There is real concern about how the UK’s heroic utility funding requirements will be financed. With the notable exception of Centrica, the big six energy suppliers are all heavily indebted. National Grid, too, is poised to play a key role, despite net debt of around £20 billion.
The coalition government has pinned much of its hopes for funding infrastructure capital expenditure on the nascent Green Investment Bank, which is unlikely to have a serious impact for some years. UK pension funds will also be pivotal in providing the finance for many long-term projects, especially if their risk profile is low enough to justify offsetting against maturing pension liabilities over the next decades.
Overseas, the investment funding focus has shifted towards Asia, which has – with a few exceptions – escaped the massive turmoil of the credit crisis, the near collapse of many banks and the ensuing recession. Recently, chancellor George Osborne led a high-powered delegation to China. Soon after his return, the Chinese Investment Corporation, a sovereign wealth fund, acquired an 8.7 per cent stake in Kemble, Thames Water’s parent company. Previously, the Abu Dhabi Investment Authority, probably the world’s largest sovereign wealth fund, had bought a 9.9 per cent stake in Kemble.
Overseas finance is obviously far from new for UK utilities (see box). However, there is now increasing interest from sovereign wealth funds based in the Middle East and the Far East, specifically China. Chinese funds have shown real enthusiasm in investing in the UK electricity, water and gas sectors. In the latter case, discussions are reportedly underway with BG Group regarding a very sizeable investment.
Is this just a passing fad, like several other utility acquisition trends in recent years, or are UK utilities likely to be increasingly financed by Middle Eastern or Far Eastern sovereign wealth funds?
The most eye-catching Middle Eastern utility investment was undertaken in 2006 by the Bahrain-based Arcapita, which paid more than £2 billion for Viridian Group. This business evolved from the privatisation of Northern Ireland Electricity’s transmission and distribution assets in 1993. Arcapita was also the one-time owner of South Staffordshire Water. It has since sold both interests on.
Far Eastern investment in UK utilities took off when the Hong Kong-based Trafalgar House controversially sought to acquire Northern Electric in 1995, which led directly to Ofgem’s unprecedented – and humiliating – U-turn on its electricity distribution review. In the event, the bid failed. Malaysia’s YTL Power International Berhad, which operates both electricity and water systems, was more successful in acquiring Wessex Water in 2002.
The biggest splash of late in the UK utilities sector has been made by Hong Kong’s Cheung Kong Infrastructure (CKI), which is part of CK Holdings, founded – as a plastics manufacturer in the 1950s – by fabled Chinese businessman Li Ka Shing. CKI owns a key minority stake in Hong Kong Electric.
In 2004, CKI made its presence felt here by buying Northern Gas Networks, previously owned by National Grid. More recently, its bid for EDF’s electricity distribution assets, covering the old Eastern, London and Seeboard areas, yielded a near £6 billion selling price, which greatly exceeded expectations: the premium over regulated asset value (Rab) approached 30 per cent.
Nor was CKI finished. It bid a further £2.4 billion for Northumbrian Water and the premium over Rab was similarly aggressive. Unsurprisingly, investors welcomed the bid.
In valuing UK utilities so highly, companies like CKI – notwithstanding leading sovereign wealth funds – take a decidedly long-term view of their prospects. In general, they work on the assumption of solid revenues and price regulation that seeks to underpin the interests of both equity investors and bondholders. Without the latter, utilities would be unable to undertake much of the heavy investment programmes with which most are saddled.
A similar investment approach is applied elsewhere in Europe. China Three Gorges recently paid more than £2.2 billion for a 21 per cent stake in Portugal’s monopoly electricity company EDP. And just a few months ago, China State Grid spent around £300 million on a 25 per cent stake in Portugal’s REN, its electricity grid business. These privatisation sales stem directly from Portugal’s dreadful macro-economic situation – driven primarily by its eurozone membership – which has culminated in an emergency bailout by the European Union and the International Monetary Fund.
China’s overseas interest also extends to financing EU high-speed rail projects, where it has considerable construction expertise. In particular, it is following the controversial HS2 project, which seeks to build a high-speed link between London Euston and Birmingham by 2026. Following last July’s disaster at Wenzhou, though, in which around 40 people were killed, China’s high-speed rail enthusiasm has noticeably waned.
Nonetheless, it seems inevitable that the financing of the UK’s infrastructure investment will become increasingly dependent on Chinese and Middle Eastern money, especially as the UK’s public debt figure has recently breached the previously unimaginable £1 trillion threshold.
Nigel Hawkins is a director of Nigel Hawkins Associates, which undertakes investment and policy research
Over here: previous foreign investment trends
The first wave of utility takeovers preceded water privatisation in 1989 as French water interests, led by CGE (now Veolia) and Suez (now GdF Suez), sought to acquire some statutory UK water companies.
The next surge engulfed the electricity distribution companies in the mid-1990s, and many were bought by US utilities. US interest subsequently waned on the back of tighter regulation and less obvious value opportunities, although the recent acquisition by the Pennsylvania-based PPL of Eon’s electricity network assets has reversed this trend.
By 2000, the core of the UK’s electricity supply industry was owned by the EU’s leading players, including France’s EDF and Germany’s top two utilities, Eon and RWE.
In recent years a further trend has manifested itself – the cult of private equity, based on low debt funding, which is particularly suitable for long-term utility investment. Of the ten privatised water and sewerage companies, only three are now publicly quoted (ignoring Northumbria’s token quotation). Most of the remainder are owned by private equity consortia, with Australian and North American-based funds being to the fore.
This article first appeared in Utility Week’s print edition of 15 June 2012.
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