A Crisis in UK Energy Policy Looks Inevitable

30 April 2013

European Equity Research

A Crisis in UK Energy Policy Looks Inevitable We Identify the Possible Triggers UK | UTILITIES | SSE.L | SSE LN | CNA.L | CNA LN | DRX.L | DRX LN | NG.L | NG/ LN

When the crisis hits there will be three possible casualties, the government of the day, the consumer, and the investors who have funded the government’s radical energy policy. Whilst no doubt there will be plenty of pain to go around, in our view investors should be under no illusions that the government of the day will seek to protect itself and the consumer (who are also the electorate) by heaping most of the financial pain on to investors.

 UK Energy Policy is not Plausible: in our view successive UK governments have grossly underestimated the engineering, financial, and economic challenges posed by the drive to decarbonise the electricity sector by 2030. Moving from a largely fossil fuel based power system to one dominated by renewables and nuclear in just a decade and a half, whilst keeping the lights on and consumer bills affordable, may simply be impossible.

 Policy Cost: we estimate that the total required investment to deliver policy goals is £161bn from now to 2020 and up to £376bn by 2030. Even with the large increase in public support provided by the Energy Bill it is extremely hard to envisage that this finance will be forthcoming given that the large European Utility companies are actually reducing capex. If the investment does take place we see electricity bills rising by at least 30% by 2020 and 100% by 2030 in real terms.

 Economic Rationale Looks Weak: the fundamental economic argument for the EU’s energy policy is that fossil fuels are scarce, and will therefore become ever more expensive. The belief is that those that move first away from fossil fuels will gain a substantial competitive advantage. But the arrival of unconventional gas and oil makes this assumption look shaky at best. Without clear economic benefits it is not at all certain that the public will be willing to bear the costs. Without public support the policy is bound to fail at some point.

 Re-nationalisation: the decarbonisation agenda has required the government to intervene in the energy market in ever more aggressive ways. The Energy Bill takes this to a new level and effectively re-nationalises the investment-making decision process in the power sector. But it is not clear that policy makers yet appreciate that this also means that the risks and costs associated with these decisions must also transfer to the public.

 Probable Triggers for the Crisis: we identify a number of possible triggers; a generation capacity crunch in the 2014-17 period leading to a sharp spike in power prices, a lack of dispatchable generation by the end of this decade onwards, and spiralling consumer costs / developer profits that a future government will find untenable.

 Utility Companies & Investors Should Limit Exposure: political risk looks certain to rise sharply in the UK energy space in the coming years as the implausibility and contradictory nature of policy is exposed by events.

We welcome recent moves by both Centrica and SSE to take a more cautious approach to allocating capital to UK renewables. UK utility stocks have benefited in recent years by being viewed as having relatively low political risk, this may well change in coming years. Most exposed will be Drax, SSE and Centrica.

Peter Atherton

Guillaume Redgwell

+44 (0)20 3100 2088 peter.atherton@liberumcapital.com

+44 (0)20 3100 2195 guillaume.redgwell@liberumcapital.com

This document is a marketing communication and is not independent research prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to a prohibition on dealing ahead of the dissemination of investment research.

For Reg-AC certification, see the end of the text. Liberum Capital does and seeks to do business with companies covered in this communication. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

30 April 2013

A Crisis in UK Energy Policy Looks Inevitable

Contents Summary Conclusions A Crisis in UK Energy Policy Looks Increasingly Inevitable UK Energy Policy – Not Plausible

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EU & UK Energy Policy UK Gold Plates Policy The Energy Bill Renationalisation of the Power Sector? Very Nearly Policy Survives Unchanged in a Changed World Economic Rationale for UK Energy Policy Looks Weak Is the UK Playing Russian Roulette?

And Guess Who Gets Shot?

Utility Companies and Investors Need to Limit Exposure

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Potential Crisis Trigger 1: Near Term Security of Supply & Price Spike Threat11 The Recent Position – Ample Capacity 12 2014-16 Period – Gas Closures are the Concern 12 Quality of Reserve Margin Declines 13 Price Spike More Likely than ‘Lights Out’ 14

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Potential Crisis Trigger 2: Security of Supply Threat in the 2020’s What is the Plan?

What Does the Plan Mean in Practice?

New Generation Additions Mix Lack of Dispatchable Generation

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Potential Crisis Trigger 3: The Cost Capital Costs 2012-2030 Impact on Consumer Bills – The Levy Framework Capacity Payments Total Capacity Payment Costs Impact on Bills Energy Efficiency Bills and Profits Rise

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Conclusions

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A Crisis in UK Energy Policy Looks Inevitable

Summary Conclusions In this note we conclude that:

1) EU policy makers have grossly underestimated the difficulties and risks of their drive to decarbonise the power sector.

2) EU policy makers have failed to take into account the huge changes in the economic, commodity and financial environments and adjust policy accordingly.

3) The economic arguments supporting the current climate change dominated energy policy look weak and public support is uncertain.

4) Given the hostile rhetoric that utility companies face today from across the political spectrum on bills and profits, it takes quite a leap of faith to believe that future governments will steadfastly defend the huge bill and profit increases that will inevitably result from current policy.

5) Political risk is bound to rise sharply in the UK energy space in the coming years as the inherent implausibility and contradictory nature of the policy goals are exposed by events.

6) A crisis in UK energy policy looks increasingly likely and therefore utility companies and investors would be prudent in limiting their future exposure.

A Crisis in UK Energy Policy Looks Increasingly Inevitable The UK looks increasingly certain to be heading for a crisis in its energy policy in our view. The crisis is likely to come to a head via either:

1) a huge spike in wholesale prices as the power market anticipates a short term shortage of physical capacity; or

2) a longer term shortage of dispatchable generation capacity that puts security of supply at serious risk, or

3) through spiralling consumer costs that will inevitably force a future government to renege on its policy commitments; or

4) sharply rising profit levels reported by developers coinciding with rising consumer bills which become politically unacceptable to the government of the day.

There is a high probability in our view that several of these catalysts could combine together to create a ‘perfect storm’ of a crisis within the next decade. If this happens then there will be three casualties in the crisis – the government of the day, the consumer, and those investors who have thus far funded the policy. Whilst there is likely to be plenty of pain to go around, the experience in continental Europe in recent years has shown that the government of the day is likely to try and protect itself and consumers by heaping the bulk of the financial pain onto investors.

UK Energy Policy – Not Plausible In our view successive UK governments have grossly underestimated the engineering, financial, and economic challenges posed by the drive to de-carbonise www.liberumcapital.com

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the electricity sector by 2030. Far too much is being asked of the power sector, which is taking on the burden of climate change policy for the whole economy.

Furthermore the government has largely failed to take account of the lessons from other EU countries that are further advanced in implementing the policy than the UK. UK policy requires the power sector to migrate from a largely fossil fuel based system to one that is overwhelmingly based upon renewable and nuclear capacity by the end of the next decade – i.e. within the next 17 years. What’s more the government has an interim target of providing circa 35% of electricity from renewable sources (up from around 10% now) by 2020 – a mere 7 years away. This would be one of the biggest industrial transformations in British history.

Delivering government plans would be hugely challenging even:

 if renewable technologies were easy to deploy at the utility scale – which they are not;

 if renewable technologies were economic to deploy – which they are not;  if new nuclear stations could be built quickly and economically – which they can not;

 if the public were willing to pay any price in their bills to fund this policy – which they are not;

 if the utilities companies were in the financial position to fund the transformation – which they are not;

 if the capital markets had the capacity and were willing to fund the policy – which at the moment they are not.

Scale of the Task Figure 1 below illustrates the tremendous challenge that just hitting the 2020 renewables target poses. In 2012 total renewable output was circa 39TWh, but needs to rise to around 115TWh by 2020. The conversion of 3x600MW units at Drax over the period to 2016 to run on biomass should add around 15TWh. But beyond that it will take a spectacular build out of offshore wind in the 2016-2020 period to hit the target.

