Wales and Lancashire, where you know that there are offshore stores close by that have been well characterised. We and others have done that. You also have minimal pipeline runs, experience in the operational base to implement those stores, from the point of view of drilling, injections and so on, and multiple emissions customers in those regions. If you look at this and say, “Let us go and do one project and load all the costs on to a single 600 megawatt power station”, you cannot expect it to make any economic sense at all. Frankly, you have to treat it as industrial strategy, in the current parlance.

The Chairman: Thank you very much. We must draw it to a close there. Dr Clarke, I wonder whether you could give us a brief note on the scoping and cost of the capacity that you feel needs to be built alongside Hinkley B.

Dr David Clarke: Hinkley C.

The Chairman: I am sorry—Hinkley C. I will catch up; do not worry. That would be very helpful to the Committee.

Dr David Clarke: Certainly.

Examination of witness

Mr Matthew Bell, Chief Executive, Committee on Climate Change

The Chairman: Mr Bell, welcome to the Committee. You heard quite a few of the questions that we are going to ask you from the previous session, which you attended. I ask Lord Sharkey to start us off.

Q53 Lord Sharkey: Last month Lord Lawson gave evidence to the Committee. He said that we needed “to reverse the current priorities and make the decarbonisation agenda subordinate to the objective of supplying the British economy and households with cheap and reliable energy”. To what extent do you think that the Government’s objective of decarbonising the power supply is in conflict with their other objectives of providing secure and affordable energy?

Mr Matthew Bell: “Conflict” is probably the wrong word to use. The reality is that we have three objectives for the power system. We have an objective around security of supply, an objective around affordability and an objective around decarbonisation. The fact that those three are articulated clearly in some instances brings out the tensions between them and allows an open and transparent discussion and debate to take place. One thing that having the three of them brings out is the importance of looking at the timeframe that we are thinking about. How they play out in decisions that are made over a very short timeframe, versus a five to 10-year timeframe, versus a decadal timeframe, is clearly different.

As an analogy, before taking on this job, I used to work for a private company that had two sets of objectives, among others. One was to do profitable work, as you need to do, and one was to do interesting work, which is also useful. On a good day, work would be both profitable and interesting. However, sometimes work would be profitable and less interesting. At other times, work would be interesting and less profitable. That is not to say that those objectives were somehow wrong. It is to say that there were tensions—deliberately so. I would say that that is broadly analogous.

Lord Sharkey: If the company is still in business, presumably it prioritised the first, rather than the second.

Mr Matthew Bell: It recognises the fact that, for a whole range of reasons, you need to meet all three, but there are tensions between them. There is not an absolute definition of affordability, there is not an absolute definition of security and there is not an absolute definition of decarbonisation. You make your system more or less affordable, more or less secure and more or less carbon intensive, based on how the tensions between those three play out. In some instances, they will all work in the same direction. In others, the tensions will require choices. The fact that we have all three of those simply reflects the fact that we now live in a world where we have to deliver on all three of them, to a greater or lesser extent.

Lord Sharkey: You talked about affordability. When you make recommendations to government, does the Committee on Climate Change take account of what the resulting costs to individuals and businesses may well be?

Mr Matthew Bell: Under the Climate Change Act, the Committee has a legal duty to take into account the costs on both households and businesses, in the form of competitiveness. As part of our advice to Parliament and to government, we take very seriously making sure that we are transparent around all the costs of these activities, to the extent that every two years we publish a stand-alone report, called the report on prices and bills, that sets out all the evidence related to that. The last one was published nearly two years ago. The next one will be published in the coming February.

The Chairman: When he appeared before us alongside Lord Lawson, Lord Turner made the point that the Government need to focus far more on the demand side, which has been neglected. Would you say that that is a fair criticism?

Mr Matthew Bell: One of the emerging trends that we see in all areas—not just the power sector—is the importance of how demand reacts. We have more real-time information and people want to use that information in all aspects of their lives. The power sector was designed with a more supply-side focus. There is a lot of discussion around technological neutrality in auctions or in how we balance supply and demand in the power sector. Making sure that the demand side can play into those markets on a level playing field with supply-side solutions would be very sensible and, probably, very cost-efficient.

Q54 The Chairman: You have been very focused on the power sector to date. What are your plans to turn a bright light on to heating and transport?

