18/10/16 – Maintaining Investment in the Light of Brexit

Speakers: Andy Koss, CEO of Drax Power, Jim Smith, Managing Director of Generation SSE, and Anna Stanford, Head of Policy and Public Affairs at RES.

All Party Group on the Costs of Energy

18 October 2016 – meeting notes

Maintaining Investment in the Light of Brexit

Chair: Lord Palmer
Parliamentary attendance: Lord Palmer, Sir Peter Bottomley MP

Lord Palmer opened the meeting, welcomed the speakers and introduced them.

Andy Koss, CEO of Drax Power

There are six units at Drax, with 4 GW capacity supporting 14,000 jobs directly and indirectly. 20% of the power supplied by Drax is renewable energy.  We have large capital expenditure commitments and so continued investment is always extremely important, but never more so than at the current time.

The National Audit Office says that £140bn of investment is necessary in the period up to 2030 (others are saying even more), and this is all about replacing old coal and gas capability. This needs to be done, so investment is certainly needed. Brexit doesn’t change the need for investment certainty, but the focus will change to home-grown regulations rather than EU ones.

At Drax we have made a commitment to undertake the largest decarbonisation project in Europe, and this was driven fundamentally by the UK regulation rather than European legislation, specifically the carbon price floor, support for renewables and CFDs. We call upon the Government to continue to demonstrate that firm commitment to UK regulation and give that investment certainty.

The Carbon Price Floor: this really is the instrument that puts a price on carbon in the UK. The European scheme, although we are a believer in it, hasn’t delivered the carbon savings that we would have wanted, and the UK has unilaterally put in place a carbon price floor which is single-handedly driving a lot of coal to gas switching and the drive to renewables. We call on the Government to extend that and possibly increase that, at least through to 2025 when coal is deemed to be off the system. We believe it supports renewables, it supports the target of getting coal off the system by 2025, it supports investment in new, more efficient gas plant, and it sends a strong signal of commitment to the investment community.

Commentators have said that if we remove it, it would save quite a lot of money, but if we remove it, it would also remove a source of income (around £2bn a year) for the Treasury. It would also drive up costs elsewhere in the sector, so we are a strong supporter of keeping in place a strong carbon price floor.

Renewable obligation is closing but another key principle is the CFD regime, which is an excellent instrument which should continue and be used to incentivise renewables. It’s absolutely critical that we see the Government continue to support the CFD. Also, the UK may have the opportunity outside the EU to make improvements that we otherwise may not be able to do. In CFDs we believe in full competition, recognising the whole costs of integration into the system, and as the CMA (Competitions and Markets Authority) have declared, it is the best way to drive the lowest cost to the consumer.

I mentioned the capacity mechanism and we believe in continued support for that, underpinned by the carbon price floor. It’s the best way to get coal off the system and incentivise new plant to fill the gaps when there is no sun and no wind. And we also believe that continued access to EU gas and power markets will improve our resilience, especially as the UK continental shelf continues to decline. So whether we are in or out and whatever the arrangement, we need continued access to those markets.

A note of caution from Drax on interconnectors. We believe that there is a case for interconnectors, but perhaps there is now an opportunity to reconsider the policy and regulatory distortions that exist. There has been news today about the French nuclear fleet, another five reactors coming offline, just shows the concern of depending on foreign generators for security of supply. So we don’t believe interconnectors are the panacea that the Government believes, but there is definitely a role for them.

To conclude: Brexit need not undermine investment in the UK power sector. We need to continue to replace ageing infrastructure, we need to keep costs down and we need to continue to reduce carbon emissions. Europe did give us one level of support and set of guidelines to do that, and if that disappears under Brexit then it is over to the UK, and we believe the policy tools are there to continue.

Question from Lord Palmer: Do you genuinely believe that by 2025 there will be nothing from coal?

Response: We were due a coal consultation in the spring, but we haven’t seen that yet. There is still time to get the right policy tools in place. This capacity market will be very interesting: I’m not sure you will see any new build come through this year, but the Government is doing everything possible to incentivise gas. At Drax we believe we can get coal off the system by giving us the option to convert more units to biomass. So I think there is still time, but there is a strong caveat, though – there must be sufficient plant in place to protect security of supply. So if there is no solution then they will keep coal running.

Jim Smith – Managing Director of Generation SSE

SSE has around10½ GW of generation from a diverse range of sources, including coal, gas, oil, hydro, pumped storage, onshore and offshore wind, and also energy from waste.

SSE is a UK-listed energy company operating right across the energy value chain and we are involved in the generation and supply of electricity and gas to over 8 million customers. Through our regulated networks business we have a distribution network in central and southern England, and the generation and supply business also operates over Northern Ireland and the Republic.