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Figure 1: Required Renewable Power Build Out to 2020 (TWh) 140

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In Figure 2 we show how the generation mix will have to evolve from now to 2020 and then to 2030 to satisfy the decarbonisation policy. As can be seen, coal fired generation is expected to provide circa 140TWh of output from a total of around 330TWh in the current year. But this needs to fall sharply to less than 60TWh by 2020 and then to zero by 2030. Unabated gas fired output will also need to fall dramatically from circa 130TWh in 2013 to probably no more than 50TWh in 2030.

Something like 220TWh in dispatchable coal / gas output will need to be replaced over the next 17 years. Replacing this generation requires a gigantic expansion in both offshore wind and nuclear output even if Carbon Capture and Storage (CCS) becomes commercially available in the timeframe (which looks highly unlikely).

Figure 2: Generation by Fuel Type (TWh) 160 140 120

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Source: Liberum Capital estimates

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EU & UK Energy Policy All modern governments face three, sometimes contradictory, drivers on their energy policy:

1) Combat climate change 2) Ensure affordable and competitively priced energy for households and business 3) Ensure security of supply.

But the EU uniquely amongst the world’s economic powers has committed itself to an energy policy that overwhelmingly emphases the first objective, combating climate change. In a 2003 Directive the EU committed member states to reduce average greenhouse gas emissions by 20% from the 1990 benchmark by 2020.

Member governments also endorsed the objective of achieving reductions of up to 80% by 2050.

The EU followed this up with an agreement in 2006 to deliver the 2020 target largely through the deployment of large scale renewable energy programs. Thus was born the target to have 20% of energy (electricity, household, and transport) produced from defined renewable energy technologies by 2020.

These climate change targets have been the primary driver on EU energy policy ever since. At the time these policies were designed and adopted little if any account was taken of the other two objectives, affordability and security of supply. But across Europe governments are finding, not surprisingly, that the cost to the consumer does indeed matter a great deal and that security of supply is economically essential.

UK Gold Plates Policy Just in case implementing the EU’s policy targets was not challenging enough the UK decided to gold plate the targets and to tie its own hands on how they might be met. The 2008 Climate Change Act was passed with overwhelming cross party support and put the 2020 and 2030 targets into UK law. It set up an institutional framework that was designed to ensure future governments would have minimal flexibility to rebalance energy policy back towards affordability and security of supply.

The Energy Bill The Energy Bill came out of the current government’s electricity market reform (EMR) process. EMR was begun in 2010 when the new coalition government decided that the existing market arrangements and intervention mechanisms were not bringing forward that level of investment at the speed that was required to meet the EU emission targets. In conducting this review the new government had the opportunity to either change or at least slow down the de-carbonisation agenda.

However, the government in fact choose to redouble its effort to deliver the policy targets with further substantial interventions into the UK energy market. EMR had four elements;

1) Carbon price floor: this has been introduced via the Finance Act and sets out a path for a minimum carbon price in the UK from fiscal 2013/14 from £16 per tonne to £30 (2009 money) by 2020.

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2) New renewable and nuclear subsidy mechanism: the government will replace the existing regime with a Contract for Difference (Cfd) mechanism. This new mechanism will very largely transfer the price risk from the developer to the consumer by guaranteeing an achieved power sale price for each power station covered. Unlike the existing Renewable Obligation the new Cfd mechanism will also provide subsidy support to the development of new nuclear.

3) Capacity market: the government will create a capacity market that will seek to ensure the retention of sufficient existing generation capacity and the building of new capacity. The design of the capacity market is still ongoing so the exact nature of the market is still unclear. However, it is known that the plan is to hold the first capacity auction in 2014 for delivery in 2018.

4) Emission performance standards (EPS): this has already been introduced and sets the maximum emission levels for each generation technology.

The Energy Bill has cross party support and is likely to become law by the end of 2013. The only area of substantive debate in parliament over the Bill is whether or not to require the government to set a mandatory carbon intensity target for electricity generation. The current carbon intensity is circa 500g of CO2 per kWh and the suggestion is to set a legally binding target of between 50g to 100g per kWh to be achieved by 2030. The government has so far resisted this call, saying that it would prefer to wait until 2016 to decide on setting a specific legally binding target for 2030 or continue to rely upon the Carbon Budget process (that was established in the 2008 Climate Change Act), that in fact has already set a legally binding pathway towards the 50g total.

Renationalisation of the Power Sector? Very Nearly To deliver its policy goals the government requires utility companies (and third party investors) to build assets that are fundamentally not economic, often in technologies that are still far from robust or mature. The government has taken upon itself the responsibly of deciding which generation technologies are bad (coal, unabated gas) and good (wind, hydro, biomass, nuclear). It has also decided the pace of change, that coal should be very largely removed form the power matrix by 2024 and that unabated gas should operate only at peak from 2027. The government has even decided what future technologies should or should not be developed and adopted, for example placing much faith in the wholly unproven Carbon Capture and Storage (CCS).

The Energy Bill will take government intervention up yet another level. Under the powers granted by the Energy Bill, the Department of Energy and Climate Change (DECC) will allocate Contracts for Differences (Cfd’s) to developers in those technologies and at those locations that DECC favours. DECC will set the strike price and so determine the revenue of the asset, what the consumer pays and the returns on investment. DECC will issue enough Cfd’s to meet the EU’s targets but within an annual subsidy budget (known as the Levy Framework) imposed by the Treasury. Via the proposed capacity payment mechanism DECC will also decide how much reserve capacity is required to back up renewable power and by implication the revenue and returns for much of the legacy fossil fuel fleet.

All this amounts to the effective renationalisation of the investment decision process in the power sector. It is now the government, not private companies, who will www.liberumcapital.com

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decide what power stations get built, when, where, and using what technology. The role of the power companies is reduced to acting as a facilitator for DECC decisions.

It is arguable that even when the industry was state owned prior to 1990 that central government had considerably less control than envisaged by the Energy Bill. But what is clear is that going forward it is inconceivable that any utility will build a new power station using any technology unless the economics are formally underpinned by the tax payer / consumer. In taking charge of the investment making process the government has to accept that the costs and risks of these decisions will also fall on to the state. It is not clear that policy makers have fully understood the implication of this.

Policy Survives Unchanged in a Changed World Quite a lot has happened since 2003 when the EU adopted its climate change driven energy policy. To name but a few;

 the financial crash, global recession, and Euro crisis;  the massive contraction in the value of European utility share prices;  the near wipe out of the European listed renewable power sector;  the Fukashima accident and its impact on German energy policy in particular;  the US energy revolution;  the failure to agree new internationally binding carbon reduction targets;  increased public concern over climate science following the ‘climategate’ email leaks and the acknowledged standstill in global temperatures since 1997;

 the fact that renewable energy technologies have proven much harder and more expensive to deploy at the utility scale than originally thought;

 the continued use of coal as the primary source of power generation in the fastest growing economies, especially China and India.

It might have been expected that any one of the above events would have provoked a policy re-think. But the remarkable thing is that the EU, and the UK, has not deviated at all from the climate change dominated energy policy strategy since it was adopted in 2003. Politicians of all parties appear determined to press on placing the achievement of climate change goals ahead of energy affordability, economic competitiveness, and security of supply. But unless the policy makers can sign the public up to this strategy there is considerable risk that its inherent contradictions will fatally undermine it over time.

Economic Rationale for UK Energy Policy Looks Weak In recent years UK policy makers have tended to emphasise the economic benefits of current energy policy rather than rely upon the climate change rationale. This perhaps reflects the shift in public attitudes shown in many opinion polls that show that public concern over global warming has waned.

