POWER & UTILITIES UPDATE – EDITION 1

POWER & UTILITIESUPDATE – EDITION 1January 2014 | kpmg.co.uk

WEL

COM

E FOREWORD

Welcome to our first edition of Power and Utilities Quarterly, our new magazine for the industry. With so much going on in an ever-changing

market, it has never been a more exciting time for businesses in the sector.

The idea to develop a new digital magazine is part of our ongoing commitment to clients, to have regular communication with you, and give you easy access to our wealth of experience in industry issues. By connecting and sharing our many insights, views and opinions, we aim to be close to our clients and respond to the needs of your business.

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DAVID GASCOIGNE

PARTNER, UK HEAD OF POWER AND UTILITIES

2POWER & UTILITIES UPDATEBACK TO CONTENTS

© 2014 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


PR14

A real sea change is underway

Workforce Optimisation

P3 – People Powered Performance

CONTENTS

Alistair Buchanan

on the Global Power & Utilities market

The funding and financing debate

How valuable are Power & Utilities companies

to cyber criminals?

Fighting back to combat cyber-crime

Global Power & Utilities Conference

Environmental Tax

How recent developments are affecting the Power & Utilities sectors

SMART Metering

How are smart metering engagement strategies strengthening the public

image of utilities

04

16

10

07

1805

12

14

Taxes and Incentives for Renewable Energy

09

INTE

RVIE

W ALISTAIRBUCHANAN

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AS ALISTAIR JOINS KPMG HOT FROM OFGEM, WE PICK HIS BRAINS ON WHAT WE CAN EXPECT IN THE SECTOR

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CYBE

R HOW VALUABLE ARE POWER & UTILITIES BUSINESSES TO CYBER CRIMINALS?

TECHNOLOGY IS ONE OF THE MAIN INNOVATION AND GROWTH CATALYSTS IN POWER AND UTILITIES. CYBER ATTACKS ON THE SECTOR’S SCADA SYSTEMS CAN IMPACT REVENUE, SAFETY AND HAVE MUCH WIDER REPERCUSSIONS.

Cyber-crime is always high on the boardroom agenda for financial institutions and internet businesses globally, but surely power and

utility executives can rest easy? After all, you can’t steal electricity or water using a laptop. Think again.

According to news outlets, the Syrian Electronic Army (SEA) launched a successful cyber attack on the main infrastructure system of Haifa, one of the most important ports in Israel, disrupting the operation of the servers in charge of urban management systems and public utilities in the city.


© 2014 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.© 2014 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

CYBE

R CYBER ATTACKS ARE EXPECTED TO SPUR SIGNIFICANT INVESTMENT IN CYBER-SECURITY BY 2018, ON SECURING NETWORKS, INDUSTRIAL CONTROL SYSTEMS AND DATA.

ACCORDING TO THE UK GOV CYBER GOVERNANCE HEALTH CHECK, 2 OUT OF 3 CHAIRS OF THE FTSE350 EXPECT CYBER RISKS TO INCREASE, WITH AT LEAST 1 OUT OF 3 STATING THEY ARE “ANXIOUS” ABOUT THE THREAT.

IN THE UK ALONE, CYBER ATTACKS COST SOME 27BILLION POUNDS A YEAR, ACCORDING TO THE UK CABINET OFFICE

In a world where electricity and the security of supply is key to a national infrastructure and critical for businesses to remain competitive in a global market, the power and utility industry and other operators of critical energy infrastructure, could find themselves vulnerable to having their cyber-security compromised. A really sophisticated cyber attack could cause a blackout bigger than ever seen in the UK which would be detrimental not only to the industry but to the national economy. The threat of state-sponsored cyber-warfare is not inconceivable either, particularly for an industry providing critical national infrastructure.

There are already examples of cyber-espionage to control energy and natural resources, across the world and given that this has been seen to be successful, many analysts see the use of cyber-espionage spreading. The 2012 attack on the world’s largest exporter of crude, Saudi Aramco, highlighted the potential impact a virus could have had on global hydrocarbon markets. More than 30,000 computers were compromised or affected. The attack on Aramco points to an escalation in cyber-attacks, with the adversaries constantly upping their game in a cyber arms race.

