The risk to GB Energy
The ease of promoting performative measures may tempt the government to delay essential but trickier tasks to get GB Energy up and running
Steve Wardlaw, July 2024
Last week was a good week for the new Government and its energy policy. Policies big and small were announced to move the needle on the Government’s aim around energy security and growth. If this administration wanted to be seen to be people of action, this plan worked well.
This government came into power less than a month ago promising rapid change. We have already seen that on the energy front with the removal of the ban on onshore wind, and the approval of three new wind farms.
However, attention is now swinging around to the flagship GB Energy. This is the state company that is going to do, well, lots of things in the energy sector. Apologies for sounding deliberately favgue, but there seems still to be an open discussion on the boundaries of GB Energy – for example, is it going to be an energy supplier or not. In short, it can be anything that it is allowed to be, but at the moment it is structured more as a vehicle to encourage investment and new technology.
So, as a major policy, we have the announcement that GB Energy is going to partner with Crown Estates (the owner of most of the offshore seabeds where offshore wind is based) to develop offshore wind faster with Crown Estates as an active partner. There is a logic to this, but with some caveats. (We also have the announcement of GB Energy’s chairman, a very experienced former head from Siemens, so bags of background in developing a portfolio of energy projects at the cutting edge.)
The logic is simple – this is a way to develop GB Energy’s portfolio faster and there is also the bonus of increasing income for the Crown Estates. The advantage is that 88% of those profits go back to the Treasury.
What are the caveats:
It is still not clear how GB Energy will attract private money – and this is discussed more below
There are a number of really interesting new technologies around offshore wind, such as floating turbines, longer blades and AI to assist in planning. The UK also has a pre-eminent position in the use of offshore wind (second to China who has 129 windfarms as opposed to 39 in the UK)
The aim of GB Energy is to assist in the promotion and development of new technology in the UK. That needs a rigorous discipline to make sure that GB Energy (in looking for better results or greater returns) does not invest in ‘safe’ technologies – the private sector can invest in those themselves without receiving government support.
And bear in mind, while the announcement about the Crown Estates is a step forward, it does not really stand for ‘private money’, even though it’s a clever idea to increase the number and scope of public bodies that benefit from the profits of these projects.
There are critics of the Government’s plan of course. An often-lobbed critique is that the Government taking a more directed roll will ‘crowd out’ private funds. While there is a risk of that, it is easily countered. The aim of the Government is to invest in new technology and so build/create sectors that were not otherwise here in the UK. This fits with the Government’s energy aim, but also the missions around good jobs, health, and generally productivity.
So where does this risk arise? Frankly the Government needs to be more suspicious of private funds, while also embracing them. In any sector where a government is putting in money to salvage ‘marginal projects’, you can guarantee that every developer will then insist that their project is also marginal to get that government support. In this the Government representatives must stay tough – there is no need to give incentives where there is, frankly, no need to incentivise. A competent government with competent advisers will be able to sniff this out.
However, for those higher-risk projects where government help is needed, how should GB Energy ‘crowd in’ funding?
This question is in two parts, and it is often the second part that gets forgotten. The first part concerns the role of GB Energy, and the second part concerns matters that are definitely not the role of GB Energy.
Looking at the first part, there are many models so here we are just using an example. The aim of GB Energy is to be the base fund, putting in £1 and attracting £3 of private funding. Even though we have been told that there is a ‘mountain’ of private money waiting to go into UK infrastructure project, why would an investor/bank/market player invest in a higher risk technically novel project as opposed to say, an onshore solar farm?
GB Energy as base lender will need to offer incentives. An obvious one is interest rates on any loan but this is a blunt tool that just drives up the cost of borrowing for a project, potentially making it less, rather than more viable. Better to have an incentive that does not hit the bottom like for the project, so better in the from of a deal between lenders. A good example of this would be where GB Energy takes ‘technology risk’. This needs a little bit of explanation.
I will use simple numbers here just to
highlight the point.
Suppose a project needs £100m. GB Energy puts in £20m and four private lenders another £20m each. The return from the sale of power from this project, using new technology and assuming that technology works properly, is £10m per year (keeping round numbers). The question is then always, what if the new technology doesn’t work to 100% output. This used to be a (common) risk with new turbines in gas power stations. How do you insulate the private lenders against the risk that the tech only works partially, so that in fact output is only 90% - in this case £9m. There’s no obligation on GB Energy to protect a lender, after all they invest in project all the time. Noted, but remember the Government is trying to attract capital in a hot market, and a higher risk project may not get off the ground. So for the Government’s own strategic goals, it wants these project to attract investment.
In this model, GB Energy takes technology risk, meaning it bears the risk (albeit with a cap) of the technology not working. Here, if the project produces £10m a year, then each lender gets its agreed £2m a year out of an annual profit of £10m. However, if the technology only works at 90%, resulting in only £9m profit, then GB Energy bears 100% of that risk ie the private lenders each get £2m still (and thus are insulated) but GB Energy only receives £1m. There is usually a lower floor on this, given that the technology will rarely fail totally. So, here if the technology really is terrible and produces 60% output and therefore 60% profit, then beyond a floor of say 20% (ie GB Energy’s percentage) then losses are born equally by the participants.
This is a very, very simple example, but shows one way (and several may be needed) to make a marginal project more attractive.
Nevertheless, the second part can be as if not more important – the national investment framework, which is a job for government – so capital allowances for the equipment (more for equipment made in the UK), special VAT regimes, special planning regimes, import duty waivers, lower tax rates, regulatory regimes etc. None of those is within the remit of GB Energy, but the Government and GB Energy (and regulators) will need to co-ordinate very closely. This is essential for technical reasons, but also to demonstrate stability in Government, which is the precursor for an attractive investment environment.
I will write more (with a special guest!) on how the Government part of this might work in a future piece. But for now the essential thing for the Government to remember? Just breathe – don’t let the temptation to be seen to be acting fast lead to lowering the bar on where public investment is needed and where it should be avoided. This is an imperfect tool and there may be one or two projects that should stand alone that slip through, but overall, if done properly (beyond the superficially attractive headlines) a framework like this could be a game changer for energy, infrastructure, and development in the UK.
July 2024.
Cover: stock