Brexit uncertainty adds to industry concerns
The prospect of tougher regulatory regimes, increased political uncertainty and growing technological demands as the sector looks to green the networks, continue to exert the biggest impact on utility businesses. These top three ‘impacts’ mirror last year’s top three, unsurprising given that the fundamental issues facing utilities are ongoing concerns that will always be a central part of the territory.
As with last year, the survey also looked to explore CEOs’ confidence levels in the political and economic outlook, as government continues to be unsteadied by rows over Brexit and the gathering uncertainty it brings. Compared with the 2017 survey, the bosses’ confidence in the economy to provide a stable operating environment had actually grown – it’s up 23 per cent (from 4.7 to 5.8).
However, that’s not to say worries over the economy have subsided – and some of the chief executives who spoke to us about the results said that the increased economic confidence was coloured by relief that the warning bells sounded in the wake of the Brexit vote in 2017, when it was being predicted that the economy would fall off a cliff, have so far proved to be false alarms.
Matthew Wright, managing director of wind power generator Orsted, is one of those who points to the better shape of the economy compared with what had been predicted a year ago. “After the Brexit vote, a lot of people thought that the economy was going into a downturn, but that’s turned out not to be the case and the economy is doing ok. The global picture has turned out to be quite robust too.”
He says, though, that the political outlook is more uncertain, with the prospect on a “no deal” Brexit presenting real difficulties for all businesses. “You can’t rule out a no deal, and how much notice would we get of that? It would be quite difficult to implement contingency plans for a last-minute hard Brexit and no deal would be the worst scenario of all for utilities and generators like us.
“We’re part of the internal European energy market, and we also import approximately 50 per cent of our materials. Without a deal, our import costs would go up and so would construction costs. There would also be difficulty moving people across borders, and we rely on that.”
The results of the survey showed that Brexit has become more of a concern amongst responding CEOs, registering 4.8, up from last year’s 4.5. Brexit’s impact is highest amongst energy retailers (6.1), where a downturn in the economy could impact on customers’ ability to pay their bills.
For John Morea, chief executive of SGN, “Brexit is not currently indicating any material issues for our business model but like all businesses in the UK just now, our assessments are ongoing as more details gradually emerge.”
Colin Skellett, CEO of Wessex Water, is also pleased with the UK economy’s progress but worried about Brexit and also the prospect of a Labour government. “Brexit brings uncertainties in terms of the cost of materials and access to labour. And then the Labour Party wanting to re-nationalise the utilities sector brings many other uncertainties too.”
Looking at the findings in more detail, regulatory change and uncertainty is the biggest issue impacting on CEOs today, and it’s a growing concern. On a scale of 1-10 (with 10 the highest impact) it reaches 8.3 – up from last year’s 7.9.
Only slightly behind, and also still increasing in impact, is policy change and uncertainty – 8.2 this year, up from 7.5.
The third most impactful issue for CEOs is new technology and commercial models, though this concern has eased fractionally – from 7.2 last year, it’s now a 7.
Other issues of concern are the increasing incidences of extreme weather (up from 6 to 6.4) and inflation and currency valuations (up from 5.1 to 6).
One CEO from the energy generation sector, who wished to be unnamed, commented: “Policy and regulatory stability and predictability are important for business planning, particularly when investment decisions taken today can be impacted by political decisions taken 5, 10 or 20 years from now. As a competitive business we can adapt to market conditions, hedge risks within a market framework, and are active in testing and using new technology and developing new business models.
“The policy and regulatory framework needs to similarly adjust and adapt within a long-term market framework and with predictability and consistency of non-market elements, such as the carbon price floor and environmental standards.”
Peter Emery, CEO of Electricity North West, was one of those who commented that as well as the three main business impacts, macro-economic factors were another ongoing concern: “For us the macro economic uncertainty is also a big deal. Currency fluctuations and inflation increase the risks we face.
“We’re under pressure to decarbonise and invest in infrastructure to do that, but I’m afraid that if the economic outlook worsens then we won’t be able to afford all of these things, and I’m not that confident in the economy at the moment. It’s not very buoyant, and if the economy struggles then there will be more emphasis on cost cutting and efficiency rather than focusing on innovation, and inevitably the pace of change slows. That makes it all the more important that the price controls being formulated by Ofgem can accommodate changes in the economy.”
Sector specific results: issues with biggest impact
Turning to how impacts and issues were rated, CEOs in the six industry sectors surveyed (energy retailing; energy generation; gas networks; power networks; non-domestic water retailers; domestic water wholesalers and suppliers) are almost united in seeing regulatory change and uncertainty as having the most impact on their individual sector.
Again this year, unsurprisingly, power network CEOs give regulatory change and uncertainty the highest impact score – 9.1. The other sector CEOs are only slightly behind, with scores ranging from 9 for domestic water wholesalers through to 8.3 for energy retailers. The one exception is non-domestic water retailers, who rate the impact on their business of regulatory change and uncertainty as just 6.5. However, Wessex Water’s Skellett says he’s surprised that water companies rate regulatory uncertainty so highly: “They may not like some of the answers, but there’s a pretty clear steer in the direction of travel,” he says of the impending PR19. “I think Ofwat has tried hard to manage expectations.”