Whilst there is no miraculous solution for keeping critical power and utility assets secure against today’s evolving cyber threats, boards need to be on the front foot and devise holistic and robust strategies to be in the strongest position for dealing with the developing cyber landscape, focussing on creating better agility and providing the capabilities needed to counter threats as they evolve.

The reality is that many businesses have a long way to go in catching up with cyber criminals.

KPMG has helped firms transform their information risk and IT security functions to deal with the new world. Many businesses are taking this issue seriously and making significant investments strategically and financially, trying to stay ahead of the criminals.

Our team includes Engineers and IT Security Professionals who understand SCADA systems and work together with our clients to tackle this matter successfully.

CHARLES HOSNER

PartnerT: +44 (0) 20 7694 5801

E: [email protected]



SMAR

T SMART METERINGTHE NEXT OPPORTUNITY FOR UTILITIESTO DISAPPOINT THEIR CUSTOMERS

Between now and 2020 every gas and electricity meter in homes across the UK will be replaced with a new smart meter which will measure energy

usage every half hour and send the meter reading back to your utility provider over the mobile phone network daily – these readings will allow them to produce more accurate bills than they do today.

Customers have an in home screen that tells them how much energy they are using.

Some smart meters are already being installed –issues include meters being hidden behind partition walls. Between 2015 and 2020 approximately 140,000 new meters will be installed each week to meet the deadline. It’s a big logistical exercise - this is an unprecedented meter swap exercise.

Between 2015 and 2020 approximately 140,000 new

meters will be installed each week to meet the deadline. It’s a big logistical exercise - this is an unprecedented

meter swap exercise.



SMAR

T The programme of work is expected to cost UK energy users between £9 billion and £16 billion.

What this means for the market

The in the UK, the big energy suppliers have major programmes underway to support the meter swap.

Internationally the installation of smart meters has proven problematic. Some installers have run out of meter supplies, in the Netherlands meter installation was delayed for a year as the public protested about whether there was enough security around the meter data being sent back by the meters and in the USA, customers had the programme delayed because they were worried about rises in the cost of energy that they regarded as being linked to the new smart meters.

The business case the UK Government made around the introduction of smart meters was that they will reduce carbon emissions. However, it is now not clear that smart meters change energy users behaviour enough to deliver this benefit either.

Unfortunately, overall, there are many bad news stories from other national installation programmes – is it going to be the same in the UK?

As UK utilities prepare for mass roll out they are really reaching a critical stage in the programme and there are clear challenges ahead. The first key challenge is for utilities to manage the customer experience throughout the meter switch where there will be a representative of the utility in the home. In theory this should not be a significant challenge as meter switches are already taking place. However, the scale of the change and also the context of rising energy prices and general dissatisfaction with utilities means getting this correct is essential, key aspects of appointment management and exceptions management will be critical.

Many utilities see smart metering as a way of starting a new relationship with their customers – but this may not be the case. Once the meter is installed and sending back messages there may well be even less cause for the customer to talk the utility than before (except to complain when things go wrong).

I am also concerned that many of the utilities’ smart metering programmes are not set up to manage the risk or secure the full benefits. A number of companies are transforming systems and their customer business with limited links to the smart metering programme – this work should be integrated and focused on delivering an outstanding customer experience that meets or exceeds the level required by Ofgem’s Standards of Conduct.

In the last year KPMG have been very active in the smart metering space and built up good credentials to help clients with:

• Programme delivery and transformation advice: delivering the benefits of managing the smart programme

• Programme readiness assessments and major project advice: ie how to deliver a programme of this nature

• Smart metering roll out planning

• Strategies for financing the smart meters

• Supply chain strategy and management

• Data analysis

• Governance and controls for the smart metering data and associated processes

DUNCAN MICHIE

Director, Economics and Regulation

T: +44 (0) 20 7896 4959E: [email protected]



ENVI

RON

MEN

TAL

Renewable energy is not always free from environmental taxation. For example, wind farm developers may be advised by HMRC to register for

Aggregates Levy because they use rock, sand or gravel from borrow pits on or near the wind farm site. Thus the developer suffers an environmental tax for taking the environmentally beneficial step of sourcing aggregate on site rather than importing it.

Wind farms generally require at least 10,000 tonnes of aggregate per turbine to construct the necessary site roads, bases and areas of hardstanding, meaning that the development of a 20 turbine site could require the payment of something approaching £500,000 in Aggregates Levy.

