Squeeze on returns will leave networks ‘hunkering down’

In the first part of our interview with Cadent chief executive Steve Fraser, we discussed the company’s past performance issues and his efforts to resolve them. In the second, we move onto hydrogen conversion, the gas mains replacement programme and returns for investors.

One problem Fraser has noticed since joining Cadent in Autumn last year is that: “People have had too many things in their job so they’ve not had simple targets to meet on individual things. They’ve been all crossing over.

“A lot of people in this company are good at getting things started but there’s been a lack of doing the last 10 per cent and finishing what we start.”

Nowhere has this been more noticeable that when it comes to its work on hydrogen: “We weren’t driving things as forcefully as we could be,” he acknowledges.

He has since brought in some “heavyweights” and assigned the work to a dedicated team: “The rest of the company needs to focus on being the best four gas networks in the sector.”

This work includes managing the HyDeploy trial at Keele University, where hydrogen is being blended with natural gas in its private network at rates of up to 20 per cent.

“The work we’ve done at Keele has gone down well,” says Fraser. “It’s been very successful at showing you can get to 20 per cent reasonably simply.”

The company is hoping to give the go-ahead to the HyDeploy2 trial, which will see hydrogen injected into an isolated section of the public gas network, by the end of this year.

Fraser says blending offers a stepping-stone to deeper decarbonisation and a way to meet intermediate emissions targets: “Let’s not try to swallow the apple in one go. If you can get a blend of 10 per cent into what we’ve got now, that’s like taking hundreds of thousands of cars off the road. In fact, it’s more than that. It’s into millions.”

In May 2018, Cadent released proposals for a large-scale hydrogen network (HyNet) in the North West of England and later incorporated this into a wider project to create a zero-carbon industrial cluster in the region.

“The partners are predominantly on board,” says Fraser. “I think we now can probably step up a bit more in terms of trying to support those partners through their development and ensure it all comes together.”

The plans initially foresee low-carbon “blue hydrogen” being produced by reforming methane and then capturing and storing the resulting carbon emissions. In February, the HyNet project was awarded £7.48 million to develop the design for a production facility at Ellesmere Port in Cheshire.

Fraser would like to see the government drive progress “from the bottom up” by mandating that all new boilers are ready for hydrogen: “I think mandating hydrogen-ready boilers from 2025 is easily doable and I think that will help flow back up the chain to say hydrogen is coming.”

This will encourage alternative forms of production, including of “green hydrogen” using electrolysis: “I think once people realise that the end user is going to be capable of receiving it, whether that’s industrial or domestic, production will develop very quickly and innovations within production will develop very quickly.”

Fraser does not think it is “realistic” to build new homes without gas boilers from the middle of the decade as would be required by the Future Homes Standard which the government is developing: “If you speak to the electricity companies, they’re struggling to keep up with the EV rollout, and particularly because everyone tends to plug their car in at the same time they’re cooking their dinner.”

One of gas networks’ main arguments in favour of hydrogen conversion is that they can reuse many of the existing pipelines, lowering the overall cost. All out electrification, they say, would require a massive increase in the capacity of the power grid, causing huge disruption to daily lives as roads and pavements are dug up to install thicker cables.

They might not be able to make this argument were it not for the Iron Mains Risk Reduction Programme. The aim of the mandatory programme is to reduce the risk of catastrophic failure of old iron mains by replacing them with the new plastic pipes. But this also makes the mains suitable for transporting hydrogen, which cannot be carried in iron pipes due to a phenomenon known as embrittlement.

The RIIO2 Challenge Group recently called for an “urgent review” of the programme to ensure “consumers pay only for what is necessary”.

Fraser is firmly against any reduction in scale: “We shouldn’t be stopping the programme and I don’t think we should be slowing it down either.”

“Every mid-term review and every previous review has concluded that the pace and the way is programme is done in terms of risk is appropriate.”

“We’re two thirds of the way through it and we just need to press on to the end.”

“Whatever happens with gas, these mains are going to be used for a long time yet,” he remarks, adding: “If you look at the failure rate of the assets that aren’t in plastic, it is higher – way, way, way higher – than the assets that aren’t.”

And as well as ensuring safety, Fraser says the programme also lower spending on repairs: “If you look at the cost of a point repair, it is really expensive nowadays… particularly if you get it in quite a difficult area.”

Another issue explored by the RIIO2 Challenge Group was network returns. Ofgem’s latest indicative figure for the real cost of equity – the baseline return for shareholders – is 4.8 per cent. Despite “vigorous protestations” from every network company, the group said that “none has persuaded us that Ofgem’s working assumptions for the cost of capital make their businesses unfinanceable”.

Speaking to Utility Week, Fraser says 4.8 per cent is “at the lower end of what the sector could cope with.”

He continues: “History has shown that in more case that not, the sectors and regulators get this just about right, because with every regulatory return, whether it’s water, gas or electricity, people find they have to move to get to the cost base and eventually they find a way to be able to make a reasonable return.”

But he says making sure networks are merely financeable is not sufficient when they need to secure billions of pounds of investment for the future, adding: “If you’re financeable but you can’t pay a dividend, owners aren’t going to put their money into these companies. They’re going to put it into other stuff.”

“What the regulator doesn’t want to do is cut the cloth so tight that there’s no flexibility to do things like hydrogen,” he concludes.

“You don’t want to have companies hunkering down just to get through the next five years because that will take the sector back.”

“We don’t want to be having to going to the regulator cap in hand for money. There needs to be a little bit of free board to allow us to make sensible long-term decisions for the good of the sector.”

Note: This interview was conducted prior to the coronavirus outbreak in the UK.