An imbalance of power

Recent changes of government in Europe and interventions in the energy market by politicians are destabilising confidence and choking off long-term investment, warns Nigel Hawkins.

The recent election of socialist Francois Hollande as French president has considerable relevance for the UK, especially with respect to nuclear new-build: a policy that is still in deep – very deep – trouble.

Generally, it illustrates the difficulty of trying to make very long-term investment decisions against a backdrop of short-term political gain. Add to that the chaos in EU financial markets, with the Euro’s very survival in question, and it is not surprising that large companies are building up cash balances and cutting investment.

Given that the UK energy sector needs about £200 billon of investment over the next decade, this trend is profoundly worrying. The energy sector is peculiarly dependent on very extended time horizons, even for the relatively straightforward task of building a combined cycle gas turbine plant. To generate an acceptable return, heavy investment is needed in the first few years before positive cash flow arises some years later.

Contrast this scenario with short-term political trends, where politicians periodically execute major policy U-turns, often with minimal warning. A prime example of this is of course German chancellor Angela Merkel’s contentious decision to shut all of her country’s nuclear power stations by 2022. This decision was taken on the back of growing public unease over nuclear safety after the Fukushima accident and as a vigorous response to the growing Green Party in Germany, with whom Merkel’s CDU Party may need to form a coalition after the next election. The ruling appalled not only Eon and RWE but also many leading German businesses.

Politicians in other countries have now also weighed in, primarily for electoral advantage. During his successful presidential campaign, Hollande pledged to close 24 of France’s 58 nuclear reactors, thereby reducing its dependence on nuclear output from 75 per cent to 50 per cent.

Whether this policy will be implemented is unclear. If it were, there would be major repercussions for cash flow at the heavily indebted EDF, over 80 per cent of whose shares are owned by the French government. The implications for EDF’s UK nuclear new-build plans are self-evident.

Italy, too, is reining back its nuclear interest after yet another change of government, notwithstanding the major financial turbulence as serious questions arise about its national debt.

Nuclear is the most high-profile utility issue, but plenty of others are affected by politics. Any CCGT investor must address the long-term issue of gas supplies, which are going to be increasingly dependent on regions such as Russia, the Middle East and North Africa, none of which can offer a stable political environment. Aside from the gas supply itself and the price being charged, the political risks of pipeline transport have to be rigorously assessed, with suitable allowance being made in the cost of capital.

Renewables are also very politicial, because generous subsidies have been the driving force in their development. After the start of the financial crisis in 2008, many EU countries – including Spain and the UK – have substantially cut their subsidies, and even discussed proposals for retrospective adjustments. Again, politicians’ long-term ambitions to promote green energy have given way to short-term concerns – in this case, anxiety to reduce excessive borrowing.

In fact, since the start of the financial crisis the EU utilities sector – once generally reckoned to be relatively recession-proof – has performed dreadfully. It has only modestly outperformed the EU banking sector, which has been on its knees. Household names such as the Royal Bank of Scotland, Lloyds and Holland’s ABN Amro – not forgetting almost the entire Irish banking sector – have needed massive state bail-outs. Now the Spanish banking sector looks to be setting off on a similar route.

Of course, EDF, Eon and RWE represent a significant part of the EU utility index, which partly accounts for the shocking performance. A combination of excessively high debt and serious nuclear setbacks have been the key factors. Even in the UK, shares in both Centrica and National Grid have performed sluggishly, although the water sector – after the implementation of the 2010 periodic review – has delivered good value for shareholders, notably Severn Trent, which has boomed of late.

Among the worst performers have been renewable stocks, led by Denmark’s Vestas. The company has failed to match its forecasts, and it is being compared with serial profit-warning companies such as Cable and Wireless – now split – and Carpetright. Indeed, many renewable stocks are now worth less than 20 per cent of their peak value, largely on the back of subsidy slashing. This is hardly the ideal scenario to encourage investors in new renewable projects.

Back in the UK, an Energy Bill has just been published to implement Electricity Market Reform (see feature, page 14). The Department of Energy and Climate Change is intervening in the market to design a regime that will promote low-carbon energy investment, especially new nuclear build. But few people fully understand the complex mix of feed-in tariffs with contracts for differences, a capacity mechanism, an emissions performance standard and a carbon price floor.

Given all these pitfalls for potential investors, and politicians’ habit of prioritising expediency over longevity, will the necessary utility investment funds be forthcoming either in mainland Europe or in the UK? The answer is almost certainly no, although the probable curtailment of the green agenda may mitigate this otherwise disastrous scenario.

Although the recent record of utility investment returns has been profoundly disappointing, many fund managers are well disposed to invest, providing there are decent returns and minimal political and regulatory risks. But ad hoc interventions by politicians, especially with frequent changes of government, will continue to choke off much-needed long-term investment funds, irrespective of so-called panaceas such as the Green Investment Bank.

In summary, political intervention – however well-meaning – has not exactly benefited the UK utilities sector during its era in the private sector. There has been a pronounced failure to provide much-needed financial stability, both here and in most other EU countries. Consequently, an era of steeply rising prices and real security of supply concerns seems nigh.

Nigel Hawkins is a director of Nigel Hawkins Associates which undertakes investment and policy research

This article first appeared in Utility Week’s print edition of 1 June 2012.

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