Those of us eager to see a utility sector transition that rapidly minimises emissions tend to think of utilities as an obstacle to progress. However, utilities appear to be ahead of investors and regulators in adapting to rapid changes in the sector.
That was one of the themes running through a recent roundtable featuring representatives from utilities, investment firms, consultants, and advocacy groups. The event, co-sponsored by PwC and Preventable Surprises, aimed to facilitate a dialogue among stakeholders about opportunities and challenges arising from a low-carbon transition. Preventable Surprises focuses on systemic risks (such as climate change) that have the potential to destabilise financial markets and destroy shareholder value. We focus particularly on the utility transition as a means of reducing demand for fossil fuels.
European utilities have struggled over the past decade as wind and solar power undercut prices at oil and gas-fired plants. Tania Tsoneva, director of Global Infrastructure Ratings for S&P Global, told the group that European utilities have seen asset writedowns of more than €75 billion (£65 billion) between 2012 and 2015, as well as multiple credit downgrades.
S&P expects the trend of flat commodity prices, the main driver of European power prices, to reverse, easing downward rating pressure. “Utilities have not managed the transition well historically but are now taking the necessary steps to transform themselves,” she said.
Spin-offs have been one part of the transformation. RWE and Eon cleaved their oil and gas assets from clean energy and retail products. “Splitting those companies into good banks and bad banks has been very successful in releasing new investment,” said Alex Murley, regulatory manager at RWE Innogy, whose initial offering raised more than €18 billion.
Murley said wholesale prices drove investment in the past but value will increasingly be split between capacity markets, renewables, and system services. “Policymakers don’t understand that the wholesale price should trend to zero, that it won’t be the carrier of revenue to drive investments,” he said.
Regulatory resistance
While Murley is confident that investors and utilities will pursue opportunities that advance the low-carbon transition, he is less confident about the regulatory regime and the signals it sends. “I’m not optimistic that the government will commit to the right level of ambition so that we can meet our environmental target at the right time and at the right scale. We need cutting-edge market design theory,” he said.
Those present agreed that technology is leapfrogging policy and they said a carbon price could provide “one fixed point in a rapidly changing landscape”. Other regulatory issues highlighted by the participants were:
• Levies are taken on electricity, not on gas or coal, which burdens the preferred method of generation for advancing electric heat and electric vehicles.
• Costs of recovering infrastructure are too high to customers and do not reflect falling energy costs.
• Auctions of offshore capacity by the government mirror earlier auctions of 3G spectrum, which were a poor investment for mobile companies. As one utility representative said: “You can’t not participate, but how do you recoup that cost?”
• Ofgem needs to gain distance from political operatives to function effectively and needs to be transparent on wind policy. One utility representative said it is “ridiculous” to be basing large offshore wind investments on a comment Amber Rudd made in November 2015, the last government statement on offshore wind.
Stuart Cook, PwC’s head of utility strategy and regulation, and a former member of Ofgem’s board, said regulators and policymakers need to balance competing objectives: affordability; security; the environment; and industrial competitiveness.
He said utility markets are approaching uncharted territory: “The job of regulators and policymakers is very difficult. They will need to be flexible in the face of increasing uncertainty. Many commentators have asked whether they are up to the challenge.” For example, he commented on PwC research that found that 17 per cent of UK commercial and industrial companies do not expect to use the grid in five years’ time. “Charging arrangements will need a fundamental review to accommodate this lost income.”
Investors once saw utilities as a top-rated, conservative investment providing stable income. Now they see new entrants in the sector, capital constraints due to write-downs, liabilities tied to legacy plants, regulatory uncertainty.
One participant suggested investors have slowed down the low-carbon transition because they want to protect dividends. Another said utilities have been loathe to discuss risks with investors for fear of alienating them: “If asset owners want the transition to work, they must push utilities to disclose their plans and they must acknowledge that there will be winners and losers.”
Other questions raised by investment analysts in attendance:
• The changing regulatory regime within countries has made it difficult to allocate capital correctly (among regions, among technologies) and to assign valuations to individual securities.
• “Are we investing in flexibility – financial and operational – so firms can react or manage the damage as changes appear?”
• New entrants such as Google, IT firms, automobile companies, and engineering firms mean utilities must be valued against non-traditional competitors.
Jon Williams, who leads the finance sector team in PwC’s Sustainability and Climate Change practice, said the shift from generation and distribution to decentralised networks, new technologies, and data will necessitate changes throughout the sector. “It’s like the transition in telecoms, it will require different skills and management over time,” he said.