Alasdair Ramage, Principal at transformation consultancy Moorhouse
Energy continues to climb the list of concerns for UK households, from worries over rising bills to the longer term concerns about energy brownouts and security of supply. But even as politicians and regulators try to find a workable framework to trigger investment, there are serious challenges over whether the UK has capacity and capability to implement the engineering in time.
Our national concerns are set against a backdrop of a rapidly changing global energy landscape. The breakneck pace of US exploitation of shale gas is driving the US towards net energy export and is already starting to lower global coal prices as gas replaces coal for power generation in the US. America is attracting investment from (amongst others) British energy firms. Emerging economies remain hungry for energy and are developing their own capabilities: China leads the world in making solar panels; Brazil produces lots of bio-fuel from crops; both have invested in hydroelectricity; and Middle Eastern countries are diversifying, including into nuclear.
The UK is failing to deliver to the sustainable, affordable, low-carbon energy we need.
Long-term planners and forecasters have identified concerns for over a decade. Short-term and politically expedient patchwork solutions have exposed households and businesses to higher bills now and uncertainty over long term pricing (from insecurity of supply). Despite legally enforceable national emissions targets, UK carbon emissions have recently increased: the current generation mix favours running relatively cheap coal-fired power stations.
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There will be a “dash for gas” over the next few years, as we build relatively quickly gas-fired power plants. This increases our dependence on imported gas. And while gas beats coal for carbon emissions, we will not meet our carbon reduction targets beyond 2030 with a predominantly gas-fired generation fleet
We are now faced with urgent need to invest hundreds of billions in power generation, transmission, distribution and consumption-reduction measures. End-of-life UK generating capacity is being shut down, yet new construction is being held up by policy uncertainty and pricing. Tentative capital markets top off this ‘perfect storm’ where institutional investors continue to demand high rates-of-return, rather than risk speculation in an uncertain market. And of course, this lack of investment also suppresses job creation in building and infrastructure – which are priority areas to enhance the UK economic recovery.
The government wants innovation, markets want certainty
The regulator is trying to reform the way companies are rewarded for innovation and to continue to increase competition. There is an ever tightening gap between energy supply and demand, with winter 2015 looking critical.
Investors are not rushing in to pressure implementation: industry players have started to act, but progress is slow. Wind power has seen significant investment, but onshore wind costs may rise as a result of recent Government changes to planning rules. Nuclear remains essential to the long term energy mix, but the number of companies willing to invest in nuclear has dwindled as politics impacts commercial planning. For instance: investments are sensitive to the long-term price for electricity, and Parliamentary debates have polarised the commercial arguments over minimum pricing – setting too high a price would mean UK “subsidy” to other nations, particularly via French owned EDF.
It is not enough to divert an increasing portion of tax revenues to low carbon initiatives for homes (the ‘Green Deal’) and businesses to reduce demand. Politicians must do more to improve market attractiveness for investment.
Consumer-led corporate change?
There is very little time contingency to implement needed national energy infrastructure changes. We should not expect business use of energy to change dramatically (they are already incentivised to keep their costs low), other than to hope energy usage will actually increase, fuelled by a growing economy. If investment fails to materialise we may have ‘brown-outs’ that force households to change their energy use. This would have dire political implications and expose energy companies to consumer ire.
A growing portion of the household energy bill is consumed by the costs of environmental policies. With bills rising seeming inexorably, this makes it even harder for politicians and Ofgem to win on issues of national consciousness including: paying the costs for emissions reduction; visual impacts from wind farms; and presenting a balanced view of the risks from nuclear. For instance: globally many more people die each year in coal mines, or from respiratory problems caused by air pollution from burning coal or diesel, than from human nuclear activity.
For financiers this should be a recipe for innovation: to find ways to fund investment without passing on short-term costs. But money faces porous borders, making it easy to invest in North America and emerging markets and avoid European laggards.
Energy companies must serve their shareholders, and generate competitive returns. Capital markets and lending conditions remain challenging, though money is available. To their credit, energy companies are already responding (Admittedly following regulatory fines for a wrongdoing such as misselling; which are much, much smaller than issues Financial Services’ face with PPI.)
But across the board, energy companies must be moved to action – triggered by shareholder confidence in investment and to compete for the spoils of a thriving market. Recent Moorhouse research (The Barometer on Change) identifies that higher growth companies:
- engage their staff more fully in delivering the strategy;
- execute their deliver more effectively (time, cost, benefits); and
- have a diversified portfolio of activity – cost reduction is balanced by clear investment in growth.
A key first step is for energy companies to streamline their current portfolios: accelerating investment in staff and asset productivity, cancelling poorly aligned and poorly designed initiatives, and building supply-chain capability to be able to deliver off the back of their financial investment.
We rely on the politicians and regulators to cement the investment environment. We will then rely on the energy industry to deliver the outcomes. The prize is significant: national GDP growth, and infrastructure investment creating jobs. At the heart of the system we need change, with a rising consumer and financial market voice calling for what we need: long-term affordable, sustainable, and secure energy supply.