Aggregate that is returned to the site from which it was extracted is not subject to Aggregates Levy. This statutory principle can often be applied to wind farm developments – the question being, to what extent? Does only rock that is put straight back into the pit from which it was extracted qualify for relief, or could rock from much further away (perhaps on the other side of a Scottish estate) also qualify? Does it matter whether the borrow pit sits on land within the same legal title or with the same geology as the rock’s destination?

HMRC’s policy is to construe the definition of “site” very narrowly but this has been challenged at Tribunal, first by Hochtief in connection with a hydro-electric plant and secondly by Northumbrian Water in connection with a borrow pit from which material was obtained to construct a reservoir wall and dam 500 metres away. Both taxpayers won at Tribunal but HMRC has appealed the Northumbrian Water case and a hearing at the Upper Tribunal is awaited. Clearly, the definition of “site” is highly subjective which means that many infrastructure projects, and particularly those involving wind farms, are at risk of an unexpected tax bill.

It could be said thatthe charging of Aggregates Levy on material extracted from wind-farm sites for use during their construction sends a confused message about Governmentistrying to achieve with its environmental policy. In most cases, the greenest option will be to source aggregates locally. However, where an additional costs arises because of Aggregates Levy charged on material extracted from a wind-farm site, it may be more economical to source aggregate from commercial suppliers, who benefit from economies of scale that are not available to wind-farm constructors. Ultimately, this could lead to environmentally undesirable consequences.including additional greenhouse gas

emissions. The government could help to give wind-farm constructors greater certainty and promote environmentally-friendly behaviour by providing a clear and broad definition of “site”.

KPMG’s Environmental Tax team has worked on numerous aggregates levy projects involving non-quarrying entities to whom the Aggregates Levy comes as something of a surprise. We are able to advise on practical ways to minimise the levy, using our deep knowledge of the legislation, industry practice and HMRC’s objectives and strategy.

CONTACTS

Barbara BellDirector Environmental Taxes

T: 0151 473 5193E: [email protected]

David FitzgeraldManager Environmental Taxes

T: +44 20 7940 XXXXE: XX

ENVIRONMENTAL TAXAGGREGATES USE IN WIND FARMS



TAX TAXES AND INCENTIVES

FOR RENEWABLE ENERGYRenewable energy is one of the world’s strongest

growth industries. Approximately 20 percent of global electricity generation now comes from

renewable energy sources1 and almost 70 percent of new electric generating capacity in the EU for 2012 came from renewables2.

Global demand for electricity is expected to rise by more than 80 percent from 2010 to 2040, driven by an increase in total population and GDP output.

To address world energy demand, the energy industry has seen a recent resurgence in oil & gas production in which shale gas has played a key role in the US. In addition, global fossil fuel subsidies rose almost 30 percent to US$523 billion in 2011, primarily for oil development in the Middle East and North Africa3. However, economic development across Europe is hampered by continued high oil prices and global CO2 emissions are at a record high. Accordingly, economies around the world are increasing their dependence on sustainable energy sources.

In terms of renewable policy, the EU continues to lead the world in its support for less carbon-intensive electricity generation, with 65 percent of electricity now being generated from nuclear and renewable

fuels. Europe increased its wind capacity by 12.3 percent in 20124 and 20 percent of Europe’s power is targeted to come from wind generation by 2040. A report by the European Commission indicated that renewable energy could meet 55 to 75 percent of final energy consumption by 2050, compared to less than 10 percent in 20105.

Globally, the rapid increase in renewables is driven by a number of factors, including falling technology costs, rising fossil-fuel prices and carbon pricing. However, the main support for growth is through government incentives, which totalled US$88 billion in 20116. For example, governments now offer a wide variety of tax incentives and related programmes , including: credits; grants; tax holidays; accelerated depreciation; and non-tax incentives. Policies and incentives have proven their effectiveness over the past decade. By the end of 2012, at least 138 countries had renewable energy targets, an increase of 66 percent from 20077. However, although the EU is maintaining its target of 20 percent by 2020, several European countries have stronger national long-term targets that will pay them in the high renewables range by 2030 or 2050, including Denmark (100 percent and Germany (60 percent)8.



