7.Historically, the UK has been viewed favourably as a place to invest. A transparent legal and political system, combined with a stable macro-economic environment have proved to be attractive to investors. In the energy sector, the relatively stable policy framework, avoidance of retroactive change and cross-party commitment to achieving long-term decarbonisation targets reinforced that appeal. The Institutional Investors Group on Climate Change (IIGCC), a forum for investor collaboration, explained:
The UK has been a leading European destination for institutional investment into low-carbon technologies over recent years. Financial investors invested nearly EUR 6.4 billion in equity in EU renewable infrastructure in 2014, of which nearly EUR 4.0 billion was invested in the UK.
8.However, the attractiveness of the UK as a destination for international investment is being called into question. We have heard consistently throughout our inquiry that the Government’s actions since the election in May 2015 are undermining confidence and unsettling the investment community. This is encapsulated in the EY Renewable Energy Country Attractiveness Index, which ranks 40 countries according to the attractiveness of renewable energy investments. The UK slipped from 8th place in June 2015 to 11th place in September 2015. This is the first time since the Index was established in 2003 that the UK has been placed outside the top 10.
9.There has been a dip in investor confidence in the UK energy sector since the election in May 2015. We have identified six factors that, when combined, are having a damaging effect on investor confidence. These are:
10.The stability of the policy regime is one of the factors that investors will consider when making an investment decision. This is particularly relevant in the UK energy sector where, as the Secretary of State herself has acknowledged, no form of power generation can currently be built without Government support, whether that is in the form of a Contract-for-Difference, Feed-in Tariff or Capacity Market payment. Policy decisions can cost money. In paragraphs 30-32 we explore the impact that recent announcements may have had on investment, particularly on projects in the earlier phases of supply chain and project development.
11.Due to the long lead time required to deliver new investment, and the long life of energy assets, investors look for a stable and predictable policy environment. However, they also understand that policy changes are a fact of life in a democracy. If changes are made with sufficient prior warning and in full consultation with the industry, investors feel able to manage their risk exposure across projects or portfolios and mitigate the risk of future changes, adapting their investment plans accordingly. When policy changes are sudden and unexpected, there is less room for manoeuvre and investors face greater exposure to losses. IIGCC explained:
Every change of policy involves a cost for some market participants. However, if policy changes are announced with sufficient lead time, are in line with the overall direction of energy policy, are not retroactive and result from an extensive and objective consultation they are acceptable to investors.
12.Unfortunately, the Government’s track record since May 2015 has not been good in this regard. Witnesses described the raft of policy announcements that was made over the summer as “dramatic”, “unexpected” and “abrupt”. This was compounded in the autumn by the decision to axe the CCS competition, with only an hour’s warning given to the industry. Investors have been left wondering “what next?”
13.The sheer number of policy changes was also a cause for concern. E.ON told us:
Considered individually, some of the recent changes may appear reasonable, but the combination of so many changes in such a short period of time with limited or no consultation has left a void. Investors have been left questioning the future direction of Government policy and its commitment to long term targets.
14.When changes are made to policy, the investment community wants to understand why. If the rationale behind a decision is not clear, or if the decision-making process is not transparent, confidence in the stability of the policy regime will be diminished, and investors may be left with the question “what will be next?” Witnesses criticised the Government’s lack of transparency, in particular the failure to make public the methodology and assumptions behind the Levy Control Framework (LCF) spending projections. Schroder Investment Management said:
None of the assumptions that underpin the [LCF] forecasts have been made available. This makes understanding the context to investment decisions difficult.
