A 'Trilemma' For Investors In UK Energy Infrastructure

Originally published Law360, November 30, 2011.

Law360, New York (November 30, 2011, 6:22 PM ET) -- At a recent London conference on low-carbon investment, the head of a private equity fund specializing in renewables chilled his audience with a report on the significant gap between investor expectations on risk and return and what was then being achieved under the United Kingdom regulatory environment.

Have the legislative developments in the last six months closed that gap?

The U.K.'s long-term energy policy revolves around three fundamental issues — low carbon, security of supply and affordability — the "trilemma." Each one of these issues in isolation can be solved; however, the key is to find a solution that manages all three of these drivers.

In particular, the reduction of carbon dioxide emissions requires significant long-term investment, and finding a way to achieve this while securing the U.K.'s energy needs without increasing the costs paid by the consumer is the current political imperative.

This situation is more acute in light of the U.K. government's initiative to set tighter carbon-reduction targets than are required by European Union standards.

To illustrate the trilemma further: nuclear energy may solve the problem of security of supply, but it, too, comes with extensive capital costs, both in the construction phase and in the decommissioning phase, along with environmental risks, which are all too public.

Natural gas is cleaner than existing fossil fuels such as coal, and new gas-fired combined-cycle generation facilities are relatively cheap to construct and to run, depending on commodity prices, but now natural gas is imported to the U.K. via international supply routes that can be subject to suspension through geopolitical fallout.

Against this backdrop, the government has announced proposals to address the energy trilemma and develop a long-term, low-carbon growth-strategy delivery plan for the U.K.

The proposals are based on increasing investment confidence through the reform of the electricity market, implementing a planning system that will encourage growth, and designing an economic model that is intended to result in no one particular class of party bearing a disproportionate share of the financial risk associated with investing in low-carbon initiatives.

Investment in low-carbon initiatives is perceived as too risky with investors not certain of the likely rate of return for their investment through a combination of market, technology and policy risks.

Investors are wary that the existing major utilities are the price-setters and can, therefore, pass through the variable price of carbon and gas feedstock into the cost of their power while...

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