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UTILITY WEEK | 10TH - 16TH APRIL 2015 | 19 Finance & Investment M any utilities have index-linked revenue streams, which provides a stable return but leaves them exposed to changes in inflation. This has led to some interesting new options being added to the inflation-hedging toolkit, such as inflation-linked public bonds. While companies can issue inflation-linked bonds into public markets, due to the buy-and-hold investor base, there is limited secondary market liquidity, which cre- ates execution risk for borrowers who are at the mercy of market conditions and investor road- shows prior to the date of issuance. Accessing the swaps market is another possible option because it is well-established and a proven method of gaining inflation protection in conjunction with raising fixed rate debt. We are increasingly seeing firms turn to private place- ment as a viable alternative. Privately negotiated debt transactions can allow the borrower to lock-in financing terms outside the glare of public markets and achieve certainty at a much earlier stage in the process. The most recent addition to the inflation-hedging toolkit, though, is accelerated inflation debt, where companies issue pri- vately placed inflation-linked debt with a non-standard indexation formula, providing a greater amount of hedg- ing "per pound" of debt raised. For instance, altering the indexation formula of a privately issued note can produce an inflation hedge covering up to three times the initial issuance value of the private debt. This accelerated version rules out one of the largest problems with the swaps market: the counterparty expo- sure. Exposing borrowers to this additional credit risk is not a welcome addition. But with an accelerated infla- tion-linkage, the accelerated note holder never has to sacrifice cash flows to the borrower, therefore providing a more risk-averse, additional source of inflation-linked funding. With a different indexation formula, documen- tation is in simple note-form, speeding up the process compared with more bespoke over-the-counter funding solutions. With swaps regularly renewed or breaks being extended, the private debt market offers long maturities beyond 30 years without renewal requirements. Tom Van Rijsewijk, Macquarie Infrastructure Debt Investment Solutions "The need to safeguard against movements in inflation has led to some interesting new options being added to the toolkit." Investor view Tom Van Rijsewijk A big problem with the swaps market is counter- party exposure This is a "make or break" point in time – like the one that shook up the telecom- munications industry when voice over IP was launched, and the same one that shook up every industry with the advent of the internet. There is no doubt that the energy sec- tor is undergoing massive change, and that the investment (and divestment) decisions made over the coming years will determine whether a utility thrives or struggles. The way ahead lies in transforming the traditional utility business model and investing in new capabilities. This will not come as a surprise to the industry. Utilities have been aware of the emerging threats for a while now and many have plans underway to respond. What will separate the leaders from the pack will be how aggressively they embrace the change, and how they invest in future growth and take an active role in shaping the emerging regulatory landscape. Specifically, this will mean the creation of distribution system capabilities to manage a more complex and distributed grid, and with a focus on engaging with regulators to secure the long-term viability of the distribu- tion business. This includes: the adoption of new tariff structures, opening up new mar- kets and aligning subsidies; investing in grid optimisation, such as automation, sensing devices and real-time analytics; and devel- oping new customer products and services. It will also mean better co-ordination and integration of the energy system across Europe. For example, recent Accenture research found that managing grid capac- ity, demand and network performance in a more integrated way across Europe, through advanced analytics and smart grid technolo- gies, could save up to €15 billion a year. Maureen Costello is managing director of Accenture's utilities business in the UK and Ireland. Stephanie Jamison is managing director of Accenture Smart Grid Services in Europe, Africa and Latin America *Belgium, France, Germany, Italy, Netherlands, Poland, Portugal, Spain, Sweden, UK 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Perfect storm €39bn €61bn Status quo Demand distribution FUTURE SCENARIOS FOR THE EU-10* 1,800 1,700 16,00 1,500 1,400 1,300 TWh Fatal disruption? Accenture has identified three scenarios that sum up the potential impact of disruptive energy technologies, based on the following assumptions: Status quo Long-term trends in energy demand and electricity price. No major breakthrough on technology costs. Withdrawal of subsidies by 2018. Low-consumer interest in the uptake of new energy products and services. Demand disruption Energy efficiency and distributed generation possible without subsidies. Falling technology costs. Moderate rise in electricity prices. Greater penetration from shiing consumer sentiment. Moderate reduction in load. Perfect storm Subsidies continue to the early 2020s. Technology costs plummet. Electricity prices rise (to cover the subsidy and integration costs). Customers accelerate energy technology deployment. Significant load reduction and revenue losses.