The following chart is a summary of the support schemes available in the European countries that were highlighted in KPMG’s recent Taxes and Incentives for Renewable Energy report. KPMG can help you navigate the wide aray of available global and local government and mancipated grant programmes or tax incentives related to the production, sale and practice of alternative energy and green products, as well as increased energy efficiencies, smart-grid technologies and carbon capture and storage technologies.

REGULATORY POLICIES AND TARGETS FISCAL INCENTIVES PUBLIC FINANCING

Renewable energytargets

Feed-in tariff/premium payment

Electric utilityquota obligation/RPS

Net metering

Biofuels obligation/mandate

Heat obligation/mandate Tradable REC

Capital subsidy,grant, or rebate

Investment orproduction taxcredits

Reductions in sales, energy, CO2,VAT or other taxes

Energy productionpayment

Public investment,loans, or grants

Public competitivebidding/ tendering

Austria

Denmark

France

Germany

Ireland

Italy

Netherlands

Norway

Poland

Romania

Spain*

Sweden

United Kingdom

Some states/provinces within these countries have state/provincial-level policies but there is no national-level policy* In Spain, the feed-in tariff (FIT) and net metering programmes have been temporarily suspended by Royal Decree for new renewable energy projects; this does not affect projects that have already secured FIT funding. The Value Added Tax (VAT) reduction is for the period

2010–12 as part of a stimulus package.

Source: This section is intended only to be indicative of the overall landscape of policy activity and is not a definitive reference. Policies listed are generally those tha have been enacted by legislative bodies. Some of the policies listed may not yet be implemented, or are awaiting detailed implementing regulations. It is obviously difficult to capture every policy, so some policies may be unintentionally omitted or incorrectly listed. Some policies may also be discontinued or very recently enacted. This report does not cover policies and activities related to technology transfer, capacity building, carbon finance, and Clean Development Mechanism projects, nor does it highlight broader framework and strategic policies – all of which are still important to renewable energy progress. For the most part, this report also does not cover policies that are still under discussion or formulation, except to highlight overall trends. Information on policies comes from a wide variety of sources, including the International Energy Agency (IEA) Renewable Energy Policies and Measures Database, the U.S. DSIRE database, RenewableEnergy-World.com, press reports, submissions from country-specific contributors to this report, and a wide range of unpublished data. Much of the information presented here and further details on specific countries appear on the “Renewables Interactive Map” at www.ren21.net. It is unrealistic to be able to provide detailed references to all sources here. REN 21 Renewables 2013 Global Status Report.

TAX

1. World Energy Outlook 2012 – Executive Summary

2. REN 21 Renewables 2013 Global Status Report

3. Op. cit., World Energy Outlook 2012

4. EurObserv’ER, Wind Power Barometer



7. Op. cit., REN21 Renewables 2013 Global Status Repor

8. Ibid

Sources:ADRIAN SCHOLTZ

Director T: +44 (0) 20 7311 4230

E: [email protected]



PR14 PR14

A REAL SEA CHANGE IS UNDERWAY

One of the primary objectives of the Water Bill and parallel regulatory reforms is to re-focus the sector on the consumer by increasing

competition enabled by separation between the retail and wholesale operations of companies. This will initially allow alternative service providers to compete with incumbents for non-household retail business; the same might be extended to the household market over time. Future reforms might also involve competition in the upstream business, which could be separated from networks that will always remain a natural monopoly.

All of this is a revolution in an industry that to date has mainly seen benchmark competition managed by the regulator. The aim is to maximise benefits to customers while not undermining sector’s ability to respond to the longer term challenge to ensure resilience of supply and respond to the climate change.

The Water Bill for England and Wales and the 2014 Price Review herald a period of major change for a

privatised industry that has hitherto not been subject to the competitive pressures and consolidation seen in

the gas, power and telecoms sectors.



The question what industry structure could provide the most optimal solution to this challenge will be part answered by the reforms and part by new market dynamics emerging triggered by these reforms.

Analysis:

Since privatisation, the water and sewage industry for England and Wales has been in effect dominated by local monopolies. Once the Water Bill comes into effect that situation is set to change as the door is opened to more competition and more transparency to create better incentives and force additional efficiencies.