Policy change and uncertainty shows a similar profile of concern, though here it is energy generators and domestic water wholesalers – both with 9 – which are just slightly more aware of politicians’ impact on their business. The heavy criticism fired at the water companies by Defra Secretary Michael Gove, regarding offshore subsidiaries and chief executive pay, is no doubt playing a part in the pressure water companies are feeling.
The third most impactful issue – new technology and commercial models – is creating the most sector-specific impact amongst energy retailers and energy generators, with a score of 8.6 – the former reflecting the importance of technology to boost efficiency and customer satisfaction levels; and the latter, again mirroring the reliance on the development of renewables. Power network CEOs are also very alert to its impact (8), but gas networks (6) and domestic water wholesalers (5.8) much less so.
Other impacts noted by the surveyed CEOs (but not marked out of 10) were: skills shortages and faster early retirement than planned/ageing workforce; cyber security; and the Labour Party’s commitment to nationalisation (which was probably scored by most CEOs as an impact under ‘policy change and uncertainty’).
Energy retailer issues
As the most public-facing wing of the utility sector, energy retailers are arguably the punch bag for politicians and consumer groups if prices increase and performance dips. Add to that the rise and falls of challenger brands, the looming price cap, and the pressure to install smart meters and the merger of two of the big six, and the end result is a sector undergoing bruising upheaval.
To this end, our survey sought to gauge the opinions of chief executives across a range of issues, which we asked them to mark out of 5.
A wide band of different size companies took part, and the size of a company has sometimes influenced its response.
Asked about the smart meter roll-out, however, all respondents agreed equally (scoring 4 out of 5) that it is putting unsustainable pressure on their business. By the end of 2020 around 53 million smart meters are mandated to have been fitted by energy suppliers, but only 12 million have been installed so far, with firms needing to invest heavily to try and ramp up the programme in the face of growing resistance amongst consumers. How hard this will prove was underlined by recent research by Harris Interactive for Utility Week which found 31 per cent were not interested in getting a smart meter, up from 28 the year before.
Suppliers, nevertheless, still believe the exercise is worthwhile, scoring an average of 3.6 when asked if they’re confident it will deliver consumer benefits proportionate to the cost of rollout. But has one chief executive told us, ‘a more pragmatic approach is needed to ensure it is deliverable and is done with value in mind’.
There was broad agreement that the market structure for delivering energy efficient measures in homes is not effective and fit for purpose (average score 2.1; mid-size challenger brand, 2; other, 2.3). Larger companies have becoming increasingly vocal about what they see as the unfairness of the two levies imposed on them but not smaller challenger brands, to pay for greening the existing housing stock.
There was equal agreement that there is not a level playing field for competition between all sizes of energy supplier, with the average score of 2.1. The fact that larger retailers provide a supplier of last resort when challenger brands go bust is one well-trodden source of contention.
David Bird, CEO of Co-op Energy says: “Regulation is changing to make barriers to entry higher and ensure there is greater stress testing to protect customers and that retailers are meeting their social obligations. But that is happening probably two to three years too late, as it will probably take another three to four years to be implemented. And a great deal of these new suppliers just won’t be around.
“A lot of these new entrants are without any understanding of how the market operates, and a lot have not delivered on regulatory obligations, such as identifying priority service register customers, or offering pre-payment meters. They have not got the knowledge or resources to do what is required.
“I think the big oil majors will enter the market and over the next three years we will see significantly more consolidations, because there is not enough money in the market. The small independents are not making any money, while larger suppliers’ results have been poor.; and a number of players are making redundancies.
“But we do need to see a more orderly approach to consolidation in order to stop suppliers going bust. We need financial stability and financial viability tests so Ofgem can intervene in some of these operators.
“It seems inevitable that we will see fewer new players coming into the market. Very few are making a profit; yet there is still a perception within local government that if it sets up an energy company it can charge low tariffs and support fuel poverty.”
Portsmouth City Council recently abandoned plans to create its own energy company after the new administration decided to cut its losses and not proceed with the venture.
Bird continues: “Those aims are very laudable – but there is no money being made. It’s a low margin, high risk business. Only the bigger companies are making money, and that’s because they have disproportionately more customers on higher tariffs. But when the price cap comes in, the market will change.
The survey results certainly showed up a shared lack of confidence (average score 2.6) that the forthcoming default tariff cap would be set at a level which reflects supplier input costs, with mid-size challenger brands the most confident (2.8) and others slightly less so (2.3). Ofgem’s proposal to set the energy price cap at £1,136 per year for a typical dual fuel customer was certainly described as concerning has been described as “concerning” for the whole industry when it was announced in early September.
Including the CMA as a route of appeal against elements of the imminent default cap was strongly supported, with an average score of 4, rising to 4.7 from some respondents. Mid-size challenger brands were slightly less supportive, scoring 3.5.
The rise of electric vehicles is seen as a game changer over the next 15 years by retailer respondents, with 4.3 the average score.
