How 2015 is likely to shape up for utilities

What is the utility investment world likely to look like over the next 12 months? And how big an influence is the upcoming general election? Nigel Hawkins casts the runes.

For the UK utilities sector, 2015 will be a big year. The general election in May could be pivotal, unless if fails to deliver a clear winner.

Six months before the election, a variety of outcomes are possible: the Conservative Party or the Labour Party could govern alone or with at least one coalition partner. Only a German-type grand coalition can be discounted.

Undoubtedly, political uncertainty is deterring investment. SSE, for example, has postponed investment decisions on key renewable generation projects until the political and regulatory environment becomes clearer. Irrespective of the election outcome, several major utility investment decisions remain outstanding.

On the nuclear front, EDF still has to commit itself irrevocably to the construction of Hinkley Point C. With a projected cost, including interest, of about £24.5 billion, it is an astonishing amount – over two-thirds of its current market capitalisation – that EDF and its financial partners would be investing.

For incoming chief executive Jean-Bernard Levy, whether or not to proceed will be an awesome decision, although the upper echelons of the French government may intervene in the decision-making process.

The dire financial plight of EDF’s struggling partner, Areva, France’s leading nuclear engineering company, may also become increasingly relevant.

And if EDF decides not to proceed, for whatever reason, UK new nuclear-build will be “up for grabs” and may be abandoned unless the UK government decides to take direct control, as it has done with the much-criticised HS2 rail project.

Various gas-fired generation projects are being developed, but recent financial returns inevitably deter potential investors.

No longer can it be assumed that such plants will be essentially base-load units as was the case at the height of the “dash for gas” era.

Centrica’s 2013 £133 million loss from its gas-fired fleet underlines just how difficult it is to make decent returns from such investments – despite the well-publicised capacity shortage.

And although coal-fired plant has enjoyed a revival in Germany, the prospects for new coal-fired generation plant here seem to depend upon designing carbon capture and storage (CCS) technology that is commercially viable.

Despite the recent opening of the Boundary Dam CCS plant in Saskatchewan, Canada, progress elsewhere has been depressingly slow.

In any event, by the end of next year, the UK is likely to have a single deep coal mine at Hatfield in South Yorkshire. A century ago, Britain operated 1,000 such pits. Hence, any new coal-fired plant would probably be fuelled by imported coal.

On the back of enormous subsidies such as those bestowed on offshore wind plants and biomass units at Drax, renewable generation investment is undoubtedly growing.

Yet, Drax excepted, it remains highly dependent on new wind projects, which are controversial onshore and highly expensive offshore.

Ofgem has just published its final determination for the electricity distribution review. The investment programme for the six companies is estimated to be £24 billion over the eight-year regulatory period, much of which will involve the repair and replacement of old networks.

National Grid’s formidable investment programme is set out until 2021. It plans to invest well over £2 billion a year in the UK, predominantly on electricity transmission equipment, although a substantial part will be spent on the core gas network.

National Grid’s investment strategy is clear cut, but the same cannot be said of Centrica. Having faced many brickbats in recent months, as well as appointing new senior management, Centrica is expected to review both its long-term strategy and its future investment priorities.

Clearly, if a Labour government is elected and implements its 20-month energy price freeze, Centrica’s domestic gas operating margins will be slashed.

Centrica is also planning to sell – rather than invest in – three gas-fired plants. And its renewable generation commitment also looks shaky since its exit from the Race Bank and Rhiannon offshore wind projects.

Furthermore, Centrica could pre-empt the likely conclusions of the Competition and Markets Authority inquiry by selling part of its domestic gas business, thereby emulating the Ferrovial-led airports-owning consortium with the sale of Gatwick.

Of course, the gas sector is beholden to the oil price, though less so than previously. Over the past five months, the price of the benchmark Brent crude – now about €70 a barrel – has fallen by over 30 per cent.

Inevitably, the plummeting oil price fall will, if sustained, have a lasting effect not only on oil investment but also on gas investment.

Once the final determinations of the ongoing periodic review are accepted, the water sector’s five-year investment profile will be effectively set in stone. The past two periodic reviews have established a base investment figure of over £4 billion a year – £20 billion over the regulatory period.

Much of this spend will be earmarked for mains replacement, especially of sewers in the old cities of England. Furthermore, a substantial element of the overall investment budget will finance new connections, which are driven in part by demographic trends.

It is very difficult to be precise about electricity generation investment, despite the government’s abiding concerns about plant margins, but there will be heavy capital expenditure by owners of the energy networks, ranging from National Grid to the more modest Warrington-based Electricity North West.

Water companies, too, will be continuing their over £4 billion annual investment programme.

So, although 2015 is a general election year, formidable levels of utility investment will still be undertaken.

Nigel Hawkins, director, Nigel Hawkins Associates