The economic argument behind the current energy policy is two fold. First, the claim is that fossil fuels are scarce and will become scarcer going forward. Therefore the 8

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A Crisis in UK Energy Policy Looks Inevitable

cost of oil, gas, and coal on the international markets can be expected to rise inexorably in the coming decades. By largely eliminating fossil fuels from the UK’s power sector the country will protect itself the inevitable sky high fossil fuel prices.

There are a couple of problems with this argument:

 US Energy Revolution: the development of non conventional gas and oil exploration in the US has destroyed the notion that the world has hit peak oil / peak gas. Looking at the 2020’s energy picture it is now just as possible that fossil fuel prices are no higher (and possibly lower) than they are today.

Substantially rising prices are still a possibility but in no way is it certain.

 Cost / Benefit of Being Right or Wrong: UK energy policy is effectively a massive long position on the oil price i.e. if the world does indeed face sky high oil prices in coming years then the policy will be seen to have worked. But even if this bet proves correct will we see much benefit? The answer is probably not unless the rest of the world follows the UK’s lead. The reason is that a future oil price shock would hit the world economy and be transmitted into the UK via trade. The trade effect is likely to overwhelm any benefits gained from the UK power sector being ex-fossil fuel.

Whereas the cost of getting this bet wrong could be economic disaster, if the UK’s major trade competitors retain a largely fossil fuel based power system. If fossil fuel prices remain at current levels (or lower) in real terms then by locking itself into a vastly more expensive power system the UK risks stranding its economy with a wholly uneconomic cost base.

The second economic argument usually put forward for the current policy is closely linked to the first. Namely, that by being in the vanguard of the fight against climate change the UK will develop an industrial capacity that can be exploited for export once the rest of the world recognises the fact of sky high fossil fuel prices and belatedly follows the UK in decarbonising their power sector. Leaving aside for a moment whether or not Europe’s industrial base (never mind the UK) is in fact benefiting for the €30bn current annual subsidy being paid each year by energy consumers, the fact is that unless fossil fuel prices do rise substantially year after year it is pretty unlikely that the rest of the world will follow the EU and UK to radically decarbonise its power sector within the same timeframes.

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Figure 3: European Renewable Energy Manufacturing Index 3,000 58bn Euro peak market cap 2,500

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Figure 3 above shows the index of listed renewable energy manufacturing companies in Europe. The sector boomed after 2005 when the renewable targets were set and the flood gates of subsidy were opened. But as can be seen the market value of the sector has crashed and is now below its 2005 position. Demand for renewable assets in Europe has faltered as some EU countries reduced support mechanisms, overseas markets have failed to materialise as expected, and Asian (especially Chinese) manufacturers have aggressively entered the market, often brutally under-cutting EU suppliers. Virtually the entire German solar manufacturing base has been wiped out by this competition. Vestas, the EU’s leading wind turbine manufacturer has seen its share price crumble from a high of over 700 Krona to only circa 46 Krona today. From this it is hard to discern that EU citizens are getting much of a benefit from reviving their industrial base with the €30bn per annum subsidy that renewables are costing.

Is the UK Playing Russian Roulette?

It is not clear that UK policy makers comprehend the risks and possible consequences of the current path they are on. Its like they are playing Russian roulette with a gun loaded with three bullets;

1) A security of supply crisis in the 2014-17 period as coal and gas plant close with little dispatchable generation being built.

2) A security of supply crisis post 2020 as the rest of the coal fleet is forced to close, more of the older gas plant also closes, and the existing nuclear fleet winds down.

3) An affordability crisis caused by surging consumer bills which would be triggered by either a security of supply crisis (see above) or indeed by the government’s radical de-carbonisation of the power sector being a success.

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And Guess Who Gets Shot?

When the crisis hits there will be three possible casualties in the firing line; the government of the day, the consumer, and the investors who have funded the government’s radical energy policy. Whilst no doubt there will be plenty of pain to go around, investors should be under no illusions in our view that the government of the day will seek to protect itself and the consumer (who are also the electorate) by heaping most of the financial pain on to investors. The experience from across continental Europe in the past three to four years shows clearly that investors simply cannot rely upon government promises to protect their returns when the crisis hits.

Utility Companies and Investors Need to Limit Exposure The complacency of policy makers should not be matched by utility companies and investors in our view. Political risk is bound to rise sharply in the UK energy space in the coming years as the inherent implausibility and contradictory nature of the policy goals are exposed by events. Companies and investors should be wary in our view of committing further capital in support of UK energy policy goals, with the partial exception of regulated network investment.

There are signs that utility companies are beginning to adjust their investment intentions in anticipation of the higher risk. Both Centrica and SSE have signalled a more cautious approach to investing in UK renewables. For example Centrica has stated that it will restrict its possible investment in the £2bn Race Bank offshore wind farm to only £200m and that it expects to focus its growth investment in North America from now on. SSE has stated that its investment in renewables will run at a rate of around £300m pa to 2015 compared to a run rate of circa £800m pa from 2009 to 2012. SSE has shifted its capex program back towards regulated networks and away from power stations.

Foreign owned utilities and other potential investors should exercise caution in our view when considering entry or expansion in the UK market. Apparently attractive returns could soon evaporate when a crisis hits. The UK market could easily become as hostile to investors in this space as Spain and Germany (amongst others) have been in recent years.

If political risk does indeed rise sharply in the UK in coming years, especially if it is due to a security of supply scare and / or a price spike, we would expect the political heat to centre upon the so called big six – Centrica, SSE, E.ON, RWE (npower), EDF Energy, and Iberdrola (ScottishPower) vertically integrated players. There is a real risk that the government of the day could be tempted to directly intervene on prices and / profits. We would expect network investment to be protected due to UK’s system of independent regulation.

Potential Crisis Trigger 1: Near Term Security of Supply & Price Spike Threat The cold winter of 2012/13 has focused attention to security of supply, with Ofgem and SSE both expressing the fear that tightening reserve margins over the next couple of years could put the UK at risk of ‘the lights going out’.

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The Recent Position – Ample Capacity Currently the UK actually enjoys an over supply of generation. At the start of 2013 total capacity on the system was circa 88GW against an expected peak demand of some 58GW. This give a reserve margin of close to 50% compared to an average over the past 20 years of around 25%. The reason for this exceptionally high reserve margin is twofold. First, 7GW of new gas fired power plant has commissioned in the last couple of years, this plant was built to replace the 12GW of old coal and oil plant due to shut under the Large Combustion Plant Directive (LCDP). But as the new gas plant was commissioning in 2011 and 2012 the price of coal / carbon fell relative to gas giving a new lease of life to the older coal plant keeping them on the system until very recently. Second, we have seen a steady build out of renewable power with some 4GW added over the last couple of years.

Figure 4: UK Reserve Margins (%) 45% 40% 35% 30% 25% 20% 15% 10% 5%

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The relative over capacity has manifested itself through very low spark spreads.

With coal operating firmly in the mid part of the merit order, gas has been pushed to peak load. This means that a lot of gas fired capacity is competing for relatively little volume – hence the low spark spreads.

2014-16 Period – Gas Closures are the Concern Power companies have announced that around 7.5GW of the 12GW of oil / coal plant that was opted out of the LCPD will close ahead of next winter. The remaining 4.5GW of the LCPD is likely to shut after next winter.

However as mentioned above, 7GW of new gas plant has just commissioned together with several GW of renewables. Therefore the system should easily be able to absorb the LCPD closures. However, the unexpected risk to security of supply comes from gas plant. The incredibly low spark spreads of the last year or so has probably rendered all gas fired power plant in the UK loss making.

