Utility Week

Utility Week 1st November 2013

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Finance & Investment Analysis Energy investment on hold? Nigel Hawkins says political posturing and sabre-rattling has spooked the market and will probably becalm generation investment until after the general election in 2015. T he ballpark estimate of a £110 billion over the next decade for electricity infrastructure investment – mostly generation-related – is one of the most oftquoted figures in the utilities sector. Most of it is expected to come from the big six vertically integrated energy suppliers, all of whom (except Centrica) are burdened with high levels of debt. Progress, for various reasons, has been very slow of late and there are now real concerns about power cuts over the next few years, as old coal-fired plant is taken off the system. A deal has been struck for Hinkley Point C, but even before a sod has been dug from the rich Somerset earth, the 2016 completion date has moved to 2023. A lot can go wrong before then. Think British Energy's collapse, think Fukushima. Think plunging US shale gas prices. And, looking forward, what happens if interest rates soar? Elsewhere, non-nuclear generation investment has seriously stalled. A key factor has been continuing – and profound – doubts about the desperately complex Energy Bill currently before Parliament. More recently, Ed Miliband's well-publicised threat to freeze energy prices for 20 months if Labour are elected has added to the risks attached to generation investment. Given the undoubted popularity of Miliband's freeze, there is widespread expectation of a response from the coalition. While the current 5 per cent VAT rate could be scrapped or even a windfall tax introduced, there may also be changes to both the current Renewable Obligation scheme or even to the controversial underwriting – at way above the current European Union trading level – of the carbon price. Not surprisingly, either, given that the water sector operates comfortably with prescribed prices, there is a powerful argument for retail price controls to be reintroduced for electricity and gas sales: with a few exceptions, they were effectively abolished over a decade ago. The fact that such issues are up for discussion can only deter – rather than promote – the necessary investment. In any event, these doubts can only raise the cost of capital and therefore lift the required financial return. Last month, the Royal Academy of Engineering highlighted the need for generation investment – and the difficulties of delivering it. John Roberts, the former Manweb chief executive who chairs a Royal Academy working group assessing electricity capacity margins, stated that "major investment is needed in the UK's electricity system to achieve a modern, sustainable and secure service that will be the foundation of economic growth". He also pointed out that "most of the energy companies operating in this country are international organisations that will invest in the UK only if it proves to be an attractive market". Too true. Within the big six boardrooms, the sombre mood was, perhaps, best summed up by SSE, one of whose senior spokespeople confirmed that "although we are continuing to develop offshore wind projects, it's increasingly hard to see how a final decision on investment in new offshore wind capacity could be made before the 2015 election." Importantly, five of the big six are operating against a background of high debt levels. Furthermore, the four overseas companies – EDF, Eon, RWE and Iberdrola – have all presided over a shocking share price performance since the start of the recession in 2008. The long-accepted view that utilities were recession-proof proved mistaken, especially if they were heavily involved in generation. RWE's decline has been particularly precipitous: the share price has fallen from €80 in mid-2008 to just €27 now. And the German economy has done comparatively well compared with Spain, where Iberdrola's share price has plunged from €9.2 (as adjusted for a 2/1 share split) to €2.1 over the same timeframe. All four of these overseas companies must not only carefully preserve their cashflow but also focus their investment budgets, which may or may not include the UK. Eon, for example, operates in many European markets but, like RWE, its future free cashflow is under real pressure as Germany works towards the phase-out of all its nuclear plants by 2022. In EDF's case, it has a major domestic investment programme as it starts replacing its second-generation nuclear plants. Newbuild is currently underway at Flamanville in Normandy, where serious costs and time overruns have already occurred. While politics directly affects all EU utilities – witness the dramatic Merkel U-turn on nuclear power and its financial impact on both Eon and RWE – the UK scenario is somewhat different. A UK general election is scheduled for mid-2015 and, for the first time for a generation, energy policy is at the top of the political agenda. Hence for UK energy companies uncertainly abounds, something that Centrica has addressed in recent months. In its half-year report for 2013, its chief executive, Sam Laidlaw, set out some key parameters regarding future investment. He reaffirmed Centrica's strategy by emphasising that it had "a strong balance sheet and a range of investment options. However, we will maintain capital discipline, only investing where we see appropriate returns – further strengthening the business for the benefit of customers and shareholders alike". In fact, Centrica's head has been turned quite sharply of late towards North America where it has invested heavily in the gas sector. While SSE has conspicuously eschewed significant investments outside the British Isles, its caution on offshore wind has also been reflected in its strategy on new gas-fired capacity. Its various gas-fired projects are unlikely to be given the go-ahead until after the next election, when it hopes the energy investment horizon is less blurred. But whether the becalming of nonnuclear generation investment will actually lead to power cuts is the $164 billion question. Nigel Hawkins is a director of Nigel Hawkins Associates, which undertakes investment and policy research UTILITY WEEK | 1st - 7th November 2013 | 19

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