Written evidence submitted by E.ON (ICE0036)

Summary of key points

• Of all the countries where E.ON has a presence the UK energy market has, in general, been perceived as one with relatively low political risk. Whilst some limited political intervention is inevitable, successive governments have recognised in the past that having a stable framework to operate in is something that investors look favourably upon when considering where to invest scarce capital. A good example of this has been the use of grandfathering protection for renewable investments that insulates investors from the risk of any future changes.
• In the run up to the 2015 General Election, political risk within the UK market had started to increase as politicians from all sides sought to address concerns around the affordability of energy bills, including a desire to intervene in retail markets via a potential price cap as proposed by the Labour opposition at the time. We agreed with the Government’s decision at this time to launch a competition investigation, something we had long called for as a means to have an open and honest debate and draw a line from which to rebuild trust and confidence in the energy market.
• Following the election of a new Conservative government in May, political risk has continued to increase. This has been recognised internationally as the UK continues to drop down the Ernst and Young Renewable Energy Country Attractiveness Index (RECAI)[1], falling out of the top 10 for the first time.
• We recognise that the new Government has taken action early in this Parliament to get more control over policy costs. However, it is far from clear that the alternative options will deliver a lower cost energy system for customers. Furthermore, the evidence around cost overruns of the Levy Control Framework (LCF) is questionable and not transparent; publication of detailed analysis of the status of the LCF should be a priority.
• The implementation of cuts to financial incentives this summer has shocked investors. This has been illustrated by the announcement by the Chancellor in the summer budget to remove the Climate Change Levy exemption for renewable generators almost immediately, and the subsequent impact on share prices for a number of investors in renewables.
• There is growing evidence of an investment hiatus around delivery of energy efficiency measures under the Energy Company Obligation (ECO) as suppliers get closer to meeting their March 2017 targets, with no clarity on the scheme that will be in place beyond then. This, and other policy decisions taken, has had a knock on impact on the supply chain, with a number of notable failures, especially as a market for energy efficiency has yet to materialise, illustrated by the withdrawal of future funding from the Green Deal Finance Company to support retrofit measures in homes.
• Investors need a vision of what the new Government wants to achieve and a clear direction. This must be backed up by a coherent, stable framework that investors can rely on. It is important that all government departments work towards consistent and clear energy goals, driven by achieving long term decarbonisation targets in the most affordable way whilst ensuring security of supply.

Q1. Where is future investment in the energy sector going to come from? Which types of entities/organisations will invest? What are their criteria for investment decisions? 

1. As the Committee highlights, it is estimated that £110 billion of investment is required in the energy sector over the next decade. Different sources of investment will be needed to meet this requirement and a large percentage is likely to be funded by equity and debt finance. We have already observed this trend in the first Capacity Market auction in 2014. This contrasts with recent history, where the majority of investment came from the balance sheets of large organisations. A stable investment environment is crucial to attract these new sources of capital necessary to meet the UK’s longer term goals.
2. In order to meet its long term decarbonisation objectives, the UK will need to see major investment in large scale projects such as wind (both onshore and offshore), nuclear and carbon capture and storage. Such projects generally involve high upfront investment, have long lead times and therefore require long term visibility of the policy framework.             
3. Energy investors seek a stable market with clear forward price signals and, most importantly, a clear policy direction that is consistent with the country’s overall energy objectives. Investors generally accept the need for limited intervention in energy markets to correct for market failures and achieve longer term goals, and accept that policies do need to change from time to time, but the overall direction needs to be consistent and supported by all parties. On the face of it, the UK has long term goals which all parties support, such as the UK’s 2050 greenhouse gas reduction target, set out in the Climate Change Act. However, recent policy changes appear to contradict these longer term targets. 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.
4. Today’s investors have a choice about where to invest, with political risk playing an important role in determining where scarce capital is allocated. It is no coincidence that most new build power generation in the UK is now backed by long term contracts from the Government (either 15 year contracts for difference or 15 year capacity agreements).

Q2. How does the UK compare with other countries in terms of policy risk? Are there examples of best practice that the UK could learn from? 