15.Genuine consultation allows the Government to gain a fuller understanding of the likely impact of a proposed policy change on industry and the investment community. A failure to consult properly risks damaging investor confidence if investors feel that the Government does not sufficiently understand how policy changes could impact investment. Consultation works both ways—investors get early visibility as well as the opportunity to provide input into policy changes, which reduces the suddenness and lack of transparency of any subsequent announcements. We heard criticism that the consultation period for the changes to Feed-in Tariff accreditation was just four weeks. There was no formal consultation on the decision to close the Renewables Obligation early, and the change to the Levy Exemption Certificates was brought in on the day of the Summer Budget without any engagement or consultation, even though it had significant impacts on the share prices of several investors in renewables. For example, Drax’s share price dropped 28 per cent on budget day, “wiping £425 million off the company’s value.” Centrica told us:
Whilst the Levy Exemption regime (under the Climate Change Levy legislation) was always recognised as a transitional support mechanism for renewable generation, it was not expected to be removed with such immediate effect and without industry consultation. The Chancellor’s announcement in the Summer Budget of the removal of the Levy Exemption Certificates from 1 August 2015 thus impacted the revenue streams of a range of projects, from new and existing renewable generation, as well as renewable electricity trading and supply to business customers thereof.
16.However, this has not always been the case. We heard praise for the efforts DECC has made in the past to take investors’ needs into consideration. Witnesses cited the Electricity Market Reform process, including the development of the Contract-for-Difference mechanism, as an example of good practice. They also noted the work of DECC’s Commercial Team and Investor Relations Team.
17.Witnesses felt there was room for improvement, though, in ensuring that investors’ concerns were better understood across Whitehall and in particular within HM Treasury. 2020 Renewables Ltd said:
Because many of the policy decisions impacting renewables (levy exemption certificates, levy control framework) and other energy investment (i.e. oil and gas taxation) are driven by budgetary issues, decisions by HM Treasury have a large impact on the investor community. It is therefore important that investor feedback is properly communicated to both Treasury and DECC in crafting policy decisions. Currently investors have little understanding on decisions being taken by HM Treasury which is contributing to investor uncertainty.
18.While investors will naturally look at the detail of policies, they also respond to the broader signals and narratives sent out by Government. Witnesses told us that the current Government is at best sending mixed messages. At worst, some of the decisions made in the last nine months appear to signal a significant change of course. Once again, this increases uncertainty and undermines confidence in the sector.
19.Siemens described some of the “apparently contradictory messages” that were “unsettling” for investors:
WWF UK added that:
Since May 2015, the Government has enacted or proposed a series of policy reforms that cumulatively have been understood by stakeholders as a significant shift away from low-carbon technologies (even if this was not the intended purpose).
20.The overwhelming number of submissions to our inquiry expressed a desire for more clarity about the Government’s intended long-term direction of travel. Temporis, a Fund Manager for the Environment Agency Pension Fund said:
The criteria for investment decisions will vary depending upon the nature of the specific transaction, but as a general matter policy stability is the one of the key investment drivers. Long term visibility is especially important here given the nature of infrastructure investment and its close ties to regulation.
Energy projects are by their nature long-term endeavours. The process of developing plans, acquiring permissions and constructing an energy project—whether that be a wind farm, thermal plant or a nuclear power station—takes many years. For nearly all, the process lasts longer than one parliamentary term. For long lead-time plant, such as offshore wind, nuclear or carbon capture and storage, the process may take more than one five-year parliamentary term, and in some cases may span multiple parliamentary terms. And of course, once it has been built, the project will likely operate for decades. This means that investors and lenders want to understand how the energy generating landscape (and supporting policy framework) will look in the medium- and long-term, in order to have an idea of the potential returns a project might provide and the risks to which these returns are exposed. Matthew Knight from supply chain firm Siemens told us:
All energy investments are long-term. It can take you 10 years to develop a project and then it operates for another 30, 40, 50 years. So you are talking about projects that take two Parliaments to go from an idea to actually being constructed.
