MR DAVID GREEN AND MR GRAHAM MEEKS

TUESDAY 13 NOVEMBER 2001

  240. Are most of them dependent on gas? What is the extent to which there are dual fuel capabilities?
  (Mr Green) At the end of the day it depends on the relative price of the fuels, but historically most CHP in the country was based on coal. There was then, as with much in the power generation section, quite a move to gas. Initially on the move to gas it was based on interruptible supplies, so it was dual fuel with heavy fuel oil. Most CHP schemes in the UK are now powered by gas although by no means all and there is a surprising variety of fuels used including geothermal fuels, biomass, energy from waste, coal. About 60 per cent of the fuel used in the CHP sector is now gas fired.

  241. We are aware that the CHP sector has experienced difficult trading conditions recently. In your submission you say that development of new CHP capacity has virtually ceased: ninety-five per cent fall in orders for new plants; project engineers indicate a fall of over 80 per cent in levels of CHP business. Is this mainly down to the new NETA arrangements?
  (Mr Green) May I take one step back. NETA is central to the challenges we are facing at the moment, but the frustration the CHP industry feels is that the Government have very firm targets for CHP—the last Government had and the current Government has them—and we feel one of the difficulties is that there is a strong need for comprehensive Government strategy in the sector, which does actually work out how we are going to deliver the 10GW target. The most immediate issue at the moment has been the impact of the new electricity trading arrangements, NETA, which has led, according to Ofgem's report, to something like a 60 per cent drop in output from CHP plant. There was one particular CHP plant which for particular reasons was left out of Ofgem's analysis. I understand that if that were included it would take the drop in power exports down to about 80 per cent. The CHP equipment is by and large produced in the UK. Some is produced in the North West of England and the two major turbine manufacturers are in Newton Abbot: Centrax; and what was Western Gas Turbines, now Alstom Gas Turbines in Lincoln. Ten days ago Centrax in Newton Abbot declared 25 per cent of their workforce redundant, 250 staff. That was in part due to the fact that they have not had any orders at all for CHP for well over a year now. Alstom, because they are a very large integrated company, have been able to redeploy about 900 of their staff who would otherwise be working on CHP to other sectors. Our worry is that if the downturn continues, it will lead to a dissipation of professional skills in the sector and that is one of the reasons why we are very keen to work with the Government on developing a comprehensive strategy to deliver the Government's targets.

  242. What sort of remedies are you seeking from the DTI in the light of the Ofgem report?
  (Mr Green) I will hand over to my colleague, Mr Meeks on this who has represented the industry on a lot of the working parties on NETA. Our discussions carry on with both DEFRA and the DTI because for reasons of history, as the Committee are probably aware, CHP is the only energy supply technology which is sponsored by DEFRA. Whilst we do have dialogue direct with the DTI, a lot of that dialogue is with DEFRA, because they are the custodian of CHP policy as it were. In terms of specific issues to do with the operation of the balancing market and the extent to which consolidation may or may not work may I ask my colleague to respond?
  (Mr Meeks) If we look at electricity trading arrangements, the fundamental problem which faces CHP is that the risk it faces in trading has changed. Wholesale price is one thing which NETA has delivered and we do not pretend that we should try to do anything other than support a general lowering in prices. If that benefits the consumer, that is beneficial. CHP itself delivers lower prices, so we are supportive of that principle. What NETA has done is introduced an element of risk which was not there before in the market. It was designed to address a problem which was created by major generators in what they were undertaking. It was not a small generator problem. The reforms have been based around trying to address a large generator problem. The inevitable casualty of that seems to have been that the impacts upon the smaller generator have been somewhat overlooked in the process of implementation. The effect has been that the risk in trading has increased dramatically for the smaller generator to the extent that it means that trading is virtually impossible and that is what has caused this drop in export revenues. People are simply not running the plant, not exporting at all. In terms of what the industry needs from a NETA solution, it is some means of ensuring that the fundamental risk which has been introduced—which small generators do not impose upon the system, they are not in a position of market power to be able to manipulate prices—can somehow be addressed and we can find some way of ameliorating the risk which has been imposed upon them. There are several positive proposals which have come forward to do that in terms of addressing the settlement system at the heart of NETA, moving towards average prices, moving towards what is called the dead band. These are quite detailed technical issues which I do not want to go into, but effectively they minimise the risk which is being imposed upon the smaller generator.

  243. Whilst achieving the other goals still.
  (Mr Meeks) They would not undermine the fundamental goals of NETA, which would be to deliver prices and could also lead to a system where cost reflectivity is ensured. We would not wish to undermine that and the proposals which have been put forward would not undermine that either.

