The CfD delay is the ‘worst of all worlds’ for investors

If you are a government official, you quickly get used to constant concerns from different parts of the sector and threats that ‘if you do this [sensible thing], then we will never be able to invest in the UK market again’. Throughout the Electricity Market Reform (EMR) process, investor worries – some genuine and, frankly, some over blown were a constant companion to any changes to the regime or plans that were laid out.

Indeed, government’s job is to manage trade-offs and to stick up for consumers so at times decisions will make some investors worse off. Equally, it is natural that those lose out will raise concerns even if, later on, they get comfortable with the new status quo. For example, given the noise around their development, it was a surprise for me how many banks and financiers quickly got themselves comfortable with the Contracts for Difference (CfD) as an instrument. Equally, moving to CfD auctions was a huge success, something we thought a ‘step too far’ in earlier stages of the EMR process.

However, the noise and tenor of concerns has been growing, and those who worry are getting more senior and more influential in the wider global infrastructure market. There are now mutterings that government should be held to account for chipping away at confidence and musings on how this should be done. This is particularly true about investment in low carbon generation where a combination of the past few months’ actions leave people wondering what the government intends and what they should expect from the Department of Energy and Climate Change (Decc)/HMT in the run up to 2020.

Lets take each of the policy shifts in turn:

1. The removal of the Climate Change Levy (CCL) exemption for renewables was, in anyone’s world a retrospective action. Investors had reasonable expectations that this exemption would remain in place for the lifetime of their assets. Equally, as a quasi-carbon tax, applying the levy to low carbon generation makes little logical sense.
2. The effective banning of onshore wind, although very clearly signposted before the election, leaves investors across all generation types concerned as to what happens if their technology falls out of favour.  
3. Equally, the necessary, but painful changes to the solar Feed in Tariff (FIT) and Renewables Obligation (RO) regimes add to investors’ worry lists.     

In this context, we now have an open ended delay in the CfD auctions – without any clear plan of what is to happen next.

This is the worst of all worlds when you are developing a project. Do you carry on (in the hope that it will be OK), do you stop and wait and risk being ‘behind the curve’ for the next auction or do you abandon the sector and find somewhere safer and easier to put your money? 

Let’s not forget there are real issues that need to be addressed by the government, so ‘no change’ is not an option:- we know the Levy Control Framework (LCF) will be far above projections unless action is taken. This is due to a falling power price, a cut in carbon tax, higher than expected build of solar and high utilisation rates of wind power. This needs to be fixed and it is not in anyone’s interest that costs are out of control. Ultimately consumers have to pay the bills and have a right to limit what is spent on decarbonisation.

But if there is pain to be had, it is better for Decc to fix the problem, deliver the bad news and move on. Leaving the situation open ended means investors will have little choice, but to sit on their hands until things are clearer. The result will be a slow sapping of confidence as their wait continues.   

As for us investors, we need to get smarter at anticipating where government may go next. For example – a few rules of thumb:

1. If spending is too high there will be cuts – the LCF budget as it is means that government needs to act. The choice is simple, increase the budget or cut spending. Most likely, in today’s political climate is cuts, so you need to work out where they are most likely to fall and what this means before/after 2020.
2. Taxes are not reliable. I know this is hard for investors to understand, but government sees tax in a different way to other incentives. To retrospectively cut the RO or CfD rates is to break the golden rule of ‘grandfathering’. To cut a carbon tax or to remove an exemption is not considered in the same way. Therefore, when projecting your future, you have little choice but to heavily discount any/all revenues that comes from tax.
3. Politics is a fundamental part of the energy market – and will be as long as there is a transition needed between our conventional thermal power plants and the low carbon alternative. Therefore, work to understand political scenarios and how you should respond as a result – do not wait to get ‘surprised’.

Finally, I am hoping that, as government sorts out the LCF, there will be better news on the horizon. There remains a huge need for low carbon generation in the years to come, so my advice is to ramp down resources, but keep your most cost effective projects going. If you can deliver more cheaply than the competition, then my view is ultimately, there will be the money on the table to enable for you do so.

Jonathan Brearley, director, Brearley Economics