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UTILITY Week 25th September 2015

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UTILITY WEEK | 25TH SEPTEMBER - 1ST OCTOBER 2015 | 21 Finance & Investment D uring the 1998 Russia/Asia crisis, UK and Euro- pean utility share prices spiked as the market crashed. Now, as a new Russia/Asia crisis hits, the best of the sector has limped sideways while utilities as a whole have dropped 8 per cent in a month. The drop in commodity prices and concern about deflation have not helped, but a big fear for the regulated networks and infrastructure plays has been rising bond yields. For some investors, the spectre of rising bond yields could mark the end of a golden era of investing in regu- lated infrastructure. Investors in privatised UK networks over the past 25 years have enjoyed impressive returns – generally easily more than 10 per cent per year aer tax for equity investors since 1990 with the occasional takeover windfall. Debt investors have generally fared well too, with predominantly falling bond yields (rising bond prices) and debt growth as companies moved from zero leverage to funding the majority of capital through debt. In general, nominal and real bond yields (interest rates) have been falling over the past 25 years. This has allowed regulators to gradually cut base allowed returns while investors have continued to enjoy a premium to the cost of capital. But how will regulatory regimes cope if we have a sustained period of rising bond yields? There have been three periods in the past 25 years of rising bond yields with three different outcomes for utility investors. In 1999, utilities did collapse as bond yields and equity markets soared, but this was partly the dot com bubble. In 1994, utilities traded sideways, despite a 270bp increase in government bond yields. In 2005-2007, utilities outperformed a rising market even as bond yields rose. If the lessons of history are mixed, what about the future? Investors must trust that the Bank of England will not raise rates in the medium term against a sus- tained backdrop of inflation well below target. They must also trust that, if interest rates do rise, key sector regula- tors will adapt to financial circumstances to allow good performing companies to earn returns that will attract global investment in infrastructure for the next 25 years. Martin Brough, utilities equity analyst, Deutsche Bank "To some investors, the spectre of rising bond yields could mark the end of a golden era of investing in regulated infrastructure" Analyst view Martin Brough "How will regulatory regimes cope with rising bond yields?" This was further exacerbated by the complex- ity of governing or mandating a national roll- out in a country where there are thousands of distribution network companies. In light of the foreign ownership of four of the big six UK energy suppliers, those suppliers particularly are currently facing an unprecedented situation. The divergent national market histories, legacy systems and processes, and the current market struc- tures have led to very different approaches to the introduction of smart meters. The UK smart meter programme has a number of unique features that from the perspec- tive of a French, German or Spanish parent company could be difficult to fathom. The complexity of the UK market should not be underestimated and industry leaders should view any communication of strategy and investment through the lens of a for- eign investor unfamiliar with the landscape. Things don't look set to get any simpler in the short term, so being a smart communi- cator when discussing smart metering with investors, is critical. Amy Marshall is a director in KPMG's power and utilities practice In order to secure the right investment and support for smart meter deploy- ment from foreign owners, UK energy company executives should: 1. Cut through the noise Given that the UK smart meter programme has a unique approach with complex regulation and multiple interested parties, it is easy to become swamped in information. Take time to filter everything that's happening within the market and try to prioritise what the top five issues/announcements are that shareholders/parent companies need to know. 2. Keep it simple Every market has its own acronyms and terminology and the UK programme is full of its own terms. Make sure any updates that are created contain a clear glossary or appendix for those who are not familiar with the market, or for whom English isn't their first language. 3. Look for synergies with other markets Explaining new processes, policies or plans is always easier when the audi- ence has a point of reference. Regularly research what is happening in the other European markets to see if there are any similarities in terms of rollout issues or successes that will help foreign owners understand what is happening in the UK. It is always easier to understand something if you're experiencing it in your "own back yard". 4. Ensure regular, consistent communication When rolling out any smart metering plan, it is critical that all interested parties are kept informed of progress and any potential hurdles. This can be through regular calls, presentations, newsletters or meetings. Sharing updates on what's happening in the UK energy market, beyond the smart meter segment, will help those not involved in the day-to-day operations to better understand the situation. 5. It's all about the benefits Regardless of the nuances of the UK market, each company's business case must deliver as expected financially, and in terms of benefits to customers. Maintain focus on these two areas in planning and in communication. Tips for smart communication about smart metering Martin Brough is speaking at Utility Week Congress 2015, taking place from 14 October. Visit www.uw-congress.net

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