My Lords, this is very much a probing amendment, designed to enable us to discuss again the detail of how the proposed capacity mechanism might work. One of the biggest problems with the mechanism is that, on the one hand, it purports to be technologically neutral by somehow treating all capacity as if it were equivalent; yet, on the other, interventions are proposed that go against that principle—the debate that we have just had is an example of that. Deciding to host the first auction in 2018-19 is not a technologically neutral decision; it is a decision designed to enable CCGTs to compete—so, already, we have a conflicting message coming from government.
Another aspect of that lack of technological neutrality is the proposed differing lengths of contracts. Again, this is explicitly stated as a way of trying to rig the market in favour of a certain outcome. In this case, it is offering potentially 10-year contracts to CCGTs and is designed as a kind of carrot to get those plants built. Similarly, three-year contracts might be made available for plant which is seeking significant refurbishment—again, another intervention to try to achieve a certain outcome. Unfortunately, the proposals will not work. The confusion between a desire to be technologically neutral and these interventions is creating a great deal of uncertainty.
My concern is that insufficient attention has been paid in the department to what I would call scenario planning in relation to the current two big market drivers, the cost of coal relative to the cost of gas. Here, while I do not fully agree with the noble Viscount, Lord Ridley, on everything, there is a real issue about the relative future prices of fuel. They are an essential component regarding whether this capacity mechanism will be needed. At the moment, gas prices are very high and gas plant is losing money, hence it being mothballed. That is neither environmentally desirable, nor is it desirable for security of supply. I can therefore see why the Government have come to the conclusion that a capacity intervention is needed. However, my concern is that the way that this is being done will not achieve the desired outcome.
The reasons for that are multiple. One is that we are in a situation of oversupply. Even though we have lost 7 gigawatts of old coal capacity, we were at historically high levels before those closures. We are still in a situation where the wholesale price is not sending a signal to either keep more expensive plant in the system or build new plant. That signal is further diluted by the fact that we are about to intervene in the market to create contracts for different for significant volumes of new capacity. The net effect is that if you are sitting there with a consented gas plant and deciding on whether to invest hundreds of millions of pounds in it, there are significant, real-world hurdles before
you would say yes to that project. The way that the department is approaching the capacity mechanism is not going to address that real-world problem.
My concern relates to the fact that existing plant in a capacity auction that is pretending to be technologically neutral, if we have an oversupplied market, will always squeeze out new capacity because the existing capacity is already on the bars and has none of the costs and risks associated with new capacity. The legacy plant will be bidding in the intervening period. While that legacy plant might be useful for keeping the lights on, it creates an environmental problem. The technology-neutral approach that the Government have chosen, although they are not consistent in that, poses a problem. Coal plant is making an enormous amount of money, far greater than the returns being made by gas plant. These coal plants are capable of running for many, many decades and are at a point when they are considering whether to continue operating under tighter air-quality restrictions. These plants have the capability of operating for many years to come and at high load factors if they decide to fit new filters, new scrubbers, to make themselves compliant with the requirements of the integrated emissions directive, the IED.
I am concerned that this capacity mechanism is not going to work because, in trying to bring on CCGT and reach that Nirvana of new investment, you are necessarily going to be paying a high price for capacity. That will provide a windfall to existing coal operators, which, if it were not for the carbon floor price, would certainly want to run for decades to come. The carbon floor price is the only thing holding them back because it is that which lowers their position in the merit order.
The capacity mechanism—you will not find this in any of the literature, advice or information that has been provided—could provide in the region of between £50 million and £75 million per year, per plant as an up-front payment. If a plant that is considering a life extension can win a three-year contract, it will then receive between £150 million and £240 million in guaranteed payments. I posit the problem—and I would like the Minister to respond to this—that that might be enough to nudge them in favour of investing in those air quality filters and would be sufficient to give them comfort that they should upgrade the plant and continue to operate. No one can predict the future, but the sums of money involved in the capacity mechanism are such that it could well be a material influence on decisions about what to do with those coal plants.
