3.12.2008 Articles / Market Reports

UK Market Report

One factor which needs to be considered in the UK following the successful purchase of Innogy by RWE is the fact that the latter already owns Thames Water, the largest water company in the UK. RWE's main focus as it reorganises a raft of businesses which have in the past included a significant range of non-utility operations is now on energy-related businesses. This is despite the fact its purchase of Thames Water in 2000 was seen as part of its aim to be a major player in the water sector worldwide, as it attempted to build itself into a multi-utility company covering not only gas and electricity but also water and waste operations. The conclusion therefore is that if Thames is to remain a core part of the group - and that at present goes without saying - then RWE is going to be looking to make further links between its UK businesses, perhaps not in the area of cross-selling energy to the Thames customers, although that remains a realistic option for RWE. There can be little doubt that Brian Count at Innogy will be looking to discuss with Bill Alexander at Thames ways in which the two companies can work together. But selling energy is not a major profit deliverer in the context of a large group. Much more significant are the opportunities for reducing costs by bringing together the support services involved in running two such large companies with up to 12 million customer accounts between them. The favourite areas for consolidation can therefore be seen as merged IT activities including the operation of billing centres and support services centres. Innogy is just going through a process of rationalising and consolidating its service centres but there must be plenty of scope for further support service rationalisation in the two companies. However, the physical overlap in terms of geographic areas is very small.

At the time of the sale of Innogy to RWE, Innogy CEO, Brian Count, commented that the fragmentation of British utilities when electricity was privatised, far from being the best approach, would have been much better if it had been organised into five vertically integrated businesses. His prediction is that this will be the end-result in the UK anyway. We shall see if that occurs. We already have Centrica, Innogy and Powergen which have established nationally-recognised brands. TXU is travelling down the same route with its TXU Energi brand combining its Eastern Electricity base with its Norweb Energi acquisition to which it has added the retail supply business of Amerada in the last couple of months. That gives four companies all of which are involved to a greater or lesser extent in retail energy, power generation and energy trading. The fifth company to be added to this list would be EDF-owned London Electricity which has the supply businesses of London as well as SWEB from the South West and newcomer Virgin Energy. This scenario would raise question marks about the future of Scottish Power and Scottish & Southern Energy if Count's view is to become reality. He considers that the fragmentation of electricity has allowed the large integrated European companies to enter the market and take control of the British companies thus preventing the emergence of a national champion.

Size is really the issue here. No single company has achieved the scale to compete with the huge state- and formerly state-owned companies of Europe. There are one or two very successful British companies which have emerged from the privatisation of the utilities - Centrica, which had the national scale in the retail side of the business so that it was able to expand into electricity as well as having a good strategy which met customers' needs in expanding into other home and related services and National Grid which has become a highly efficient transmission company and whose skills are being used to good effect in improving electricity network performance in North America. One could also cite Scottish & Southern Energy as a successful, tightly-operated and integrated company but one could also argue that one of the large European utilities could easily purchase it if it decided to. This is a situation where Brian Count's argument has validity. The European players remain large integrated companies - Europe's liberalisation is running up to 10 years behind liberalisation in Britain with the result that the size of Europe's largest utilities and their associated financial strength gives them the scope to buy Britain's much smaller (in general) utility companies.

Over the coming years the requirements of regulators - agreed in Barcelona for every country - will mean the separation of the different businesses and the need to focus on particular parts of the value chain so that the necessary skills can be properly organised to meet customer needs. Going down that route will mean that Europe will end up with many smaller companies than the integrated groups in existence at present. The separate companies may still remain in common ownership - it is not possible at this stage to determine the strategy each of today's European groups will pursue, although there will be different approaches to this. The mixture of approaches which will result will provide opportunities for any British companies able to develop a coherent growth strategy - and Centrica and National Grid will be among these. Whether there will be any others who can grow out of the current landscape is questionable - especially with 9 of the original 14 electricity companies at privatisation now in foreign hands. However, all is not gloom - the skills which have been developed in the UK will be in increasing demand - the foreign takeovers are a reminder on a very positive front that our skills are going to be increasing demand - and the changes which need to be brought into existence across the whole of Europe are going to need huge amounts of input. The key issue is therefore that huge opportunities remain - at a corporate and individual level. Yes, there could have been some larger companies created in Britain when privatisation occurred but it is our view that the fragmentation will in the end have provided even greater opportunities from the systems and processes which have resulted - and in the long run there will be other corporate opportunities which will develop for British utility companies in Europe.