  244. How is that progressing?
  (Mr Meeks) At the moment the process of moving forward is concentrating quite narrowly on the issue of consolidation. Consolidation addresses the symptoms, it does not address the fundamental problem. The fundamental risks are still there, whether we consolidate or not. At the moment the emphasis which seems to be being placed by Ofgem is on delivering consolidation. We do not believe that is going to deliver a sustainable long term solution to the risks which have been introduced by NETA.
  (Mr Green) There are some 1,700 CHP units in the country varying in size hugely but basically a small generator or a 50 megawatt CHP plant means there will always be some exports to the system. They are relatively small compared to major players and the idea that Ofgem have floated for some time now, about three years, is that by trying to create a facility in the new electricity trading arrangements, in effect third parties will come into the marketplace, buy portions of that export power and then be able to trade it. The difficulty that arises is that no-one ever enters a market for charitable endeavour. They enter a market because they are commercially driven, which is fine, but they will want to take their cut on that and the worry is that it will further destabilise the viability of CHP schemes. I should say that the last Energy Minister, Peter Hain, was extremely helpful on commissioning the review of small generators from Ofgem. That then reported to Brian Wilson and Brian Wilson has made it quite clear that he is determined to see this problem resolved. Ten days ago, the DTI issued a consultation paper on options which we are still looking at. All of us feel that whilst consolidation has a role to play, it is not going to solve the problem fundamentally and it will need to be issues to do with the way that risk is handled in the market. We do have a worry as to whether or not we are moving to a situation where the market becomes risky to the extent that it is not just going to be CHP operators who cannot develop plant but other players in the longer term as well.

  245. Are those more technical measures you were talking about something which the DTI have taken on board?
  (Mr Meeks) Yes, DTI have taken some of the principles. The idea of an average price is opened up which is very welcome. It needs to be put into play and that opened up for consideration. There are other principles as well which people had put forward from our membership and individually which we feel need an airing within that process of consultation.

  246. In your submission you took issue with the way in which Customs and Excise decided to implement the Chancellor's decision to exempt CHP from the climate change levy. How important is the failure to extend the exemption to power supplied off-site through a licensed supplier in two circumstances: firstly, in the present market circumstances, with NETA operating as it does now; secondly, in circumstances where the adverse effects of NETA, which you have described, have been corrected?
  (Mr Green) Talking with colleagues in the industry, in both circumstances getting full exemption from the climate change levy as the Chancellor originally outlined is something we would attach great importance to. It is all the more important in the context of NETA because if you look at the timescale for changing NETA some of the software can only be changed once a year, so you are talking about October next year for some software changes which might need to be done. In terms of things which can be done reasonably quickly, to restimulate confidence in the industry, if the Chancellor were minded to indicate in his November statement that he was willing to encourage Customs and Excise to fully exempt CHP as originally envisaged, that is something which would send a very positive signal to companies. In addition it is also the case that if NETA were changed it would still be likely that you would need to have some changes to the climate change levy in order to make sure that there was an adequate market for the power which could be traded, particularly given it would have an attractive premium and it would be levy free. The other thing which is worth bearing in mind is that one of the reasons why Ofgem always took the view they did that it was not their job to deliver the Government's targets for CHP and renewables through NETA was because they took the view that there was a range of other Government measures which should do that and full exemption from the climate change levy is one of those, along with others, which need to be put into place even if it is going to call into account the need for more fundamental changes in NETA. What we are trying to seek is to preserve the integrity of NETA, have some changes which make it more beneficial for small generators and make sure that in terms of achieving the targets, they are done through other measures of which there are several in play at the moment.

  247. The target for 2010 of 10GWe. You have mentioned in your memorandum that DTI projections and Cambridge Econometrics have both suggested that we shall fall short of that target. Do you see any circumstances in which you would predict that we would be able to meet that target? What might those circumstances be?
  (Mr Green) The circumstances needed to get it, in terms of immediate issues, are to do with sorting out the climate change levy. The next range of issues would be to do with NETA. In the longer term it would be using the powers the Government took in the Utilities Act 2000 to introduce arrangements for CHP similar to those which operate for renewables. Renewables to a certain extent are less affected by NETA because there is the underpinning of the obligation. At the moment no such facility exists for CHP although the Government did take the powers in the Utilities Act to introduce such an arrangement. We are in discussion with DEFRA and the DTI about what might be the circumstances in which they would activate the powers they took in the Utilities Act to introduce arrangements for CHP similar to those which operate for renewables.