Older CCGTs with low thermal efficiency rates will be severely loss making at current spreads. The concern is that 10GW of the largest gas plant on the system will be 20 years or older by 2016 with a further 7GW 15 years or older. CCGT plant built in the 1990’s had a typical design life of 20 years. The life of this plant can be extended but this usually requires substantial investment. For example SSE recently 12

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spent £100m to refurbish its Keadby power station that had been commissioned in 1996.

Given current spark spreads it is inconceivable that any company would today authorise a substantial investment in updating an old gas fired power plant. Indeed, in March, SSE announced that it was to place the 735MW Keadby station into ‘deep mothball’, meaning it would take around two years to bring the capacity back on line.

Centrica also closed two aging gas fired stations Kings Lynn (320MW) and Roosecote (229MW) in 2012 due to market conditions.

When it announced the mothballing of Keadby, SSE called for the government to bring forward the implementation of the proposed capacity market from 2018 to 2014, so that existing gas plant could receive support in order to keep them on the system. The government has rejected this call so far. The danger for security of supply is that other generators now follow SSE’s lead and take out more gas fired capacity.

Quality of Reserve Margin Declines If we assume that all of the remaining LCPD plant closes in 2014 and we also see 5GW of additional gas fired power stations closed or mothballed, that would leave around 73GW of capacity on the system to meet a peak demand that is unlikely to be greater than say 58GW. This is still an apparently healthy reserve margin of over 20%. However, by the end of 2015, 8GW to 9GW of the capacity will be provided by wind turbines and 3GW via the interconnectors. Wind and the interconnectors are not ‘firm capacity’ in the sense that National Grid can dispatch the plant whenever required.

In this possible scenario dispatchable generation could be as low as 60-63GW by the winter of 2015/16. This would be uncomfortably low. On December 12 last winter National Grid had to call upon all available generation capacity to meet demand. At least 5GW of that capacity will not be on line next winter and anywhere between 715GW won’t be available by winter 2015/16. Figure 5 shows how dispatchable generation as a percentage of peak demand could evolve over the new few years.

Figure 5: Dispatchable Generation as % of Estimated Peak Demand 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% 2012

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Source: Liberum Capital estimates

The UK government hopes and expects that this tight(ish) reserve margin will prove to be temporary. The Energy Bill should receive Royal Assent by the end of 2013.The first Cfd’s should be awarded by the end of 2014. If government plans are www.liberumcapital.com

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to be met then anywhere between 20-30GW of new renewable and gas fired capacity will need to be added to the system from 2015-2020. That means around 5GW a year of new gas and offshore wind should be commissioning each year.

Price Spike More Likely than ‘Lights Out’ Despite the potentially tight reserve margins from winter 2014 onwards in our view the risk of actual disruptions to supply is low. National Grid has considerable powers to manage short term supply constraints and to maximise the use of available power capacity. Mothballed plant can be brought back on, albeit with a delay, and there is some scope for a limited demand response.

Nuclear Reliability is the Wild Card However, this can not be guaranteed and the real wild card is the reliability of the existing nuclear power fleet. The seven (8.2GW) AGR nuclear power stations are entering very late middle age and have had a troubled reliability record. If during the winters of 2014-16 two or more of the AGR’s suffer an extended forced outage, then the capacity crunch could become a physical reality. The point being that the system is likely to be sufficiently tight so that an additional unexpected event like to loss of a nuclear station could trigger a security of supply event.

Prices will Rise Ahead of the Lights Going Out But the real danger in our view is that the power market may get concerned about security of supply and start to price in a material risk premium into the forward prices. This is what happened in the gas market in the mid 2000’s when the decline of the North Sea output exceeded expectations before new import capacity was commissioned. We saw winter gas prices spike up over 50% until the concerns were eased when the new pipeline to Norway and two LNG terminals were completed.

A similar move on power prices could easily push winter season wholesale prices up to the £70 to £80/MWh range compared top £53/MWh today. Such a move would likely increase retail electricity prices up by some 15%-25%. Current average retail electricity bills are currently around £550 pa so such a rise would push prices up to £690 pa.

Potential Crisis Trigger 2: Security of Supply Threat in the 2020’s What is the Plan?

The push to de-carbonise the power sector is scheduled to accelerate as we move into the 2020’s. To meet the target of a 60% reduction in emissions versus the 1990 baseline the government’s official advisory body the Committee on Climate Change (CCC) states that the carbon intensity of electricity generation needs to be reduced from over 500g per kWh to close to 50g. The reason why a reduction of this scale is necessary is that the plan requires a substantial electrification of transport and heating by the end of the 2020’s. If this is to take place and reduce the UK’s emissions by the required 60% then electricity has to be substantially carbon free by 2030.

Although the government has not yet set the 50g per kWh figure as a legally binding target, it has formally adopted the Fourth Carbon Budget that sets out the pathway 14

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for decarbonising the sector through to 2027 with the 50g target embedded into the assumptions.

The Fourth Carbon Budget states: “To meet the indicative 2030 target … it is essential to radically decarbonise power generation, cutting emissions intensity from today’s level of around 500gCO2/kWh to around 50gCO2/kWh in 2030. This will require the addition of up to 40GW of (baseload equivalent) low carbon plant during the 2020’s on top of the 30GW needed over the decade 2010-2020.”1

What Does the Plan Mean in Practice?

The CCC sets out a series of possible demand and generation scenarios that would achieve the 50g target by 2030. National Grid in its ‘UK Future Energy Scenarios – September 2012’ also examines what the power generation mix would need to look like to get down to around 50g carbon intensity.

Demand in 2030 The CCC forecasts that overall electricity demand will stay fairly flat through most of this decade at circa 350TWh as the impact of economic growth pushing up demand is largely off-set by greater energy efficiency. However, from the latter part of this decade through to the 2020’s demand should pick up sharply as the impact of the electrification of transport and heating kicks in. The CCC estimates that 43TWh of transport load and 51TWh’s of heating will be added to the electricity system by 2030. Therefore the CCC estimates that demand will be around 460TWh in 2030.

We think this figure looks on the low side if such a large amount of load is moved from transport and heating to electricity, but we will use that figure in the following analysis.

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4 Carbon Budget page 33 15

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Figure 6: Electricity Demand Forecasts (TWh) 500

450

400

350

300

250 2012

2020

2030

Source: CCC Fourth Carbon Budget; Liberum Capital estimates

Generation Plant Closures 2020-30 The CCC in the 4th Carbon Budget (page 244) estimates that some 28GW of existing power plants will be retired in the 2020’s. A combination of the ever growing carbon price and the Industrial Emissions Directive (IED) is likely to kill off the remaining coal fired power plant by the mid-2020’s at the latest – see Figure 7.

Some coal plant can be expected to convert to biomass burn and if Carbon Capture and Storage (CCS) can be commercialised by the early 2020’s (highly unlikely in our view), then one or two coal stations might be preserved if they have CCS retrofitted.

Figure 7: UK Carbon Price Pathway (£ per Tonne) 160 140 120 100 80 60 40 20 0 Jul-12

Jul-14

Jul-16

Jul-18

Jul-20

Jul-22

Jul-24

Jul-26

Jul-28

Jul-30

Source: Liberum Capital estimates

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New Generation Additions Mix The precise mix of new generation capacity that needs to be built to hit the 50g target depends on a number of factors. The most important being, first whether or not CCS can be made commercially viable in the timescale, and how many new nuclear reactors can be built? The fewer CCS and nuclear plants, the more reliance will need to be placed on off shore wind.

Liberum 50g Carbon Intensity Generation Scenario Hitting the 50g carbon intensity target will require a remarkable amount of new build in the 2020’s. The exact mix of plant depends on the assumptions discussed above.

