Written evidence submitted by the Department of Energy and Climate Change (ICE0088)

 

 

 

Executive Summary

 

  1. The United Kingdom is one of the most stable regimes in the world and its transparent regulatory framework, strong financial markets and lowest corporation tax rate in the G20 make it an attractive long-term destination for both domestic and international investors.

 

  1. At the foundation of our successful economy is the energy sector, which offers considerable opportunities for investment. Significant investment is needed over the next decade in our energy sector as a fifth of our existing power stations close by 2020 due to age, inefficiency or pollution. As legacy coal, gas and nuclear plants come offline, they will be increasingly replaced by a range of energy technologies that are cheaper, more efficient and environmentally friendly. At the same time, we want to improve energy efficiency for consumers and businesses and reduce overall energy demand.

 

  1. Our Government has the challenging task of creating policy that attracts investment across a diverse range of technologies that will ensure we have a secure, affordable supply of electricity and meet our decarbonisation targets in the most cost-effective way. It is one of this Government’s key priorities to bring about the transition to low carbon generation as cost effectively and securely as possible. However as DECC does not decide on the exact technology mix, the future of the energy sector will depend on a number of factors, including demand and affordability.

 

 

Introduction

 

  1. Since its formation earlier this year, this Government has had to take some difficult but necessary decisions. With a considerable overspend of the Levy Control Framework (LCF) budget, DECC decided to act swiftly and introduce a package of reforms to get costs under control and tackle the rapid over-deployment of certain technologies.

 

  1. To date, DECC has provided significant financial support to the energy sector, helping new and innovative technologies while increasing the amount of low-carbon electricity that powers homes and businesses across the UK. Our support has had a significant role in driving down generation costs. It is our view that Government support is designed to help technologies ramp up in the early stages of development, not to encourage a permanent reliance on subsidies. As costs continue to fall, it becomes easier for the industry to succeed without subsidies.

 

  1. DECC is committed to keeping energy bills low, encouraging further investment in the energy sector and creating opportunities for industry jobs across the UK. We need to balance this commitment with our responsibility to provide value to the consumer and as part of the EU state aid requirement, review subsidies on a regular basis to ensure that we are not over compensating the sector.
  2. We are currently working to set out the next steps in our long-term plan to move to a low carbon economy, transitioning from demand-led to competition-led schemes. We will be setting out a framework for energy policy shortly, which will provide developers and investors with the clarity and confidence of our long-term ambitions over the next decade.

 

 

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. The transition to a lower carbon energy mix is essential for ensuring a secure, sustainable and affordable energy supply. The UK needs to accommodate new low carbon generation such as renewables, gas and nuclear; ensure energy security and meet its decarbonisation targets. As the UK has a liberalised market model, energy infrastructure in the UK will continue to be delivered through private-sector investment, supported by government policy.

 

  1. As DECC remains focused on maintaining security of supply and affordability in the energy sector, we recognise that securing private financing and ensuring that investors retain confidence in the UK market are crucial components of the Government’s long-term aims for a low-carbon energy market. With respect to further investment, the Government’s objective is to ensure an open market for financing, maximise competition and ultimately drive down the costs of energy projects.

 

  1. Increasingly, international investors will play a significant role as the UK broadens appetite for its energy sector and opens up its funding markets. In 2014, the UK was the top destination for foreign direct investment (FDI) in Europe, having increased by 12% over the previous year, passing the £1 trillion level for the first time.[1] DECC welcomes private sector investment across the energy sector, including areas such as renewables, heat networks and energy efficiency. We have substantial international capital already invested in the UK energy sector. Some notable examples are Chinese and Japanese strategic investments in UK nuclear plants, Canadian pension funds invested in offshore wind farms and Danish infrastructure funds in biomass plants.

 

  1. The types of entities that will play a significant role in financing the energy sector over the next decade can be broadly summarised thus:

 

 

  1. In terms of the type of financing, this varies by individual project structuring. However, DECC expects typical energy infrastructure projects to receive financing primarily from project developers on balance sheet where investment is financed from the companies’ own resources. However in certain areas, such as energy generation where developers may have limited room for investment on balance sheet, project financing remains a better model, and involves long-term financing for both debt and equity, to be repaid from cash flows when a project becomes operational.

 

  1. DECC recognises that financing in the energy sector is in transition from traditional utility-funded infrastructure projects to a wider range of alternative financing structures, driven by a more constrained balance sheet environment. DECC has seen the emergence of structures such as incorporated/ unincorporated joint ventures and combinations of refinancing models for projects which have limited ability to take construction risk, which in turn has helped create a vibrant secondary market.

 

  1. As private sector financing originates from a wide range of entities and sources, it is not appropriate for DECC to comment on the investment styles or strategies that investors use. However, all investors share the common investment criteria of risk appetite and reward, albeit at differing levels. This can vary from pension funds which focus on long-dated liabilities with low risk to private equity funds that have capacity for high risk and high returns.

 

 

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?

