Analysis: The Crisis In UK Energy Policy Has Arrived
Yesterday Britain’s energy policy crisis became a reality.
In our April 2013 report ‘A Crisis in UK Energy Policy Looks Inevitable’ we argued that the inherent contradictions and implausibility of UK energy policy would eventually trigger a crisis. We pointed out that the political risk faced by the sector would undoubtedly rise as these forces played out. Yesterday those concerns crystallised with the announcement by the leader of the Labour party of a 20 month price freeze for power and gas bills across both the domestic and business sectors should Labour win the May 2015 General Election.
Yesterday the affordability crisis that we have foreseen in our April report became a reality. In response to rising gas/electricity costs, the Labour party promised to impose an arbitrary price freeze on energy suppliers from May 2015 to January 2017 should they win the next general election. Labour predict a £4.5bn hit to suppliers. In other words Labour are proposing that the supply companies pick up at least £4.5bn of the cost associated with government policy implementation. In our view the implications of this are as follows:
1. Renewable target now untenable: The Labour Party has implicitly abandoned its commitment to the 2020 renewable target and probably the 2030 greenhouse gas reduction target. We assume that Labour could not be so staggeringly naive / stupid / miss-informed as to believe that an arbitrary price cap is compatibile with the threefold (£100bn plus) increase in investment required from next year to hit the renewable target. Therefore we can only conclude that Labour have now abandoned their environmental targets.
2. Energy Bill dead on arrival: This announcement seriously undermines the Energy Bill currently before parliament. It is very hard to see how the institutional framework for the creation of the Cfd’s can work with the threat of a price cap hanging over the suppliers. Also if this measure is deemed to be a foreseeable change of law under the terms of the Cfd then any company signing the Cfd would be taking on considerable risk.
3. The generation capacity crunch just got bigger and longer: As Ofgem and others have warned, the UK power market is likely to be tight (to very tight) over the winters of 2014/15 and 15/16. This is because the government imposed closure program of coal and oil capacity is running to time, whilst the replacement new build program of low carbon generation is running 3 years late. The current governement hopes that the crunch will be short lived as the Energy Bill would reinvigorate the new build program from next year.
Following Labour’s announcement that now looks unlikely in the extreme. So it is now very unlikely in our view that new generation assets would received FID before the May 2015 election, stretching the capacity crunch to at least 2018 even if Labour did not win the election. And if Labour were to win and implement this policy then most new build would remain on hold in our view.
4. The supply business is a lot less attractive: The big six suppliers will need to consider their position in the UK market. Facing a potentially open ended loss during the price freeze, it would be prudent of suppliers to consider their options for reducing exposure to this business segment. Supply in a volatile business that ties up huge amounts of working capital and balance sheet capacity and therefore its attractiveness is already relatively weak for some companies. Exit would not be straight forward and value loss would be a risk. But the supply companies must also consider that the risk of further interventions by future governments as the affordability crisis is not magic’d away by a 20 month price freeze.
5. Prices to be higher: First, the wholesale electricity price should rise as the market prices in the longer and deeper generation crunch mentioned above. Second, the supply companies will need to go into the forward markets and fix as much power / gas as they can for the 2015 – 16 period, as forced buyers they are likely to a) over purchase capacity to be on the safe side, and b) face higher prices as upstream companies charge a premium. Finally, as the political risk faced by the sector in the UK just increased markedly then the general cost of capitalal also increased in our view.