We have modelled the generation mix to bring the carbon intensity down to 50g per kWh by 2030, our assumptions are similar to those used by the CCC and National Grid to achieve the same target;

1) Demand will be 460TWh; 2) CCS will be commercially available but is deployed only on a limited number of existing gas fired power stations;

3) All coal plants are closed by 2025; 4) 32GW of existing plant closes in the 2020’s; 5) A large new nuclear program is undertaken.

Figure 8: Generation Plant Additions & Closures Total (MW) 80,000

60,000

40,000

20,000

0

-20,000

-40,000 Closures

Newbuild

Source: Liberum Capital estimates

Figure 8 shows our assumption of the total plant closures and additions that would be required in the 2020’s to hit the 50g per kWh benchmark. In our scenario circa 32,000MW of existing plant comes off line, including the remaining 16,000MW of coal plant, 9,500MW of aging gas plant and all of the AGR nuclear reactors. To replace the closures, and provide the additional generation capacity to still meet the 460TWh’s of demand, circa 60,000MW of new capacity would need to be added to the system during the decade.

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Figure 9: Generation Capacity Additions & Closures by Type 2020-30 (MW) 20,000 15,000 10,000 5,000 0 -5,000 -10,000 -15,000 -20,000 Off-shore wind On-shore wind

Hydro

Nuclear

Coal

Gas

Closures

CCS Retro

CCS New

Newbuild

Source: Liberum Capital estimates

Figure 9 shows the additions and closures by plant type. As can be seen in this scenario we add a fairly staggering 18,000MW of new nuclear in the period – the equivalent of 11 new EPR reactors. If such a large nuclear program proves undeliverable (highly likely) then more offshore wind would need to be built. For every 1GW of nuclear not built, 2.5GW of offshore wind would need to be built to give the same output and some additional capacity (probably gas) would be needed to provide back up.

Figure 10: Generation Capacity 2030 – 50g Intensity (MW) 140,000

120,000

100,000

MW

80,000

60,000

40,000

20,000

0 20 13 2014 2015 20 16 2017 2018 20 19 2020 2021 20 22 2023 2024 20 25 2026 2027 20 28 2029 2030 Off-shore wind

On-shore wi nd

Nucle ar

Coal

Gas

Oil

Coa l to Biomass

Inte rco nnectors

CCS

Other

Source: Liberum Capital estimates

Figure 10 shows the total capacity that would be on the system in 2030. As can be seen, we would end up with a system with around 130GW of capacity. There is still a large amount of unabated gas plant on the system (34GW) compared to the circa 18

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33GW today. However, to get to the 50g target unabated gas would only operate at peak or as backup, and we envisage an annual load factor of only 15%. As mentioned, all coal would be eliminated by 2025.

Market share by output is shown in Figure 11 & Figure 12. As can be seen the market share of nuclear would increase from 16% today to some 34%. Offshore wind would increase from negligible to 30% and on-shore wind would rise to 7%.

Low carbon generation (nuclear, wind, biomass, hydro, and CCS) would have a 90% market share in 2030 up from around 22% today.

Figure 11: Generation Market Share 2013

Biomass Conversion 1%

Figure 12: Generation Market Share 2030

Off-shore wind 2% Onshore wind 3%

Hydro 1%

Nuclear 16%

Coal 40%

Hydro 1%

Gas CCS New 11% Off-shore wind 30%

Biomass Conversion 7% Gas 10%

Onshore wind 7% Gas 37%

Source: Liberum Capital estimates

Nuclear 34%

Source: Liberum Capital estimates

Lack of Dispatchable Generation In our 2030 scenario total capacity on the system would be circa 130GW. However, only around 65GW would be fully dispatchable by the system operator. Figure 13 below shows the build up of dispatchable plant (coal, gas, oil, nuclear, CCS, biomass) in dark shades and the non dispatchable capacity (wind, interconnectors, biogas) in green shades. The horizontal line on Figure 13 is an estimate of peak demand. As can be seen, currently there is circa 75GW of dispatchable generation to meet peak demand on around 57GW. But under our scenario by 2023 peak demand will exceed the amount of dispatchable generation on the system. Bear in mind that in this generation scenario we expect the amount of unabated gas fired generation to remain at around 33GW which is by no means guaranteed and will certainly need substantial subsidy via a capacity payment mechanism or some other facility.

Looking at our own generation scenario, and those that have been produced by others, the common theme is that dispatchable generation falls dramatically as a percentage of total capacity. Indeed it is hard to model a generation scenario that meets the 50g target that does not see dispatchable generation falling dangerously close to, or indeed below, the level of peak demand. Clearly the lower the percentage of dispatchable generation relative to peak demand the greater the risk of demand not being met.

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Figure 13: Generation Capacity 2030 (MW) 140,000

120,000

100,000

80,000

60,000

40,000

20,000

0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Nuclear

Coal

Gas

Oil

Coal to Biomass

CCS

Off-shore wind

On-shore wind

Interconnectors

Other

Source: Liberum Capital estimates

Another way of looking at this problem is to look at the percentage of peak demand than could be met by non-wind resources. Figure 14 below shows that currently over 140% of peak demand can be met from non wind generation sources. This would fall to less than 120% in 2020 and to only 105% in 2030. Again, it stands to reason that the lower the ratio of non wind to peak demand the greater the risk to security of supply.

Figure 14: % of Peak Demand from Non-Wind Capacity 160% 140% 120% 100% 80% 60% 40% 20% 0% 2013

2020

2030

Source: Liberum Capital estimates

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Potential Crisis Trigger 3: The Cost We need to look at the possible cost in two ways. First, the total cost in terms of upfront capital costs and then the impact that those investments are likely to have on consumer bills.

Capital Costs 2012-2030 The generation scenario set out in this note has a number of key assumptions:

1) 110TWh of renewable power is produced in 2020 to hit the government’s target; 2) the carbon intensity of power generation is reduced to circa 50g per kWh by 2030 via a balanced build out of renewables and nuclear, together with a modest contribution from CCS;

3) a substantial amount of new gas fired capacity (20GW) will also need to be added to the system to cover peak load and provide system back up.

We also need to take account of other areas of costs that government policy is driving, such as investment in networks, roll out of smart meters, compliance costs to meet the IED etc.

Figure 15: Capex Required to Meet Government Policy (£bn 2013 prices) Offshore wind Onshore wind Hydro Nuclear Gas Gas CCS New CCS Retro-fit Biomass Conversion Biomass New Smart Meters Elect Transmission Offshore Transmission Gas Transmission Elect Distribution On-shore Wind Connection Gas Distribution Gas Storage IED Energy Efficiency Total Source: Liberum Capital estimates

2012-20 45.5 6.5 0.8 15.0 8.0 0.0 1.0 2.5 0.0 12.0 17.4 9.1 3.6 16.0 1.3 2.0 2.0 4.0 14.0 160.6

2021-30 54.0 3.3 0.8 39.1 8.0 14.0 5.0 0.4 0.0 2.0 12.2 10.8 4.3 40.0 0.7 4.0 5.0 2.0 10.0 215.4

Total 99.5 9.8 1.5 54.0 16.0 14.0 6.0 2.9 0.0 14.0 29.6 19.9 7.9 56.0 2.0 6.0 7.0 6.0 24.0 376.0

The first column of Figure 15 sets our estimates of the capital costs required to hit the 2020 renewable target. As can be seen, we estimate that a further £56bn needs to be invested in wind and some £8bn on new CCGT gas stations. We assume 4 new EPR reactors are under construction (but not completed) by the end of the decade, and that some £12bn will be invested in rolling out smart meters. Total capex required in the period to 2020 across all categories comes to some £161bn or some £20bn for each of the eight years.

Looking to the period 2021-2030 total expenditure would in fact be even higher at some £215bn, with the really large costs being for offshore wind (£54bn), nuclear (£39bn) and electricity distribution (£40bn). This last cost reflects the likely costs of the infrastructure required at the distribution level to handle the proposed mass roll www.liberumcapital.com

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out of electric vehicles and distributed generation as the electrification of transport and heating is undertaken.

