Read investor hints for 2015 and you can’t fail to receive advice that National Grid is your best bet for a safe and generous return.
With a market capitalisation of approximately £35 billion, it achieved an earnings per share rate of 66.4p in 2013/14 and this is expected to rise by 2.7 per cent per annum over the next two years. In short it is the epitome of sound, defensive stock and with its cost controls now firmly in place, investors can be sure of regular earnings.
And yet, National Grid is also at the heart of a turbulent and uncertain transformation of the UK’s energy system – a metamorphosis that will require it to adjust to a world of distributed, intermittent generation, smart technology and the increasingly imminent likelihood of a significantly electrified transport system. And all the while, it must keep in line with expectations to minimise costs to consumers.
National Grid chief executive Steve Holliday, who has been in post since 2007, appears sanguine in the face of the challenge. He declares himself to be an “optimist” before admitting that the UK’s progress towards a smart world – including, but not limited to, the energy system – is a “deep subject” and, at times, “an area of frustration” for people in the energy industry.
“This is because it attracts buzzwords that very quickly come to mean different things to different people,” Holliday comments. “That’s certainly true when it comes to the word smart and what is expected of smart grids.”
While Holliday is firm that there is “no question” about the direction of travel for the UK energy system and its supporting technologies, he is also cautious of second guessing the pace of change or the detail of future grid operation and energy supply.
Using a smart grids pilot project in the US to demonstrate his thinking on this topic, Holliday says: “This pilot represents a $56 million investment in the local network and 15,000 end consumers. We’ve got four offerings for those consumers in terms of home energy automation, from the most basic smart meter to a fully integrated system across heating and cooling and a lot of the big white goods which works on a demand control premise.
“We’re looking to learn an awful lot from this project over the next couple of years and get some time of day pricing introduced. I mention this because one of the most interesting things about projects like this is how they show you that companies or government cannot dictate consumer behaviour.
“In our Worcester example, of the four offerings – all of which are free – if you’re an optimist, perhaps naively so like me, you might expect everyone to opt for the fully fledged automated system. But in fact we’ve had to incentivise people to allow us to install that, while there are plenty of volunteers for the bottom end tier.”
Why didn’t consumers want the top end technology? Holliday says it was commonly down to concerns about invasions of privacy and data security. He continues, “We have to be careful, therefore, about trying to predict exactly what the world will look like in 2025 – it will be based on a mixture of the necessity for a smarter system – to address our trilemma – the appearance of lots of new technology, the familiarisation of existing technology which most consumers are not using today, but ultimately it will be driven by customer preferences.
“Today – in both the UK and the US – as consumers we get a standard offering, fundamentally. We can choose our supplier but essentially, whatever tariff you choose, the delivery mechanism is a standard package. That is not the future. The future will involve lots of different packages. The government has said that every home will have a smart meter, but I think we should be careful of assuming even that.”
This seems an alarming comment given that the UK is due to embark on its £11 billion smart meter rollout this year. Are we wrong to do so? Holliday elaborates, “The question is: ‘Is the way in which the UK is going about this necessarily the right or clever way?’ We have to get to a smarter world, so in principle I think we are right to try and accelerate towards it.
“What I am arguing, however, is that we need to be prepared for a group of customers who point blank refuse smart meters. Thinking that the smarter world will exist in all businesses and all homes is flawed. We will see a much more flexible, consumer-driven world.”
What will that world require of National Grid compared with its operations today? Holliday loyally insists that today’s grid is “actually already pretty smart”, particularly compared with the US, but adds, “This world will still need bulk transmission. It is unlikely we will need to massively increase the capacity of the system in its entirety – even with the electrification of transport, which will clearly massively increase the load – but with smarter systems we will smooth that load out.
“For National Grid it is about developing reliability and flexibility to ensure that the capacity is there. So the business doesn’t shift significantly in terms of the assets. In terms of the operation and balancing of the system, we are on a journey. I am very proud, actually, of what we have already been able to do in this field to accommodate the amount of wind generation on the system today.”
