According to Cornwall Insight, the ongoing energy crisis in the UK supply market has possible spill-over effects for the wider net zero transition. Therefore, focusing on how best to maintain investor resilience should be a critical part of the current response.
How the crisis is affecting investors?
- The large swing in prices catching companies out is unnerving
- Highlights long-term market forecasting tools only focus on general directions and trend-lines
- Market shocks in adjacent segments of the value chain can lead to hiatus in decision making
- How governments and regulators react to global commodity-driven events signals how much implied political protection risk-takers will receive in markets exposed to these risks
What policymakers can do?
- Continue work on policy mechanisms that remove volatile commodity risks – particularly for flexibility solutions
- Investigate the comprehensive impact of the current situation on the wider energy value chain
- Opt for a case-by-case assessment of why failure has happened rather than a “bad companies fail” approach
Daniel Atzori, Research Partner at Cornwall Insight, said:
“The current crisis serves as a sobering reminder of the danger of being exposed to material elements of merchant risk. It reminds people that they can be blind-sided by extraordinary and relatively short-term deviations to their modelled trend line.
“This is a problem for any investor – like a pension fund or a debt provider – who wants a relatively stable return and regular capital repayments. The trouble is that these provide the cheapest forms of capital and have the most money to invest in energy infrastructure.
“To protect against this, the government needs to continue to work on policy mechanisms that remove volatile commodity risk from the energy investment equation. For example, the Contracts for Difference (CfD) scheme has been highly effective in mobilising cheap capital precisely because it takes this risk off the table. A similar mindset needs to be brought to bear on delivering genuinely investable signals in the short term, and long-term flexibility solutions, which recent events show are of paramount importance.
“Market shocks prompt everyone about to put capital at risk “on notice”. In the worst case, it could lead people to pause whilst risk is crystalised in full across interconnected systems, and the full value chain impacts are known.
“To address this, the government could urgently investigate the comprehensive impact of the current situation on the wider energy (and wider economic) value chain and publish this analysis, including any mitigating actions to insert firebreaks or ring fences to contain fall-out and risks. This should be an immediate priority.
“How governments and regulators react to global commodity-driven events signals how much implied political protection risk-takers will receive in markets exposed to these risks. In making capital investments where certain risks are unhedgeable, actors likely take a view on whether governments would leave their assets high, dry, and stranded.
“If politicians take the view that enterprises should be allowed to fail when exposed to costs outside of their reasonable control, then general faith in “soft political” support starts to be undermined. Governments that wash hands of their private sector partners can find confidence in them is damaged generally.
“To negate this, the government may want to carefully consider whether maintaining the “bad companies fail” general characterisation of the present situation, and a “one-sized” solution is advisable. Arguably, a more case-by-case assessment of why failure has happened and how best to intervene would show that policymakers appreciate that risk-taking and risk management are complex in a complex market.
“All this matters, given net zero is going to require billions of pounds of capital in infrastructure. The success of the UK model to date has been the way that it has encouraged risk-taking, with great policies intelligently leveraging private sector investors in a fashion that fairly shares risks and rewards. It hasn’t been all plain sailing, but the thriving and dynamic investment world that has developed around energy infrastructure in the UK is a testament to its broadly positive effect.
This is a triumph of the last twenty years which should be protected from the vagaries of the next six months. Some of the suggestions we have positioned are not straightforward and demand some in-depth work. And like gas, time is another scarce commodity, given interventions need to happen quickly.
Notes to Editors
For more information, please contact: Charlotte Nelson at c.nelson@cornwall-insight.com
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