  248. Meaning that you would want an obligation in relation to CHP in order to meet the target?
  (Mr Green) I think so. That is the thrust of what we are suggesting. We are not suggesting anything like the level which has been suggested for renewables because CHP is fairly near commercial. What we are seeking, through raising the issue of some form of obligation or however it was done—there might be different ways in which it could be done—is to provide some long-term stability in the marketplace which will then enable companies to invest. If we get the messages right, then the CHP industry will be investing about £3 billion over the next eight or nine years in new CHP plant. That needs to be done in certain market conditions, one of which is getting a reasonably stable price for electricity, when clearly in the very nature of a commodity market the price will be up and down. We are trying to find some way in which some stability could be introduced. The figures we have done indicate that if there were to be some form of obligation for CHP, the price would be about one third, if not less, than it is for renewables, just because of the nature of the technology being more mature. If it would be helpful we should be very happy to send more details afterwards.

  Chairman: When we pause and reflect, we may get back to you. Thank you.

  249. You suggest that CHP should be exempt from the renewable obligation. Could you give the reasoning behind this suggestion? How did you arrive at a figure of £100 million for the cost to your sector?
  (Mr Green) May I just explain the background to it? Quite a lot of CHP plants are licensed suppliers and in order to get the CHP physically into the marketplace you have to be a licensed supplier and meet certain criteria. The way in which the renewables obligation operates is that it is an obligation on suppliers. As soon as you become a licensed supplier, you have either to pay the buyout price or invest in the designated renewable technologies. We became aware earlier this year that there was a problem in the Utilities Act in the way in which it was drafted in that the way in which they defined the base on which the renewables obligation was going to be created included CHP. The DTI were as surprised as DEFRA was that the legislation had not sorted this out in 1999 when it was being passed through the House. For whatever reason, the way in which it was drafted does not appear to have given Ministers any discretion about where the levy is collected from. That is one of the reasons why we have raised this as an issue. In order to sort this out I understand new primary legislation is likely to be needed. The way we worked out the cost is based on the likely level of supply from CHP plant over the next few years, the likely value of that supply and the way in which the levy would apply to CHP supplies. There is a degree of frustration that CHP is driven in terms of the Government's target by its environmental policies, yet an unintended consequence of the Utilities Act is that it is captured in the supply obligation therefore has the effect of placing this additional burden on the industry. I have to say that Ministers have indicated that they would like it to be sorted out but it will depend on how much parliamentary time is available for any changes to the Utilities Act.

  250. May I move on? I get the impression that CHP is in danger of being stuck in an old technological mind set: you generate electricity and you sell off the surplus. What about things like fuel cells. If you had fuel cells fuelled by distributed natural gas, could that become an alternative?
  (Mr Green) The short answer is yes. The debate at the moment—and there is a lot of interest around the whole concept of domestic or micro CHP—several UK companies, some of whom you might be hearing from, BG Group and others, have invested quite heavily in the technology and are hoping, subject to certain conditions, to be able to go live with commercialisation of the technology in two or three years' time. That is based on a Stirling engine rather than a fuel cell. There is also work going on in parallel in the motor industry to develop fuel cells based largely on the automotive sector. It is going to be interesting to see which one comes to the market first of all, whether or not it is the Stirling engine based system or the fuel cell based system. A lot of the developments in CHP technology have been spin-offs from other sectors. High efficiency gas engines are spin-offs from the truck industry for example, high efficiency gas turbines are spin-offs from the aeroplane industry. It is difficult to judge whether or not the ones which come to market first of all will be fuel cells based on natural gas, or Stirling engines based on natural gas but suffice it to say that in both sectors there is a lot of work going on at the moment to bring the technology to commercialisation so you can introduce what would be the ultimate in competition, giving all of us the opportunity to generate power in our own homes and to heat them as well, be it from a fuel cell or Stirling engine.

  251. I live in a block of flats which has combined heat and power. I often wonder whether it might be cheaper to go into the liberalised electricity market to buy my electricity to run a central heating system. I am not able to do that because CHP denies me that right. Okay, I entered the block of flats knowing this was so. Does that trouble you at all? I do not mean you to address my personal case.
  (Mr Green) No. I always believe in consumer choice. Our former Chairman's mother lives in a block of flats in Leeds powered by CHP so there is quite a strong connection in the industry. We have never argued that consumer choice should be restricted, it just depends what you mean by consumer choice. If for example that block of flats is owned by a local authority, under the legislation which governs investment by housing authorities it would have to have gone to tenant consultation about the energy choices for that block of flats. If as the result of that tenant consultation the tenants voted in favour of going the CHP route, excellent. If the tenants voted in favour of going another route, it is their democratic right to make that choice. What we are seeking to do is to make sure that the technology exists on a level playing field so that customers can make an informed choice about which way they want to go. For example, there are strong links to CHP in the Government's fuel poverty strategy in that we know from the work, for example, at St Pancras Housing Association next to Euston Station that a small-scale CHP system there was able to reduce the tenants' energy cost by about 20 per cent. The tenants have been highly satisfied with that and they voted for it and they voted for a payment system which got rid of the standing charges as well. They did that three or four years ago. There are similar examples elsewhere in the public housing sector where tenants have voted in favour of it once they were given the choice.

