Mark Williamson: SGN deal fuels energy market concerns

The change means bills will increase by 12 per cent and 13% respectively at a time when wages are under pressure.

Ofgem said the cap, which was introduced by the Theresa May government, applies to 15 million people. The change will come into effect shortly after the furlough programme is due to end, threatening thousand with unemployment.

The regulator said the increase was justifiable because firms that supply energy have had to deal with a big increase in the price of gas on wholesale markets in recent months.

“This increase is driven by a rise of over 50% in energy costs over the last six months with gas prices hitting a record high as the world emerges from lockdown,” it said.

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“Surging global fossil fuel prices are already driving up inflation for consumers, making fixed rate energy tariffs not covered by the price cap, as well as petrol and diesel more expensive.”

Ofgem insisted that people on default tariffs would still be up to £100 a year better off then they would be without the cap.

It claimed the system ensured consumers benefited when prices fell.

“Ofgem sets the cap level for summer and winter based on the underlying costs to supply energy. This keeps prices fair and makes sure suppliers reflect any drops in costs in your rates,” said the regulator.

Critics, however, reckon Ofgem acts faster to allow firms to pass on increases in the price of gas than it does to cut bills in response to price falls.

The decision to allow a double-digit increase in the cap at such an uncertain time as we emerge from the pandemic can only increase unease about the regime that Ofgem polices.

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What it effectively seems to be doing is acting to ensure that energy firms are immunised from the impact of market developments over time, so that they are guaranteed to make profits from the sale of energy to consumers.

This seems an odd state of affairs, particularly as big energy firms employ armies of well-paid treasury specialists and advisers to help them use futures markets to hedge against price movements.

Some market-watchers are worried that the ranks of competitors to the big energy firms have thinned significantly following the failure of a range of firms in recent months. That some hit the buffers after struggling to cover the costs imposed by the regulator to help fund investment in renewables raises further questions about the quality of decision-making in the private sector.

At the same time, the increase in gas prices poses awkward questions for campaigners who want the UK Government to ban new North Sea developments. They have focused their ire on Royal Dutch Shell and Siccar Point Energy, who applied recently for clearance to develop the Cambo field West of Shetland.

Cuts in UK production may only increase reliance on imports and result in an increase in total emissions.

The turbulence in the market may lead some to feel that Scottish energy giant SSE made the right call when it decided to sell its retail arm to Ovo for £500m in January last year.

READ MORE: SSE boss defends treatment of Scottish supply chain amid windfarm row

Ovo has made inroads into the market after casting itself as a challenger. Japanese industrial giant Mitsubishi acquired a 20% stake in the firm in 2019. US investment bank Goldman Sachs was recently reported to be in talks to acquire a stake in Ovo.

SSE was in the news again last week when it announced a deal to sell its stake in the business that runs Scotland’s gas networks, SGN, for £1.2 billion.

The Perth-based giant said SGN is a good business but it expects to be able to make more money by focusing investment on renewable energy generation assets and related infrastructure.

However, it looks like the sale will allow SSE to crystallise a huge gain on its investment in SGN, which also runs networks in Southern England.

The Scottish Hydroelectric owner acquired a 50% equity share in SGN in 2005 for £505m. It sold a 16.7% stake to an Abu Dhabi sovereign wealth fund for £621m in 2016.

So the latest deal means SSE has tripled the investment it made in SGN. That looks like a pretty good return even after allowing for the time value of money.

Picture: SGN

The deal agreed by SSE with Canadian investors last week will result in one of the other shareholders in SGN increasing its holding in the business.

The Ontario Teachers’ Pension Plan Board already has a 25% interest in SGN. It is increasing its holding to 37.5%, as part of a consortium that has also agreed to acquire the interest held by the Abu Dhabi Investment Authority.

The other consortium member is a vehicle managed by Canadian asset management firm Brookfield. It is acquiring a 37.5% interest in SGN.

The enthusiasm of the Canadian investors may partly be explained by the fact that the regulatory system in the UK allows investors in energy infrastructure such as gas networks to earn attractive returns under long-term contracts.

SGN will be allowed to generate a 4%-plus return on equity over the next five years under the settlement announced in December. That makes assets like UK gas networks very attractive for pension funds and the like, particularly when the yields on low risk government bonds are at very low levels.

SSE booked a £72m profit on the disposal of a stake in the MapleCo smart meter business to funds managed by the Equitix private equity business last year.

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The investors that bought the SGN stake can be confident that the gas network capacity offered by the firm will be in demand for years.

Given the time it will take to develop facilities such as windfarms on the required scale, gas will be required in huge quantities well into the future.

It can be used to substitute for the burning of coal, which results in higher emissions.

North Sea industry leaders note gas could be used as a feedstock for the production of low emission hydrogen fuel, in a process that will involve capturing and storing the associated carbon.

So-called green hydrogen, that would be produced from water using electrolysis, could be added to the gas pumped through networks to reduce emissions.

READ MORE: Aberdeen engineering group hails potential of hydrogen projects

There is huge excitement among politicians about the potential to use hydrogen on a big scale.

However, as the Government prepares to publish its long-awaited hydrogen strategy, consumer champions will be concerned by talk that householders may be expected to fund the required investment through a levy that would be imposed on their bills.