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UTILITY WEEK | 26Th sEpTEmbEr - 2nd ocTobEr 2014 | 23 Finance & Investment T he rollout of the UK's electricity market reform has brought forward an increase in interest from a diverse range of new investors who have a number of requirements as new entrants. They need: • To build up their understanding of the GB market and, in many cases, of the principles underpinning liberalised energy markets in general; • To be clear on the allocation of risk and reward; • To look to limit the level of risk to equity returns. This is leading to innovation in the structuring of deals, with project contracts re-allocating risks that the investor is uncomfortable with, for example to a utility also investing in the project. Different types of equity investor are attracted to each stage of the project lifecycle, from early project develop- ment to mature, proven operation. Over the past decade, vertically integrated utilities have played a dominant role in providing capital for genera- tion projects right across this lifecycle. O en, the inves- tors involved in developing an asset then hold that asset through its operational life. Market reforms have focused on helping to mitigate risks for operational assets, rather than assets under development or construction. So investors interested in entering the sector are largely focused on providing equity to operational assets, where debt gearing levels can also generally be increased through refinancing. The perceived risk that new investors identify in construction finance constrains the provision of equity to projects under development or under construction. To generalise, the risks involved in these investments require skills to manage, whereas the risks involved in operational assets can o en be managed effectively through contracts. For renewables projects, pure project developers are playing an increasing role in developing projects, then selling them to recycle capital into the next project. This leads to a stream of acquisition opportunities for market participants, which vertically integrated utilities are una- ble to capitalise on in light of their constrained balance sheets. This situation is unlikely to change soon, as the premium that some investor classes are prepared to pay for well-structured deals helps to perpetuate this cycle. Dr Jayesh Parmar, partner, Baringa Partners LLP "The perceived risk new investors identify in construction finance constrains the provision of equity to projects under development." Investor view Jayesh Parmar Investors are largely focused on providing equity to operational assets Market view Energy policy waits on politics Scotland may be staying in the UK, but energy policy is far from united, says Martin Brough. S hares, including Infinis, SSE and the wider UK equity market, rose last Friday as the risk of Scot- tish independence was removed. However, the end of the independence debate may simply mark the begin- ning of political campaigning for the May 2015 general election, and a discussion of further devolution of pow- ers from Westminster. Low-risk returns are worth a great deal to investors in the current low interest rate world, but UK energy policy risks have not been eliminated completely. While investors expected a No vote, there was still a worry about the potential downside in the event of a Yes. Over and above currency and credit rating concerns, many energy-specific issues might have been consid- ered to be at risk, including renewable subsidies (largely backed by English customers), market wholesale prices, retail margins and even network regulation. A downside scenario might have cost Infinis and SSE 20 per cent of their group earnings. S0 the United Kingdom will now stay united, but energy policy is still a divisive topic. Energy regulation is an area reserved for Westminster rather than the Scottish parliament, but Northern Ireland has a different energy regulator to Britain and it is possible this could be an area of competence demanded by Scotland. Retailers might be nervous about the implications, while network companies would also be likely to want to retain current arrangements, even if a new Scottish energy regulator promised to be "fair". The existing Renewables Obliga- tion Certificates look likely to continue to be traded on a national basis, but Scotland may want more control over awarding future contracts for difference for clean generation. Taxation of carbon emissions for generators is already different in Northern Ireland, and a different Scottish carbon price might be possible, if not sensible. At a UK level, since Labour leader Ed Miliband's price freeze promise in September 2013, energy has been a key political issue and is likely to remain so through to the general election in May 2015. Labour is currently lead- ing in most national polls and has promised to abolish Ofgem if elected, creating a tougher regulator with a mandate to penalise perceived poor performance. The political reaction to the results of the current Competi- tion and Markets Authority inquiry into energy supply is also likely to be important to future sector returns. While global equity investors want UK utilities to look as much like bonds as possible, political noises around energy policy will not be banished by the No vote. Martin Brough, utilities equity analyst, Deutsche Bank