BMI View: Our view that the UK's Conservative government will focus on energy security and affordability at the expense of renewable energy policies is firmly in play. Energy security and the construction of new gas power plants could be boosted by the implementation of a capacity mechanism and falling gas prices, while efforts to improve transparency in the utilities sector could create greater competition and a better deal for consumers.
Many of the views we outlined ahead of the UK's May 2015 general election are firmly in play - with a clear Conservative majority at least giving investors and utilities some clarity over future energy policy. With regards to our key views, we maintain that Prime Minister David Cameron and his Conservative government will struggle to balance concerns about energy security, affordability and green energy policies - the so-called 'energy trilemma'. We maintain that the government will focus on the first two areas at the expense of policies associated with renewables and sustainability. A series of cuts to onshore wind and solar subsidies, as well as roll back on a number of energy efficiency measures and the sale of the Green Investment Bank, support this view.
In the traditional power segment, we maintain that the biggest challenges facing the government relate to energy security. National Grid, which operates the majority of the UK's grid network, stated in July 2015 that UK power capacity margins will fall to their lowest level in a decade over winter 2015/2016 due to an absence of investment in new power plant capacity. The closure of coal plants to comply with tightening EU emission regulations and weak margins on gas-fired power plants due to low wholesale electricity prices will mean that capacity margins remain tight over the next few years. This will continue until market dynamics - or government incentives - lead to the construction of new gas or nuclear capacity.
Key Trends And Developments
Questions remain over whether or not the introduction of a capacity mechanism will be sufficient to spur investment in new gas-fired power capacity, but we do believe the mechanism will at least support some stranded capacity - and lead to the construction of a relatively small amount of new-build gas capacity. To this end, Chinese-controlled Watt Power announced in July that two of its subsidiaries had been granted planning permission for two open-cycle gas peaking power plants. The plants, which will have a capacities of 299MW will be located in Suffolk and South Wales respectively, but will be contingent on success in the December 2015 capacity auction and will not be completed until 2019.
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. The clean spark spread (the notional profitability of a gas-fired power plant) has improved over July and August 2015 due to lower National Balancing Point (NBP) gas prices, which are oil-linked. We forecast that NBP prices will remain relatively low over 2015 and 2016 and this will drive switching from coal to gas in the UK electricity mix - as will the rise in the UK carbon price floor to GBP18/tonne of CO2.
UK-based energy group SSE will close its coal-fired Ferrybridge Power Station on the West and North Yorkshire border in the UK, by March 2016. The power station has been running since 48 years and costing the group millions due to environmental compliance and aging infrastructure. SSE will shift staff from the facility to other facilities, which include the Keadby gas-fired power station near Scunthorpe, which the group aims to reopen by end-October 2015.
Our view on the UK regulatory environment - that the Conservatives would not be as aggressive in regulating the energy markets as the opposition Labour Party - is also in play. The launch of a Competitions and Markets Authority (CMA) investigation into the dominance of the UK's 'Big Six' energy companies is ongoing, but initial findings indicate that the worst-case scenario for utilities - that vertically integrated utilities would have to separate their generation and retail businesses - is highly unlikely. Instead, we expect the government to place a greater emphasis on ensuring utilities give customers more information and make it easier for them to switch to cheaper suppliers - something that still creates a risk to energy company margins.
We are increasingly bearish in our view on the UK's flagship Hinkley Point C nuclear new-build. The project is not due to come online until 2023 at the earliest, and we believe there is the risk of delays based on concerns about the very high strike, the reactor design and a legal challenge in the European courts over government state-aid for the project.