The big fight

How can we attract widespread investment in the independent and renewable sector and break the stranglehold of the big six, asks Miles Thomas?

Ofgem’s recent proposal to increase competition in the energy market is intended to “force” the biggest eight generators to become market makers in the forward market out to two years. Large suppliers and generators will be encouraged to trade fairly with smaller players or face cash penalties, while the big six energy suppliers will be required to post the prices at which they buy and sell power two years ahead and will not be allowed to refuse “reasonable” requests from small suppliers wanting to buy power from them. All sounds good for the independent and renewable sector – in theory.

However, most of these recommendations are targeted at the consumer retail sector, with little to support the wider challenge facing independent and renewable generators – namely, investment in new plants. In addition, while orthodoxy states that more competition will drive lower prices for the consumer, there is a question about whether the cost will be shifted elsewhere. And if investment is already a challenge for the smaller energy companies, will the big six also curtail their investment plans if they lose their dominance in the marketplace, potentially putting pressure on the overall cost of meeting demand?

The UK currently has some of the lowest electricity and gas prices in Europe. However, with resources at an all-time low and Ofgem warning that the UK could face blackouts in the middle of the next decade as our old conventional plants close, the price UK consumers pay for their power will have to rise. Additionally, to protect against the volatile imported fossil fuel price, the UK will need to increase and broaden the energy mix domestically, though our critical capacity margin will have to be bolstered with some new flexible generation, mainly gas. This means focusing on increasing investment in renewables with energy storage, and low and lower carbon generation, with demand reduction measures to ease pressure on capacity.

If the answer is investment, the question is how quickly can the UK encourage those with the finance to come forward? Large numbers of coal-fired and nuclear power stations are to be closed over the next five years and yet, at this stage, we keep hearing that the risks still look too great to persuade the industry to invest in and build the required replacement capacity.

At a time of tightened public purse strings, this not insignificant capital will need to be sourced from private investment through institutional investors, hedge funds, property developers, pension funds and sovereign wealth, a group which, though not averse to risk of varying degrees, likes to make calculated decisions based on familiar-looking asset-based portfolios.

Seasoned investors are looking for an opportunity where the assets are packaged as an equity product (similar to shares in a corporate), a bond or a real estate investment where they can be easily managed. They want to see investment-grade counterparties on power purchase agreements (PPAs) and watertight operations and maintenance agreements – and rightly so. The way such investments are presented and packaged must change so that investors who are used to looking at, for example, property leases and rents, understand that, for investment purposes, a PPA works in a similar way.

In addition to securing private investment, there is a desire in the business community for greater clarity in terms of the Energy Bill, Electricity Market Reform, strike prices and contracts for difference. While the earlier than expected announcement this month of the strike prices for renewable technologies has gone some way to providing stability for the future, this is negated by the fact that the electricity market itself remains largely unreformed. Regardless of the innovative low-carbon generation technologies on the horizon, the grid itself, capacity, connections and energy storage, are in dire need of investment if the UK is to see a truly integrated and modern energy mix.

In the long run, rules on price transparency and regulatory clarity around subsidies will all help investors to decide when to invest in new power plants or whether to carry out maintenance on existing infrastructure. Increased stability and long-term security in the sector is required to generate investment interest from the wider business community, a necessity if the UK is to summon the additional £110 billion required to plug the energy gap to 2025. Energy minister Greg Barker has called for the big six to become the “big sixty thousand”, with new companies leading the transformation.

There is plenty of opportunity for co-operative or community energy schemes, where communities come together to finance, build and own local renewable projects, and also crowdfunding – sourcing micro-investments from thousands (or mvillions) of interested parties. A recent poll by the Institution of Mechanical Engineers found that one-third of people would consider personally investing in small-scale community renewable energy projects and one-quarter would invest in energy bonds to support renewable energy projects elsewhere in the UK.

These types of solution are unlikely to be much more than a novelty in the short to medium term. This is one of the reasons the big six have dominated – they can develop, build, hold and operate plants, as well as trade the energy they produce.

Early stage development of energy projects is ­capital-intensive and huge quantities of risk capital are essential to get projects to the point that institutions will invest, which is generally at the point they have been de-risked – at operation or just pre-construction. For institutional investors to get on board, the opportunity has to be packaged appropriately and at a scale that looks appetising. If this is to be the case, the smaller independent generators and developers will need to work with consultants and advisers who are able to aggregate and assemble investment packages and portfolios that appeal to the marketplace. This is a task that requires intricate knowledge of every stage of the planning, development and operational process.

An arbitrage must exist for the two markets to coexist and feed each other – higher risk and return at the development level and low risk, lower return at scale in the institutional market. The development market is adaptable and needs to be, but it must be treated with the respect it deserves.

Miles Thomas, head of operations at Savills Energy

This article first appeared in Utility Week’s print edition of 19th July 2013.

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