This is reflected in the changes to the regulatory regime. Ofwat is putting more pressure on companies to reveal the costs of different functions along the value chain while at the same time forcing them to take on more responsibility (and hence more risk) for potential outcomes of their business plans. Ofwat is also trying to introduce a risk-based approach to regulation, where the regulator’s role in determining prices will be reduced as the increased competition and new market dynamics create more direct relationships between suppliers and their customers. This is ambitious but difficult because it requires a combination of a more intrusive intervention to start with to create a market environment that allows it then to step back.

In the not too distant future the industry might look very different. Operations will be segmented and managed differently – retail, household and non-household, water and wasterwater networks, upstream etc – while we could see consolidation as well as new entry across the value chain.

Unsurprisingly, given the scale of the change, there are genuine concerns. Within the industry itself there are certainly fears that the changes will mean more regulatory burden without tangible benefits. Without additional revenue the reforms rely on creating value by cutting costs and improving customer service while absorbing the costs of the restructurings all at the same time. Meanwhile, water companies will face new responsibilities in terms of measures to maintain the integrity of supplies in the face of rising demand and the impact of climate change which will be more difficult to meet.

This means more uncertainty for investors and more differentiation across companies creating more winners and losers. In common with power and gas, the water sector struggles from the perception that the returns enjoyed by investors are too high despite the fact that companies can only earn a few percentage point return on their investments. From another perspective, the focus on creating competition within the industry has caused some to question whether enough is being done to secure supplies and long-term investments in an industry, which will have to remain focused on maintaining and improving infrastructure as well as customer service.

Point of View:

All stakeholders in the industry are facing a challenge to ensure that the reforms are constructive but also well managed, and to respond to these reforms as quickly, effectively and efficiently as possible to maximise value for consumers and shareholders. This is a complex process and a very tight timetable to finalise PR14 running in parallel with the introduction of the Water Bill makes it even more difficult. The outcome of this is critical and could enable or undermine companies’ ability to effectively respond to the industry transformation.

KPMG proposition:

KPMG has worked in various capacities on almost every business and financial plan in the sector helping companies to prepare their strategies and submissions as part of the PR14 review. We have built financial models reflecting the new regime for more than half of the industry and developed a longer term strategy for many industry players. While there is still a significant challenge to close PR14, with the Bill progressing through Parliament we believe all companies should be considering how to respond to the industry structure that will evolve in the future.

The reforms are accompanied by a major cut in companies’ allowed profits by almost 20%.

There are currently circa 20 vertically integrated water companies in England and Wales compared to just 6 major energy retailers who do not own networks.

Water companies’ new business plans outline how over £45bn is to be spent over the next 5 years to meet environmental obligations, ensure resilience of water supply, and improve customer service.



P3

Overall, the power and utilities industry is facing some fundamental workforce optimisation issues:

• Factors such as an ageing workforce, mergers and acquisitions, outsourcing and redundancy programmes have a profound impact on people management, as does the continual requirement to shape the workforce to face the challenges of tomorrow.

• The UK industry has an image problem – one only has to consider recent press articles regarding the rising cost of domestic electricity or how much money will be added to consumers bills to help cover the cost of the Thames Tideway Tunnel (super sewer) project. This could make it harder to attract and retain the best calibre workers.

• Under-investment in the past means that many companies now face a shortage of younger skilled workers who would in a natural progression replace those skilled workers nearing retirement.

Traditionally, companies have tended to address people challenges on a case-by-case basis with responsibility for individual projects often split between functions within the organisations. It’s a silo-based approach that encourages a focus on single issues rather than the bigger picture. But people-issues are interrelated and organisations need to take a strategic and holistic view of their business and develop an integrated

According to the Energy & Utilities Alliance

“in the power sector alone over 93% of the workforce needs

to be replaced” by 2030. There are many reasons for this from reduced investment, an aging

workforce and a perception of better career opportunities

in other industries.

WORKFORCE COST OPTIMISATIONTHE NEED TO ASSESS FUTURE PEOPLE MANAGEMENT REQUIREMENTS

[...]

[...]T: +44 (0) 20 [...][...]

E: [...].[...]@kpmg.co.uk



approach that builds, manages and motivates teams with the right mix of skills not only in the face of today’s shifting economic climate but also to ensure long-term success in the power & utilities market of tomorrow which will be a very different environment to that of today.