21.Unfortunately, again, this is an area where the Government has not performed well to date. For the six months following the election, the Government did not set out a positive vision about how it envisaged the power sector evolving over time, other than to say that it believed the UK was on track to meet its 2020 renewable electricity commitment. It was not until November 2015, when the Secretary of State gave her long-anticipated energy policy “reset” speech, that the Government’s direction of travel became a little clearer. The industry association, Energy UK said:
The sudden, near retroactive, changes have been difficult for investors to explain to credit committees, and the absence of a longer-term policy direction makes it hard to construct a compelling narrative to persuade the decision makers that medium term projects in the UK merit support.
22.We also heard how cross-party support for a long-term vision was something that investors would welcome. We heard that the cross-party consensus over the recent Electricity Market Reform (EMR) process was an example of good practice. Siemens told us:
Investors were prepared to wait during the lengthy EMR process with the promise of clarity beyond. [ … ] Investors were then reassured by the cross-party consensus on the 2013 Energy Bill.
We note the approach taken by the Swedish Government, which has appointed a cross-party Energy Policy Commission to prepare the basis for a long-term, cross-party agreement on energy policy.
23.The “reset” speech set out aspirations to replace coal with gas, to get nuclear “off the ground” and to hold three further Contract-for-Difference auctions for offshore wind, conditional on meeting cost reductions. However, witnesses told us that further clarity was needed, as evidenced by the overwhelming call for greater long-term visibility on energy policy. Investment over the past decade has put us on track to meet our 2020 renewable electricity commitments, but concern remains about the course for 2030 and beyond. We return to these points in paragraphs 45–49.
24.As we have already noted, energy projects can take many years, or even decades, to go from conception to fully operational. Investors therefore want to have clarity about the policy framework over a project-long timescale. Witnesses described a policy “cliff-edge” in 2020: beyond this point, there is no information about the Levy Control Framework budget or the Carbon Price Floor.
25.In the pre-2020 timeframe, witnesses also called for greater clarity about the next round of Contract-for-Difference (CfD) auctions. ScottishPower explained that investors “need clear visibility of budgets and timing of auctions in order to be prepared”. RenewableUK called for clarity on the following aspects:
Who is allowed to compete for contracts, when the auctions will be, and what budgets are available for each of the pots, all on a rolling horizon. A clear plan for how technologies will move through the allocation system, from negotiated contracts to the less-established pot to the technology-neutral established pot.
26.In October, DECC told us that it would “set out plans for the next CfD allocation round this autumn”. In November the Secretary of State suggested in her “reset” speech that the Government would make funding available for three further CfD auctions this Parliament, and that the first of these would take place by the end of 2016. These auctions are subject to “Government’s conditions on cost reduction” being met.
27.While the speech provided some reassurance to investors that there would be further CfD rounds, it did not set out a detailed “plan” and many questions still remain unanswered: When will the auctions take place? How big will the budgets be? Which technologies will be eligible to participate? How much must costs fall by in order to remain eligible for support? Further clarity is needed on these issues.
28.Although the UK’s standing in the attractiveness league tables has dipped a little in recent months, investments are still being made. For example, DONG Energy recently announced that it had taken a final investment decision on Hornsea One, which will be the world’s largest offshore wind farm. The issue is whether any loss of confidence is having a material impact. The picture is actually a great deal more complicated than it appears at first glance.
29.We have heard about two ways in which reduced investor confidence may have serious consequences for the UK energy system. The first is that the development of new projects—creating the medium-term project pipeline coming forward for investment—may have been put on hold, pending further clarity on energy policy. The second is that the overall costs of building the energy infrastructure that is needed for a secure and low-carbon future may be higher than they would otherwise have been.
30.As Siemens explained to us, “energy investments occur in four distinct phases: supply chain, project development, construction and refinancing [of operational projects]. The types of investors and decision criteria are different at each stage”. We also note that there are varying rates of return and, as we note in paragraph 37, all energy project costs—for renewable as well as other forms of energy production—are ultimately passed onto consumers. We heard that there is no shortage of money available for projects in the later phases: late construction and operating projects which are lower risk as they are at or close to revenue generation. We also heard that there may be a strong level of activity at present financing through construction in order to meet the new 2016 cut-off date for the Renewables Obligation and getting in ahead of other regulatory charges. Energy UK said:
There is unlikely to be an immediate tail off of investment in the UK, especially as banks and developers hasten to finish projects ahead of the RO [Renewables Obligation] and FIT [Feed-in Tariff] termination deadlines.
