What’s in this report?

Utility Week’s new CEO Insight research series will provide regular access to the sentiment of industry chief executives on key themes and developments impacting the sector, and their businesses individually.

Our analysis of the findings from the first iteration of this research will be published in easy to digest instalments, however, a complete research report will also be made available.

This instalment of research analysis focuses on CEO views on the ease with which their organisations can currently access finance, and their feelings on the question of investor confidence in their business, and the sector more broadly.

Meanwhile, previous instalments of research analysis for the first iteration of Utility Week’s CEO Insight series covered:

• The macro environment
• Regulation
• Business model transformation – workforce talent challenges and consumer perceptions and satisfaction

This final installment also includes a short conclusion on the overall findings of all research analysis installments.

Executive Summary

As utilities grapple with the transformational change sweeping the sector, company chief executives face challenges on many fronts. In the first of a new, regular series of research reports – CEO Insight – Utility Week surveyed the leaders of the UK’s major utilities, to understand their views on the political and economic climate their organisations are operating in, the regulatory and policy landscape surrounding them and what the future holds in terms of change and challenge.

The results paint a picture of chief executives poised for sector disruption. They expect radical changes to business models, even in the short term; are dissatisfied with or lukewarm to the regulatory regimes they operate under and express concern in relation to wider economic and political factors impacting their businesses.

While responses to some questions show significant variation in opinion between different utilities subsectors, qualitative commentary on the survey findings, provided by sector leaders, showed the findings generally resonate with chief executives across the board.

Even in areas where a single subsector stands out from the crowd – for example with regards to networks’ support for their regulatory regime – qualified comments shows that there are significant and growing concerns about the direction of travel for the future, and the influence that political interventions are having on this.

In this first iteration of our CEO research, respondents from the water sector – spanning wholesale and water retail – provided especially robust responses to questions about satisfaction levels with the regulatory and market structures which envelope company operations and profitability.

To acknowledge this, as well as including observations on water responses in our general commentary, we have broken them out in a special subsector focus chapter.

The next iteration of our CEO Insight series will gather evidence over spring 2018, with a second report appearing in the summer.

Access to finance and investor confidence

In a market experiencing significant levels of transformation, the question of access to finance and investor confidence is understandably high on the agenda – especially given the rising predilection for political intervention in regulated utilities which have long been considered secure long-term investment vehicles for those interested in sustained, above-market yields.

In survey responses, CEOs expressed mixed views about the current environment for raising debt and equity investment for their businesses. On a scale of 1 to 10, where 10 equates to “extremely easy” CEOs overall rated debt as easier to raise, scoring it at 6.7 compared to 5.9 for equity.

The exceptions to this rule were contributors from challenger energy brands and water retailers, who both said it is easier to raise equity to invest in their businesses. Especially with regards to challenger energy brands, this may reflect the entrepreneurial, start-up nature of some smaller firms and their need for growth capital in the short term.

As one commentator from a big four financial services firm observed, challenger energy brands also tend to have limited access to the debt market and, of necessity, focus on “an equity play”.

Despite the current political turbulence around the UK utilities sector and the impending threat of slashed dividends on the back of the PR19 and RIIO price reviews, regulated utilities remained confident of their ability to raise debt, with power networks expressing the highest levels of confidence (9 out of 10) and water companies the lowest (7 out of 10).

Commentary confirmed that water and energy networks leaders are not currently experiencing any decline in their relationship with debt financiers. However, there was some definite nervousness about how this situation might change in the coming decade, especially among regulated water companies.

This is unsurprising given clear messaging from the financial community and credit ratings agencies that a punitively low cost of capital in the next AMP period, and downward pressure on dividends, could negatively impact the profile of the water sector for investors.

In a recently review of top trends for European regulated utilities in 2018, ratings agency S&P Global classed the UK water sector’s outlook as “at risk” due to rising political interventions and the possibility of renationalisation under a Labour government.

The concerns of water leaders also resonate with CEO survey responses which indicated lukewarm sentiment at best regarding the final framework for PRI19. Almost half (43 per cent) express low or very low satisfaction with the regulator’s approach to calculating the cost of capital in PR19, with the remainder only “adequately” satisfied.

Likewise, in the networks space, leaders reiterated their concerns about political intervention in the regulator regime – referenced earlier in this report – and the impact this might have on the availability and cost of debt.

One leader said that a mid-period intervention would “massively” undermine the trust investors have in the ability of UK regulators to offer a secure utilities investment environment as well as jeopardising the positive way in which RIIO supports reinvestment in network businesses by incentivising investors to focus on increasing performance rewards.

Beyond the regulated utilities arena, large vertically integrated energy companies also expressed confidence in their ability to access both debt and equity, rating each at 8 and 7 out of 10 respectively for ease of access.

As a forward-looking trend, Orsted’s Matthew Wright suggested that debt markets may well become harder to access for companies without a clearly expressed sustainability agenda.