SSE has a unique vantage point of the market, but it was striking, listening to Andy Koss of Drax, how similar our views of the market are. Implications of Brexit for SSE are that Great Britain and the whole of Ireland are our core markets. How the market develops following the referendum result is therefore a key issue for us, with 10s of billions of pounds invested in the infrastructure in the last decade or so. For SSE the investment has been around £1½ bn each year. There’s no question that the market needs continued substantial investment in the years ahead. In electricity generation we need to replace all the coal assets with flexible gas-fired capacity as we’ve just heard. We need to address the replacement of an ageing nuclear fleet, and we need more renewables. We will need to increase the flexibility of the system to accommodate this changing mix of technologies, accommodating increasing levels of interconnection, storage and more responsive demand cycles.

Maintaining this investment against a backdrop of Brexit does present a challenge, and SSE has three priorities:

The first, and probably the most important, priority is stability. The government needs to provide stability by maintaining existing policy mechanisms. SSE is ploughing on with major infrastructure projects. These kinds of projects take between five and ten years from initial scoping to operation, so decisions need to be taken now for projects for the 2020s. We need a stable policy and regulatory framework in order to secure finance. Long-term projects need long-term policies. As has been said before, and a robust and stable carbon price is needed between now and at least 2025.

Secondly, the UK should remain a member of the EU’s internal energy market in order to maintain reliable, affordable and low carbon energy supplies. Whether the UK is able or willing to remain a participant in that market is ultimately a decision to be made between the UK government and the EU.

A word of caution: we need to know what the rules will be for cross-border trade. Clearly they need to be transparent, sustainable and controlled. Finally as a major participant in Northern Ireland and Ireland, it is clear to us that we need to enable the Northern Ireland energy consumers to continue to benefit from market efficiencies by maintaining the single electricity market and arrangements for gas. Since 2007, the all-Ireland arrangement has allowed the efficient wholesale electricity trading between the two countries. This harmonised market has undoubtedly benefitted customers.

Question: Is it true that you are selling one of your distribution networks?

Response: Yes, we are selling a stake in Scotia Gas Network. We currently own 50% and we are selling under 18% of that, so we’re retaining a third of the investment

Question: Is it true then that the prospect of Brexit on its own isn’t as damaging for the industry as some people fear it might be?

Response: I definitely think that it’s more a wider issue for the economy as a whole. The energy companies will see their way through it, as people will always need energy.

Question: You’ve spoken about interconnectors – is there ever a prospect of the UK producing 100% home-grown wholesale energy for GB other than emergency interconnector use, or do you think it’s going to go down the road of more heavy reliance on interconnectors?

Response: We don’t know, as the new Government is different and we’ve seen very little of energy policy from the new Government. The last Government was very supportive of more interconnectors but there are signs that this new Government may be softening away from that position. Drax would urge caution about embracing interconnectors, as (referring to a recent Aurora report) not all are necessarily good for the UK consumer.

Anna Stanford, Head of Policy and Public Affairs at RES

RES is a British independent developer of large-scale wind and solar, and battery storage. Our headquarters are in the UK, but we are active in 13 countries around the world. We’ve built about 12 GW of capacity since the early 1990s, and several thousand megawatts in the pipeline. For us as investors and developers in renewables, EU legislation has been important: the policy and targets have been key drivers for growth. Targets give long-term signals to investors: they lead to deployment, they lead to jobs and they lead to further cost reductions. Globally, the growth in clean technologies is quite extraordinary: a record $285bn worth of investment in renewables last year. Wind energy alone, according to a report that came out today, could be providing 20% of global electricity by 2030 and 2½ million new jobs. China, for example, has huge plans to increase its wind and solar activity.

We supported the ambitious EU targets and proposals on electricity market design. For us they inspired confidence and provided a framework for action by individual member states. As we grow our storage business, it offers us opportunities for growth. But unfortunately in the UK market we’ve had a lot of policy uncertainty and some political interference, which has been unhelpful.

The latest Ernst & Young Renewable Energy Country Attractiveness index put the UK down to 13th, citing the policy changes that have happened as a cause, while emerging countries, such as Chile, Mexico and Morocco have surged, because of their clear targets and policy mechanisms.

In terms of post-referendum impacts, there have been some immediate short-term damaging impacts for us, the main one being the cost of capital, since uncertainty always impacts the cost of capital. As an example from our wind energy portfolio, if there is a 1-2% change in the cost of capital, that translates to a £4-£9 increase per MWh. If you extrapolate that across the capacity that needs to be built over the next ten years, then that means billions of extra costs to consumers.

In the short term, we’ve seen much nervousness, and many deals cancelled or postponed as a result of Brexit. The uncertainty is around tariffs, import duties, working permits, has particularly affected Far-Eastern investors. Others have responded by increasing their return expectations on investment. I think foreign investors need some reassurance.

Then we have the macro economic impact, e.g. the falling pound affects us an importer of equipment. Equipment, such as wind turbines, is priced in euros and there has been a 15% increase in the cost of imports. RES can hedge against currency charges in the short term, but we can only hedge at the point of executing the contract, so it is having an impact on projects that are at an advanced stage. It also has an impact on operational expenditure, because some of that is euro-denominated.

