[PPT] - Energy efficiency and the power sector: USA perspectives on PowerPoint Presentation

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Energy efficiency and the power sector: USA perspectives

n regulation and carbon pricing

Thursday 19th March

The UK investor perspective

John Hargreaves – Indepen Consulting

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AGENDA

1 UK context 2 Security of supply 3 Investor perspective 4 Investment in energy efficiency 5 Points for discussion

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1 UK CONTEXT

Challenging times What energy efficiency can do to help

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Challenging times

The UK economy, along with most others is severely challenged in a number of dimensions Those that are relevant to this talk are

The poor state of the economy and its prospects

– associated with instability in the capital markets

Increasing concerns about the security of energy supply

– particular focus on power and gas

Slow progress in meeting emissions targets

– falling behind the previous set not to mention the new ones

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What energy efficiency can do to help

Challenge Potential contribution of energy efficiency

Economy

Contribution

Productivity is good for the economy Many efficiency initiatives have a positive NPV Green recovery?

Supply security

Major contribution

Emissions

●● Major contribution

Among the most cost effective

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2 SECURITY OF SUPPLY

Security is a problem in the UK It is getting worse There are plenty of options The investment required is big

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Security is a problem in the UK

In a paper, dated November 2008*, we concluded that

“A generation gap in the UK is likely on unchanged policies. The analysis indicates that with unchanged policies there is likely to be a capacity shortfall in the second half of the next decade and this is so on a range of assumptions

The cases we looked at would entail capacity margin lows in the period up to 2020 ranging from +14% to -1% compared with a range from +18% to +26% in the period from 2003 to 2008 and a target planning margin of +20% Since then

some developments have made the security of supply picture, on the

whole, less rosy

the investment climate has deteriorated

* Energy and climate security - coal and the alternatives to coal in the transition to a low carbon economy by 2020. Paper by Indepen, sponsored by the Ecofin Research Foundation, Nov 2008

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It is getting worse

Adverse - fossil fuel capacity

some LCPD opted out plants will close sooner due to shift to coal as base

load and little prospect of life extension of these old plants even with derogations

some opted in plants may close before 2020, timing of new may slip

Adverse – renewables

lower carbon and fossil fuel prices are bad for renewable investment
recent evidence that previous assumption on capacity factor was generous

Adverse – capital markets Helpful – demand for power

high prices and recession - demand down by between 5 and 10% cf last year

No change/adverse – nuclear and CCS

carbon price and fossil fuel prices lower
no change in schedule for old nuclear, new not available in medium term
slower progress on CCS

Mixed – policy

helpful - heat and energy efficiency but effects and timing uncertain

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There are plenty of options

Supply side policies to reduce the planning margin by encouraging

a net increase in large scale, central generation capacity
building or retention of capacity that is more flexible and better able

to match the profile of demand – oil and gas fired capacity

non-generation supply side options - interconnection, grid

intelligence, storage

Demand side policies reduce the planning margin by encouraging

net reduction in demand – energy efficiency measures e.g. insulation
changing the pattern of’ demand using demand side response

measures, e.g. smart metering

– information and control systems – time of day and location tariffs – interruptible contracts – direct load control

micro/local generation including waste heat (equivalent to negative

demand) and distributed storage (e.g. electric vehicles)

All of these require substantial investment although in some cases the investment will pay back via lower energy bills

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The investment required is big

Since last year

central estimates of the likely generation capacity shortfall are now

towards the upper end of the range we found

uncertainty about the capacity margin has not diminished

In addition to generation, there will have to be substantial capex in transmission, distribution and supply to provide for

infrastructure renewal
network enhancement and connections for distributed generation
gas storage
smart meters and associated systems
energy efficiency and micro-generation

Ernst & Young report for Centrica, February 2009

“UK energy industry will need to invest over £225 billion by 2025 to

meet security and carbon targets”

£15bn a year, cf approx £6bn a year (National Accounts Blue Book

sector tables) invested by the utility sector*since 2000

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* This includes water at approx £3bn pa

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3 INVESTOR PERSPECTIVE

Financial market conditions – cost and availability of capital

Equity
Debt
Bank loans

Other investor considerations – attractiveness and risks of the investment Consequences of market conditions Other investment considerations

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Financial market conditions

We interviewed infrastructure investors in mid January to mid February this year and last and held interview with several energy corporates Since 2008, capital market conditions have deteriorated and by more than investors expected

key indicators of credit availability and default rates worse than

expected

ptimism about a quick end to the credit crisis has evaporated
continuing uncertainty about the depth and duration of recession
continuing sensitivity to bad news

Consider briefly the position in terms of the availability of finance and its cost with respect to

equity
debt
bank loans

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Equity finance

Investors are expecting – cost shocks from refinancing, dividend cuts, rights issues, ownership changes Some are overweight in infrastructure because values have held up Acquisition finance, infrastructure funds and private equity dried up Traditional funding available but cost (driven by the equity risk premium – see chart) higher due to market volatility but the non-availability of debt makes high returns unlikely