5. In general, across all sectors of the economy, the UK has been rising steadily as an attractive location for Foreign Direct Investment (FDI) for many years. Between 2012 and 2014, the UK improved its place in the A.T. Kearney FDI confidence index[2] from 8th to 3rd, which is its highest position since 2002.
6. However, we see the opposite picture if we isolate the renewable energy market. The UK has lost its top ten position in the Ernst and Young Renewable Energy Country Attractiveness Index attractiveness index (RECAI) for the first time since the index’s inception. As outlined above, since the General Election a number of policy changes[3] have been perceived by investors as highly inconsistent with the objectives of the UK Government, most notably, to achieve the greenhouse gas reduction targets set out in the Climate Change Act at lowest cost to customers. As a result, investor confidence is declining, with onshore wind, solar PV, biomass and marine investments deteriorating the fastest.  The table below illustrates the UK’s steady drop down the rankings in all but two renewable technologies:

[4]

7. As a global investor in energy, E.ON has experience in unstable political environments. The UK market has been generally regarded as having relatively low political risk compared with other countries that E.ON is active in. In particular, as an investor we have been satisfied that UK policy decisions have generally been based on the principle of making only forward looking changes, underpinned in some sectors via the provision of grandfathering protection. However, the raft of policy announcements since the General Election is changing this view. The UK is now increasingly viewed alongside a number of other European energy markets where political risk is increasing:

• In autumn 2010, the German Federal Government extended the operating lives of all of the country's nuclear power plants. However, the accident at the Fukushima Daiichi nuclear plant in Japan in March 2011 led Germany to reverse its decision. Germany's amended Nuclear Energy Act, which took effect in July 2011, mandated the immediate shutdown of eight nuclear plants, and significantly curtailed the operating lives of the remaining nine. This change in policy direction significantly affected investor confidence in the German market.
• Controversial and retrospective policy changes in Spain following the financial crisis towards the end of the last decade created an unstable renewable energy sector in that country. The effect of retrospective tariff changes undermined investment decisions in operational assets and led to a step change in our perceptions of the market, including a dramatic scaling back in the development of projects.

8. At the other end of the spectrum, the USA currently leads the RECAI ranking by being able to provide investors with clear signals for the medium and long term direction of energy policy. The “All-of-the-Above” strategy[5], establishes clear goals, supported by a series of defined policy actions. In addition, the federal government is making efforts to promote investment in renewable energy by providing information to prospective investors daunted by an unfamiliar clean-energy landscape.

Q3. How well does DECC consider the needs of investors in its policy making process?

9. There are examples where DECC has made considerable effort to take account of the views of investors in designing future policy. The Electricity Market Reform (EMR) process is an example where DECC made considerable effort to explore different policy options and included stakeholder groups in the planning process. Prior to making its final decisions, DECC conducted extensive consultation with investors and a number of working and expert groups. Its conclusions were also reviewed by a series of independent experts through the EMR Panel of Technical Experts. We believe that this is the appropriate approach to implementing major policy interventions.
10. However, this approach is not always followed, as recent policy changes have demonstrated. Some of these have appeared unplanned and reactive in nature and therefore reduce confidence of all investors in energy, even if they are not directly affected. Once precedent is set, investors become concerned that negative interventions will eventually hit their area of investment as well.
11. DECC increasingly appears to set policy and consult without being truly open to feedback. The recent consultation on changes to Feed-in Tariff pre-accreditation[6] is an example of a major policy change with a very short consultation period (4 weeks). Such practice limits stakeholders’ ability to engage constructively and, in fact, DECC has recently been notified of legal action[7] against it over the FiT pre-accreditation changes. Consultation timescales need to be long enough to encourage robust, evidence-based feedback which Government should consider when making decisions. The Government Code of Practice on Consultation[8] states that consultations should last for at least 12 weeks with only very limited exceptions for shorter consultation periods which must have a clear justification. We believe that this is a reasonable approach which should be followed.
12. There are a number of examples where decisions by departments other than DECC have also had a retrospective impact on existing investment. These have a particularly damaging effect on investor confidence.
13. HM Treasury (HMT)’s removal the Climate Change Levy exemption for renewables meant going back on clear signals to the market from DECC. In 2012, in its analysis supporting changes to the Renewables Obligation, DECC assumed that the value of the CCL exemption for renewable source electricity would remain constant in real terms[9]. We accept that policies such as this may need to change over time, but changes need to be made in a predictable manner and without undermining investment made on the basis of earlier signals from Government.
14. DEFRA’s weakening of the UK’s implementation of the EU’s Industrial Emissions Directive (IED) since the late 2000s has had an impact on our investment in environmental upgrades at our Ratcliffe-on-Soar coal-fired power station, the decision to do which had been based on expectations around how IED would be implemented. In contrast to the intent of this legislation, the UK’s weakening is likely to result in existing UK coal power stations operating without meaningful emissions restrictions this decade.
15. With increasing uncertainty over the future role of coal-fired power generation in the UK, Government now has an opportunity to clarify that the transition from coal will be driven by robust implementation of exiting environmental regulations. The use of existing frameworks allows Government to achieve its objectives without undermining further confidence in the regulatory environment.

