Dig for victory

Nigel Hawkins says we should bring forward utility capital programmes to help grow our struggling economy

The UK economy remains in a pretty awful state, with minimal – if any – economic growth, high unemployment and a net debt figure that recently powered through the £1 trillion mark.

Despite concerted efforts to tackle the UK’s economic plight since 2010, the coalition’s record has been dismal. It has, though, been redeemed by the ultra-low yields on government gilts that have curbed the anticipated surge in borrowing costs.

Back in 2010, a medium-term annual growth of around 3 per cent was confidently forecast by the Treasury, a projection proved to be wildly optimistic. Indeed, when the UK will resume its growth path is now widely debated. UK corporate balance sheets are strong, even if confidence is fragile.

Various recent reports have addressed the growth issue, not least that from a committee chaired by Lord Heseltine. He put forward a raft of proposals, including a reduction in red tape.

At the heart of the flat economy, though, lies the lack of desperately needed investment. Within the public sector, notwithstanding the highly discredited Private Finance Initiative (PFI), the vast financial deficit precludes a massive expansion in investment. In the private sector, an estimated £300 billion of infrastructure investment is needed before 2020.

Some “shovel-ready” public investment projects are being finalised, notably road-building and improving school facilities. But the sums are comparatively small. In the private sector, utility companies are crucial. Putting planning issues aside, perhaps for the good of the national economy, some of the sector’s investment plans should be advanced, with appropriate regulatory adjustments made to reflect any material time changes.

The key utility investment challenge relates to new power stations. In its recently published Gas Strategy, the government concluded that up to 26GW of new gas plants may be needed – a colossal figure – by 2030.

Furthermore, there is the planned – and controversial – new-build nuclear programme, along with smaller renewable power projects.

Given the many inherent financial uncertainties attached to new power plants, as the Energy Bill starts its long and highly complex passage towards eventual Royal Assent, it is perhaps unrealistic to expect much progress in this utility sub-sector for the time being.

However, the UK electricity distribution sector, which is highly regulated, offers a better template, although its size is much smaller. Much of the planned investment lies in modernising a system that was built in the 1950s and 1960s. Moreover, the technical challenge is relatively modest.

As part of the price-regulated electricity supply system, distribution companies have their revenues periodically fixed by Ofgem. If some of the more straightforward electricity distribution investment projects were advanced – assuming no serious planning problems – this could help stimulate the UK economy, especially in deprived areas, where aggregate demand is well below equilibrium levels. If necessary, adjustments could be made to the pricing formula to allow for any advancing of the capital investment programme, preferably on a financially neutral basis.

By far the largest investor in UK electricity and gas infrastructure is National Grid, which is reputedly close to reaching agreement with Ofgem on its unprecedented RIIO-T1 eight-year regulatory determination. This will apply from April 2013 right through to March 2021.

National Grid’s eight-year UK investment programme seems set to exceed £20 billion, comprising part electricity and part gas infrastructure. In many cases, planning issues (notwithstanding the technical complexity of individual projects) will preclude any advancing of its investment. But some more standard projects might be suitable for advancement, especially if they are not dependent on individual power station projects proceeding.

Before RIIO-T1 is finalised, Ofgem should consider whether there is real scope for some projects within the eight-year investment plan to be brought forward, especially in the north of England and in the Midlands.

The water sector offers particular scope for advancing some of the industry’s capital expenditure programme, much of which is both predictable and straightforward. The cost of the current five-year water investment programme exceeds £20 billion.

Within this total, there is heavy provision for modernising the sewerage network, much of which dates back to Victorian times. Furthermore, many planned projects are predicated on expected demographic growth, most notably in the south of England. There is a strong case for larger and mid-sized projects to be analysed by Ofwat to see if any can be sensibly advanced, especially in areas where the local economy is particularly dire. If there were suitable candidates for project advancement, Ofwat could make the necessary pricing adjustments, perhaps through its well-established cost pass-through mechanism.

In principle, part of the formidable water sector investment programme, along with elements of its electricity distribution counterpart, may be suitable for advancement. Furthermore, with National Grid’s regulated investment programme, there is probably scope to advance some of the standard gas pipe refurbishment programme.

This strategy could be extended to other sectors with standard utility features. They would include maintenance projects on the railways, via Network Rail, and some enhancements at the UK’s major airports. Within the telecoms sector, substantial investment is expected once the much-delayed 4G auction is completed later this year. The one certainty is that proceeds from this auction will be well below the £22.5 billion raised by the 3G auction in 2000, thereby leaving funds for asset investment.

Of course, any advancement of individual utility projects will have a minor effect on the UK economy overall. If, however, there were a concerted effort to deliver many projects ahead of time across the utility sector – as widely defined this would have a noticeable impact on aggregate demand, especially if some major power station projects also became a reality.

Undoubtedly, these are difficult times for the UK, but the utilities sector could make a useful contribution by bringing forward some of its planned investment. Developing such a policy would require radical thinking right across the utilities sector, but it could help kick-start the economy.

After all, the gloomiest outcome would be for the UK economy to replicate the lost decades of Japan, whose economy boomed in the 1980s but has stalled badly subsequently.

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 8th February 2013.

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