People issues have the potential to affect every part of an organisation and we see many examples of fragmented decision making and people initiatives being managed out of silos – whether that be in the HR Function, Finance or other operational business units. It is this ‘silo’ based approach that can encourage a focus on single issues rather than a more effective integrated and joined up approach to addressing the needs of the business.

Added to this, we have found that many organisations currently rely on intuition or widely held beliefs and assumptions to manage their workforce issues. The problem with both of these starting points is that decisions about people management are neither fully holistic, nor evidence based. This in turn causes issues such as talent not being available when and where it is needed; or problems with disengagement and reduced productivity/performance.

At KPMG we apply an evidence based methodology

P3

we have branded P3 (People Powered performance). As part of our approach, we collect data across a wide range of aspects relevant to a workforce and review effectiveness through five key lenses – namely Cost, Capacity, Capability, Connectivity and Compliance.

This evidence-based starting point resonates with organisations because it gives them genuine insight across all aspects of their workforce, thereby targeting efforts to those areas which will make the biggest difference. And targeted efforts matter when running a lean organisation and delivering maximum benefits to shareholders and other stakeholders.

However, this assessment isn’t simply an inward looking exercise.

Combined with the analysis of an organisation’s own data, this approach also feeds in best practice and learning from other businesses around the world. And in the case of the Power and Utilities industry we can use that learning to develop a plan for finding and integrating new skills, developing a forward looking culture and creating a motivated, appropriately rewarded workforce that will deliver on the goals of the business.

For an industry like Power and Utilities that is operating in an increasingly complex environment where there are many regulatory, environmental and economic

Many larger organisations face a number of people-related issues, including: finding and recruiting the right personnel; matching capacity to demand; motivation and reward; and getting more from the workforce while very often reducing overall costs.

Going forward, the pressures will only be added to as changes to regulation in the power & utilities sector aim to make organisations put the customer first.

The power and utilities industry is operating in an environment of rising costs at a time when new and increasingly complex infrastructure projects are required in both the power and water sectors in order to keep the lights on, keep water flowing and meet the UK’s climate change challenges.

challenges to contend with that directly impact their workforce requirements it is crucial to devise a strategy which supports an agile, efficient, motivated and appropriately skilled workforce.

To do this, it is essential that management teams consider their workforce against a backdrop of ongoing change. As an example, how will the UK power industry bridge the knowledge gap in the nuclear sector?

Management must take a holistic and multi-stranded approach to people management to address all of the organisation’s people requirements. And grounding this in data and evidence through technology such as KPMG’s BIO (Benchmarking, Insights and Opportunities) tool provides HR, Finance and the CEO with a single view of their people related management information so that they not only have a common understanding of the problems, but can join up to agree potential solutions. Change can come at a cost, but here again organisations must consider any employment related savings arrangements, using salary sacrifice or otherwise, which can help deliver efficiencies that can help ease the cost of change.

It is a case of joining up the dots so that all executives across the business have a common understanding of the opportunities for improvement and their role in delivering these.



P3FU

NDI

NG

AND

FIN

ANCI

NG THE FUNDING AND

FINANCING DEBATEFUNDING AND FINANCING ARE OFTEN USED INTERCHANGEABLY BUT THE EXAMPLE PROVIDED BY THE ELECTRICITY MARKET REFORM IN THE UK ILLUSTRATES THE NEED TO BE CLEAR IN TERMS OF THEIR DEFINITION.

The international project finance banking market has seen both a reduction in capacity and an overall reduction in the appetite to lend long-term; however there remains an ever increasing number of private and public sector financing solutions to fill the gap. Hence it is debatable in a number of markets whether any projects are not able to proceed solely due to the lack of financing.

The key issue remains the ability to pay for the infrastructure, and for most governments there are only two ways that projects can be funded: either through general tax revenue or via the consumer. The former route is challenging, especially in fiscally constrained countries, and the latter is a sensitive issue depending on the ability and willingness of the general public to pay for new infrastructure investment. Hence, there are a number of examples of Government

1https://www.gov.uk/government/news/new-energy-infrastructure-investment-to-fuel-recovery

In 2013, Secretary of State Ed Davey said “no

other sector is equal in scale to the British

power market, in terms of the opportunity that

it offers to investors, and the scale of the

infrastructure challenge”

seeking to expand and diversify its sources of funding to pay for new infrastructure. Some of these examples are arguably more targeted ways of capturing value from the local beneficiaries of the infrastructure development, such as Tax Incremental Financing or development levy type schemes.

