Cheap-Energy Campaign Seen Risking Britain's Climate Goals

(Bloomberg) -- Britain's zeal to protect consumers from higher energy prices may be about to upend measures to rein in fossil-fuel pollution.

Power grid operators warned they won't be able to break even on future investments to upgrade the electricity system if a proposal to slash authorized profit margins takes effect. Backing that view is Moody's Investors Service, which said tighter limits from the regulator Ofgem would have a knock-on effect of reducing the credit quality of network companies.

“Ofgem has gone too far,” Paul Bircham, the chairman of Electricity Networks Association's public affairs committee, said in an interview. “Investors are seriously concerned about this. “They want to know if it's a short-term blip or is it an indicator of a much more hostile environment.”

The remarks underscore the headwinds Prime Minister Theresa May's government is facing in balancing a desire for building greener industry against efforts to lower household energy bills. The government wants utilities to help build a more flexible power grid that can absorb flows from intermittent wind and solar farms -- and help spur the spread of electric vehicles.

The government's pledge to cut energy costs is shared by the opposition Labour Party. Its leader Jeremy Corbyn has said he wants to go even further and bring grid companies under state ownership.

Last month, responding to concerns that utilities are overcharging, Ofgem proposed a cut to authorized returns that network operators can make. It suggested lowering the cost of equity earned by the companies to 3 percent to 5 percent from the current range of 6 percent to 7 percent.

“Ofgem has told the networks to prepare for tougher price controls from 2021 onwards, with lower expected returns,” an Ofgem spokesman said. “The tougher approach” is expected to deliver savings of over 5 billion pounds ($6.8 billion) to consumers, he said.

For operators including National Grid Plc and SSE Plc, that would slash the amount of cash they have available to service debt and pay dividends to shareholders, leaving little left for investments. Regulators want to limit incentives for grid investment that don't create tangible benefits for consumers, according to Jefferies Group LLC.

Over the past 25 years, grid companies have been able to borrow money cheaply to finance capital investments because their regulated returns are generally stable and predictable. A lower permitted return would make more risky companies that once ranked among the safest assets, including Northern Power Grid, the U.K.'s biggest electricity distribution company, which is owned by Warren Buffett's Berkshire Hathaway Inc.

Read more about Ofgem's plans to cut network company returns

Bircham said the industry needs “an environment where investing in that network makes sense and there's a return to be earned.” The industry is due to invest 38.2 billion pounds on Britain's grids under Ofgem's current rules, which run until 2021.

Higher rates are needed to fund the expansion of the grid, since peak power consumption is expected to jump 42 percent by 2050 as the nation plugs in a fleet of electric cars, buses and trucks. About 24.2 billion pounds of the industry's overall investment will be spent on new and upgraded infrastructure. Plans are still being drawn up for investment in the next price period.

Regulators pounced in part because the grid industry is thriving at the moment. In the current price control period that runs until 2021, companies are expected to outperform the “baseline cost of equity” by as much as 3 percentage points on average, according to Jefferies.

Ofgem will finalize the framework this summer and will publish its final view on price control allowances by the end of 2020.

To contact the reporter on this story: Rachel Morison in London at rmorison@bloomberg.net.

To contact the editors responsible for this story: Reed Landberg at landberg@bloomberg.net, Andrew Reierson

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