Stability is ­treasured above all in ­unstable times

Money makes the world go round. It fuels business and the delivery of essential services. It funds advances in transformative ­technologies and it builds the infrastructure society depends on.

But money likes stability and certainty, both of which are in short supply in the UK today, exacerbated by the news this week of a snap general election. With huge investment needed in the utilities sector over the coming decade and beyond, this could pose an existential challenge.

As industries go, energy and water are among the most money-hungry. Our energy infrastructure needs an estimated £215 billion by the middle of the next decade, water companies will spend £44 billion on improving services and resilience in AMP6.

This money will help fund the roll out of electricity and gas smart meters, the construction of the Thames Tideway Tunnel and Hinkley Point C. It will enable the development and deployment of smarter technologies, as well as supporting essential maintenance and replacement of vital infrastructure and assets.

Without this money, UK utilities will falter and the wider economy – and consumers – will suffer.

Traditionally, utilities’ position as “defensive stocks” has mitigated the investment challenge. Regulators Ofwat and Ofgem have provided predictable and reliable frameworks for returns. Combined with strong reputations for steady sector oversight, this has offered a safety blanket for conservative investors with an interest in consistent return on equity and dividend yield.

But then came Brexit, throwing the UK’s once relatively stable political regime into turmoil and introducing new levels of uncertainty over the environment the UK will offer to investors in years to come.

This makes investors wary, and allows them to place a premium on the capital which utilities so sorely need.

To counter the negative implications of investor nervousness, government has a big role to play and its communication of the developing Brexit deal will be crucial. But companies can take action to improve their investment prospects too. Efficient businesses with strong track records for returns and positive interactions with their regulators during price setting processes, will be favoured. So will those with robust strategies for adapting to a changing world for utilities operations.

In this Topic, Utility Week looks at what is being done to attract vital investment to the UK, and what more can be done to keep the cash coming despite the uncertainties that cloud the future.

Renewables in the doldrums

Offshore wind is thriving, but elsewhere in the renewables sphere the UK is seen as a much less attractive destination than it was a few years ago.

Money has been vital to an explosion in renewables deployment. As a result of the billions of pounds that have been poured into aiding its growth the renewables industry has leapt from aspiration to dominance in a few short years.

Onshore wind and solar technologies have been the most successful in reducing costs and are being widely deployed.

In fact, from almost no investment before 2011, solar is expected to total £11.9 billion between 2011 and 2020, while onshore wind will see investment of £8.1 billion and offshore wind a total of £12 billion.

However, despite these high figures, renewables investors have become increasingly wary of the UK. This is reflected in the UK’s fall in the EY Renewable Energy Country Attractiveness Index, falling from a high of 4th in 2013 to its current low of 14th.

The uncertainty caused by changes to the Renewables Obligation regime, and the removal of the Levy Exemption Certificates, coupled with the closure of the Department of Energy and Climate Change (Decc) and the approval of Hinkley Point C, are behind the decline.

However, EY states that some respite was achieved when the government approved 1.8GW Hornsea 2 offshore windfarm, which will be the world’s largest offshore windfarm when completed.

EY energy corporate finance leader Ben Warren says: “A non-committal approach to energy policy is putting the attractiveness of the UK’s renewable energy sector on a landslide.

“The current approach is going against the grain of almost universal global support for renewables and is masking the UK’s advantages – a growing energy imperative as ageing power plants are retired, strong natural resources and efficient capital markets.
“In the absence of real changes to the direction of policy support and greater demand for renewables in the energy generation mix post-2020, the only way for the UK in our index seems to be down.”

Onshore wind has suffered particularly hard blows, with subsidies being scaled back. Hopes of a revival are few and unless the general election changes things, the government has stuck to the previous pledge to “halt the spread” of onshore projects. So much so that Bloomberg New Energy Finance analyst David Hostert says: “Without some form of change in support, we could see investment drop off a cliff after 2019.”

Solar has also suffered from subsidy cuts, but offshore wind is currently favoured by the government, with significant investment and new projects being brought forward.

In the first six months of 2016, the UK attracted more than £10 billion of investment into the offshore wind sector, roughly three-quarters of all European investment.

Renewable UK’s deputy chief executive, Maf Smith, said the performance underlines the UK’s status as the leader in the offshore wind sector. “Offshore wind has been a real success story for the UK, and these latest figures are further evidence of this – investment in UK infrastructure so far this year are worth over £8.5 billion across their lifetime.

“We know there’s more to come as well – the UK will invest over £20 billion in wind energy in the next five years. Throughout the country, offshore wind is creating jobs and revitalising coastal areas,” he added.

