From start to finish, policy uncertainty, unexpected announcements and shifting strategies shaped the world of utilities last year. Many of these developments will significantly impact the way in which companies in the sector do business in 2016.
Foremost among the changes of 2015 was the ushering in of a new government. But hopes that a majority administration would bring policy certainty are as yet unfulfilled. Despite a policy reset, question marks remain over government intentions for both energy and water.
Elsewhere, energy giants were shifting shape with three major players taking steps to radically reinvent themselves for a low carbon future. National Grid also made clear its intentions to increase its use of demand-side response and to sell a majority stake in its gas distribution business. All these organisational transformations will continue into 2016, no doubt with a few more to join them.
It was a busy year at the Competition and Markets Authority, though not in the way many had expected. While the results of the investigation into the energy market were delayed it found its hands full with appeals from Bristol Water, British Gas and Northern Powergrid. It also approved the takeover of Bournemouth Water by Pennon as merger and acquisition activity and investment continued to flow into the UK (see p22).
While investor confidence was tested by policy shifts, 2015 did include big investment calls, most notably in relation the Hinkley Point C and the Thames Tideway Tunnel.
Our annual revue takes a closer look at these formative trends and events, and more, setting the scene for utilities in 2016.
Politics and policy
Last year began with the industry under a general election-induced cloud of policy uncertainty. Ed Miliband’s Labour was promising a price freeze and plans to radically overhaul the energy market. The Lib Dems – losing the PR battle with their senior coalition partners – were eager to push the message of going green, while the Tories set out their plans to press ahead with shale gas and to “halt the spread of onshore wind”. Thrown into the mix, and adding to the complexity of an election nobody was able to call, was the SNP, seeking to ban fracking and remaining staunchly opposed to nuclear power.
Fast forward past the surprising exit polls to 8 May and David Cameron is heading the first all-Conservative government since the mid-90s. And the new Tory administration wasted no time in making its mark.
Subsidies to renewables were cut, with solar and onshore wind being hard hit, as well as biomass generators such as Drax.
Further cuts were made to keep the Levy Control Framework under control, and energy secretary Amber Rudd also urged suppliers to pass on falling wholesale prices to consumers as part of a concerted campaign to keep bills down.
Rounding off the year came the shock announcement that the £1 billion carbon capture and storage funding was being pulled, although extra cash is being awarded for research into small modular nuclear reactors. The interest in gas – both shale development and as the “transition fuel” – appears to remain from for the government, with it voting in December to allow fracking in national parks and other protected areas.
Returning to Number 11, chancellor George Osborne continued with its austerity drive, making cuts of 22 per cent and 15 per cent to Decc and Defra respectively.
On the opposition benches, Miliband stood down and Jeremy Corbyn took on the Labour leadership. He and his new shadow energy secretary say they want to “democratise” energy – whatever that means.
Industry hopes that a clear election result would lead to clarity and stability have only been met with cuts and more uncertainty. The only clarity to emerge from Rudd’s policy “reset” is that gas is the would-be king.
Commodity prices and pressure to cut bills
At the start of 2015, the major energy suppliers cut prices by a maximum of 5.1 per cent despite wholesale gas prices falling by more than 20 per cent. At the time, they blamed the spectre of Ed Miliband’s price freeze pledge.
With oil now languishing below $40 a barrel, and likely to remain there, the squeeze on gas prices will heap the pressure on suppliers to pass on the benefits. Energy secretary Amber Rudd has already made her opinion clear, as has Ofgem chief executive Dermot Nolan.
The smaller players have cut their electricity and gas prices as they continue to fight for market share (see p15), but the silence from the big six since their early 2015 cuts has been marked. Calls to reduce bills – both electricity and gas – from the regulator and the government will only grow as the winter gets colder.
CMA rebukes retail and backs the regulators
The Competition and Markets Authority (CMA) had a busy 2015. Its energy retail probe made its initial findings (see box, below), and both the government and energy companies will be keeping an eagle eye out to see if anything changes when it reports again in April.
The CMA also saw its workload added to in March when British Gas and Northern Powergrid appealed against Ofgem’s RIIO-ED1 price controls. The competition authority rejected all but one complaint each from the two appellants, and then only conceded that £105 million needed to be cut from the distribution companies’ revenue over the eight-year price control, and granted NPG an additional £11 million over the same period. Not much compared with the £17 billion settlements the regulator originally dished out.
The ruling left British Gas licking its wounds as it was ordered to pick up the majority of the CMA’s and Ofgem’s costs.
The CMA also ruled largely in Ofwat’s favour in the PR14 dispute with Bristol Water. The water company only managed to gain an additional £20 million over and above the amount the regulator set out in its price control, a result Bristol Water chief executive Luis Garcia nonetheless described as “worthwhile”.