However, there is concern among investors about an impact on new investment in the earlier phases of supply chain and project development. Energy UK went on to add that “the uncertainty may already be impacting longer lead projects which are struggling to attract earlier stage development capital”. The UK Energy Research Centre (UKERC) explained why this was the case:
Development stage investors are potentially embarking on a process lasting several years before the project is operational. This is because it is necessary to undertake detailed site assessment (for example wind regime monitoring) and to secure planning and consent before construction can take place. [ … ] Investors therefore need a good deal of certainty that there will be a market for the construction of their developed asset a considerable time into the future. This means that these investors are most concerned with the long-term commitment of policy–for example that the CfD regime will sustain and have sufficient budget to offer contracts. They are likely to be concerned more about a signal that sufficient volume of projects will be demanded in the future than they are with the price at which their power will eventually be remunerated. This is because so many factors in a projects costs and revenues can (and have) change over the timescales in which most developers operate.
31.Returning to our previous example of DONG Energy’s recent investment in Hornsea One, this project secured a Contract-for-Difference (CfD) in April 2014. The contracts are legally binding, private law contracts between the developer and a government-established company and so will not be affected by any future policy changes. That is, once the wind farms are built and operational, the CfD top-up payments will be guaranteed. This is clearly a very different proposition for investors than putting capital into, say, the development of a new onshore wind farm in England, which may not be granted planning permission, may not be eligible for any support schemes and for which returns would be highly uncertain.
32.In relation to offshore wind, DONG Energy told us that whilst the “short-term pipeline, up to 2020 is assured, the medium-term, 2020–2025, is less clear, with a lack of clarity about future auctions and the potential volume that could be accommodated”. An indication that there is an impact on new projects coming forward was provided by Carol Gould, Bank of Tokyo-Mitsubishi who told us:
At the moment we are actively working on a number of offshore and onshore wind projects, but there is a much smaller pipeline of earlier development projects. [ … ] from the pipeline perspective, there are fewer discussions with developers regarding new projects. [ … ] It is probably closer to 95% less conversations with onshore wind [developers].
33.The pace of current investment activity in projects that are close to completion (in order to get ahead of regulatory changes) may be masking a slowing down of investment in the earlier stages of the project pipeline. However, the impact of this will only really become visible in three to five years. While there is anecdotal evidence that this slowdown is taking place, it is too early to provide hard data. The Government should monitor this through DECC’s Renewable Energy Planning Database and the Planning Inspectorate Register of Applications and report back to us annually, through the course of the Parliament, on the health of the energy project pipeline.
34.The cost of building a new power plant is made up of many different elements: the cost of attaining relevant permits and consents; the cost of the equipment, engineering and construction, labour costs and so on. One important factor is the so-called “cost of capital”. Put very simply, this reflects the cost of borrowing money—interest and fee payments on loans and/or the cost of equity (the return that shareholders require to invest in the project)—that is needed to finance the project.
35.The cost of capital is itself a reflection of a number of factors, including the creditworthiness of the borrower, operating history, profitability, interest rates and so on. Lenders and investors will assess a “risk premium” for projects, reflecting factors that may impact the ability of a project to deliver the anticipated returns. Generally speaking, the more risky a project looks, the greater the risk premium will be. In much the same way that someone with a poor credit rating will have to pay higher interest rates when they take out a bank loan, so a project that is perceived to be higher risk will have to pay a higher risk premium. Schroder Investment Management said “In the light of recent changes to support mechanisms, we perceive that there is now increased policy risk and therefore require a higher premium to compensate for this risk”.
