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UTILITY WEEK | 16Th - 22nd JanUarY 2015 | 23 Finance & Investment M ore than half of global emissions are covered by the recent announcements from the US, China and the European Union about their intended greenhouse gas reduction contributions to the Paris agreement. But most observers see the outcome from the recent UN climate summit in Lima as only a moderate success, if a success at all. Why did the UN negotiations stall in Lima and what can we expect from Paris? The UN negotiations are as much about protecting the climate as they are about development opportuni- ties. As long as negotiators perceive mitigation as a burden rather than an opportunity to provide certainty to investors and attract the necessary investment into future-proof energy infrastructure, these negotiations will oen end up as a zero-sum game. At the national level, many countries understand the benefits of investment-friendly policy frameworks, but this perspective has not yet penetrated the mitigation negotiations at the UN. Investors are faced with a diffi- cult choice between investing in high- carbon assets – that are increasingly stranded – and low-carbon assets that will depend on policy frameworks for some years to come. The negotia- tions need to shi from burden-sharing to a race for the new opportunities. The UN negotiations also continuously suffer from the so-called firewall between developed and develop- ing countries reappearing. While in principle, agreement has been reached that all countries should be part of the Paris agreement, the precise nature of their contribu- tions and legal obligations remains under dispute. This second point is crucial heading towards Paris. The likes of China, India or the US will not accept legally binding obligations copied and pasted from the Kyoto protocol. The Paris agreement will be a much more bottom-up structure in which efforts are comparable and reviewed, but not linked to penalties. The main risk will be reputational, and the main incentive will be attract- ing low-cost capital through stable regulatory frame- works. This approach – as paradoxical as it may sound – might actually generate higher levels of ambition and action than any other previous agreement. Martin Schoenberg, head of policy, Climate Change Capital "Many countries understand the benefits of investment- friendly policy, but this has not yet penetrated mitigation negotiations at the UN." Investor view Martin Schoenberg The Paris agreement will be a much more bottom-up structure Shifting economics The UK's push towards low-carbon technologies is supported by the belief that rising fossil fuel costs will drive bills higher. But as falling oil prices weigh on gas and power markets, the economics could shi. EY's head of power and utilities, Tony Ward, says the falling price of oil and gas will "shi the relative attractiveness of different types of assets (gas, coal, renewables), making longer-term investment and planning decisions less clear cut". Centrica and SSE both have exposure to upstream oil and gas assets, which sill come under pressure with lower market prices. Already, Centrica has seen its target price per share fall from 290 pence to 270p because of oil price exposure and political risk. In its latest results, SSE's wholesale business reported operating profit 83.4 per cent lower as its gas production operating profit fell by 80.7 per cent because of low summer prices. In addition, the nascent shale industry might prove uneconomic if the market price for the gas produced is too low. Early shale projects include Cuadrilla's licence area in Lancashire, in which Centrica holds a 25 per cent stake, and the Dart Energy-operated licence near Stirling in Scotland, which has already secured a five-year gas supply deal with SSE Energy. The economic case made for EDF's Hinkley Point C new nuclear project, already criticised by many as being too expensive, could also become less palatable as prevailing market prices sink. However, Bloomberg New Energy Finance analysts say the collapse in world oil prices will have a "moderate impact" on the development of low- carbon technologies generally and may reduce the use of coal-fired power: "Renewable energy rollout in Europe is generally driven by specific targets and policy initia- tives, so cheaper gas, combined with a carbon price that has increased 44 per cent so far in 2014, is likely to reverse the recent surge in coal-fired generation. In the UK, for instance, the Department of Energy and Climate Change's Energy Trends, published last week, shows coal-fired production down by 11.5TWh in Q3 2014 over the same quarter in 2013, a reduction of 43 per cent, with gas gaining 8.0TWh and renewables 2.6TWh." Dramatic improvements to the cost competitiveness of wind and solar tech- nologies as well as by the removal of barriers such as grid bottlenecks should help renewables costs to fall further in the future, the analysts add. Within the UK, business energy suppliers and smaller independent companies have made moves to cut consumers' costs. But the larger the customer base, the larger the risk, meaning the big six will need to act with greater caution. "Every 1 per cent off retail prices cuts around 8 per cent off Centrica's earnings per share [EPS] and 5 per cent off SSE's if pro- curement costs are flat," Brough said. "The [approximate] 25 per cent drop in forward gas and power wholesale prices in the past 12 months could in theory drive a 10 per cent reduction in retail prices once hedges unwind. However an early price cut of more than a few per cent could be extremely damaging for 2015 EPS for both companies," he adds. Both have already faced heavy declines in share prices as mild weather has sapped earnings and the Competition and Markets Authority investigation threatens greater political risk. Whatever their next moves prove to be, they are unlikely to be rushed.