A very good example of the funding and financing debate is the UK power generation sector given the major changes taking place due to the Electricity Market Reform (EMR). The main pillar of EMR is to create a mechanism to support investment through a Feed-in Tariff structured as a Contract for Difference (CfD). The CfD will provide revenue stability to low carbon generation through a long-term contract. The CfD will provide support between a market price and an estimate of the long-term price needed to support an investment, the Strike Price. The legislation underpinning



EMR is currently on its passage through the UK Parliament and the implementation will commence in 2014 onwards. The key to EMR’s CfD is that the revenue support – when the market price is lower than the Strike Price – will be levied against consumers and hence the funding will flow from the user and not the Government.

The CfD structure in EMR is now seen as a key trigger to unlock the investment required in low carbon generation. However, it is important to stress that EMR addresses the funding concern and doesn’t fully address the financing question. While an investor or financier will be concerned with the long-term revenue stability of a project, which will be supported through EMR, the mechanism is not designed to support the construction and delivery risk of the underlying projects. Furthermore, this risk is considerable for a range of projects under EMR, particularly new nuclear and offshore wind.

Hence, additional support may be required to solve the financing issues for projects under EMR. This has been addressed in the UK through initiatives such as the Green Investment Bank and the UK Guarantee Scheme (UKGS), which are being used to support access to the credit market across the whole of the infrastructure sector. Recently, the

Government announced that the UKGS will be used to support the new nuclear plant at Hinkley Point. The UK nuclear industry has therefore addressed both the funding and financing challenge through two different mechanisms.

Developers will still need to provide capital to projects and therefore the £110 billion investment required in the UK will still need to be financed through developers and the debt markets. This remains a huge challenge and we should not be complacent that EMR will solve this issue. While large amounts of infrastructure investment capital remain interested in operational energy infrastructure, the appetite for development risk remains limited. Therefore, a lot of the burden will fall in the main to European utility developers. These companies are increasingly looking to attract infrastructure fund capital earlier into projects often based on limited transfer of development/construction risk. This trend will need to expand further if the total investment challenge is to be met.

Point of View

The above example illustrates the importance of being clear whether there are funding or financing constraints in a market. In many instances, the funding of projects remains the greatest constraint and this is increasing the need to diversify the sources of funding available. Within funding, the role of the consumer must be recognised and, increasingly, the cost of infrastructure is being socialised to the end user.

KPMG Proposition

Developers of low carbon projects now face not only the challenges of sourcing debt financing but also increasingly sourcing equity from strategic and financial investors for development projects and this is all under a new contractual mechanism. Hence, they need to carefully analyse the underlying contractual risk within the CfD and articulate appropriate risk allocation to debt and equity investors.

KPMG has been at the forefront of the development of the CfD and provide deep expertise in analysing the commercial and financial risks and supporting developers accordingly. Hence KPMG can offer deep independent advisory expertise to work alongside developers to deliver their part of the UK EMR.

According to the National Infrastructure Plan issued in December 2013, the UK plans to invest £110bn between now and 2020 in the energy sector.

Since the global financial crisis and the European sovereign debt crisis, there has been much debate around how to provide the necessary infrastructure investment required. This often leads to the lack of financing being identified as one of the key constraints.



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IN KPMG GLOBAL POWER & UTILITIES CONFERENCE

KPMG’s third annual Global Power & Utilities Conference, held in Berlin, Germany on November 27 and 28, 2013, brought together

over 200 energy experts from industry, politics, the investment community, regulatory agencies and other opinion leaders.

Conference participants discussed future strategic and financial challenges and heard keynote addresses by prominent experts in the energy industry including:

• Günther Oettinger, European Commissioner for Energy

• Dr. Fatih Birol, Chief Economist, International Energy Agency

• Thomas Piquemal, Senior Executive Vice President, Finance, The EDF Group

• Anton Yurievich Inyutsyn, Deputy Minister of Energy, Russian Federation

• Denis Vladmirovich Fedorov, Head, Directorate for the Development of the Power Sector and Marketing in Power Generation, Gazprom, Chief Executive Officer, Gazprom Energoholding

A growing population not only demands more energy

but will put an increasing burden on energy

infrastructure planning.