Mr Matthew Bell: Just last week, we published for Parliament a report specifically on heating, in recognition of the fact that the committee has been saying for at least the last couple of years that one of the biggest risks to the carbon budget—particularly if you look out to the mid-2020s—is the lack of progress on low-carbon heat. By way of helping with evidence, we set out what we think a sensible low-carbon heating strategy would look like. We have made similar recommendations on the transport side.

The Chairman: In a report last year, the Royal Academy of Engineering said that we were “only just” on course to meet the targets. Do you agree with that?

Mr Matthew Bell: There are lots of different targets. To be precise—

The Chairman: It was talking specifically about the emissions target.

Mr Matthew Bell: So far, Parliament has legislated five carbon budgets, which takes us out to 2030, roughly speaking—2032. We met the first carbon budget. We are in the middle of the second carbon budget and are very much on track to meet that. We are fairly confident that we will be on track to meet the third carbon budget, which centres on 2020. The ones where we look like we are off track right now are the fourth carbon budget, in the mid-2020s, and the fifth carbon budget, which was passed by Parliament only in July. We are off track to those—unsurprisingly, when you look out at those time periods.

The Government have committed, as they are required to do under the Climate Change Act, to produce what is called an emissions reduction plan, which we are expecting in the coming months. The purpose of that is to say how we should get back on track to those mid-2020s and 2030 targets.

Lord Turnbull: You have produced a document that has a chart that looks like this. It shows that, if you extrapolate the decline, we are pointing down to where we want to be. My submission is that this is an extremely misleading target, because the left-hand scale is arithmetic. It is saying that reducing by 100 million tonnes is as easy or as difficult when emissions are 800 million as it is when they are 200 million—that getting from 800 million to 700 million is of the same degree of difficulty as getting from 200 million to 100 million. I just do not believe that. It should be on a logarithmic scale. Then you would find that this is getting more and more difficult. To put it simply, there will be fewer bad power stations left to close. The idea is that we are on a nice glide path down to this number, but I think that you are misleading us.

Mr Matthew Bell: That is obviously one of very many charts that we produce. I would invite you to look across all of them. The answer, of course, is that it is not a question of mathematics. How easy or how difficult it is to take the next steps depends on a combination of technological change, demand-side behaviour, which we have talked about, and measures to do with carbon pricing, which have been raised in other sessions—a whole range of factors. Whether it is on a linear scale or on a logarithmic scale is not where the causality lies.

We are very clear—this is the benefit of the Climate Change Act—that when this becomes very difficult and expensive is if you leave it until the last minute to do something and to think about it. I was not here then, but I have no doubt that if we had been sitting here 10 or 15 years ago and had said, “We will cut power sector emissions in half over a period of time”, we would have said, “That is impossible. We will never be able to achieve it. It is very difficult. Where do we start? What do we do?”

As a caricature—it is clearly not as simple as this—if we think about a strategy and implement it step by step, slowly and steadily, eventually we get there. We need to take the same approach with buildings and transport. We are starting on that. The reason the committee published its report on buildings last week is that we need to start the decadal-long process of getting there. That is not to say that it is easy; it is to say that you do it a step at a time and in a logical way. That is how you make the steady progress that is implied in the chart. It is not about mathematics; it is about what the drivers of these changes are and how you put them in place in a sensible manner.

Lord Turnbull: There were two one-off events in this. One was the dash for gas, which you do not want to be repeated. The second was the financial recession, which means that GDP is lower than it was ever expected to be. You have to maintain that momentum without recourse to recession or gas.

Mr Matthew Bell: We spend a lot of time trying to assess how much of the change to date is because of active government policy—or, indeed, private sector reaction to that policy—and how much of it is because of a wide range of other events. You are absolutely right to say that a combination of factors contributed to the decrease historically. I would not want to count on random events in the future helping us to meet our target. That is precisely why we need sensible sets of strategies and policies. Having said all that, since 1990, emissions are down by 38% and GDP is up by over 60%. Since the financial crisis, we have had GDP growth year on year of 2% to 3% and manufacturing growth of 2.5% to 3%, while emissions have continued to fall, so the two are not inextricably linked.

