Utility Week

UTILITY Week 20th June 2014

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UTILITY WEEK | 20Th - 26Th JUnE 2014 | 21 Finance & Investment T here is much talk in the US cable TV industry of "cord-cutters" who are seeking to stop paying for pay TV completely by replacing traditionally distributed content with internet streaming. While part of the motivation is technology and convenience, oen customers are so frustrated with the perceived behaviour of the incumbent cable TV providers that they want to punish the industry by denying it revenue. Cord-cutting in energy may sound fanciful, but technology may move over the next decade to a position where going "off-grid" might be possible. Another order of magnitude drop in solar costs, together with load shiing by smart appliances, ground-source heat pumps for heating and batteries to meet dark peaks could be enough to make self-supply feasible. Engineers and economists might be quick to point out that a purely home-based solution could not com- pete on cost or reliability with a centralised network, but cord-cutters might do it anyway, to punish the energy companies. How can energy companies defend themselves? First, they must make sure prices are competitive for the things the new technologies are good at. Solar is great for providing commodity but not capacity (at least for winter peak- ing countries). Energy companies are foolishly trying to recover fixed costs from marginal prices – inviting progressive displacement by "self-consumption" of solar. Halving unit prices and increasing fixed charges would make charges more cost reflective. Second, energy companies must have a deeper understanding of the product they provide. In a world of zero real interest rates, pricing closer to marginal costs might not be enough to stop the substitution of com- modity with domestic capital. If most energy is produced at home, what is the energy company really providing? At this point the industry will find itself selling an insur- ance product not a commodity product. Just as cord- cutters in TV are reluctant to give up access to live sport, it is important for the energy industry that customers value the security of energy being there when they need it most. Martin Brough, utilities equity analyst, Deutsche Bank "Home energy solutions could not compete with a central network, but cord-cutters might do it anyway, to punish the energy companies." Analyst view Martin Brough Going 'off-grid' might be possible over the next decade Wacc in exchange for fast-tracking, in the case of South West Water and Affinity Water, or earlier dra determinations, for Welsh Water and Northumbrian Water. Ofwat is set to publish dra determinations for the remaining companies in August. The true test of Ofwat's approach will be whether it prompts investors to quit the sector. There is little evidence of that so far. Share prices of the listed companies have risen in the past year: Severn Trent is up 12 per cent, United Utilities 22 per cent and Pennon (which owns South West Water and waste company Viridor) 16 per cent. As for mergers and acquisitions, no activity is expected until next year, aer Ofwat has made final its determinations. All the same, water companies cannot take investment for granted. At the same time as negotiating with Ofwat over their finan- cial settlements, they are under pressure to reassure investors that they can perform well enough to bring in a decent return. comparison of The uk waTer secTor wiTh oTher regions or counTries over Time – all respondenTs percepTion of ofwaT's performance over Time 100% n Strongly agree n Agree n Neither n Disagree n Strongly disagree 2008 2013 2014 2008 2013 2014 2008 2013 2014 Ofwat is enabling water companies to finance their functions Ofwat is independent of political influence Ofwat is balancing customer and investor interests reasonably 80% 60% 40% 20% 0% 100% 2013 2014 2013 2014 2013 2014 2013 2014 2013 2014 2013 2014 Northwest Europe Eastern Europe Southern Europe Australia Canada US 80% 60% 40% 20% 0% n Express no view n More attractive n As attractive n Less attractive

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