It seems appropriate to briefly comment on the latest position in which Scottish Power finds itself at this time. The last year has been a difficult one for the company which has been changing its focus so that it can concentrate itself as an international energy business. The changes have been difficult ones from its well-publicised problems in the US with its Pacificorp acquisition, which resulted in the departure of its US CEO Alan Richardson; its exit from its financial services joint ventures with Royal Bank of Scotland which many thought presaged an exit from retail supply in the UK - and which may well do so - to its expected exit from retail stores as well as the demerger of Thus, the former Scottish Telecoms. The latter has suffered hugely from the problems of the telecoms sector and it was another appropriate step to exit from direct involvement in telecoms. Such activity diverted management attention. The same comment can be applied to the sale of Southern Water which was recently announced. These changes, and in particular the sale of Southern Water, strengthens the financial position of the redefined Scottish Power in its role as an international energy business currently based around generation, transmission and distribution networks and retail supply. In the light of other comments in this report, the real issue remaining for Scottish Power relates to whether it has the scale to survive and thrive in the competitive markets now being dominated by large players.

The New Electricity Trading Arrangements (NETA) began operation at the end of March 2001 and were aimed at producing more efficient and competitive trading arrangements in electricity generation. NETA replaced the Electricity Pool whose centralized arrangements for setting wholesale electricity prices meant that prices failed to reflect falling costs and increased competition. NETA put in place market-based trading arrangements, more like those in other commodity markets, together with balancing arrangements to ensure the operation of a secure and reliable electricity system. In a review Ofgem is very pleased with how the arrangements are turning out with electricity generation now being traded through the markets just like other commodities. Large customers have found that prices have declined further in the last year but the market is becoming more sophisticated with the result that demand flexibility especially at times of high demand is a crucial factor in attracting good prices for large customers. Nevertheless, Ofgem claims that wholesale electricity prices are "down by around 40%". Such numbers make good headlines but they are misleading when they refer to the reduction in prices since the reforms to the trading arrangements were announced in 1998 as a joint initiative by energy regulator Ofgem and the Department of Trade and Industry (DTI). Nonetheless, industrial and commercial customers have seen prices for forward contracts fall since NETA began operations but the position is more complex for domestic customers. The effect of suppliers' long-term wholesale contracts results in price reductions taking time to feed through to customers and this has been combined with the impact of rising gas prices on dual fuel contracts with electricity price reductions helping to provide some protection to suppliers squeezed gas margins. At the same time there have been additional costs relating to environmental measures such as the Energy Efficiency Commitment and the Renewables Obligation. The amounts of electricity traded grew on a monthly basis in 2001 compared with 2000 with some increases being as much as three-fold.

Within the overall broader picture which Ofgem paints about NETA with an increasing variety of contracts being struck in the market the position is a promising one. When new trading arrangements are introduced there is clearly an important issue over the reliability of systems. Fortunately the huge test which the system had to endure as a result of the collapse of Enron went through without any significant problems. This says a lot for all the players in the market. Governance arrangements have clearly worked fine with the arrangements established under the Balancing and Settlement Code (BSC) to handle the necessary adjustments to the BSC, and managed by a separate company, ELEXON, allowing the complex issues to be handled quickly as they arise. However, there are still significant problems which still need to be addressed, especially at a time when Government is encouraging renewables and more efficient energy production. In the case of the smaller generators - principally combined heat and power and the renewables generators whose supply volumes vary significantly depending on the weather or the amount of electricity available for export to the grid from CHP plant - the various attempts by Ofgem and the DTI to try to address their problems have been inadequate. The problems relate to the penalties for imbalances under NETA and no manner of attempts to solve these problems has yet worked. Meanwhile there are losses of renewables and CHP power for the nation which goes completely against Government policy to increase the role of greener and renewables in the production of power. There have so far been plenty of studies but little practical action to assist these players. Those companies such as British Sugar, Boots and Leicester City Council which commented in a statement about the inherent mismatch between economic and environmental objectives at the heart of energy policy have a sound point. The sooner the recent pledge by Energy Minister, Brian Wilson, to "level the playing field" for smaller generators is implemented, the better - so it was good that combined heat and power plants are to be exempted from the climate change levy as a result of the Budget - as well as coal gas methane. With new capital allowances for research into renewable energy technologies, the green sector received some positive help from the budget.

