July 9, 2020 / 1:28 PM / a month ago

Breakingviews - UK tests financial limits of green transition

The sun rises behind electricity pylons near Chester, northern England October 24, 2011.

LONDON (Reuters Breakingviews) - Britain’s transition to a zero-carbon future is experiencing growing pains. National energy regulator Ofgem said on Thursday it was halving the returns it would allow energy companies to make from operating gas and electricity infrastructure up to 2026. Its stance is understandable, but problematic.

UK energy transmission and gas distribution companies, which include publicly listed heavyweights like $40 billion National Grid and overseas entities owned by Canadian pension funds and Hong Kong tycoon Li Ka-shing, were expecting a slap. Charges for using gas and electricity networks make up a quarter of UK consumers’ utility bills. Moreover, the National Audit Office said in January that the 9% annual return on equity that Ofgem had previously allowed operators of regulated electricity assets to earn was too high. The decline in long-term interest rates as a result of Covid-19 makes it even harder to defend.

Even so, Ofgem’s proposal is tough. The regulator wants to limit the return on equity for a notional company with debt equivalent to 60% of its assets to 3.95% a year – significantly lower than the 4.8% the industry had expected.

At the same time, Ofgem issued fuzzy guidance on how much operators can invest. It wants to cut the 24 billion pounds companies have requested for capital and operating expenditure but said they may get permission to raise a separate 10 billion pounds. It’s not totally clear how much of either pot is for maintaining the existing networks, and how much is for upgrading infrastructure to cope with increased electricity demand in a world where cars are no longer powered by fossil fuels.

The United Kingdom has other ways to meet its legal requirement to cut net carbon emissions to zero by 2050. The government could finance the overhaul of power networks itself or allow private sector companies to recoup the cost through higher customer bills. But Britain’s sovereign debt is already spiking and politicians are wary of lumbering customers with too much of the cost of the energy transition.

Transferring the risk to the private sector fits with the British government’s preferred self-image as a magnet for sovereign wealth and private equity funds. Even so, at some point politicians and regulators may have to consider the risk that those capital providers can find more attractive investments elsewhere.

Breakingviews

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