Q4. What steps could DECC take to reduce policy uncertainty and increase investor confidence?  

16. We accept that certain policy interventions in energy are sometimes necessary and existing policies are occasionally going to change, it would be unrealistic to expect otherwise. However, we believe that investors need to see a consistent policy framework, which is driven by simple, stable and clear long term objectives.
17. Furthermore, this framework needs to be backed by cross party support. We strongly believe that sudden changes in policy, particularly those where clear investment signals to the markets are subsequently reversed, such as the unexpected removal of the Climate Change Levy exemption for renewable electricity, must be avoided. Ensuring that investors trust the Government to keep its previous commitments and not make retrospective changes is critical for restoring confidence in the sector.
18. Government needs to consider the wider messages its policy changes give to investors. Whether intended or not, recent policy changes have been sending signals to energy investors that the current investment environment is very unstable.
19. We are seeing increasing involvement from other Government departments in energy policy, in particular HMT, BIS and DEFRA. It is not always clear that these departments have a consistent approach to energy policy or the energy sector. Wider coordination and consistency of messages across Government would be helpful.
20. We understand that subsidies for low carbon energy cannot continue forever. However, we urge DECC to implement a long term framework where subsidies are withdrawn gradually, based on robust evidence of cost reductions, with timelines that are communicated well in advance. This will reduce uncertainty in the market and allow investors to plan projects with long lead times and high capital costs using real policy signals. It will also facilitate investment in innovation by the supply chain to proactively respond to these long term signals.
21. There is an opportunity to improve the communication of the messages in DECC’s impact assessments. For example, it would be helpful to provide in policy decision documents an executive summary of the impact assessment, which can then provide prompts to stakeholders on where to access the main report.
22. Furthermore, clearer referencing of the cost and benefits of policy options should be better reflected in decision documents, thereby helping to justify why a particular choice has been made. There may be a case to introduce an independent body or panel of experts to review and challenge impact assessments before they are used to set or justify policy.
23. We would also suggest that impact assessments are not accessible to most consumers, and messages from Government can often create confusion. For example, the suggestion that bills will be lower in the future thanks to particular policies indicates to the average reader that bills will go down. The reality is often somewhat different, with bills still going up, but at a rate or to a level, which is lower than what they would have reached otherwise, if those policies did not exist. In other words statements like this are often based on a particular counterfactual which is unlikely to be clear to many consumers.

Q5. How does DECC’s use of evidence affect investor confidence? Can you provide any specific examples where evidence has been used well or poorly?

24. DECC’s use of evidence is best analysed in the impact assessments that it routinely carries out to justify a particular policy decision. This analysis is not always as robust as it could be and is often difficult to digest. It is important that stakeholders have confidence in the way that policy decisions are made and robust impact assessments are an essential tool to help make this happen.
25. Our view is that DECC’s assessments typically pick up the direct impacts, normally costs of policy options, but too often fail to take account of the indirect impacts, often benefits, in a sufficient way. Impact assessments also rely heavily on long term assumptions around counterfactuals that are inherently difficult to predict (for example, movement in gas prices). Recognition that these are often difficult predictions to make and therefore a greater focus on policy impacts in different scenarios would be welcome.
26. When considering impact assessments, investors expect to find clear analysis that justifies policy decisions. When evidence is not robust, investors may question whether the policies in question will be sustainable when they come into effect. This adds additional risk to investors that policies may be ineffective and therefore, changed in the future. This additional risk will inevitably increase the cost of investment which is paid for ultimately by customers.

October 2015