In the long term, things are more optimistic. There are huge investment challenges ahead of us in the UK, with the need for low-carbon generation needing investors like us, and we are ready and willing to provide the capital and the skills to help achieve that.  The good news is that the policies that affect our investment decisions in the UK are UK-controlled, and the policy tools are available to incentivise investment regardless of what happens in the EU.  In the past few years a lot of policies have been driven by energy security concerns, and we also have very ambitious domestic low carbon policies, we have the Climate Change Act, carbon budgets, and an emissions reduction plan coming through. We were very pleased to hear immediately after the referendum that the Government is still committed to the Climate Change Act, improve the carbon budget in early 2017, and is going to ratify the Paris agreement. These are very important investment signals.

There could also be some opportunities from having a more decentralised approach to policy, not just from EU to UK but from Westminster outwards. Devolution can be positive.

The Government is also launching a consultation on flexibility, and regardless of what happens with the EU electricity design, this could give an opportunity to change regulations that can bring forward storage in the UK and .create a successful market there. But above all we already have an extremely effective and efficient market mechanism in the shape of the CFD contracts for difference, and I think that’s the biggest thing for us: it was the result of successful market reform and it provides strong investment signals, it reduces the cost of capital through competitive auctions, and provides best value for money to consumers. It’s needed because there isn’t a strong enough wholesale price signal.

We are seeing in emerging markets auctions that are bringing about cheap renewables, but auctions in the UK will only act as an effective market support mechanism if the cheapest technologies like onshore wind and solar are able to compete in them and we have technology-neutral auctions.

If we have more variable renewables, and bring onshore wind and solar forward through the auctions, what do we do about intermittency? How do we have security of supply? That can be solved by adding more flexibility into the system, like storage and demand-side management.

We do need to see the Government committing to an enduring CFD regime and allowing all technologies to compete. We need to have continued access to the people and skills that we need. We need access to the single market, and the issue of Ireland and the single electricity market there is really important to us, and we need to maintain that strong commitment from the Government to maintain low carbon targets, Climate Change Act and emissions reduction plan. These are all things that have strong investment signals for us.

Question from Sir Peter Bottomley: Martin Rees has said that by 2025 the cost of carbon-free electricity could be generally lower than the cost of coal. Will this be achieved?

Response from Jim Smith: There’s two parts to it really – firstly there’s the price of coal. If coal becomes very cheap then that prediction become very difficult, especially if there are no emissions restrictions.

Onshore wind is not that far away. We’ve seen the price of offshore wind, which looked very expensive a couple of years ago, coming down.

How much? The price in the last CFDs £119 MWh, so still relatively expensive, but previously it was £150 MWh, and it may keep on moving in that direction. Until recently commodity prices had dropped, e.g. gas has gone from 67p therm down to 25p this summer, which shows how volatile the gas price is. It was partly the exchange rate but also linked to supplies of LNG.

I like to think it will happen but 2025 might be ambitious

Response from Anna Stanford: We’ve seen more than 10% reduction in three years, and industry believes it can be subsidy-free by 2025. Onshore wind is already the cheapest form and we think another auction would show that wind can be the cheapest technology.

Comment from Andy Koss: regarding biomass, the mix is good as wind and sun are not consistent and the system needs to be stable. We need to look at whole system costs, including back-up costs. The CFD numbers are not the all-in costs.

Question from Sir Peter Bottomley: Is biomass truly carbon-free?

Response from Andy Koss: Yes. Sustainable biomass from forests where there is more growth than is being harvested. There is carbon associated in the supply chain. You have to measure the carbon footprint at all stages from plant to plug. The biomass we source is 80% lower than the carbon emissions of coal. If we look at the whole supply chain then it’s not entirely carbon-free, but is certainly is low carbon.

Question from Dan Starman, Cornwall Energy: In the GB energy markets we now have around 28 GW of embedded generation. A combination of Brexit and what has been referred to as “a bonfire of policies”, and the decision to ask Ofgem to review embedded benefits, have combined to impact on the investment decisions for small-scale renewable generation. Would you agree with that from your own experience, and what are you seeing in response to that from renewable embedded generation?

Response from Anna Stanford: There needs to be a holistic review of the whole system and a colleague in the audience who has been working on this can answer much better than I can.

Comment from Alex Coulton: There have been changes and there are some distortions, and it’s now much more messy, and the whole market arrangement needs updating. There are distortions that exist from historical market rates, and a holistic review would address these. It’s a complex picture and one of the things that we are trying to encourage is that reforms, for example around network charging arrangements, would make the market fit for the future.

Response from Andy Koss: The current charging arrangements didn’t envisage the level of embedded generators on the system. I agree that the whole system needs to be reformed and we should avoid the danger of tinkering with one or two bits of it.

The meeting closed at 1900.