BMI View: A Conservative victory in the UK general election removes one element of political uncertainty that has stalled investment in the domestic power sector. However, investment will continue to undershoot its potential, as other significant risks remain. A perceived lighter-touch, market-based approach to the power sector and the Conservative's focus on energy security will be offset by risks such as an EU referendum and the outcome of a competition investigation into the 'Big Six' utilities.
The emergence of a clear Conservative majority following the UK general election will at least give domestic utilities some clarity over future energy policy. The Conservative Party unexpectedly won a majority of 331 seats at the election on May 7, removing the prospect of protracted uncertainty for investors during a period of coalition-building, and concerns that an opposition Labour Party victory would lead to a freeze in investment as it sought tighter regulation of the industry.
We now expect the Conservatives to follow through with reforms that were introduced in the previous parliament - under the UK Energy Bill - to bolster energy security. Although we maintain that the bill targets too many different electricity supply options, we do not anticipate any roll back on key policy tools that were introduced in the last parliament - including contracts for difference (CfDs) and a capacity mechanism. Such tools will be needed to encourage investment in the UK power sector in order to allay concerns about narrowing capacity margins. The falling capacity margin is a consequence of outages at existing power plants as well as a bigger problem in the UK power sector; a historical failure to mobilise the investment needed to replace aging coal-fired facilities.
Other areas of energy policy, however, remain more difficult to decipher. One of the biggest risks remains an ongoing Competition and Markets Authority (CMA) investigation into the UK's 'Big Six' energy companies - based on public concerns about the affordability of energy bills. Another major risk under a Conservative government is the possibility of a referendum on membership of the EU. This would be hugely damaging for the power sector, with the threat of a 'Brexit' throwing into question EU-mandated emissions and renewables targets - creating more uncertainty for utilities and crimping investment.
With regards to renewables, we believe there is a risk that the Conservative Party will be less supportive of renewable energy without the influence of their former coalition partners the Liberal Democrats, who were firmly in favour of more stringent green energy and emissions targets. Newly appointed Conservative Energy Secretary Amber Rudd appears to be a firm believer in climate change and a strong proponent of renewable energy, but much will depend on whether green energy policies are decided in the Treasury or by her Department of Energy And Climate Change (DECC).
Key Trends And Developments
The provisional results of the UK's first power capacity auction in December 2014 support our forecasts for gas-fired power generation to claim a greater share of the domestic power mix and indicate that the EMR package is finally registering some success. The three-day reverse auction closed on December 19 and secured the 49.26GW of new and existing capacity for delivery in 2018-2019 - in line with government targets. The auction was highly competitive and as a result the clearing price was lower than expected - at GBP19.4 per kilowatt. At the least, the auction will create added momentum behind government efforts to avoid a capacity deficit.
In spite of the uncertainty that stems from coal-gas pricing dynamics, we have long maintained that gas will ultimately replace coal as the biggest component of the UK's electricity generation mix. This view is supported by the results of the aforementioned December 2014 capacity auction and the closure of coal capacity to comply with EU directives, as well as the implementation of the UK's carbon price floor. Low European gas prices are also boosting the share of gas-fired generation in the UK electricity generation mix.
In the nuclear segment, we believe a Conservative victory will ensure that there is political support for the UK's flagship Hinkley Point C nuclear power plant, but we question whether the project can be delivered, as investors remain reluctant to commit and EDF is yet to make a final investment decision. Negotiations are still ongoing between the UK government and reports emerged in February 2015 suggesting that EDF had delayed a final investment decision until autumn 2015 (the original deadline was March 2015) - after Chinese backers demanded that the French government (the majority-owner of EDF) offer them financial protection if there are delays to the project due to the European Pressurised water Reactor (EPR) design. Legal action in the EU courts on the part of Austria - which is against the proposed subsidies that will be paid to incentivise construction of the plant on the basis they are anticompetitive - is also a threat.
In March 2015, Norway-based Statnett and National Grid signed an agreement to build the 1.4GW North Sea Network (NSN) subsea electricity transmission cable, connecting Blyth in the UK and Kvilldal in Norway. The 730km NSN interconnection will enable the UK to use Norway's hydropower capacity during high demand and sell wind power to Norway during local surplus. The project is scheduled to be completed by 2021.