Green Investment Bank

Written evidence submitted by Centrica (GIB 38)

1. Centrica welcomes the opportunity to respond to the Environmental Audit Committee’s Inquiry into the Green Investment Bank.

2. Centrica plc is the parent company of British Gas, the UK’s largest energy supplier, with around 16 million customer contacts in the domestic sector and around one million in the non-domestic sector. British Gas already enjoys the position as the energy supplier with the lowest carbon intensity of the electricity that it produces and supplies to its customers.

3. We also own upstream gas production and power generation assets through Centrica Energy to support our supply businesses:

i. We own 8 gas-fired power stations including Britain’s newest power station in Langage, near Devon.

ii. We are a leading developer of offshore wind and were recently awarded exclusive rights to develop the Irish Sea zone which provides us with the potential to develop up to an additional 4.2 gigawatts of renewable electricity.

iii. Centrica also plans to play a role in the UK’s new nuclear renaissance. We own 20% of British Energy, through our Joint Venture with EDF Energy and are undertaking the pre-development activities for a planned nuclear new build programme.

4. The threat of climate change demands action now and the UK has rightly set itself the task of meeting this challenge. We have demanding greenhouse gas reduction targets of 34% by 2020 and 80% by 2050. Separately, the UK needs to deliver 15% of all energy from renewable sources by 2020. With concerted effort and commitment from government and industry, these targets can be achieved. We support the Green Investment Bank, believing that if it is correctly designed and implemented, it could play a substantial role in enabling the UK meet its energy and environment challenges.

5. The low carbon investment challenges are significant and long-term. In order to have a meaningful impact, the GIB institution must be able to make long-term decisions that sit outside the political and economic cycle. It must be constituted with a sense of durability and independence so that investors are confident that it, and its investment decisions, are for the long-term. Only in this way can it live up to the vision of a Green Investment Bank as opposed to another Government grant scheme or fund.

6. The GIB should supplement and not replace important reforms such as to planning or the electricity market that are essential for investment in new low carbon infrastructure. Two areas where we believe the GIB could help accelerate the speed and scale of finance are offshore wind and energy efficiency.

Pre-construction Equity for Offshore Wind

7. Investment in offshore wind has increased dramatically but is still not taking place at the scale or speed needed in order for the Government to meet its targets. This is being addressed through a range of important reforms including planning, RO support etc. Getting the framework right for investment must be the Government’s priority.

8. With the right framework the investment will come forward. However, in the longer term there may be an inherent shortfall of available capital in the UK acting as a barrier to deployment of investment at the speed and scale required. This is because only a few companies have the skills and capacity to undertake these investments (utilities) and these have limited balance sheet headroom combined with competing calls on resources. These balance sheet constraints will require utilities to find other sources of finance that do not utilise balance sheet capacity. This is a feasible and tested route. However, there is a risk that new equity partners may not come forward at the speed and providing the scale necessary to meet the renewable energy deployment rates the Government envisages.

9. The GIB could play a role in overcoming this by providing project equity at key points e.g. pre-construction offshore wind. The GIB would simply be expanding the pool of available capital, not providing a subsidy. It would co-invest on pari passu (equal) terms with the private sector project promoter(s). On completion of the project, capital can then be released and then recycled for further projects. A modified version is for the GIB to co-invest with first loss equity, requiring it to make a smaller contribution to the project finance.

10. In addition to plugging a funding gap, GIB co-investment would also provide reassurance to utilities and the broader investment community that the Government was committed to providing the support mechanisms necessary to make the investments required. In doing so, it would enhance investor confidence and increase the amount of funding coming forward from the market.

Initial Debt Provision to kick-start the Green Deal

11. For the Green Deal to be successfully implemented on a large scale it must be readily financeable. Energy suppliers’ balance sheets will not be able to absorb the full costs given the scale could be as much as £80bn. Banks would be the natural lenders but so far they have indicated they are unwilling to provide the finance, initially at least. This is because Green Deal finance is new asset class (loans tied to a meter point not a person) at relatively small levels (~£6k) over a long payback time (up to 25 years). In addition, a low interest rate (approximately the risk-free rate +1%) is required to achieve the Green Deal ‘golden rule’ [1] . Banks therefore see it as too high-risk for significant investment until it is more proven and understood, thereby limiting the availability of debt to finance the Green Deal.

12. The lowest cost of financing would be to access the capital markets. However, to build up a portfolio of Green Deal Obligations prior to securitisation, an interim ‘warehouse’ facility would be needed to aggregate and structure the Obligations. In its early days, there is a risk that Green Deal uptake will not be successful and the Government will withdraw support of the policy which would leave the warehousing banks with a portfolio of assets they cannot sell. As a result, commercial banks have shown reluctance to act initially as ‘warehouse’ sponsors. The GIB is ideally placed to act as a strong and credible sponsor for a Green Deal Special Purpose Vehicle, warehousing Green Deal obligations prior to securitisation.

13. In addition, the GIB could act as a short-term liquidity provider for the period it takes to package up enough GD loans to securitise into a bond. This could be alongside any private banks willing to lend to the Green Deal or as an upfront finance provider until they are more confident in the policy. The GIB should not be seen as a long-term provider of finance for the initiative and, once the Green Deal is established as an investable asset class, it is envisaged that public markets will take over the role of the GIB.

14. To achieve AAA-rating for the securitised note, the SPV could create a reserve account to cover default payments funded by the first year or two of Green Deal payments.

15. The GIB is not essential to developing the Green Deal but it can be key to speeding up delivery. One option is to hope that a range of banks will come forward and offer commercial loans, despite early indications of their caution. They are likely to be much more willing to participate if this was alongside or through the Green investment Bank. Another option is to rely on installers to turn to their own balance sheets, but in capital constrained times this could discourage Green Deal participation. Both these options therefore risk slowing down the uptake of the Green Deal

16. The proposed possible structure is outlined below.

17. In terms of capitalising the GIB, we believe this is an issue and decision best left to Government. Instead our focus has been to look at areas where the GIB can add most value and what characteristics it would require to do so. However, we would point out that the energy customer already funds significant policy and investment through various levies and obligations (e.g. the RO, CERT, the CCS Incentive, CESP etc.). Because these levies and obligations are raised through the energy bill, they are regressive. Therefore we believe a taxpayer route would be the fairest.

22 October 2010