Energy companies need to finance over £230bn of new investment to meet UK energy goals - Ernst & Young - United Kingdom

Ernst & Young launches new study commissioned by Centrica plc – Securing the UK’s energy future – meeting the financing challenge.

London 24 February 2009: The need to replace ageing power plants and the recent Russia – Ukraine gas dispute have heightened concerns over energy security and thrown into the spotlight the significant investment required to meet the UK’s energy goals. The landscape in which this investment must be raised has altered fundamentally as the credit crunch and economic downturn take hold.

In response, Centrica has commissioned Ernst & Young to update its 2008 Costing the Earth study, published last summer, which examined the cost implications for UK energy customers of meeting carbon emissions and renewable energy targets by 2020.

The study, Securing the UK’s energy future – meeting the financing challenge, updates the increased development costs for new energy projects over an extended time frame to 2025 to capture the recently announced new nuclear build programme and the need to improve the UK’s resilience to security of supply risks.

Ernst & Young estimates that the UK energy supply industry will have to invest over £230bn in new infrastructure by 2025 to ensure the country’s future security of supply and that current climate change and renewable targets are met. This level of investment is equivalent to doubling the value of the UK’s total energy supply asset base.

The investment challenge

Steve Jennings, partner and head of Ernst & Young’s power and utilities team, says that against a back drop of the financial crisis, raising funds to meet these investment requirements will be more challenging, but remains vital to securing our energy future.

“Raising finance on this scale would have been tough in buoyant economic times, but in the midst of a global credit crisis and economic recession the environment for raising capital has altered fundamentally.

“Securing this investment will rely upon energy companies’ ability to access debt and equity finance. They must be able to persuade their lenders and shareholders that income on new assets will be enough to service and repay the debt and provide sustainable shareholder returns.”

The study also says that new investment will be needed to renew the country’s electricity generation infrastructure (including new nuclear plants and the development of renewable energy projects) and to increase the level of gas storage and import infrastructure, future proofing the networks and making them robust enough to deal with changing patterns of electricity generation and consumption.

Return on investments

“In order to finance this investment, industry will need to raise debt and equity, and deliver secure and sustained shareholders returns – after covering operational and tax costs – to make such investment possible,” Jennings says.

Ernst & Young estimates that the energy supply industry will need to earn an annualised return on invested capital (pre-tax) of c.12% for the three years post construction (2026-2028) on the £234 billion of new investment. This is in line with returns made by the industry in recent years, which averaged c.12% from 2005-2007 (pre-tax).

“A lack of confidence that future returns on new investment will be sufficient to cover financing costs means that there is an increased risk that the UK’s energy investment needs will not be met and that investment capital will be redeployed to other sectors of the economy and possibly other countries. However the energy supply industry will need to play its role in funding the new investment in the most efficient way, for example through optimising financing costs, operating expenditure, tax liabilities and capital expenditure programmes,” he adds.

Key role for energy efficiency

The study also outlines the need to deploy the £234bn as cost effectively as possible, and reinforces the need to focus industry and government on the importance of demand reduction and energy efficiency.

“As part of a package of measures to maintain security of supply, supporting and educating consumers on ways to improve energy efficiency will play a pivotal role. Investment in energy efficiency will play an important role in achieving the industry’s objectives,” adds Jennings.

He concludes, “What’s clear is that the right balance needs to be struck between the most cost-effective means of reaching the UK’s energy sector goals, whilst ensuring the energy supply industry can deliver these goals through being able to adequately finance the significant levels of investment required to meet them.”