Q55 Lord Layard: Given the targets for decarbonisation, do you think that the Government have been trying to achieve them in the most cost-effective way? Could you answer that in a general way? I also want to ask a very specific question. Are you happy about the way the Government’s R&D for cheap, clean energy is organised?

Mr Matthew Bell: The first, general question was, has it been cost-effective? Cost-effectiveness is a relative concept—it depends on what state of the world we are in. If the state of the world is that we have a Climate Change Act and are legally committed to reaching a reduction in greenhouse gas emissions of 80% by 2050—and maintaining security of supply and affordability, in the way that you have discussed—we can talk about its being cost-effective in that context. The second question that you have to ask yourself is, are we looking in hindsight or are we looking as situations were at the time? In hindsight, you could absolutely point to things that could have been done better. Sitting there at the time, “Did you have those options?”, I think is a question.

I would answer it by saying, “What are the characteristics that we would like to see in something that would deliver cost-effectiveness?” At a high level, you would say that there are two. First, you want to do things that you know are cheap today, which we might call low-regrets options—things that meet that set of objectives and are relatively inexpensive today. Let us make sure that we are deploying those. The second thing that you want to do is to put in place plans, strategies and R&D—to link it to your second question—to pave the way to ensuring that, in five and 10 years’ time, there is another set of lower-cost options available.

Do I think that, broadly speaking, that is what has happened over the last decade or so? The answer is yes, which is not to say that we could not have made different decisions or that some decisions about signing contracts on particular technologies in particular renewables could not have been done more cost-effectively, but you do what is relatively lower risk now and take a series of actions, of which R&D is an important one, to deploy and look at different technologies to reduce costs for the future.

That brings me on to the second part of your question, around the current systems for R&D. We have not done a detailed analysis of how research and development funding at a governance and process level works in the UK, so I do not have a sense of a judgment on the R&D process. What is clear—this is certainly what our analysis shows—is that you need a combination of fundamental research and development and deployment. Deployment means that you learn an awful lot, so in some respects the separation of the two here is a bit artificial. You need a combination of those two things to drive down costs, to drive learning and to develop supply chains. That dynamism lies behind a lot of our recommendations. It is about making sure that we are combining taking advantage of low-carbon options now and driving down costs for the future.

The Chairman: Could we stick with cost-effectiveness? This morning the National Audit Office published a report that said that the UK Government miscalculated the costs of renewable energy support and are likely to overshoot their £7.6 billion budget by about a fifth in 2020-21. Therefore, there is little left over to fund new projects between now and 2021. The report goes on to say that it would have been more cost-effective to spend more of the budget later, as technologies such as wind turbines and solar panels are much cheaper now than they were a few years ago. How would you respond to that quite damning criticism from the NAO?

Mr Matthew Bell: As you say, it was published this morning, so I have not had a chance to read through all of it in detail, although we contributed to the report and spoke to the NAO about it. There are two things that are worth saying. First, the £7.6 billion at which the levy control framework was set for 2020 was off the back of a lot of analysis. It was supported by the Committee on Climate Change as the appropriate level to do the R&D and bring forward the types of technologies we were talking about. Broadly speaking, we think we are on track. We will deliver the level of renewables that we thought we needed for around 2020 to keep us on track to the carbon budgets. In order to meet the carbon budgets, there is no reason to overspend that level.

Then there is the question of why the overspend arose. There are a lot of lessons that can be learned from that about how quickly particular mechanisms can adjust as costs fall. Are we adjusting the levels of subsidies fast enough? Did too many contracts get signed at too early a stage, leaving too little now for lower-cost technologies? Those are all questions. There is then a big debate about whether they had the knowledge two, three or four years ago to know where we would be today. Could they have made a different decision? The NAO has drawn its conclusions.

The Chairman: Is it part of your remit to speak truth to power and to say, “Frankly, you have botched this, and it is costing the average household £17 more a year”, as the NAO is suggesting?

Mr Matthew Bell: It is part of our remit to advise on how cost-effectively to meet the carbon budgets—and, to that extent, to make sure that we are investing in the range of technologies that are required to meet the carbon budgets.

Lord Sharkey: Is it part of your responsibility to look at the fact, as the NAO has said, that the assumptions on how much power would come from new offshore wind farms were not updated for 18 months, despite the Government signing £615 million-worth of new contracts in that time? Is that the kind of thing you would intervene on?