Water market opening
The Open Water programme had a tumultuous start to the year when in February it was overhauled for a second time.
Ofwat abandoned plans to appoint Wics, led by Alan Sutherland, to oversee the programme, after the move was voted down by the Scottish regulator’s board. Instead, it elected to make Market Operator Services Limited (MOSL) the delivery body and to keep the programme to create the non-domestic water market on track for its April 2017 deadline.
However, at the end of the year, the Treasury made the shock announcement that the domestic water market could open up to competition by 2020, which could change the view of retailers and incumbents on how involved they are going to be in the market. PwC says the big six energy suppliers may now take an interest in the sector, while those potentially considering an exit may reconsider.
With the challenge of meeting the tight timeframe for non-domestic water opening at the forefront of chief executives’ minds going into 2016, the curve ball from government will only add to the issues they need to consider and deal with.
As PwC water analyst Richard Laikin observed: “The era of converging utility retail may be a step closer.”
Investment
Last year billions of pounds were earmarked for major infrastructure projects and the construction of them will begin in earnest this year. In August, a deal was struck for Bazalgette Tunnel to take on the £4.2 billion project to build and deliver the Thames Tideway Tunnel. The special purpose company is made up of Allianz, Amber Infrastructure Group, Dalmore Capital Limited and DIF.
Work on the first pier near Blackfriars Bridge has started as the group strives to deliver the project two years ahead of the forecast completion date of 2023.
EDF Energy and the UK’s nascent new nuclear industry received a boost when the Chinese company CGN struck a £6 billion deal to take a 33.5 per cent share in Hinkley Point C.
This marked the start of a wider deal paving the way for the Chinese company to develop a second new nuclear plant at Sizewell and a nuclear plant of its own design in Essex in which it will take a two-thirds stake.
With the government also ploughing money into research and development for small modular reactors, 2016 marks the beginning of something big for the UK’s nuclear sector.
Climate change
The key event in terms of a global shift to low-carbon energy and tackling the growing threat of climate change was COP21 in Paris in November.
The talks were seen as the “last chance” for a deal to be struck that could keep global temperature increases below 2C, especially after the failure to get a legally binding deal agreed in Copenhagen in 2009.
A deal was drawn up and agreed to by the 194 member states, although parts of it are not legally binding, and the key points of the agreement are:
• A partially legally binding agreement for climate change action.
• Five-year reviews.
• $100 billion-a-year price floor to support developing nations.
• No timescale on the fossil fuel phase out was agreed.
The fifth carbon budget
The end of 2015 also saw the Committee on Climate Change issue its fifth carbon budget advice to the government. It said “urgent action” is required to keep the UK on track to meet its carbon targets as set out in the 2008 Climate change Act.
The committee stated:
• “A number of new policies and clear long-term signals to investors are urgently required” to cut emissions by 57 per cent by 2030 and keep the UK on track to meet its 2050 climate target.
• The UK should aim for a carbon intensity of 100g/CO2/kWh by 2030 for electricity generation, down from 450g now.
• One in seven homes should be using low-carbon heat sources by 2030.
Toils and troubles, restructures and reshuffles
The major energy companies had a tough 12 months, which saw Eon and RWE making some significant structural changes as they aim to separate their conventional generation businesses from the renewables side. The move has aimed to keep their struggling thermal generation away from their renewables operations, which are seen as an avenue for future growth.
Eon announced its move at the end of 2014, and at the start of 2015 RWE ruled out following its German counterpart. However, in December, it announced it was going to create a new “innovative decentralised energy group” within a year. The new company will take control of RWE’s renewables, grids and retail operations in Germany and abroad to create a “platform for growth” which will “strengthen the viability of the group overall”.
Centrica stated in July it would reallocate around £1.5 billion in investment from its struggling upstream arm to drive growth in its more profitable downstream supply and services business.
The development of new business models is something that other energy players may look to join in with in the coming year.
National Grid
2015 saw the wheels set in motion for signifcant change at National Grid, with long-serving chief executive Steve Holliday set to leave this year. The company confirmed in November he would depart and be replaced by John Pettigrew, who has been with the company for 25-years. Top of Pettigrew’s agenda will be to ensure Grid is able to cope with diminishing margins and the changing dynamics between supply and demand. In June, National Grid’s head of commercial operations, Duncan Burt, exclusively told Utility Week that the company is preparing to revolutionise how it maintains secure supply by relying on demand-side measures for “well over 50 per cent of the time” by 2030.
Alongside this, National Grid is also set to sell a majority stake in its gas distribution business, with SSE the early favourite to take it on, although the “usual suspects” are following developments closely.
The gas sale, plus the change of attitude towards demand-side response, marks a shift for National Grid, and one that will continue to take shape this year.