What the government wants to achieve is enough investment to drive down costs, so subsidies can be scaled back and ultimately removed once the technologies are at or close to grid parity. For this to be achieved, steady policy adjustments and subsidy reductions are required, rather than sudden changes and cuts, which put off investors and damage the UK’s reputation as a safe place to put their money.

The UK is achieving this with offshore wind, but for onshore wind and solar, while investment is still coming in, critics will charge that too much has been cut too soon, damaging the pipeline of potential investment coming in.

Brexit

The UK’s vote on 23 June 2016 to leave the European Union sent shockwaves through the investor community.

There is huge uncertainty about how the UK will interact with the remaining 27 EU countries, with trade and freedom of movement among the top concerns. There is a lack of clarity about the political situation, and how EU law will be transposed into British law, and the future pathway for it once the Article 50 process has been completed. The announcement this week of a general election adds to the mix.

Uncertainty and investors don’t mix very well, and usually result in costs being pushed up.

However, one upside of the Brexit vote has been the fall in the value of the pound, which makes sterling a cheap currency to buy for international investors, and therefore makes UK investment cheaper.

Mike Felton, UK equity fund manager at M&G Investments, says the weaker pound will attract investors to the UK. “There were significant spikes in foreign purchases of UK companies following previous sterling devaluations – the pound’s exit from the ERM [Exchange Rate Mechanism] in late 1992 and the 25 per cent fall in sterling in 2008/09 around the financial crisis. In both cases, within six months there had been a sharp rise in acquisitions and this persisted as the currency stayed weak.”

He adds: “A big effect of the pound’s weakness post-Brexit is to make those UK-listed companies that may have previously appeared attractive to overseas buyers look even better value.”

It appears Brexit could attract some foreign investors, and be enough to tempt those who were already keen to press ahead with a deal.

Interview: Susan Davy, chief financial officer, Pennon

Susan Davy is rolling with the punches that Brexit has already started throwing.

The chief financial officer at FTSE 250 company Pennon says that the firm has seen the cost of key investment projects rise in the wake of the referendum result and that she expects to have to “work harder” as the divorce settlement is hammered out, to reassure, retain and attract investors.

Pennon is among the largest infrastructure groups in the UK. Under its wing sits Bournemouth and South West Water (now merged) as well as the successful waste and recycling company Viridor.

In its first half year financial results for 2016/17 the company reported revenues of £685.5 million and operating profit of £153.9 million. It also recorded £183.3 million capital investment. Most of which is possible only because of Pennon’s investors, who currently enjoy dividends of around 11p per share.

With more significant plans for both capital investment and new business opportunities stretching into the future, its crucial for Davy that she is able to soothe the concerns that have come with Brexit, and keep the company performing.

“There is great uncertainty around at the moment,” Davy says. And with that, comes risk.

Pennon has already seen the costs of a £242 million investment in Bristol hit by increased technology costs as a result of Brexit, Davy tells Utility Week. Other investments are being looked at again to see how they will be affected.

In part, this will depend on the future availability of lending from the European Investment Bank (EIB). In 2015 the key strategic areas of the energy, transport and water, benefited from €5.2 billion of EIB ­financing.

But Brexit has put this at risk. “The EIB does lend outside the EU, but that is currently only about 10 per cent of its current lending, so it’s not significant. That is something I’d call on the government to think about,” says Davy.

Of more direct concern to Davy, however, is what she and other finance directors can do to remain attractive to investors despite the intense uncertainty that now surrounds the UK.

Davy admits that she and her peers will have to “work harder at your relationships and make sure your business case is good”.
This will be about more than simply reporting numbers. “You’ve got to take them through the investment plans. They like the whole picture of what’s going on,” she says.

Much of this big picture vision relies on successfully communicating the impact that evolving regulatory drivers are having on the business and showcasing how the “contract in place between the utility and the customer” still supports an attractive, de-risked home for investment.

But Davy believes more can, and should, be done to attract investment to the UK.

She states that chief financial officers from across different sectors should come together, and work with government, to join up thinking on this important topic.

Setting up a chief financial officer network could deliverthis alignment, mitigate uncertainty and shore up the UK’s attractiveness to investors.

“The UK does need more joined-up thinking, especially when you have that same pool of investors, and any unintended consequences from other sectors or government policy could have significant impacts.

“You have to be careful,” she concludes.

What’s the plan?

The National Infrastructure Plan brings a welcome commitment to a pipeline of major projects, and energy and water have the most to deliver.