 

  1. The UK remains an attractive place to invest, with continued interest from debt and equity markets. It is widely seen to be one of the most stable markets due to its constant risk and return profile, world-class regulation, transparent policy development, strong financial markets and clear property rights for investors.

 

  1. Since 2010, over £42bn has been invested in renewables, nuclear and carbon capture storage in the UK while a record £8bn was invested in renewable energy in 2014 alone. The UK is widely recognised as the leading country globally for offshore wind, attracting £9.5bn of investment between 2010 and 2014. It is ranked as the world’s second most attractive place to invest in marine energy while the solar PV sector attracted £11.4bn of investment between 2010 and 2014. Meanwhile, onshore and offshore GB electricity networks attracted £16bn of investment over the same period.[2] On nuclear, the Government is close to finalising its first new nuclear power station in more than a generation, Hinkley Point C and is working to attract private investment for further new nuclear plants.

 

  1. As announced over the summer, the latest forecasts under the Levy Control Framework show that uptake of Government’s renewable energy schemes is much higher than previously expected, compounded by accelerated developments in technological efficiency. The projected future spend under the LCF is set to be £11.4bn (in nominal prices) or £9.1bn (in 2011/2012 prices) in 2020/21. As the Government has set a limit of £7.6bn in 2020/21, the current forecast is £1.5bn above that limit, a cost that is paid through additions to consumers’ electricity bills. As a result, the Government has decided to act quickly to get its costs under control. DECC intends to provide further clarity on the LCF overspend and details of future CFD auctions shortly.

 

  1. The UK is not the only country to have recently taken difficult decisions and place controlling costs as a priority over spiralling over-deployment. Several European governments have been reducing subsidies for renewable energy over the last few years, in an effort to lower increasing electricity costs that put the competiveness of the European energy industry at risk.[3]

 

  1. Some foreign governments have had to implement retrospective measures related to renewables, particularly solar and wind. These measures have had overwhelmingly negative repercussions on the affected energy industries. Measures included[4]:

 

 

  1. DECC recognises the negative impact any similar measures would have in the UK, both on investor confidence and on actual investment. This is why we have not considered any retrospective changes, despite the pressures of budgetary overspend and technology over-deployment and have taken steps to protect investors as we make any proposed policy changes. To protect investor confidence, DECC has made it clear that no projects already accredited and that have started to receive support under subsidy schemes will be affected. We have provided grace periods and exceptions to the removal of grandfathering to protect those who have already made significant financial commitments or who experience grid delays.

 

  1. The Government is determined to act in a responsible and fiscally responsible way to get costs under control and continue to provide the necessary support for energy investment in the future. We are focused on achieving our long-term energy goals for decades to come and acting in a prudent and responsible way for the consumer.

 

 

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

 

  1. DECC recognises the significant role that the private sector has in funding energy infrastructure. Large-scale investment in gas and low-carbon electricity generation is vital in order to replace ageing energy infrastructure, maintain secure energy supplies and meet legally-binding environmental targets. Approximately £100bn of investment is required in electricity generation and networks by 2020.

 

  1. More widely, the UK has been at the forefront of developing a model of infrastructure investment where responsibility for funding, financing and delivery is split between the public and private sectors. It is forecast that 20.6% (£67.5bn) of the planned investment across the infrastructure pipeline until 2020/21 is entirely public investment; with a further 13.8% (£45bn) representing a mix of public and private sources and 65.6% (£214.4bn) will be purely private investment.[5]

 

  1. DECC has established a dedicated Investor Relations team, within the wider capability of Corporate Finance and Advisory expertise at the department whose mandate is to provide advice on commercial analysis, risk management, due diligence, commercial structuring and financial modelling throughout the policymaking process.

 

  1. The role of the Investor Relations team is to engage constructively with current and potential UK-based and international investors by explaining DECC policies and relevant subsidies, understanding how policy changes impact specific investments and ensuring that policy-making teams and Ministers are sufficiently informed to take appropriate decisions.

 

  1. DECC’s Investor Relations team engages with a wide range of investors on a regular basis, from pension funds, infrastructure funds, insurance firms, asset managers, commercial banks to sovereign wealth funds. In addition, DECC collaborates closely with UK Trade & Investment (UKTI) on international investors who have an interest in investing in UK’s energy sector. DECC helps such investors better understand UK energy policy and the outlook for specific technologies across the energy landscape.

 

  1. In a constantly evolving sector such as energy, DECC needs to demonstrate sufficient flexibility and adaptability by providing subsidies to areas where they are most needed and protecting the financial sustainability of the system, taking some difficult decisions in the process. However, through its engagement with investors, DECC strives to balance the needs of investors with its other priorities.

 

 

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

 

  1. DECC has developed instruments to increase investment and lower policy uncertainty. One such instrument is the Capacity Market which gives investors the certainty needed to put adequate energy supply in place by providing a predictable revenue stream to providers of capacity. Similarly, CFDs in the form of long-term contracts are intended to provide stable and predictable returns for companies to invest in low-carbon generation. Both these instruments have had a significant role in increasing investor confidence and furthering investment opportunities.

