Investor view: Nigel Robinson

“There is much talk about the lights going out, yet power companies are closing power stations and postponing investment in new plants.”

There is so much discussion in the media right now about the “lights going out” in this country over the next two to three years that it almost starts to be believable. In its annual Electricity Capacity Assessment, Ofgem prophesied very recently that our reserve margin could fall below 5% of total peak demand by 2015/16. At the same time, our power companies are closing existing power stations and postponing investment in new generating capacity due to low power prices and the lack of so called ‘scarcity premium’ (difference or margin between the power price and the cost of fuel indicating that the market needs more capacity to be delivered). High levels of political uncertainty is also a chief cause for postponement of new capacity. Scottish & Southern has publicly stated that it “won’t be taking any definitive decisions on new generation investments unless comfortable with the policy position” and Sam Laidlaw, Centrica’s CEO, stated that “We will only invest if we see sufficient value and have regulatory clarity”. By way of contrast, China announces that almost 35,000MW of new solar parks will be built over the next three years, and 200GW in nuclear by 2030. So why have we got into this position, and what can we do about it?
To answer the first question, I would ask you to cast your mind back to the Blair-Brown days and the Energy Policy of the day. Grand visions for a clean energy, self reliant energy platform based on 10,000MW of new nuclear power plant and at least 39,500MW of offshore wind were proposed – meeting our own low-carbon targets and mitigating reliance on projected growth in gas imports: each technology satisfied various political lobby groups and promised to keep Britain at the top table of the global de-carbonisation agenda.
However, there were two major oversights to this policy – namely the cost of new nuclear power plant is extremely high and rising (EdF have stated that they believe the capital cost of the 3.2GW plant at Hinkley Point will cost £16bn – i.e in excess of £ 5 million/MW), while offshore wind remains a largely unproven technology, which is also expensive to develop (£3.0 million/MW). A rough estimate of the total costs at today’s prices to build out this entire nuclear and offshore wind fleet would be close to £170 billion. Nuclear and Offshore wind are 7 and 4 times more capital intensive than gas fired generation (build cost of 0.7million/MW). Delivery of these expensive technologies require subsidies, which the government has started to award. The second point is that nuclear power plants and intermittent offshore wind are not natural bedfellows in the power supply equation – nuclear does not have the flexibility to adjust for non-windy or very windy days. Thus in addition to very high investment costs we would also have an unbalanced generation system. How the above points affect the whole sale power market and power price is not yet known. This creates uncertainty even for the much cheaper gas plants.
The answer to the second question, in my opinion, lies in the significant level of uncertainty in the power market over prices, structure and returns on capital. It is this uncertainty that has caused utilities to shelve investment plans, and institutional investors such as our pension funds to largely stay away from direct investment in the sector. Investors understand, manage and price risk: they direct their investments to areas where they can quantify such risks,
In this sense, the FIT – CFD mechanism, together with capacity payments, will and should play a big role in providing institutional investors a much greater degree of confidence to provide both debt and equity to the electricity generation sector. In solar PV, both smaller ground-mounted and roof-top (FIT) and larger ground mounted (ROC), we see pension funds and insurance companies owning both the equity and the debt on operating assets. The cost of capital of these investors is such that operating assets giving low but inflation linked returns (as given by Feed in Tariffs) are very much worth holding. The recent run of flotations in the renewables sector has proven that wealth funds and retail investors also feel comfortable with well structured assets earning a regular and visible rate of return.
These positive investment signals in renewable power should flow through to conventional generation under EMR. A CFD for nuclear – now announced at £92.5/MWh for 35 years for Hinkley Point – or a capacity payment for thermal power will support the underlying earnings of the asset, just as a regulated rate of return underpins the net income of a regulated gas or electricity networks business. These infrastructure assets in the UK are now widely owned by private equity, infrastructure funds and foreign investors such as CKI of Hong Kong or WPD and Berkshire Hathaway of the United States.
 Power generation is a capital intensive business. In a low and falling wholesale power price environment, the cost of capital plays an even larger part in generating adequate returns on investment. Low cost capital can be instrumental in reducing our energy bills by delivering new generation capacity at low price levels. But for capital to be attracted, we need the clarity and certainty derived from a long-term stable support mechanism.
Institutional capital should follow, and with access to a lower cost of capital, energy companies should be able to pass these cost savings onto the retail customer and reduce the man on the street’s utility bill. If solar is anything to go by, well structured and managed conventional power plants with long term earnings visibility should fit well within institutions’ investment portfolio.
The time for tinkering is over.
Nigel Robinson, head of power, Investec Power and Infrastructure Finance