My fear is that the Government have no back-up plan for if that happens. Previously in Committee, we have discussed measures that could apply—an emissions limit for carbon for coal plants seeking life extensions—and they have been rejected. We have also tabled suggestions that suppliers ought to have a decarbonisation obligation. They have been rejected. It is almost as if the Government are not really committed to decarbonisation. I am sure they are, but if you look at the Bill at the moment, it is very possible that this will see a large number of coal plants opting in to the ID, refurbishing and staying on the system well into the 2020s. That is not compatible with a strategy for building CCGT because it will simply squeeze out the capacity that is expected to be brought on.
Combined with that, we have a demand profile that is flat, or falling, and the peak is falling, so not only are the demand profile and the whole not rising, but the peak is softening as demand is shifting. If we had a rising demand profile, one might be able to argue that that is where CCGTs will bid in. We would still have all the old coal, we could bring back the mothballed gas and there would still be room for CCGTs, but with a flat or declining demand profile, there is simply not the room. What scenario planning have the Government done for a situation where a larger number of plants than expected opts into the ID, fits filters and stays on the bars? What impact will that have on our emissions profile, our carbon intensity and the cost efficiency of the whole EMR package?
The EMR is meant to be about trying to transition to a low-carbon economy. We should be seeking to do that in the most cost-efficient way. It is evident that the most cost-efficient way is to switch from high-emissions coal to low-emissions gas. That is what we did in the 1990s and it delivered all our targets to date. We can obsess about tiny micromanagement of renewables and try to get nuclear on the bars, but if we get the coal to gas ratio wrong, we will be running to stand still. We will not see emissions or carbon intensity coming down. In the interests of consumers and the environment and security of supply, we have to get the capacity mechanism right. At the moment, I am very worried that it is not.
I have one or two specific questions. I have been trying to dig down to where the Government’s optimism about the closure of coal comes from. It is obviously partly because they have great faith in the carbon floor price. I do not share that faith. It is a highly political policy with only two years of forward planning. For me, it is not a politically bankable policy. There is also some analysis underpinning this. There is a reference to research done by Redpoint. I can give the reference. It is mentioned on page 30 of National Grid EMR Analytical Report. I would like to see that analysis. It seems to be the crux of the Government’s assumptions about the impacts of ID. We should see that because it is so crucial.
I could go on and talk about the falling costs of the air scrubbing equipment and the fact that there are flexible options now arriving in the market which mean that you can fit a low-cost version of SCR and still comply. There are lots of ways of trading once you are in TNP that give you flexibility, but I do not want to bore the Committee with the detail. The main point I am trying to make is that there is a great possibility that the Government’s modelling does not match what is happening in the real world.
I would like to see far greater emphasis on scenario planning that looks at the relative impact of coal. I am supported in this; the EMR panel of technical experts, in its final report for DECC, said:
“It might be helpful if DECC considered best practice from the private sector by adopting a light-touch Scenario Planning methodology. In this, the models play an important but more limited role compared with exogenous guidance. We believe that this could lead to greater realism and enhance plausibility. Most importantly, we believe this or a similar methodology could promote deeper discussion and broader consensus on the key market drivers”.
It went on to relate a whole series of advantages that would come from this light-touch scenario planning, as opposed to the pure quantitative modelling approach, which I am fearful underpins some of the Government’s assertions and plans.
4.30 pm
This is definitely a probing amendment. It is not the only way in which to solve the problem of trying to ensure that we have a carbon-efficient and cost-efficient outcome in the longer term in dealing with the security of supply. If you ignore the role of coal, there could be all sorts of unintended consequences.
I have sat in boardrooms with CEOs of power companies—or with one particular CEO—when they were deciding whether to opt in to the LCPD, and fitting the sulphur scrubbers. Ultimately, those decisions are made not on pure economics but on a gut feeling, often with a degree of sentiment—that they have a station that is making a shed load of cash, and they take a hedge that they can continue to make more money in future. That is what leads to them opting in rather than opting out. Unless you appreciate that the real world does not always match up with the models that you have in your spreadsheets, very strange unintended consequences come about.
I am passionate about this one because it will be a binary situation. Once people say yes to fitting the scrubbers, there will be no opportunity to introduce retrospective corrections into the market. They will quite rightly say that they have invested in good faith and will continue to operate having done so. So there is an opportunity to get it right now; if the Government get it wrong now, their hands will be tied, as will those of subsequent Governments. That is my major concern. The amendment deals with a very serious issue, so I hope that the department can provide more reassurance and think again about the role of coal and the IED in these plans.