 

  1. The purpose of the Capacity Market is to ensure sufficient investment in the overall capacity to provide secure electricity supply. The first auction in December 2014 contracted 49.3GW of capacity. The second auction will take place in December 2015 and demonstrates our long-term commitment to ensure existing capacity will remain open at the end of the decade and unlock new investment.

 

  1. The first competitive CFD auction for renewables support completed earlier this year. 25 contracts were signed, worth over £300m per year by a range of developers, including independent and small-scale companies across the UK. This has the potential to deliver over 2GW of new renewable energy capacity, enough to power 1.4m homes. As we move from demand-led to competition-led allocation of support, DECC expects to see cost savings as we support renewable deployment in a competitive way.

 

  1. This Government is continuing to promote investor confidence across a range of technologies:

 

 

  1. The Government recognises the success story of the UK renewables industry, which has exceeded all expectations and created substantial investment opportunities. An average of £7bn has been invested each year in UK-based renewable energy since 2010. Due in large part to this investment, we are on track to reach our renewable energy capacity target of 30% by 2020 and meet or exceed the EMR Delivery Plan 2020 deployment ranges for onshore wind, offshore wind, solar and biomass.

 

  1. Government support has driven down the cost of renewable energy significantly and helped deployment increase rapidly. Our analysis shows that in Q2 2015, renewables’ share of electricity generation was a record 25.3%, up from 16.7% in Q2 2014 and up from 22.6% in Q1 2015. The support schemes that the Government has put in place have helped to attract approximately £39.6bn of investment in renewable electricity generation capacity between 2010 and 2014.[6]

 

  1. As costs continue to fall, it becomes easier for parts of the renewables industry, such as onshore wind and solar to survive without subsidy support. As costs fall, Government has taken steps to scale back support on these technologies and allocate the limited amount of money to where it is most needed. Despite this, DECC still provides a generous amount of support to the renewables industry with £5.1bn allocated in 2015/16.

 

  1. DECC does recognise that there is a need for further clarity on details of the next CFD auction and the long-term strategy beyond the next 5 years. We recognise the challenges this poses for developers and investors, and understand the urgency to provide further details.

 

  1. We will set out plans for the next CFD allocation round this autumn and we are working to set out more detail on the post-2020 LCF budget shortly to give investors certainty for the long-term and provide support for investment into the next decade. Our key priorities are to provide transparency and certainty.

 

 

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

 

  1. Evidence-based research is at the foundation of DECC’s policy making process. Research, evidence and analysis are produced by analysts across disciplines, including Commercial, Customer Insight, Engineering, Science, Operational Research, Economics, Statistics and Social Research.

 

  1. DECC collects, creates and applies a wide range of evidence and data across its energy and climate change portfolio from a wide range of sources. We are keen to share our research and data, and recognise that its wider use by analysts, economists, investors and researchers has an important role in helping us work better and reach our goals. Currently there are 60 of the Department’s key data publications available online.[7] Additionally, much of the Department’s analysis and commissioned research is and will continue to be published on the DECC section of the gov.uk website.

 

  1. DECC remains committed to ensuring that rigorous economic analysis, robust statistical and social research evidence underpin DECC strategy and policies. In addition to quantitative analysis, DECC also makes use of qualitative evidence to develop or amend existing policies in its recognition of affected developers and investors.

 

  1. Following the Secretary of State’s announcement to Parliament on 18 June, confirming the Government’s intention to close the RO early to new onshore wind, DECC outlined proposals for a grace period for affected projects that meet the relevant criteria in order to protect investor confidence. Over the summer, DECC conducted an engagement exercise through numerous roundtables and select events to better understand the views of industry, developers and investors and hear individual concerns.

 

  1. DECC met with hundreds of stakeholders at events held in Scotland, England and Wales and carefully reviewed the feedback and evidence provided to ensure that any policy decisions strike the right balance between the public interest of protecting consumer bills and the interests of onshore wind developers and investors.

 

  1. DECC listened, gathered evidence from the industry and decided to take an extra step to protect the interests of affected developers and investors. DECC has decided to extend the grace period to projects which were granted consent at appeal, after having their planning permission refused on or before 18 June or where the planning authority failed to determine a planning application where a decision was due by 18 June. DECC has also introduced an “investment freeze condition” allowing certain projects that qualify for the grace period an additional nine months in which to accredit under the RO.

 

 

 

October 2015

 

 

 

 

[1] https://www.gov.uk/government/publications/ukti-inward-investment-report-2014-to-2015/ukti-inward-investment-report-2014-to-2015-online-viewing

 

[2] Delivering UK Energy Investment Networks (DECC, January 2015)

[3] https://www.bnef.com/Insight/10640

[4] http://www.windaction.org/posts/40104-governments-rip-up-renewable-contracts

 

[5] HM Treasury Estimates. National Infrastructure Plan 2014

[6] 2012 prices

[7] https://data.gov.uk