Mr Matthew Bell: Some of the figures that the NAO quotes are our figures. We were among the people putting out the research that said, “These are the load factors that are being realised in offshore wind plants”, and saying that, as a consequence, you might end up paying more than you anticipated. We were the body putting out some of that evidence.

Lord Sharkey: You were making representations to government about that.

Mr Matthew Bell: Yes. We were making representations to Parliament and publicly.

Q56 Lord Tugendhat: I saw that you were here at the beginning of the session. You have read all the documents, anyway. We have been talking about the present Government’s objectives for energy policy. The first one is to, “Ensure … a secure and resilient … system”. The third is to, “Secure ambitious international action on climate change”. Would you agree that, with those two, it is virtually impossible for the Government to take more than the most cursory account of changing market conditions? If you are trying to attain those two absolutes, it is impossible to pay more than the most glancing attention to changing market conditions, is it not?

Mr Matthew Bell: It depends what you mean by market conditions. I am an economist by background, so the effort that I would very much support is one where the market is allowed to determine what the least-cost way of meeting those two objectives is. There is clearly a range of different technologies and options competing in different markets—in the power market, the transport market and heating.

Lord Tugendhat: If you are committing yourself to meeting certain objectives about reducing carbon in the atmosphere and all the rest of it, what happens in the market is almost irrelevant, because you have committed yourself in the first instance. If you attach a high importance to security of supply, the cost is less important than the guarantee of availability. In talking about changing market conditions, one is dealing with something that is very difficult to take into account.

Mr Matthew Bell: Clearly this is beyond the remit of the Committee on Climate Change. I would say that we are committing ourselves to making sure that there is bread on the shelves of supermarkets, but it does not mean that you cannot use the market as a mechanism to deliver that. In the same way as somebody making bread would expect to pay for the flour as an input to that bread, somebody producing something based on carbon should take account of the costs of that input to their production process. The scientific evidence then leads to that. The reason we have a global objective around climate change is that the scientific evidence suggests that there are very real risks to not having that. However, I would argue that the mechanism that you use to deliver that can be embedded very firmly in the market, in the same way as we supply very reliably against a range of other objectives in other markets.

Lord Tugendhat: No, I do not think that you are committing yourself to getting bread into the supermarket. What we are committing ourselves to—if I can pursue your analogy—is having bread in the supermarket that is made to a particular formula. That is very different from having bread in the supermarket. The problem that we face in the energy market in trying to think in market terms is that we want two different things. We want the bread, and we want it to be made of organic dough.

Mr Matthew Bell: The committee were being very careful not to commit to the particular type of bread that is being produced. We were being very careful to say that, effectively, we are trying to make sure that the impact of all the inputs to production is being properly taken account of. If you do that, there is a range of different types of bread—different technologies. In the power sector, as in other sectors, a range of different solutions can be accommodated within that.

Q57 Lord Kerr of Kinlochard: Surely successive Governments have been resolutely ignoring the market. They know that the price of gas is going to rise. They have known that for 10, 12 or 15 years. Actually, the price of gas has fallen for 10, 12 or 15 years. What is the role of the committee? Are you saying that you really do not mind how the bread is made—that you have no view? Surely the committee should be expressing a view on how to achieve the objectives that it thinks are very important, with least economic damage in the short term to the country. Surely combined-cycle gas turbine generation should have been constructed massively over the past decade. Should the committee not have been saying that, or are you one of those who believe that, because gas is only a transitional solution and not, in your view, a long-term solution, it should be discouraged?

Mr Matthew Bell: The committee publishes scenarios. In order to be able to advise the Government, we publish a set of scenarios that say, “We think that these targets”—for example, the fifth carbon budget in 2030, which reduces emissions by 57% compared with 1990 levels—“are achievable, while taking into account competitiveness, affordability and the range of other factors that we have a legal obligation to take into account”. Those scenarios—as a matter of fact, in the case of the power sector—include gas-fired capacity through the 2020s. By the time we get to 2030, it will account for about a quarter—about 25%—of what is being generated.