He observed that the cost of capital and insurance for low carbon energy projects has dropped significantly in recent years, with technologies and business plans in these areas moving from a position of relatively high risk, from and investor perspective, to low risk.

“I think the fanatical community has woken up to the fact that a sustainable business model is a lower risk business model,” he said

In terms of M&A expectations as a reflection of investor sentiment, survey responses were more bullish with 81 per cent of CEO saying that in an M&A scenario, their organisation would be a buyer.

One CEO commentator observed that this sentiment seemed to contradict the rather lukewarm feelings overall about the availability of debt and equity. But nevertheless, they agreed that significant utilities M&A activity should be expected.

This rise in M&A activity may not manifest in the immediate future however, with 76 per cent of CEOs who classed themselves as buyers, saying they expect “very little” activity in the next 12 months. Commentary suggested a three year horizon may be more realistic in terms of seeing M&A ambitions manifest.

The focal point for utilities M&A is likely to be the energy supply market, according to commentary. Several chief executives said they believe more oil majors will look for technology and retail targets to advance their interests at the utilities-customer interface – as Shell has recently done in its impending acquisition of First Utility.

The possibility of more deals like the SSE-Npower retail merger was not ruled out however, and there was a high expectation that many of the smaller suppliers currently active in the market will be consolidated over the next three years, either joining similarly sized companies with a shared business ethos, or being subsumed into larger organisations if they have a unique technological capability to bring to the table.

Orsted’s Matthew Wright in particular believed that the market for low carbon technology acquisitions is ripe, and that there will be some significant activity in this space in the coming year. “The only thing that might stall that is if the market for some of these targets overheats,” he said.

A significant inflation in the valuation of battery storage firms in response to market hype, for examples, may cause some buyer to hold back.

While regulated utilities tend to have a less dynamic M&A profile, the significant upcoming changes to regulatory regimes are expected to drive some exchange of ownership for these large infrastructure companies. In addition, increasing commercial opportunities in deregulating market mean that CEOs in this space are increasingly alert to advantageous technology investments for their unregulated business arms.

Conclusion

Utility Week’s first CEO Insight clearly defines the tensions being felt at board level, by utilities braced for disruptive change.

While energy system transformation is well underway, some of the most radical alterations to competitive propositions and technological infrastructure are just around the corner – reflected in our CEOs’ expectation of mounting business model transformation over the coming fifteen years.

As this sector metamorphosis progresses, it is inevitable and right that policy and regulatory frameworks surrounding the utilities sector should also adapt.

However, our research shows significant concern among CEOs about the populist flavour of current policy decision making and its impact on the independence of utility regulators, especially for monopoly networks.

The biggest fear in the near term for energy networks, is that a threat to review revenue agreements as part of a midpoint RIIO revue will cause serious immediate damage to investor confidence and company valuation. For some, even the suggestion of this possibility has proved damaging. In an interview with Utility Week, Robert Symons, chief executive of Western Power Distribution, claimed that Ofgem’s proposal to reopen the price settlement wiped 20 per cent off the share price of its parent company PPL.

Not all utilities leaders are concerned by a propensity for snap decision-making from regulators however. On the contrary, for energy suppliers it is the cumbersome and persistently slow nature of regulatory change which is problematic.

Beyond the ramifications of either revolution or evolution of the policy and regulation arena however, utilities must overcome other challenges if they are to successfully achieve the business model transformations CEOs anticipate.

Our research showed that long-running concerns about attracting and retaining talent for both traditional and emerging disciplines to sustain the business into the future persist and could become more pronounced as workforce mobility continues to increase and skills competition with major national infrastructure schemes like Hinkley Point C and HS2 intensifies.

Then too, business model transformation could be hampered by an increasingly problematic relationship between most utilities and the customers.

Our research showed an overwhelmingly negative CEO outlook on customer perceptions of the firms delivering essential services in the UK, with only a handful of challenger brands or renewable- energy focussed companies expressing optimism about the scope for building trust and popular interest in their businesses.

If customer perceptions of utilities do continue to decline, the ability of utilities to achieve positive outcomes from business model transformation will be compromised and the scope for new entrants into the sector to usurp the customer relationship, will be increased.

While subsector views on the significance of different macro-economic and political factors varied broadly in this research, the importance of customer perceptions and the potential for environmental factors to impact these was commonly accepted to represent a core challenge to the future sustainability of businesses.

To some degree, this challenge may be behind the high expectations CEOs generally expressed for M&A across utilities subsectors in the near to mid-term future. As brands seek to change the way they operate and establish new ways of serving customers, it makes sense that they will look to bring new technology and business capabilities into the fold.

Overall, the findings of the first iteration of Utility Week’s CEO Insight series depict a sector in the throes of significant change but poised for further, potentially radical, disruption.

Future iterations of the research will build on this window into the utility CEO’s world and track changes in sentiment against some of the most influential factors effecting company transformation strategies.

The second iteration of CEO Insight will be published this summer.