  252. Is it sophisticated enough now for each tenant to be metered for their energy use both for heat and electricity?
  (Mr Green) Yes.

  253. So there is still incentive for each person to be economical?
  (Mr Green) Absolutely. It may surprise the Committee but we never argued that you should always do CHP first of all. We always argued that first of all you should make sure this building or any building is well insulated to reduce the energy demand. Secondly, you should then look at the appropriate size of CHP and it may well be that the building is so well insulated you can power it with a solar cell and you do not need CHP. Fine. You are still achieving the same objective of carbon reductions. Ultimately what CHP is is a transition technology to wider use of renewables and other benign sources in the UK.

  254. If I am right, you want a remission of NETA, you want changes in the implementation of the climate change levy, you want CHP to be exempt from the renewable obligation. Anything else?
  (Mr Green) I am sure I could think of a number of things.

  255. We have a vote at seven!
  (Mr Green) I am aware of that, Chairman. If we had had this conversation two years ago, you would probably have had a very different reaction. It would not have been a reaction where the market was essentially in a downward spiral, it is where the market was very buoyant. Therefore I suspect the shopping list—and everyone is always going to have a shopping list—would have been much smaller. The reason all these issues have come up is fundamentally because although the Government has got a target for 10GW CHP by 2010, it is fair to say that there is no clear strategy in place for achieving it. DEFRA Ministers have made clear that they intend to bring the strategy out shortly and we hope that "shortly" will be this year not next year. All the industry is looking to get some—excuse the phrase « joined-up government to make sure we not only have this vision which the Prime Minister and others have endorsed—and the target was first set by the last Government—but a clear strategy for getting there. At the moment it is quite difficult to say what the clear strategy is for how we are going to get there, so we end up in a sort of shopping list approach to policy. What we should like to see is a clear strategy which underpins a clear target. We have the target but not the strategy.

  256. You will have submitted to the PIU and they may well inform the strategy development of DEFRA. Would that be correct?
  (Mr Green) We have submitted to the PIU. The industry was getting somewhat frustrated with the lack of progress on the CHP strategy about 18 months ago and after extensive consultation with various players we produced a draft UK CHP strategy which we submitted to the Government. That has been submitted on to the PIU, together with an update on one or two areas which need to be looked at in the more immediate future.

  257. Do you not think this is the product of sloppy wishful thinking on the basis that they think of a figure and then eventually they will get round to trying to will the means?
  (Mr Green) I would not quite use the phrase "sloppy wishful thinking". The frustration in the industry is that the Government have a target but they have been very focused on some short-term promotional measures in the CHP sector and whilst they have been focused on the short-term promotional measures the market has changed so fundamentally that it undermined the goal of where you are wanting to be. That is why we believe it is very important to have, as soon as possible, a clear strategy, preferably with some legislative underpinning as well.

  258. The Government have been spinning one way and unfortunately the market has been spinning another.
  (Mr Green) Yes.

  259. You speak so passionately about CHP. Could you just tell us why we lag behind the European partners in CHP as such?
  (Mr Green) In some senses we are actually ahead of the rest of Europe in the development of small-scale CHP, particularly the potential on domestic or micro CHP. The reason why it is so much further advanced in the Netherlands where about 47 per cent of electricity is from CHP, Denmark is quite a high proportion as well, Germany quite a high proportion, is to do with the different ownership structures of the industry. In Denmark for example, the industry is very driven by what local authorities are engaged in. Local authorities have clear duties in relation to energy policy and that has produced a different outcome. In Germany you find the La­nder own a lot of municipal CHP plants. That has driven the policy in a slightly different direction. In the Netherlands they use CHP very consciously as part of a way of spreading in an efficient way the growth of the natural gas grid in the Netherlands. They have gone for a very distributed model of energy production in the Netherlands. It is a combination of circumstances which have been different in Europe. What is interesting at the moment is that as liberalisation rolls out across Europe challenges similar to those we have been seeing in the UK have also been noticed in other countries as well. If I talk to my opposite numbers in some of the other countries, they are experiencing similar downturns at the moment. We have always argued in favour of liberalisation but it needs to be liberalisation which is informed by wider policy objectives.

  Chairman: Thank you very much. It has been very instructive. We have got through a lot in a very short time. Thank you very much.