Holliday says having new demand-side tools at its disposal has been key in allowing National Grid to make that accommodation and insists there is a real need to develop more of those products. Yet energy market commentators have expressed doubt in the past about National Grid’s enthusiasm for demand-side mechanisms.
“How can you say that!” Holliday bursts out in disbelief. “We absolutely can’t do the job we need to do unless we have a lot more demand-side response. We’ve got a lot of work to do as a business over the next year or so to work with that market and develop more products because the UK needs it and we need it as part of our job balancing the system.”
While this will be a complex innovation process, Holliday is hopeful that the innovation structures and incentives set out under the RIIO regime will be effective in finding the right solutions. He describes RIIO as “a credit to the regulatory system in the UK” – even if it did suck in a lot of time and resources to prepare for.
“I would say that we spent 18 months to two years getting ready for RIIO; recognising that there was a step change in approach that would require us to think very differently about customers and what’s the right answer for them. How to get that balance right, particularly between the life extension of an existing asset versus building a new asset – or can you achieve an outcome that’s required without making any investment? It requires very innovative thinking.” (See more on RIIO on page 16.)
Our session is drawing to a close, but you can’t conduct an interview with the chief executive of National Grid without asking one essential question – are the lights going out?
Holliday is patient with the enquiry. “There’s less margin today than there was two years ago. Demand may have been pretty low throughout December but we are not through winter yet.
“The extra tools that we now have available through supply-side measures to pay generators who weren’t going to be there to be available, and the demand side –which we need to do more on – will be helpful in making sure that we can balance the system.”
Holliday sums up with confidence. “Yes, we are in a world where the margin is tighter than it has been for six or seven years – but what that also tells you is that we are not in uncharted territory.”
A point of passion
You can’t get far in reading about Steve Holliday without finding reference to his unstinting commitment to reducing the UK’s significant and widely documented skills gaps in science, technology, engineering and mathematics (STEM).
But after years of involvement in initiatives to improve the profile of engineering jobs, promote apprenticeships and develop standardised approaches to training and development, does Holliday feel all the activity is making a difference?
“Well first of all,” he comments modestly, “it’s not me, it’s the company. The way we think about what National Grid does – its longevity and sustainability as a business – is, of course, about delivering for our customers and shareholders, but I have a deep belief that in order to be really successful we’ve got to have a bigger purpose.”
That purpose, as Holliday sees it, is to be “plugged in” to the communities in which National Grid operates – understanding their environmental, social and economic requirements and providing for them. It’s this purpose which makes investment in STEM skills development so important, he explains. “The data in the UK shows that 58 per cent of all jobs over the next ten years – not just in the energy sector – will need GCSE level STEM qualifications. But often kids don’t understand that.” Hence, there is a mounting mismatch between qualifications and economic aspirations.
While reports such as Engineering UK’s annual publication on the STEM skills pipeline continue to show that the UK has a long way to go in providing for its skills requirements, Holliday is generally buoyant about progress in increasing the coherency, scale and strategic significance attached to a few central skills initiatives in the UK.
Primary among these is the Energy and Efficiency Industrial Partnership (EEIP), which Holliday chairs. One of 11 industrial partnerships to have benefited from a £250 million employer ownership of skills funding revolution, Holliday says it has drawn in a “phenomenal” response from the energy sector and its supply chain. There are around 60 companies involved who aim to achieve a 10 per cent reduction in the sector’s skills gaps and a 10 per cent reduction in job vacancies over five years.
Perhaps most importantly though, according to Holliday, the EEIP is beginning to change beliefs that education and training are a point for competition within the sector, rather than an area which needs consistency and standardisation in order to assure quality and to improve the movement of talent nationally.
“The breakthrough that we need, which is not quite there – but is starting – is that this is not a place for competition. Creating a skills base in the UK that the economy needs,” Holliday explains with emphasis, “is something we can all collaborate on”.