36. Witnesses explained that “policy risk” is one of the factors that lenders and investors will take into account when calculating their project risk premium. Increased policy risk will result in increased risk premiums and therefore an increased overall cost of the project. Andrew Lee, CEO and Managing Director of Velocita Energy Developments Ltd, explained in more detail why a more risky environment resulted in demands for higher rates of return:
Long-term investments in the onshore wind sector in France have achieved 5% or 6% returns, currently, in a low interest rate environment. In the UK we probably have to add 2% or 3% on to that, because we have learnt from experience that, over the years, [the return] will be salami-sliced back and that probably, at the end of the day, when [ … ] someone has managed to slice off a piece of our revenue for some reason, it will come back to the same amount. Investors are looking for that sort of return from long-term infrastructure projects, and then you have to price the perceived more risky areas higher up.
37.Since all project costs are ultimately passed on to consumers, it was argued, the consequence would be higher consumer bills. Statkraft UK explained:
The biggest risk is that UK is seen as risky and unreliable destination for long term capital-intensive investments—precisely what EMR [Electricity Market Reform] was designed to avoid. This won’t stop investment, but it will make everything more expensive for investors and—ultimately—consumers.
38.Octopus investments provided an example of how an increased risk premium could affect UK investment costs. Using their methodology, and a 2% risk premium, the cost to the UK could be an additional £3.14 billion per annum of additional financing costs.
39.However, the Minister explained to us that the recent actions taken by the Government were motivated by the need to keep consumer bills down:
It is the case that when this new Government came into office we could immediately see that there were serious problems with, effectively, significant impacts on consumer bills, so we had to take action.
40.We are concerned that the Government appears to be considering only short-term costs to consumers when making energy policy decisions. Increasing policy uncertainty leads to increased risk premiums, which will result in consumers paying more in the long-run. In addition to considering the needs of today’s consumers, Government also has a responsibility to consider the impact of its decisions on risk premiums which will directly affect prices paid by the next generation of consumers.
5 Barn Energy Limited (), Environment Agency Pension Fund (), Greenpower Developments ()
6 ABB (), DONG Energy (), Environment Agency Pension Fund (), IIGCC (), Siemens (), UKSIF ()
7 IIGCC ()
8 EY , accessed 23 February 2016
9 DECC, , 18 November 2015
10 IIGCC ()
11 ABB (), Centrica (), Environment Agency Pension Fund (), Hallidays Hydropower Ltd (), IIGCC (), Lightsource Renewable Energy (), Scottish Renewables (), US Industrial Pellet Association ()
12 Energy and Climate Change Committee, Second report of session 2015–16, , HC 692
13 Scottish Power ()
14 E.ON ()
15 Q 112 (Andrew Koss; Paul Spence), Q 170 (Paul Barwell), Carter Jonas (), CCSA (), Greenpower Developments Ltd (), Green Highland Renewables Ltd (), IREGG (), Nextenergy Capital (), RWE (), Energy UK (), RenewableUK (), Schroder Investment Management (), UKERC ()
16 Schroder Investment Management ()
17 E.ON (), Hallidays Hydropower (), Endurance Wind Power ()
18 Financial Times, , 8 July 2015; TheBusinessDesk.com, , 28 July 2015
19 Centrica ()
20 ENGIE Energy-UK Turkey (), Siemens ()
