Decarbonisation, Political Risk and the UK Energy Sector–an increasingly unstable cocktail
Concerns over climate change and a desire to decarbonise the UK energy sector have significantly changed the nature and level of political risk in liberalised UK energy markets in the last decade. Decarbonisation is challenging the fundamental premise of the liberalised UK energy markets that the free market, and not government intervention, leads to the most efficient allocation of capital underpinning economic growth, energy security and consumer value from a key strategic sector. This, in turn, has made it even more challenging to make investments in an industry characterised by high capital intensity and long investment lead times as UK energy policy becomes increasingly politicised. This is especially true in the power sector which has been the primary focus of UK energy sector decarbonisation to date.
Decarbonisation continues to push up the level of political risk in the UK energy industry and especially the power sector. There are two reasons for this:
- Decarbonisation requires greater government intervention to achieve a politically prescribed 'optimal' energy mix. Not only is the decision on the 'optimal' energy mix essentially a political one but also free markets are ill suited to delivering such a mix especially given the sub economic nature of decarbonisation technologies on a stand - alone basis. Understandably investors are cautious as to the level and duration of such subsidies.
- The coincidence of decarbonisation and a severe recession has led to subsidies (such as for domestic solar) to be changed at short notice and a lack of transparency in showing additional retail energy costs to the consumer/voter of decarbonisation measures. As a result, investors in the power sector push up the returns they require for renewables projects, due to this higher policy and associated political risk.
Furthermore, the level of political risk associated with the UK power sector and input fuels will continue to rise due to the inherently unstable nature of coalition government, the fraught relationship with the EU and the looming fixed term election date in 2015. Declining capacity margins with the associated risk of the 'lights going out' and rising retail power bills are inextricably linked with EU decarbonisation policies. Mapping political risk in the UK energy sector and power generation technology has rarely been more important.
BW Energy