I recently wrote about the challenge faced by Labour in delivering their “People’s Power Plan” in terms of its scale and reach. One of the other interesting aspects is the new ownership model. Here are some thoughts.
If Labour intends to buy into existing development projects, what is the basis on which they will do that? Would they compel existing project owners to offer up 51% for sale? If so for what price, when and on what terms? The least disruptive model for this would be for these transactions to be for full market price – but with early stage development projects this will be hard to establish without earn outs. A worrying clue is in the more detailed policy on energy networks where it’s clear Labour expect the price to be set by Government, with a hefty list of deductions from a starting point of book value. If you think this suggests expropriation you’d be right – and unless more reassuring noises are made expect investment in development projects in UK waters to be more cautious as a Labour majority government becomes more likely.
A stake of 51% gives the Government control, so what do they want to use this control for? This will be a key question for any incoming minority investor. If Labour wants to direct decisions about placing work for construction or O&M, perhaps with an industrial policy in mind, then this presents additional risk. Would they also want to place restrictions around how funding was made into the project, or the tax structure or choice of main contractor? Neither Labour nor the Government have any direct experience of building and operating offshore wind farms so the balance of control will be key for large developers interested in participating. It’s easy to see a large number of reserved matters being demanded in Shareholder Agreements to protect their interests.
As well as needing to account for minority shareholder rights, being the major shareholder also means finding the majority of the money – and offshore wind is expensive, especially as sites move into deeper waters. 35GW worth of offshore is a major economic commitment from a Labour Party already committed to spending an estimated £196bn on nationalisation as well as large sums on social investment. At current construction costs of £2.5m/MW the total cost of an additional 35GW of wind would be in the order of £87bn with the public sector needing £45bn in capital investment (there will be reductions as technology advances but this will, to an extent, be offset by more challenging sites). Where is this investment going to come from?
In practice, funding investment from general taxation or Government borrowing runs up against natural limits (where markets begin to demand higher returns on Gilts as borrowing increases above a level markets are comfortable with). This means that some capital rationing is needed – and energy will be hard to prioritise over health, education and so on. This was one of the issues with British Rail – it wasn’t badly run but starved of adequate investment by successive governments who had borrowing limits and other priorities
Also relevant is how the minority partner finances their share – traditional leveraging models can’t be used as the Government will not want to use commercial debt (as it will be able to raise funds more cheaply via the Treasury) and won’t want any leverage from their partner to find their way onto the Government’s books. This means that more novel financing solutions will need to be found by investors who do not want to take full equity exposure (for example, to introduce leverage at a Holdco level). Whilst not an insurmountable problem this will take time to develop as a standard and will introduce complexity and cost.
The last point to make on the ownership model is to ask why Labour feels it would be appropriate to invest public money and take development, construction and operational risk. These are the very risks that the current CFD model insulates taxpayers from and it continues to be the case that Government doesn’t have the skills to manage such risks.
Which leads us to the next issue – for Part 3 – of what the revenue model will be for these new assets, and how it will interact with ownership?
An Energy View 