What does the Energy Bill mean for UK generation investment?03 Dec, 2012
The UK government published its Energy Bill last Thursday after releasing most of the headline measures the previous week. The Bill represents a compromise outcome after a protracted battle between the Conservative led Treasury and the Liberal Democrat led Department of Energy and Climate Change (DECC). This conflict, combined with ongoing uncertainty around a set of somewhat complex and inconsistent market intervention measures, has resulted in substantial damage to investor confidence. So now the Bill has finally been submitted to Parliament, what does it mean for generation investment?
Low carbon generation investment
The government to its credit appears to have understood that delivering meaningful volumes of low carbon generation investment will require clear guidelines on financial support. Firstly the Energy Bill establishes a government backed counterparty for the FiT/CfD contracts, shoring up their creditworthiness. Secondly it provides much stronger guidance on the cash that will be available to fund low carbon investment (£7.6bn a year by 2020 vs around £2.4bn today). However there is still no clarity on how that support will be split by technology. The process for determining the FiT/CfD strike prices will continue into 2013.
Guidance on financial support out to 2020 is a step forward for wind and biomass investors. Subsidy allocation is likely to be particularly focused on offshore wind which will have to do the heavy lifting if there is to be meaningful progress towards the government’s 30% renewable target by 2020. However a number of other hurdles remain in the path of offshore wind delivery, particularly in relation to transmission network investment. Nuclear plant will presumably fall outside financial support defined in the Energy Bill on the basis that it will not be delivered until after 2020.
Several weeks ago we published our projections of potential renewable build levels. At the time we noted that a step change in policy support for renewable plant would be required to get close to government’s 2020 target. Does the Energy Bill constitute that step change? In a word – No. It is a step in the right direction, but we see nothing than changes our view that renewable generation share in 2020 will be closer to 20% than the 30% target.
Gas-fired generation investment
It is thermal plant not renewable plant that will be the key to UK security of supply over the remainder of this decade, as we have set out previously. Security of supply is where the government has a real policy problem. Low carbon policy support in the form of FiT/CfDs and the carbon price floor is increasingly inconsistent with viable returns on thermal plant.
The government have in part recognised this problem by including the outline of a Capacity Market in the Energy Bill. But there is nothing bankable in promising to design a mechanism that may be used to support gas plant returns at some undefined point in the future. So the Bill offers little from a security of supply perspective. Instead the government appears to be relying on its Gas Generation Strategy expected to be announced this month.
For all the noise around an Osborne Treasury supported dash for gas, it is unclear how government policy will have a meaningful impact on gas plant investment with gas generation margins (spark spreads) close to historical lows. The impact of a capacity market looks to be years away and it is debatable whether it could be effectively used to plug such a large hole in new gas plant economics.
Osborne may try and promote a UK style shale gas revolution but it will be of little benefit to gas plant investors. The UK is not an island when it comes to the gas, but part of an interconnected European market. Shale gas or not, the wholesale gas price will be continue to be set at the borders based on European (and increasingly global) pricing.
When it comes to addressing security of supply, the government faces two substantial hurdles:
- The investor credibility damage it has suffered through inconsistent policy, continuing uncertainty and the barely disguised brawl between Treasury and DECC.
- The investment impact of capital constraints in a deleveraging global economy which looks to be in the early stages of another cyclical downturn.
Those factors will continue to present formidable headwinds for UK generation investment long after the Energy Bill has passed into legislation.