In July 2015, the newly elected Conservative government unveiled the country’s latest National Infrastructure Plan (NIP), which included work worth more than £270 billion across the energy and water sectors.

Energy is the largest sector featured in the NIP. It is worth £245 billion, according to the government, and accounts for 60 per cent of the national pipeline’s total value.

There are 56 programmes and 102 energy projects outlined as part of the NIP, including the Neart na Gaoithe offshore windfarm and the Dorenell onshore windfarm, both in Scotland.

The NIP also includes one water project – the Thames Tideway Tunnel – and 28 water programmes worth more than £25 billion. The 28 programmes outlined include AMP6 work covering most of the water and sewerage companies and water-only utilities in England and Wales.

The infrastructure pipeline provides an assessment of planned investment in infrastructure, across both public and private sectors, to 2020 and beyond. It is hoped that this pipeline will enhance visibility and certainty for investors and the supply chain and allow government to work more effectively to ensure that the UK’s infrastructure needs are met.

Chief secretary to the Treasury David Gauke said: “It is the largest and most comprehensive pipeline the government has produced and will provide greater certainty for investors and the supply chain, as well as helping us to improve our forecast of future skills needs.”

Mark Wiseman, president and chief executive of the Canada Pension Plan Investment Board, agreed that the move is a positive one for investors coming to the UK.

“There’s a tremendous amount of capital right now that’s interested in investing,” he says, adding that having longer-term certainty for major projects not only makes them more attractive but there is a knock-on effect to other projects.

The Institute for Civil Engineers’ public affairs manager, Alex Green-Wilkes, says there is now a focus on delivery in the plan which is “apt” and will reassure investors.

He says: “The new focus on helping to improve the delivery and performance of infrastructure projects, in particular by considering the interdependencies of our networks and their future resilience, is certainly welcome.”

The NIP is working hard to reassure investors that major projects in the UK will still go ahead, and aims to provide them with the certainty that means they will continue to invest at competitive rates in the UK.

European Investment Bank and the UK Green Investment Bank

EIB investments in the UK economy came to €6.9 billion in 2016, making the country the 5th largest recipient of EIB loans last year.

Over the past five years (2012-16) the European Investment Bank has invested more than €31.3 billion in the British economy. The total investment of the EIB Group (the European Investment Bank and the European Investment Fund) in the UK in 2016 was €8.1 billion.

The UK Green Investment Bank (UKGIB) was created by the government, which provided it with the initial capital to invest. This was used to back green projects, on commercial terms, across the UK and mobilise other private sector capital into the UK’s green economy.

It has invested in 99 green infrastructure projects and seven funds, directly committing £3.4 billion to the UK’s green economy into transactions worth £12 billion, with the other funding coming from other investment funds and sources.

The UKGIB is currently being sold off by the government, with the privatisation process beginning last month. Australian bank Macquarie is poised to take over and there are fears that it could sell its existing stake in green projects and threaten the environmental credentials of the bank. Former business secretary Sajid Javid, who instigated the sale, said a “golden share” would be created that would enable the holder – a company formed specially by the government – to reject any changes to the bank’s green ethos.

Community schemes

The UK has been slow to embrace community energy schemes, but the concept is now gaining traction.

Community energy schemes are a burgeoning area for investment. In the UK there are more than 600 community-owned renewable energy projects and the number is growing.

Bristol Energy was one of the first to gain traction in the UK. In 2012, Bristol City Council successfully applied to the European Investment Bank (EIB) to fund a feasibility study for the project.

The council plans to allocate £1.6 million in cashflow support to enable the new energy company to start trading this summer. EIB provided half (around £70 million) of the capital, with the rest coming from private sector investment.

Community Energy Scotland goes back further, being established in 2007. It is a registered charity that provides local communities with assistance on green energy development and energy conservation.

With an extensive portfolio of community energy projects under its belt, the group aims to: help communities become stronger, more self-reliant and resilient by generating their own energy and using it efficiently; offer education, finance and practical help; and provide a voice for communities who want a more secure and sustainable energy future in Scotland.

There is also support coming from some of the UK’s energy suppliers. Co-op Energy has pledged to have 60 power purchase agreements (PPAs) in place with community generators over the next three years, as part of a new strategy.

The supplier’s community energy strategy sets out a number of goals, including a commitment to develop “simplified and longer” PPA contract terms with more commercial benefits for community energy groups.

According to the document, Co-op Energy currently has 40 PPAs in place with community groups, compared with just nine in 2014, and it aims to increase that number to 60 in the next three years.

This is also a sector that former energy secretary Ed Davey states “will weather the political storm” and continue to grow and attracting investment at a grassroots level.

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