Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
Issue link: https://fhpublishing.uberflip.com/i/262834
14 | 21sT - 27Th FEbrUarY 2014 | UTILITY WEEK Policy & Regulation H istorically, the UK and Germany have adopted different approaches in developing their offshore transmis- sion markets. Both want the best value for money, but their starting points differ. In both cases, many industry participants con- sider the respective approaches sub-optimal and are unhappy with where they are today. It is important to understand the reasons for the different starting positions, and the rationale that has got them to where they are, so that each can learn from the other about the relative strengths and weaknesses of both regimes. More importantly, inves- tors can be in a better position to assess the attractiveness of the different markets. Both countries – but especially Germany – have struggled in the past to create a regu- latory regime that facilitated offshore grid investments. In pursuit of its ambitious Ener- giewende targets, Germany opted for a "stick approach", obliging transmission system operators TenneT and 50Hertz to connect off- shore windfarms in the North Sea and Baltic Sea, respectively. The UK, by contrast, ini- tially preferred a laissez-faire policy: wind- farm operators were responsible for their own grid connections so that both wind- farms and connecting grid were traditionally built and owned by the same private entity. These unequal regulatory regimes resulted in considerable differences between the invest- ment climates in UK and Germany. For the UK, the regulatory structure developed by Ofgem, known as the off- shore transmission operator (Oo) regime, has attracted over £1 billion in investment under transitional tender rounds 1 and 2. A series of auction-style processes has resulted in attracting investors with a very low cost of capital, saving consumers £350 million, according to Ofgem. The acquisition of the Greater Gabbard Oo was supported by a credit enhancement facility from the Euro- pean Investment Bank, which facilitated an A3 rating from Moody's in November 2013, on a par with onshore regulated assets. The Oo regime has also delivered high opera- tional availability, reported at 99.9 per cent as of September 2013. A key reason for this successful outcome is that the development and construction risks for building the off- shore links have remained with the windfarm generators. The generators build the assets and then transfer them upon completion to the successful Oo appointed by Ofgem under its competitive tendering process. The focus of the Oo regulatory regime has been largely on reducing the cost of capital . The initial transitional regime developed to transfer already-constructed offshore grids to Oos will, from 2014, be replaced by the enduring regime. The first enduring tender, Round 3, retains the generator build model, with transfer to the Oo upon construction by the generator. The main difference is that the Oos will bid to own a yet-to-be-built asset, with the flexibility required to accom- modate differences in outturn costs and performance. The design of the Oo build option under the enduring regime is ongoing, with con- siderable complexity being encountered in designing an efficient risk transfer mecha- nism for the development and construction risk. Generators are reluctant to lose control of setting capital and operating parameters of the grid connections to their windfarms, especially in a regime that does not compen- sate them to the same extent as elsewhere in case of grid outage. Given these challenges, Ofgem currently expects Oo build tenders to be launched in 2015, depending on the outcome of tender Round 3. While UK efforts mean a steady replace- ment of the former laissez-faire environment with a concerted "carrot approach", focused on reducing the cost of capital, Germany is fine-tuning its stick approach to speed up offshore grid extension and overcome his- torical lack of investment. Three key blocks to investment are: grid operators lack the necessary financial liquidity; the obligation to build offshore grids does not rest on there being a minimum capacity connected, so investors are le with an uncertain pay-off period; and potentially unlimited liability payments in the case of construction delays or interferences of operations. The second and third reason make the risk-return pattern for third party investors extremely unattrac- tive, which intensifies the first obstacle, due to the unavailability of external funds. To address these problems, Germany's Energy Act was amended in December 2012, reducing to €110 million a year the maxi- mum liability of grid operators in case of construction delays or interferences. This seems to have been well received: in April 2013 Mitsubishi bought a 49 per cent share in four of TenneT's offshore grid projects for €576 million. Political risk has also abated somewhat since the recent coalition negotiations, when offshore transmission grids came into focus once again. Although the new government has cut offshore wind targets from 10GW to 6.5GW in 2020 and 25GW to 15GW in 2030, support for offshore wind remains strong, with the coalition agreed on extending the increased feed-in tariff for offshore wind beyond 2017 until the end of 2019. There seems to be renewed confidence that this regulatory amendment will even trigger future engagements of institutional investors. The liability limitation consider- ably reduces risk, which moves such invest- ments toward the bond market model of the UK, at least in part. The result is that investors face a choice between two different regimes. The UK offers a stable, low risk investment where the cost of capital is low, but missing the ability, so far, to price in the higher risks and returns of design and construction and competition in capital and operating costs. The German regime, on the other hand, features a focus on regulated capital and operating expendi- ture, exposure to greater design and build risks but with less competition on the cost of capital. Both regimes are attempting to drive com- petition into the areas they have so far not reached. However, in starting from different places, the success of that shi is depend- ent on an efficient risk transfer mechanism being developed in both systems. Dr Jim Fitzgerald, associate partner, London, and Carsten Middendorf, manager, Munich, at The Advisory House Linked thinking offshore Jim Fitzgerald and Carsten Middendorf compare the very different approaches of Germany and the UK to ensuring that offshore windfarms are connected to the grid at a reasonable cost. Market view