There is another issue which faces the so-called distributed generators, such as the smaller combined heat and power (CHP) generators or renewable generators such as wind, solar or hydro power. They currently find it difficult and expensive to connect and operate on the electricity distribution networks which were not built with a view to accommodating them. Typically, the costs of these often remote plants will require additional costs for connecting to the electricity network but on the other hand domestic Combined Heat and Power (DCHP) customers will need to have the facility to export any electricity which their gas-fired system produces, over and above the household demand, into the public network. In the short term therefore Ofgem is proposing to: -

 

as well as providing full information for prospective distributed generators. In addition Ofgem will ensure that the framework within which the next electricity price control review is undertaken - work begins this year on the distribution price control review to take effect from April 2005 - will fairly reflect the requirements of distributed generation. It is clearly to be hoped that these aims are met in a shorter timeframe than that which has occurred with the NETA changes for these generators.

The World Energy Council believes that 15% of the world's energy needs could be met with electricity generated from the motion of waves. With two-thirds of the planet covered with oceans the figure seems conservative but perhaps we are thinking just of potential rather than practical figures. However, to keep us on a practical track, Norsk Hydro Technology Ventures, a division of Norsk Hydro, is to invest over £5m in a wave generation technology known as Pelamis now under development by Scottish company Ocean Power Delivery. The Pelamis design looks like an enormous semi-submerged snake that is made up of cylindrical sections connected by hinges. Each hinge joint includes rams which force oil through a hydraulic generator in that section as the snake moves with the waves. Electricity generated is fed by cable to the head of snake then along the sea bed to an onshore connection with the local grid. Ocean Power is now building a 750-kilowatt, 150-metre long Pelamis.

The Pelamis has a similar output to a modern wind turbine and the first full-scale pre-production prototype will be built later this year and tested at the proposed UK Marine Energy Test Centre in Orkney. The company has won a bid for a 750kW project off Islay, Scotland under the Scottish Renewables Obligation and has recently signed a memorandum of understanding with BC Hydro to develop a 2 MW project off the coast of Vancouver Island, Canada. It is anticipated that these and other projects will form the basis for larger, multi-machine 'wave-farms'. A typical 30MW installation would occupy a square kilometre of ocean and provide sufficient electricity for 20,000 homes. Twenty of these farms could power a city such as Edinburgh. What is really encouraging about the renewables scene is the fact that the developments create an environment where the initiative and foresight of individuals have the opportunity to make a real difference in what s going to become a major part of the energy sector - as BP and Shell have made clear with their major investments in the renewables sector.

When the UK's spot market in the trading of greenhouse gas allowances started in April with the launch of the emissions trading scheme this put Britain at the top of the league in carbon emissions trading. It represents a real opportunity for everyone. With the skills already in the UK in the form of financial trading in London and the growth in energy trading, then this is another area where UK skills can provide long term opportunities by proving the system. With trading held up as the best means of cost-effectively meeting commitments to reduce global warming for countries and companies we can expect plenty of growth beyond the 36 companies which signed up for the trading at the start of the market. The start of the emissions trading scheme goes back to the 80% savings in the Climate Change Levy for companies signing agreements to meet exacting targets for improving energy efficiency/reducing greenhouse gas emissions. With the start of the UK Emissions Trading Scheme participants in these agreements will now be able to achieve their targets either by trading emission allowances with other companies in a climate change levy agreement, or by participating in the wider UK emissions trading scheme. With 6,000 companies involved in the Climate Change Levy's agreements and able to use the emissions trading scheme to meet their targets or to sell their over-achievement, the scheme is expected to grow rapidly during this year.

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