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16 | 21ST - 27TH OCTOBER 2016 | UTILITY WEEK Finance & Investment Market view B idders are now likely to have been shortlisted for the 51 per cent sale of National Grid's four gas distribution networks (GDNs). If reports are correct, this involves at least three consortia: Cheung Kong Infrastructure (CKI); Macquarie Bank and various partners; and one involving China Gas Resources, Singapore Power and Hastings Funds Management. A fourth involving Global Infrastructure Partners (GIP) has also been rumoured, how- ever if it is bidding, GIP is maintaining a very low profile. The super-consortium involving CPP and various other funds has fallen by the wayside. While much of the focus has been on the consortia, there has been little examination of some of the key issues and challenges of the sale. It is worth doing so because these issues will be key determinants of value. So, why has National Grid decided to sell a majority stake in gas distribution? The stated reason is that it frees up capital for other investments and provides additional returns to shareholders. In reality, the future GB energy mix is probably the key driver. Gas consumption is declining and electrification of transport and heat is producing stronger growth in the electricity sector. National Grid is probably considering future investment in the electricity network sector. It promises stronger growth and returns. The company has previously been a bid- der for electricity distribution networks, and although there are currently none for sale, who knows what could happen in the future? Another driver is that although there are efficiencies that can be achieved in the businesses as they currently stand, there is a question mark over how much the owner will be allowed to profit by them. The four GDNs are currently ranked 4th, 5th, 6th and 8th in Ofgem's ranking of totex spending performance. They significantly lag in direct and indirect opex performance and across the business there are substantial opportunities for efficiencies. On the revenue side, National Grid underperforms in the var- ious Ofgem incentive schemes, providing the opportunity for additional upside. However, the key issue will be the propor- tion of these savings that Ofgem allows the owner to retain. In the current regulatory period, RIIO-GD1, Ofgem allows GDNs to retain 60 per cent of cost efficiencies deliv- ered beyond the regulatory settlement. There is no guarantee this will continue to be the case in the future and the regula- tory landscape has changed since RIIO GD1: • RIIO-GD1 was the first under the RIIO regime. Ofgem has learnt from sub- sequent transmission and electricity processes and is likely to take a more rig- orous approach in future. • The suppliers are now much more active in challenging Ofgem regulatory determinations. • Perhaps the biggest is the completely dif- ferent management team now in place at Ofgem. A new chief executive and new head of the networks group are likely to take a different approach. Certainly, com- ments from the regulator are now much more consumer benefit focused. So while regulatory uncertainty is not high, it must surely be a concern to some of the consortia, particularly those with limited experience of operating in the GB sector. Another issue that will affect the sale is whether there will be restrictions on foreign investment. Foreign investment and ownership has long been a feature of the UK energy sector. The issue is whether foreign state-owned energy operators should be able to control the majority of the UK's gas networks. This will mainly relate to the China Gas Resources consortium, because it is the largest gas net- work owner and operator in China. The government will first need to deter- mine whether or not the gas network is essential infrastructure. In the case of elec- tricity it unquestionably is, but gas is less certain. If there is sufficient political agi- tation about Chinese government control of gas, then the government may consider restrictions. At this stage it seems unlikely the govern- ment will block a Chinese government domi- nated bid, but there will be a lot to play out over this issue in coming months. Competition concerns Also, when it comes to CKI, will it be allowed to control six of the eight networks? It's unlikely that the Competition and Markets Authority, or Ofgem, will permit CKI to con- trol 75 per cent of the gas networks in the country. Performance comparison between different network owners has long been a feature of energy regulation. However, there should be nothing pre- venting CKI from controlling four of the eight networks, given that this is the situation that exists today. If CKI successfully acquires NGGD, then it will likely be required to dis- pose of NGN and WWU. Given the current appetite for regulated networks, this is prob- ably not such a bad outcome for CKI. In conclusion, although there are a num- ber of uncertainties, consortia are likely to submit strong bids. The current regulated asset value is £8.5 billion. We expect a 40 per cent premium above regulated asset value. This will be an easier play for CKI and Macquarie, which have experience in oper- ating in the GB market. The uncertainties for China Gas and Singapore Power will be greater, potentially limiting their ability to deliver a strong bid. If all goes to plan, National Grid will receive a tidy pot of money at the end of this process. Scott Flavell, partner, Energy and Utilities Practice Sia Partners Drivers behind GDN sale Scott Flavell looks at the issues and drivers behind National Grid's sale of a majority stake in its four gas distribution networks, and at the consortia lining up bids. 1,200 1,000 800 600 NATIONAL GRID SHARE PRICE, FIVE YEAR 2012 2013 2014 2016 2015