I don’t know how many people in the UK buy into the climate crisis narrative, although people might be starting to wake up to what the push towards a zero-emissions future will mean in practical terms: increased price volatility, higher household bills, rising subsidies (ie taxes), intermittent power supply, potential outages and the spectre of energy rationing.
Of course, all the problems we’re experiencing in European energy markets can’t be blamed on the green energy transition; underinvestment in key infrastructure areas, principally gas storage, has left us ill-equipped to deal with supply-side disruption, but another miserable northern winter will surely serve to heighten the political debate over climate change – and much else besides.
For investors, the rush towards a decarbonised future has profound implications across a range of sectors: automotive, mining, civil aviation, civil engineering, agriculture, even defence. But what of the utilities themselves? They already go about their business in a regulatory straightjacket, with pricing, distributions and enforcement issues at the behest of the Office of Gas and Electricity Markets (Ofgem). It has always been hard to imagine how the directors of a privatised utility could meet their fiduciary duty to shareholders when they’re faced with the conflicting demands of consumers and government agencies.
Ultimately, both Whitehall and the market accepted the view that listed infrastructure utilities could offer a revenue stream comparable to bonds, so they both proceeded on that basis. However, recent events may have undermined the viability of the ‘bond proxy’ model.
The trouble is that this effective trade-off can only be successfully maintained if wholesale energy prices are relatively stable. Unfortunately, wholesale gas prices have gone through the roof since the start of the year, and the UK generates upwards of 40 per cent of its electricity through gas-fired plants. Despite the spike in underlying costs, UK households are still protected to a certain degree by the energy price cap; £1,277 a year for standard variable rate ‘default’ tariff customers. In short, suppliers have limited scope to pass on price increases to UK consumers.
Soaring wholesale energy prices are already having a negative impact ahead of the winter freeze. Ofgem recently announced that three more energy suppliers are ceasing to trade, bringing the total to nine in recent weeks. Prior to the pandemic, a handful of companies supplied around 70 per cent of the UK’s gas and electricity requirements, but we are now witnessing further consolidation despite the best efforts of regulators and politicians to promote competition.
One of the criticisms levelled at the regulatory framework governing the privatised utilities is that it has allowed them to push leverage well beyond a level they might have been comfortable with prior to privatisation. The extent to which the post-privatisation surge in borrowing has been undertaken to support distributions, rather than physical infrastructure, has also been subject to debate.
That debate could intensify if the current energy crisis is a harbinger of what is to come, particularly if the government forges ahead with plans to reduce greenhouse gas emissions by 78 per cent (from 1990 levels) within the next 15 years. It may be technically feasible to hit this target – the UK has made significant strides since 1990 – but who will be on the hook for the tab? Consumers? Taxpayers? The utilities? Perhaps all three, but it may be that income seekers will also need to recalibrate their expectations.
The International Energy Agency (IEA) estimates that the push towards 'net zero' will require sunk costs above and beyond existing capital commitments. The annual global investment in transmission and distribution grids would need to grow by 215 per cent to $820bn (£599m) by 2030. As such, the ability of power utilities to fund distributions could grind up against green capital commitments and existing debt levels.
It’s a difficult juggling act; a point borne out by recent speculation that Elliot Management had convinced the board of SSE (SSE) to split its wholesale energy business from the segment that builds new wind turbines and other renewable assets. SSE, which is “currently building more offshore wind than any company in the world”, sold its energy supply arm to Ovo Energy in 2020 and closed out FY 2021 with net debt of £7.81bn, representing 117 per cent of net assets. Short of further large-scale divestments, something has to give.