Therefore total required capex across the 18 years to 2030 would be £376bn or some £21bn per annum. It is worth noting that this is not the only capital expenditure that investors in UK utilities asked being ask to fund as it doesn’t cover the water sector. If we add in water capex, the total utility sector capex would add up to £445bn from now to 2030 or some £25bn per annum.

How Much Would Be Spent Anyway?

Of course some of this expenditure would be required to be spent anyway regardless of government policy just to replace assets that were reaching the end of their economic lives, and normal course investment. Figure 16 sets out our view of what the capex requirements would look like if there were no specific decarbonisation targets. We would expect some wind to still be built, albeit at a more modest scale and over a timeframe to allow the technology to mature. The replacement of the nuclear fleet would not begin until the 2020’s and gas would replace those coal plants that close for economic / engineering reasons. We would still expect smart meters to be rolled out but again on a less rushed timescale.

Figure 16: Required Capex Without Decarbonisation Target (£bn 2012 prices) Offshore wind Onshore wind Hydro Nuclear Gas Gas CCS New CCS Retro-fit Biomass Conversion Biomass New Smart Meters Elect Transmission Offshore Transmission Gas Transmission Elect Distribution On-shore Wind Connection Gas Distribution Gas Storage IED Energy Efficiency Total Source: Liberum Capital estimates

2012-20 5.0 6.5 0.8 0.0 8.0 0.0 1.0 0.0 0.0 4.0 8.7 1.0 3.6 16.0 0.7 2.0 3.0 4.0 7.0 71.2

2020-30 5.0 3.3 0.8 7.8 14.0 0.0 0.0 0.0 0.0 3.0 9.1 1.0 4.3 16.0 0.3 4.0 4.0 2.0 5.0 79.6

Total 10.0 9.8 1.5 7.8 22.0 0.0 1.0 0.0 0.0 7.0 17.8 2.0 7.9 32.0 1.0 6.0 7.0 6.0 12.0 150.8

As can be seen total expenditure over the period to 2030 would still total a very sizable £150bn or £8.3bn pa. Capex spend would remain at a steady pace through the 2020’s. Adding in the water sector, utility investors would need to fund a total of £230bn of capex by 2030. This is a very substantial sum but is more plausible in terms of financing than the £445bn required under the scenario of meeting the 2030 targets (including investment in the water sector). Figure 17 below shows the total capex requirements under both scenarios (excluding water sector capex).

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Figure 17: Capex: Govt Policy vs. No Decarbonisation Target (£bn 2013 prices) 400 350 300 250 200 150 100 50 0 Government Policy

No Decarbonisation Target

Source: Liberum Capital estimates

Impact on Consumer Bills – The Levy Framework The Office for National Statistics classes payments made by consumers to support renewable and other low carbon generation as a tax. Therefore the government needed to establish a mechanism in its budgetary process to forecast and potentially control the level of subsidy. Hence the government has created the Levy Control Framework (LCF).

At the moment the LCF covers three subsidy mechanisms, the Renewable Obligation, Feed-in Tariffs, and the Warm Home Discount. Going forward the proposed Cfd’s and support for new nuclear will also be included. The government has set a annual ‘budget’ limit for the LCF starting at £2.6bn for 2012/13 rising to £7.6bn in 2012 . These figures are in real prices, so assuming 2.5% inflation the money of the day limit in 2020 would be around £9.2bn. To put the £9.2bn in context the total revenue of the electricity sector in the UK in 2012 was £31bn.

In our generation scenario the levy cost in 2020 would be £8.6bn, so in our view it should be possible to deliver the required 110-120TWh of renewable power within the proposed 2020 levy cap of circa £9.2bn.

Looking at the period 2020 to 2030 the costs under the LCF is likely to increase substantially as the wave of new nuclear power stations and phase 3 offshore wind comes on stream. Under the Cfd arrangement the exact size of the costs in the LCF will depend on the difference between the strike price and the market price. If we assume a range for new nuclear between £20 per MWh and £40 per MWh, we calculate that the levy cost in 2030 would be between £24bn and £27bn. Bear in mind that in 2030 around 400TWh of output would be subject to LCF support mechanisms compared to circa 115TWh in 2020.

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Figure 18: Levy Cap Total (£bn) 30

25

20

15

10

5

0 2020

2030 (20+)

2030 (+40)

Source: Liberum Capital estimates

Capacity Payments Details on how the capacity payment system will work are still few and far between.

But what is clear is that the capacity payment mechanism will need to work to retain existing capacity and to attract new capacity in order to protect the security of the system. It is very likely that these very different requirements will in effect require two separate capacity markets.

To try and gauge the scale of the capacity payments that will be required to provide security of supply we can make a couple of assumptions.

New Plant The capacity payment would need to cover fixed operating and financing costs.

Given the security of revenue provided by the capacity payment 80% leverage would be achievable and a regulated like return (5% post tax) would be sufficient.

Energy sales by the plant would provide upside to the developer. Figure 19 sets out the calculation that shows that for a 1GW CCGT with a build cost of £650m and an expected load factor of 15% revenue support of £95m per annum (£8 per kW per month) would be required.

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Figure 19: New CCGT Capacity Payment Calculation Capacity Capex Depreciation Fixed operating costs Maintenance capex Gearing Cost of equity Cost of debt Tax rate WACC Annual FCFF requirement Total annual cash expense Capacity revenue requirement Capacity payment Capacity payment Source: Liberum Capital estimates

1000 650 -32.5 -35.0 -10.0 80% 7% 5% 20% 4.6% 50.4 -45.0 95.4 95.4 8.0

MW £m £m £m £m

£m £m £m £/kW/year £/kW/month

Existing Gas Plant Needless to say for an existing CCGT to capacity payment should be considerably lower. Again, assuming fixed costs would need to be covered by the capacity payment we calculate that the revenue support for a 1GW CCGT (80% depreciated) would be £23m per annual, or £1.93 per kW per month. This would be in line with the sort of prices paid in other capacity markets world wide.

Figure 20: Existing CCGT Capacity Payment Calculation Capacity Fixed operating costs Maintenance capex Total annual cash expense Generation EBITDA Capacity revenue requirement Capacity payment Capacity payment Source: Liberum Capital estimates

1000 -35 -10 -45 21.9 23.1 23.1 1.93

MW £m £m £m £m £m £/kW/year £/kW/month

Total Capacity Payment Costs In our generation scenario to hit first the 2020 targets and then the 50g target by 2030, we see 19GW of new CCGT’s required to be built from now to 2030 and a further 14GW of existing CCGT plants retained on the system. Assuming all of this plant requires capacity payment support, then the 19GW of new plant would need total revenue support of £1.8bn pa and the existing plant some £320m pa, giving a grand total of £2.2bn pa in 2013 money.

For the 2020 target alone to be met, we assume 10GW of new CCGT plant is built (£940m) 13GW of existing plant is retained (£299m cost), requiring a total per annum capacity payments of £1.3bn.

Impact on Bills To try and get a feel for the total impact on energy bills we need to add up all the additional costs (LCF, network costs, capacity payments) whilst netting off those costs saved, namely the cost of the fossil fuels that will no longer be burnt.

Impact 2020 We calculate that the government can deliver the circa 115TWh of renewable power in 2020 for an annual LCF of £8.6bn (within the inflation adjusted £9.2bn cap). We estimate that the additional revenue that will accrue to network operators www.liberumcapital.com

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(specifically transmission) will be circa £800m by 2020 compared to the 2012 baseline. As mentioned above we estimate a capacity payment of some £940bn would be required in 2020, giving a total additional cost of circa £10.34bn.