Rightly, it is not the committee’s job to say what the policy should be—that is for a debate to take place in Parliament. We set out the sets of scenarios that we think are consistent with achieving the objectives at least cost. We are very clear about those. On an annual basis, we report to Parliament. In every one of those reports, we include a series of recommendations saying very clearly whether the committee thinks that we are or are not on track, and, to the extent that we are not on track, what needs to be done to put us back on track.

Q58 Lord Livermore: I asked the previous witnesses whether sufficient investment was being made in new technology. I would like to ask you the same question. Specifically, do you think that the next round of offshore wind should go ahead?

Mr Matthew Bell: I do not have a view of new technology as a whole and of whether a sufficient amount is being spent. On offshore wind, we have said very clearly that, to be consistent with the objectives that have been set out, there need to be future auctions for that. The Government have said that they will go ahead with at least three CfD auctions in this Parliament, and one right now. That will certainly be part of our least-cost scenario towards 2030.

Q59 Baroness Wheatcroft: You have now produced a paper on the potential effects of our leaving the EU. Could you summarise what you think government should be doing in the short term to prepare for that event?

Mr Matthew Bell: They should be taking our paper very seriously. Effectively, the paper does two things. It is intended very much as a piece of information to help with the process. The first thing it does is say that there are three things that have not changed as a consequence of the referendum. One of those is the scientific evidence around climate change. The second is the international agreement—the latest Paris agreement, which the current Government have committed themselves to ratify. That is the set of international action that is taking place. The third is the UK’s Climate Change Act, which is a purely domestic piece of legislation. Those three things are invariant to whatever outcome there was from the referendum.

Then there is a whole series of mechanisms, some of which are linked to reducing emissions, that the UK has negotiated at EU level. The EU Emissions Trading Scheme is one of those. Vehicle fuel efficiency standards are another. The common agricultural policy is a third. There is a long list. In the note, we have set those out for everybody’s information, to say, “These are the sets of initiatives, policies, regulations and standards that were negotiated previously at EU level. To the extent that they change, either to result in more emissions reduction or to result in less emissions reduction, that should be taken into account in the discussions and measures that are taken in one way or another”. It is very much a note for information at an early stage in the process.

Baroness Wheatcroft: National Grid submitted evidence saying that it thought that leaving the EU could result in a loss of benefits of up to £500 million a year. Do you think that that is accurate?

Mr Matthew Bell: I have not seen the analysis. We have not done any particular calculation on the implications of leaving the EU. There are clearly some concerns over interconnection between the UK and Europe, for example. Once we know how those are going to be resolved, we will have to assess what the impact is.

Baroness Wheatcroft: We will not be part of the EU energy security arrangements, will we?

Mr Matthew Bell: I do not know. If anybody knows, I will be happy to look at it. Right now, I do not know what we will and will not be part of.

The Chairman: Can I follow up on the question of affordability, which has come up on a number of occasions? If the price of energy gets to a point where it is uncompetitive in this country for a heavy energy user, that plant closes. Instead of smelting aluminium or whatever here, we import it from abroad. How does that get captured—no pun intended—in your calculation about our carbon footprint?

Mr Matthew Bell: The legal duty on the committee to consider the competitiveness impacts of all our actions to address climate change is one that we take very seriously. The committee is very clear that there is no point in any plant closing in the UK only to open somewhere else and emit the same or even more emissions in another jurisdiction. That would be completely counterproductive.

As a consequence, we do a lot of detailed analysis to try to understand which industries and plants are at risk specifically from climate change policy. When you do all that analysis, you find that, as a proportion of all manufacturing or all GDP, it is a relatively small number of sectors. It is hugely important for those sectors and all the people involved. However, the reason that we can address them is that it is not the vast majority of GDP, but a small percentage.

Then you focus on those. You focus on the ones that are clearly energy intensive and the ones that compete on a global scale. We ask ourselves—and do the analysis—about the impact of climate policy on those specific industries. In the past, we have recommended hundreds of millions of pounds of compensation to those industries as a consequence of the analysis. We can have a debate about whether it has come fast enough or how it has been arranged, but that compensation has been agreed by the Treasury and passed over in a number of different forms—in free allowances, through the EU Emissions Trading Scheme or through direct financial compensation for things like the carbon price floor. You make sure that climate policy is not the reason for those industries shifting location. There is a whole range of other reasons—international trade, relative labour costs and local taxes—why industries move that have nothing to do with climate change. The Government may want to address those for other reasons, but they are clearly outside our remit.

