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UTILITY WEEK | 17TH - 23RD APRIL 2015 | 23 Finance & Investment "Cash-out prices are central to the delivery of a secure, smart and competitive electricity market" Market view Analysis Cash-out reform Despite resistance from incumbent suppliers, Ofgem pressed ahead with its cash-out reforms. Tim Emrich explains why. Bristol stands alone Bristol Water's fight with Ofwat may prove brave but foolish, says Nigel Hawkins. O n 2 April 2015 Ofgem introduced a single marginal cash-out price, significantly strengthening the bite of such imbalance charges and rejecting a competing modification from RWE Npower that sought a more incremental approach to cash-out reform and implementation. This reform stabilises supply and facilitates a better deal for consumers, more culpability for energy suppli- ers and a greener energy mix. It is also an opportunity for the UK to take the lead on forward-thinking energy policy in Europe. Cash-out reform is vital for the UK energy mix for a number of key reasons: 1) Security of supply As National Grid seeks to guarantee our energy security in winter 2015, the reform gives the price signal neces- sary to provoke investment in technology and flexible smarter capacity – providing the stick to the capacity market's carrot. 2) A better deal for consumers and culpability for suppliers Although current cash-out costs are low, the overall cost of failing to provide power is much higher, and likely to be borne by the end user. By incentivising against fail- ure, the consumer benefits from more stable pricing and fewer shocks down the line. It is also important for consumers to know that their suppliers are appropri- ately culpable for failing to provide the power they've promised. 3) A smarter, greener grid As more intermittent generation comes online, we need flexible capacity options to provide a safety net. With a global drive to lower emissions and EU reduction targets, a greener mix is coming. Cash-out prices provide incentives for generators and suppliers to be smarter when securing supplies to balance positions and meet energy demand when most needed. They are central to the delivery of a secure, smart and competitive electricity market. Some incumbents have understandably been resistant to the change. Higher potential for penalties places the onus on suppliers to deliver. The upside is that compa- nies operating efficiently and effectively will benefit. Cash-out reform is a key part of energy policy to support Electricity Market Reform. It is important to minimise the market's reliance on subsidises. Cash-out reform is a mechanism that rewards flexible capacity for keeping the lights on and is a step in the right direction to developing a purer energy market. Tim Emrich, chief executive, UK Power Reserve B ristol Water's appeal to the Competition and Mar- kets Authority (CMA) over its periodic review deter- mination is building up into a real tussle. In its final determination, Ofwat allowed for total costs of £409 million over the five-year period, compared with Bristol's application for £541 million. Ofwat's figures would have brought down water charges for Bristol's 1.2 million cus- tomer base to an average £152 a year in 2019/20. Bristol's own numbers project comparative bills of £188. Normally, the gaps to be bridged by utilities seeking the intervention of the final court of appeal – now the CMA – are modest. But, in Bristol's case, it is vast, and partly related to its previous appeal in 2009/10 to the CMA's predecessor, from which it received some benefits. This time round the stakes are higher, as Bristol's key shareholders, Canada's Capstone and Spain's Agbar, accept. The latter's representative, chief executive Luis Garcia, exudes confidence, which may or may not prove misplaced. Recently, Bristol announced a series of restructur- ing moves that would cut costs but nothing that would deliver £132 million of savings over five years. Ofwat must be frustrated by Bristol's lone stand. Its staff will feel they have bent over backwards to little avail. They will note, too, that the other 18 water companies have all accepted their final determinations. Most significantly, perhaps, United Utilities had a massive gap in its sewerage figures, but it responded pos- itively while Bristol did not. In January, United Utilities felt able to accept Ofwat's final determination. At the heart of its dispute is Bristol's capital expendi- ture, part of which has been disallowed. In particular, its investment proposals for Cheddar reservoir. Further- more, based on its extensive comparative operating cost analysis, Ofwat believes Bristol's cost base is excessive. The latter will be hard-pressed to overturn this view. The CMA may take six months to rule on the case. In the meantime, two events could intrude into the CMA's deliberations. First, Bristol's shareholders may change tack, espe- cially Capstone, which (possibly under new and less uncompromising management) could decide to settle before the CMA's final verdict is delivered. Second, if interest rates change and markedly impact the weighted average cost of capital before the CMA's ruling is deliv- ered, things could get very messy. But the odds remain heavily in favour of Ofwat, which will surely emphasise the acceptance of its methodology by every other regulated water company. Nigel Hawkins, director, Nigel Hawkins Associates