Assuming everything else stays the same, we can add this to the current sector revenue of £31bn, giving a total revenue requirement of £41.3bn in 2020. However, savings will be made in fossil fuel costs. In our generation scenario coal burn drops from 142TWh to 55TWh in 2020, although gas burn actually increases from 132TWh to 148TWh in the period. Assuming current coal costs the savings would be some £2.13bn in 2020. Although this would be off-set by an increase in gas burnt of some 16TWh, which at today’s power price would cost £700m. So the net fossil fuel saving would be in the order of £1.4bn.

So total costs would be £41.3bn - £1.4bn = £39.9bn. This is a 29% increase over the 2012 total power cost in 2013 money.

Impact 2030 As we set out above the LCF is likely to balloon in the period 2020-2030 due to the impact of new nuclear and additional offshore wind. If nuclear maintains a £20/MWh positive differential to the wholesale price the LCF could hit £24bn pa and a £40/MWh differential would give a £27bn LCF. Add on estimated capacity payment cost of £2.2bn and additional £4bn of network costs, this would give a total additional cost of £30.2bn to £34.2bn. This would be a 100% rise in total power costs compared to 2012.

Energy Efficiency DECC’s latest impact assessment of government policy on bills was published on 27 March 2013.

Figure 21: Cost of Govt Policies and Estimated Energy Efficiency Savings

Source: DECC

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As shown above DECC calculates that energy efficiency measures should more than off-set the rise in power costs caused by the de-carbonisation policy. The efficiency measures largely apply to heating and there is evidence that consumption has reduced in recent years due to a combination of the high prices, better installation, and more efficient appliances. However, there are a few concerns that should be highlighted regarding DECC’s assumptions:

1) most of the energy savings require consumers to incur upfront costs and in the case of the Green Deal ongoing annual costs which don’t appear in the calculations;

2) DECC’s calculations assume duel fuel household, and one which is able to take full advantage of all the energy savings measure available. Poorer households are unlikely to be able take advantage of all the energy efficiency measures;

3) DECC’s comparison is for the year 2020 which is before the huge ramp up of costs associated with new nuclear are due to kick in;

4) DECC admits that the unit cost of electricity will be substantially higher in 2020 than today, but argue that households will use less power so overall bills wont be any higher. But it is also the policy that households will start to transfer heating and transport load to electricity early in the next decade. Households will be expected greatly increase their use of, and dependence on electricity, despite very high unit costs.

Bills and Profits Rise The big test for the sustainability of policy will be the willingness of future governments to defend both rising consumer bills AND the profits that will inevitably flow from the £100’s of billons of investment that the government policy calls for.

By way of example, Figure 22 shows various scenarios for the EPS of SSE in the second half of this decade. If SSE was to invest in proportion to its market share to meet the 2020 targets, we would expect its annual capex to increase from £1.5bn pa to £4.0bn, with the bulk of the increase going into offshore wind. Figure 22 shows the sort of EPS growth that could result from such a level of capex at £55/MWh and £70/MWh power prices (assuming current levels of subsidy levels are maintained).

At a perfectly feasible £70/MWh power price, SSE would be seeing 33% annual increases in EPS towards the end of this decade. Investors have to believe that the government of the day will be willing to stand behind these profit increases and defend them to the public at the same time that bills are also rising sharply.

Given the hostile rhetoric that utility companies face from across the political spectrum on bills and their profits today, it takes quite a leap of faith to believe that future governments will steadfastly defend the sort of bill and profit increases that policy will require.

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Figure 22: SSE Profit Scenarios: EPS (pence) 350

300

250

200

150

100

50 2015/16

2016/17

£4bn @ £55/MWh

2017/18

2018/19

£1.5bn @ £55/MWh

2019/20 £4bn @ £70/MWh

Source: Liberum Capital estimates

Conclusions In summary we conclude that:

1) The scale of the industrial transformation and investment required to meet the targets set by UK energy policy is implausible.

2) EU policy makers have failed to take into account of the huge changes in the economic, commodity and financial environments and adjust policy accordingly.

3) The economic arguments supporting the current climate change dominated energy policy look weak and public support is uncertain.

4) Given the hostile rhetoric that utility companies face from across the political spectrum on bills and profits today, it takes quite a leap of faith to believe that future governments will steadfastly defend the huge bill and profit increases that will inevitably result from current policy.

5) Political risk is bound to rise sharply in the UK energy space in the coming years as the inherent implausibility and contradictory nature of the policy goals are exposed by events.

6) A crisis in UK energy policy looks increasingly likely and therefore utility companies and investors would be prudent in limiting their future exposure.

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Value and income may be adversely affected by exchange rates, interest rates, or other factors. Levels of taxation may change. The investments discussed in this communication may not be eligible for sale in some states or countries and may not be suitable for all investors. Investors should make their own investment decisions based upon their own financial objectives and financial resources and, if in any doubt, should seek advice from an investment advisor. Past performance is not necessarily a guide to future performance. The stated price of any securities mentioned herein will generally be as at the end of the business day immediately prior to the publication date on this document, unless otherwise stated and is not a representative that any transaction can be effected at this price. In the United Kingdom: this communication is for the use of (a) professional clients and institutional counterparties (as those terms are defined by the rules of the Financial Services Authority of LCL and (b) other persons who are not clients of LCL who have expressed interest in receiving it and who are investment professionals (persons having professional experience in matters relating to investments, as defined in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (as amended) and any other persons to whom this document for the purposes of sections 21 of the Financial Services and Markets Act 2000 can otherwise lawfully be communicated). This communication may not be re-distributed, re-transmitted or disclosed, in whole or in part, or in any manner, without the express written consent of LCL. For the purpose of clarity, this communication is not intended for and should not be relied upon by Retail Clients (as defined by the rules of the Financial Services Authority) For EU investors: This communication is issued by Liberum Capital Limited (“LCL”). LCL is a member of the London Stock Exchange and is authorised and regulated in the United Kingdom by the Financial Services Authority in connection with its distribution and for the conduct of designated investment business in the European Economic Area. The registered address of Liberum Capital Limited is Ropemaker Place, Level 12, 25 Ropemaker Street, London EC2Y 9LY. Telephone: 020 3100 2000.

For US Investors Analyst Certification The analyst (s) who prepared this report hereby certifies that all of the views expressed in this report accurately reflect his / her personal views about the subject securities or issuers. No part of his/her compensation was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this report.

The analyst (s) responsible for preparing research report received compensation that is based upon various factors, including total revenues of Liberum Capital Inc. and its affiliates, a portion of which are or have been generated by investment banking activities of Liberum Capital Inc. and its affiliates.

Liberum Capital Limited may make a market in the securities of the issuer and may act as principal with regard to sales and purchases of this security.