10 20 30 40 50 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 0% 2% 4% 6% 8% 10% FTSE 100 Implied Volatility (LHS) ERP (UBS Estimate) (RHS) 12

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Corporate bonds

Corporate bond market has re-opened, after closing Autumn 2008, but only for high quality names More fickle market – “early part of year may have been a mini rally” Wider spreads (up to 5 times recent levels) and shorter terms, index linked market closed The chart illustrates the cost of debt in terms of yields on UK utility bonds issued before 2003

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0.0 1.0 2.0 3.0 4.0 5.0

Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Real Yield to Maturity (%) NATIONAL GRID ELECTRIC UNITED UTILITIES WATER YORKSHIRE WATER THAMES WATER BBB+ NATIONAL GRID

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Bank loans

Many foreign banks have left the market - impact of weak sterling Remaining banks lack of enthusiasm for lending has led to them requiring

Higher pricing, Libor plus 200bp-400bp depending on rating and term

compared with less than 100bp before

Higher arrangement fees c100bp vs 25bp 18 months ago and other

fees, e.g. on un-drawn facilities

Shorter terms – typically 3 year with steps up to 5 years

Bank lending can be efficient finance but the “cost of carry” is now substantially higher

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Other investment considerations

As well as the usual technical, construction and commercial risks, investors perceive a high level of political and regulatory risk

EU political commitment looks weaker in poor economic conditions
risk of stranding –when a new UK administration arrives
lack of clarity and realism about UK emissions targets in transport and

heat may have consequences for power sector

partition of market to favour renewables increases risk of

underinvestment elsewhere

failure of policy makers to focus on lowest cost solutions will result in

loss of legitimacy

Recent rends in the economy and prices have been bad for energy efficiency in the short term

global slowdown is depressing fossil fuel prices - clean projects look relatively

less attractive as fuel savings are less valuable –may be short term

carbon price – EU ETS targets quantity of carbon, and so its price is uncertain –

lack of credible carbon price is bad for low carbon investments

The negative factors may be offset to some degree by diminished supply chain and scarce skills constraints

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Consequences of market conditions (1)

Conditions in the capital markets have affected the availability and cost of equity and debt finance

some will find it hard to get external finance
some debt markets not open, access limited to A+ ratings
cost of finance significantly higher

These consequences could be prolonged – may reflect a fundamental shift rather than a temporary set back Such changes have a big impact on capital intensive sectors with big capital programmes, including energy

increased returns needed on projects
amount of debt that can be secured will be lower and so more equity

will be needed

this puts up the WACC and projects that had marginal returns will not

be viable – deferred or cancelled

particularly problematic for long pay back projects as many in energy

If power prices and valuations collapse - risk that regulation and rating agencies will not be well orientated to deal with the consequences fo capital market instability

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Consequences of market conditions (2)

Losers and winners

Experience suggests that the impact may be particularly significant

n
highly geared companies – more so in combination with any of the

following

un-hedged generators
new entrants into the energy market
small businesses
businesses with overseas parents
businesses targeting emerging markets

Well placed will be those with the capital and management resources to take part in work outs

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INVESTMENT IN ENERGY EFFICIENCY

A seemingly intractable problem, so far The reasons for it being intractable are all tractable

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A seemingly intractable problem, so far

A string of EU actions over the years has demonstrated that the political determination to act has gone beyond mere rhetoric in after-dinner speeches. These include the SAVE programme, the Intelligent Energy Europe programme, the fuel-efficiency agreement with car manufacturers and importers, energy efficiency labelling requirements, directives

n energy services and on energy efficiency in buildings and,

during this Commission, an energy efficiency action plan. However, regrettably little has actually been achieved. EU energy and climate policy – two years on EPC Issue Paper No.55 September 2008 By Jørgen Henningsen)

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The reasons for it being intractable are all tractable

Ignorance among many of those who must act

Too much policy not enough communication
Example – many CEOs are unaware of the Carbon Reduction

Commitment (cap and trade arrangements for large organisations classed as non-energy intensive) and its implications for their businesses

Example – lack of trust among those who must invest, incl householders

Institutional and policy confusion – not joined up

Central government – DECC, Defra, BERR, CLG
Ofgem and other regulators (e.g. the EA and its effect on the carbon

footprint of water companies)

EU level involvement
Policy confusion and risk – see page 15, example smart meters

Regulatory barriers

Old fashioned regulation
Industry structure
Sector business models and transparency
CERT may be OK, but …

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4 POINTS FOR DISCUSSION

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Points for discussion

Given credit crunch and recession, decide

what a low carbon recovery should mean
how to respond to the set back to private investment
how to use whatever stimuli to promote sustainable growth
focus on

– NPV +ve productivity enhancing initiatives some of which will be LC – lowest cost carbon solutions, including DSM – level policy treatment of all low carbon and all security enhancing solutions

whether, and if so how, to use the newly nationalised banks

In any event

change regulation to incentivise necessary grid investments
changes to planning regime – not just major strategic projects
policy to

– resolve carbon price/tax – tackle market failures for NPV positive investments that reduce emissions – including but not limited to energy efficiency and DSM – sort out targets for transport and heat (latter possibly via distributed generation)