The Chairman: Tata Steel cited energy costs as being one of the key factors. The other one was pensions. There was some discussion around how pensions could be mitigated. Did you make any proposals to the Government about how they might mitigate the energy costs so that it was not just sent overseas, meaning that the same carbon footprint would exist internationally?

Mr Matthew Bell: We have certainly made recommendations and proposals in the past about how to compensate the steel sector and other energy-intensive sectors, such as cement, to ensure that climate policies specifically are not adversely affecting their competitiveness. There is a whole range of reasons why electricity costs are higher in the UK than in other countries, of which climate costs are only one component. The evidence right now is that we are offsetting the climate policy costs within electricity costs. Electricity costs are still higher than in other countries, but that is because of a range of other factors that have been examined by the Competition and Markets Authority and others.

Q60 Baroness Bowles of Berkhamsted: Could I take you back to the issue of gas? It was talked about quite a lot with the previous witnesses. Where do you see the role of gas in generation? Is it entirely dependent on there being carbon capture and storage? Where does the development of UK shale gas fit into that equation?

Mr Matthew Bell: I will answer first on the power sector question and then come on to the shale gas question.

On the power sector question, clearly it matters what time period you are looking over. Right now, gas is providing about 25% of our generation needs. The least-cost pathway that we discussed before suggests that in 2030 you would want it to be in roughly the same position—still providing about 25% of electricity generation. Depending on the age and location of plant, that may or may not involve more investment, as plants retire and so on, but it is roughly the same proportion as it is now. For gas-fired power generation to continue to exist beyond the mid-2030s requires carbon capture and storage to come online, to be consistent with meeting the 2050 target of a reduction of at least 80% in greenhouse gases compared with 1990 levels.

The committee has a legal duty to provide advice to the Government on the exploitation of shale gas. We provided that report in April this year. In the report, the committee said that the exploitation of shale gas on a significant scale is not compatible with the UK’s climate change targets unless three tests are met.

First, the development, production and decommissioning, eventually, of shale gas wells needs to be done in such a way as to minimise the emissions that come from them. They must be properly regulated. The Environment Agency and others are involved in that. One of the lessons that we have learnt from the US is that there is a small outlier of very high emitters—so-called super-emitter wells—that may not be subject to such strict regulation. You want to avoid that type of scenario and to have proper regulation of emissions.

The second test that we set is that the use of shale gas in the UK must effectively substitute for importing gas from overseas. Gas consumption as a whole for the UK should not increase as a consequence of exploiting shale gas. That allows us to keep it in line with having lots of gas in the carbon budgets and in the targets—not only in the power sector, but for heating and other things. There is a lot of demand for gas in the UK. If we use shale gas here, it must substitute for imports, rather than increase the overall amount of gas that we use.

The third test is that whatever emissions are produced as a consequence of exploiting shale gas—even if you have good regulation, there will be some—should fit within the carbon budgets. The carbon budgets say that we have a fixed amount of emissions. If there are some additional emissions from producing shale gas, they have to be offset by reducing emissions somewhere else, whether it is in transport, agriculture or heating. Wherever that is, overall we have a legal duty to meet the carbon budgets. The committee has said that the exploitation of shale gas is not consistent with the carbon budgets unless those three tests are met.

The Chairman: We heard in the previous session, which you witnessed, that in addition to building Hinkley C it was necessary to build other baseload—possibly other modular nuclear and gas. It follows from that that gas is likely to be an increasing source of energy—we hope, shale gas, because that has enormous benefits to the UK from a tax and employment point of view. As you look at the various sources of energy over the next decade, have you factored that into your planning?

Mr Matthew Bell: We have factored in a range of different scenarios—different combinations of nuclear, gas and carbon capture and storage, alongside all the renewable technologies. There are different combinations that are consistent with where we need to be in 2030. You may have more gas capacity on the system, but it is also a question of how many hours it runs for and how much generation there is. That is where my figure of about 25% of energy being produced by gas in 2030 could be consistent with a range of different capacities on the system.

The Chairman: Mr Bell, thank you very much for joining us today and for your interesting responses.

Mr Matthew Bell: You are welcome.