This publication has been approved by Liberum Capital Inc. (member of FINRA), which is a U.S. registered broker-dealer and which accepts responsibility for this report and its dissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank acting in a broker or dealer capacity and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report, should contact and place orders with Liberum Capital Inc. Disclosures Please refer to http://www.liberumcapital.com/legal/legal.aspx for detailed disclosures relating to:  the meaning of LCL’s investment ratings system (buy, hold, sell),  quarterly information on the distribution of LCL buy, sell and hold ratings; giving within each category the proportion to which LCL provided corporate finance services in the last 12 months,  previously published non-independent research on the companies mentioned herein,  whether LCL acts as corporate finance adviser or provides investment banking services to the companies mentioned herein and receives remuneration thereto.  whether LCL has in the last 12 months lead or co-managed an offer of securities for the companies mentioned herein.  whether LCL and / or its affiliates held more than 1% of the issued share capital of the companies mentioned herein.  whether LCL makes markets in the shares of the companies mentioned herein.  whether the author of this communication is a director or officer of any company mentioned herein,  whether the author or an individual who assisted in the preparation of this report received or purchased shares in the companies mentioned herein prior to a public offering.

www.liberumcapital.com

29

Research

Equity Sales – London

Large Cap Research

Specialty Chemicals & Materials

Banks

Adam Collins +44 (0)20 3100 2075 adam.collins@liberumcapital.com Sophie Jourdier +44 (0)20 3100 2072 sophie.jourdier@liberumcapital.com

Cormac Leech +44 (0)20 3100 2264 cormac.leech@liberumcapital.com Building Materials & Housebuilders Charlie Campbell +44 (0)20 3100 2090 charlie.campbell@liberumcapital.com Consumer Goods Pablo Zuanic +1 212 596 4814 pablo.zuanic@liberumcapital.com Anubhav Malhotra +1 212 596 4834 anubhav.malhotra@liberumcapital.com Media Ian Whittaker +44 (0)20 3100 2089 ian.whittaker@liberumcapital.com Lisa Hau +44 (0)20 3100 2098 lisa.hau@liberumcapital.com Mining, Metals Richard Knights +44 (0)20 3100 2087 richard.knights@liberumcapital.com Ash Lazenby +44 (0)20 3100 2085 ash.lazenby@liberumcapital.com Kate Craig +44 (0)20 3100 2077 kate.craig@liberumcapital.com Ben Davis +44 (0)20 3100 2083 ben.davis@liberumcapital.com Kit Bottomley +44 (0)20 3100 2052 kit.bottomley@liberumcapital.com Charlie Bendon (Specialist Sales) +44 (0)20 3100 2078 charles.bendon@liberumcapital.com Oil & Gas

Technology

UK Small & Mid Cap

Tim Mayo +44 (0) 20 3100 2127 tim.mayo@liberumcapital.com

Steve Tredget +44 (0)20 3100 2236 steve.tredget@liberumcapital.com Julian Collett +44 (0)20 3100 2113 julian.collett@liberumcapital.com Thomas Inskip +44 (0)20 3100 2274 thomas.inskip@liberumcapital.com

Transport, Travel & Leisure

Equity Sales – New York

Peter Hyde +44 (0)20 3100 2094 peter.hyde@liberumcapital.com Alexia Dogani +44 (0)20 3100 2254 alexia.dogani@liberumcapital.com

Mark Godridge +1 212 596 4823 mark.godridge@liberumcapital.com

Sarah Port +1 212 596 4818 sarah.port@liberumcapital.com

Harry Jaffe +1 212 596 4811 harry.jaffe@liberumcapital.com

Sumeet Gupta +1 212 596 4807 sumeet.gupta@liberumcapital.com

Utilities

Larry Stevens +1 212 596 4812 lawrence.stevens@liberumcapital.com

Peter Atherton +44 (0)20 3100 2088 peter.atherton@liberumcapital.com Guillaume Redgwell +44 (0)20 3100 2195 guillaume.redgwell@liberumcapital.com Alternatives & Funds Conor Finn +44 (0)20 3100 2257 conor.finn@liberumcapital.com Rob Jones +44 (0)20 3100 2252 rob.jones@liberumcapital.com Nicole Kwan (Specialist Sales) +44 (0)20 3100 2259 nicole.kwan@liberumcapital.com James Bouverat (Specialist Sales) +44 (0)20 3100 2253 james.bouverat@liberumcapital.com Support Services

Renewable Energy, Agriculture & Water

Graham Doyle +44 (0)20 3100 2031 graham.doyle@liberumcapital.com

Nick Walker +44 (0)20 3100 2267 nick.walker@liberumcapital.com Sophie Jourdier +44 (0)20 3100 2072 sophie.jourdier@liberumcapital.com Daryl Smith +44 (0)20 3100 2092 daryl.smith@liberumcapital.com

Real Estate

Capital Goods

Alison Watson +44 (0)20 3100 2276 alison.watson@liberumcapital.com

Ben Bourne +44 (0)20 3100 2275 ben.bourne@liberumcapital.com

Rob Jones +44 (0)20 3100 2252 rob.jones@liberumcapital.com

Consumer Cyclicals

Roger Franklin +44 (0)20 3100 2096 roger.franklin@liberumcapital.com

Edward Blair +44 (0)20 3100 2117 edward.blair@liberumcapital.com

David Parsons +44 (0)20 3100 2125 david.parsons@liberumcapital.com

Lawrence Sugarman +44 (0)20 3100 2074 lawrence.sugarman@liberumcapital.com

Joe Brent +44 (0)20 3100 2272 joe.brent@liberumcapital.com William Shirley +44 (0)20 3100 2271 william.shirley@liberumcapital.com Jack O'Brien +44 (0)20 3100 2273 jack.obrien@liberumcapital.com

Naresh Chouhan +44 (0)20 3100 2095 naresh.chouhan@liberumcapital.com

Iain Whiteley +44 (0)20 3100 2126 iain.whiteley@liberumcapital.com

Telecom Services

Rob Mundy +44 (0)20 3100 2107 rob.mundy@liberumcapital.com

Pharmaceuticals

Simon Champ +44 (0)20 3100 2112 simon.champ@liberumcapital.com

Sean Dixon +44 (0)20 3100 2124 sean.dixon@liberumcapital.com

UK Small & Mid Cap

Fergus Marcroft (Specialist Sales) +44 (0)20 3100 2242 fergus.marcroft@liberumcapital.com

Tajender Sandhu +44 (0)20 3100 2238 tajender.sandhu@liberumcapital.com

Janardan Menon +44 (0)20 3100 2076 janardan.menon@liberumcapital.com Eoin Lambe +44 (0)20 3100 2191 eoin.lambe@liberumcapital.com

Andrew Whittock +44 (0)20 3100 2073 andrew.whittock@liberumcapital.com

Kate Sloan +44 (0)20 3100 2217 kate.sloan@liberumcapital.com

Richard Mawer (Head of Sales) +44 (0)20 3100 2114 richard.mawer@liberumcapital.com

Sales Trading – London Nina Dixon +44 (0)20 3100 2109 nina.dixon@liberumcapital.com

Mark J. Edwards +44 (0)20 3100 2061 mark.j.edwards@liberumcapital.com

Nick Worthington +44 (0)20 3100 2106 nick.worthington@liberumcapital.com

Keith Raulli +44 (0)20 3100 2116 keith.raulli@liberumcapital.com

David Thompson +44 (0)20 3100 2062 david.thompson@liberumcapital.com

Harry Preece +44 (0)20 3100 2118 harry.preece@liberumcapital.com

Paul Somers +44 (0)20 3100 2063 paul.somers@liberumcapital.com

Trading Jonathan Plant +44 (0)20 3100 2102 jonathan.plant@liberumcapital.com

Peter Turner +44 (0)20 3100 2170 peter.turner@liberumcapital.com

Dominic Lowres +44 (0)20 3100 2103 dominic.lowres@liberumcapital.com

Michael Wackar +44 (0)20 3100 2104 michael.wackar@liberumcapital.com

Simon Warrener +44 (0)20 3100 2105 simon.warrener@liberumcapital.com

Convertibles Simon Smith +44 (0)20 3100 2171 simon.smith@liberumcapital.com

Richard Tomblin +44 (0)20 3100 2172 richard.tomblin@liberumcapital.com

Market Making STX 77440 +44 (0)20 3100 2200

Patrick Coffey +44 (0)20 3100 2192 patrick.coffey@liberumcapital.com

Liberum Capital Limited Ropemaker Place, Level 12, 25 Ropemaker Street, London, EC2Y 9LY Tel: +44 (0)20 3100 2000 Fax: +44 (0)20 3100 2299 www.liberumcapital.com Authorised and regulated by the Financial Services Authority Registered in England & Wales No. 5912554