21 Energy UK ()
22 Schroder Investment Management (), Velocita (), North East Chamber of Commerce (), Oil and Gas UK ()
23 2020 Renewables Limited ()
24 Siemens ()
25 WWF UK ()
26 Environment Agency Pension Fund (), Scottish Renewables (), RWE (), Q 149 (Abid Kazim), ABI (), Glenmont Partners (), SSE (), IET (), Association for the Conservation of Energy (), Siemens (), Renewable Energy Association (), NIA (), Scottish Power (), Centrica (), Hallidays Hydropower Ltd (), E.ON (), Energy UK (), Drax (), Vattenfall UK (), EDF (), British Hydropower Association (), Green Highland Renewables Ltd (), ABB (), UKSIF (), CCSA (), Q 117 (Paul Spence), DONG Energy (), Q 75 (Andrew Koss), Durham Energy Institute (), Green Switch Solutions (), IIGCC (), Renewable UK (), UKERC (), Tempus Energy Supply Ltd (), Rathbone Greenbank Investments (), The Investment Association ()
27 Environment Agency Pension Fund ()
28 Environment Agency Pension Fund (), Green Alliance (), RWE (), Velocita (), Glennmont Partners (), Centrica (), SSE (), VPI Immingham (), Energy UK (), Carter Jonas (), Greenpower Developments Ltd (), Durham Energy Institute (), Friends of the Earth (), IREGG (), Q 186 (Andrew Lee)
29 Q 180 (Matthew Knight)
30 Q 26
31 DECC, , 18 November 2015
32 Energy UK ()
33 ENGIE Energy-UK Turkey (), Sustainability First (), E.ON (), RenewableUK (), Siemens (), Energy UK (), UKSIF (), Q 111 (Paul Spence)
34 Siemens ()
35 Vattenfall UK ()
36 DECC, , 18 November 2015
37 Environment Agency Pension Fund (), Scottish Renewables (), RWE (), Q 149 (Abid Kazim), ABI (), Glenmont Partners (), SSE (), IET (), Association for the Conservation of Energy (), Siemens (), Renewable Energy Association (), NIA (), Scottish Power (), Centrica (), Hallidays Hydropower Ltd (), E.ON (), Energy UK (), Drax (), Vattenfall UK (), EDF (), British Hydropower Association (), Green Highland Renewables Ltd (), ABB (), UKSIF (), CCSA (), Q 117 (Paul Spence), DONG Energy (), Q 75 (Andrew Koss), Durham Energy Institute (), Green Switch Solutions (), IIGCC (), Renewable UK (), UKERC (), Tempus Energy Supply Ltd ()
38 ENGIE Energy-UK Turkey (), Alan Neale (ICE 0030), UKSIF (), Scottish Renewables (), ScottishPower (), SSE (), IIGCC (), Siemens (), ABI (), Schroder Investment Management (), EDF (), UKERC (), CCSA (), Green Alliance (), RenewableUK (), Vattenfall UK (), Aldersgate Group (), Energy UK (), Drax ()
39 CCSA (), Environment Agency Pension Fund (), EDF (), Green Alliance (), Q 86 (Paul Spence), RWE (), ScottishPower (), Renewable Energy Association (), Low Carbon Ltd (), Alderney Renewable Energy ()
40 ScottishPower ()
41 RenewableUK ()
42 Department of Energy and Climate Change ()
43 DECC, , 18 November 2015
44 DECC, , 18 November 2015
45 DONG Energy , 3 February 2016
46 Siemens ()
47 Energy UK (), 2020 Renewables Ltd ()
48 Energy UK ()
49 Energy UK ()
50 UKERC ()
51 DONG Energy ()
52 Qq222-224 (Carol Gould)
53 DECC , 18 September 2014
54 National Infrastructure Planning, , accessed 23 February 2016
55 Schroder Investment Management ()
56 Q 196 (Andrew Lee)
57 Statkraft UK (), UKSIF (), Solar Trade Association (), Old Mutual Global Investors (), Vattenfall UK (), Aldersgate Group (), Nextenergy Capital (), Centrica (), ABB (), Q 70 (Andrew Koss), Green Highland Renewables Ltd (), IIGCC (), Environment Agency Pension Fund (), Hallidays Hydropower Ltd (), Octopus Investments (), Orbis (), British Hydropower Association (), The Investment Association ()
58 Statkraft UK Ltd ()
59 Octopus Investment () p 3. The Committee has not verified this methodology and expects that there will be other methodologies also.
60 Q2 (Andrea Leadsom MP)
Prepared 1 March 2016