On the opening day of the conference, Dr. Fatih Birol presented the International Energy Agency’s publication “World Energy Outlook 2013”. In his keynote address to top decision-makers in the energy sector, he cautioned that change was imminent: “Countries that once imported energy have now become exporters.” Despite great efforts in recent decades, a profound change in energy supply had not yet occurred. The share of fossil fuels in the global mix, he said, is currently 82 percent, which is just as high as 25 years ago. Dr. Birol called for a continuation of efforts towards more sustainable energy generation. Moving towards a more efficient energy sector was not always easy, he remarked, but it is an urgent task that cannot be delayed because demand for energy will continue to rise, Birol commented. That is because demand for energy will continue to rise, Birol said. Currently, China is the main driver of this development, the economist said, adding however that as early as the next decade, India will take over the role of the growth engine.

On day two of the conference, the opening keynote address was delivered by the European Commissioner for Energy Günther Oettinger, who presented “The European energy system:



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IN

challenges and opportunities in a changing landscape”. At the beginning of his address, Mr. Oettinger highlighted the increasing relevance of electricity generation and that a growing world population and increased demand for energy due to electric mobility meant that an efficient energy supply is increasingly important. It is therefore all the more alarming that the energy sector is the sector with the greatest lack of investment.

The Commissioner also touched on the issue of efficient energy generation and climate protection, his view being that the challenges of the energy sector can only be overcome if national funding rules are integrated into a European framework. In that scenario, solar energy could be produced in the southern countries of the EU, while wind energy would be efficiently harvested in the northern countries. Oettinger sees cross-border cooperation as a prerequisite for reaching existing climate targets, saying that in 2030, only 4.5 percent of global CO2 emissions will come from EU countries, representing a relatively insignificant proportion. If carbon emissions are therefore to be significantly reduced, he continued, binding agreements are required with China, Russia and the US.

In addition to keynote addresses, seven roundtables were held. Topics discussed included future business of utilities, coal power generation outlook, future hotspots for global M&A in the power sector, smart cities – the impact of technology on consumer behaviour, the future of the photovoltaic market, pushing the boundaries of offshore wind and cyber-security as a challenge for the industry in an interconnected world. Roundtable panelists included executives from international power companies (including RWE AG, Vattenfall, E.ON SE and Iberdrola), financiers, political

figures and representatives of non-governmental organizations. These sessions discussed not only the current state of affairs the in the energy sector, but also looked at how panelists believe the industry will evolve.

Overall, the conference made clear the future will be marked by great challenges: the industry must respond to the increasing energy needs of emerging markets and improve existing infrastructure in developed markets while respecting ambitious climate targets. Those who set the right course now can look to the future with optimism and take advantage of the growing significance of power generation and supply.

The fourth annual Global Power & Utilities Conference will be held in London on 7-8 October 2014. For further details, please contact David Gascoigne.

Partner and Head of UK Power & Utilities

T: +44 20 7311 4314E: [email protected]

DAVID GASCOIGNE



Ajay SaldanhaCapital Markets PartnerT: +44 20 7311 4774E: [email protected]

Adam RentonTax PartnerT: +44 20 7311 3293E: [email protected]

Andy Cox Transactions PartnerT: +44 20 7311 4817E: [email protected]

David Gascoigne Partner, UK Head of Power & UtilitiesT: + 44 (0)20 7311 4314 E: [email protected]

Duncan Michie Director, Economics & RegulationT: +44 20 7896 4959 E: [email protected]

Marc Van GrondelleUK Head of Joint VenturesT: +44 20 7694 4603E: [email protected]

Matt Firla-Cuchra Partner, Corporate FinanceT: +44 20 7694 5308 E: [email protected]

Sarah McNaughtPartner, UK Head of Energy & Natural ResourcesT: +44 20 7694 3368E: [email protected]

Name TBCDebt Advisory Partner

Vicky Parker Strategy PartnerT: +44 20 7694 8707E: [email protected]

Name TBCValuations Partner

Name TBCAudit Partner

CON

TACT Global Energy Institute is dedicated to helping

businesses and their stakeholders identify and understand emerging trends, risks and opportunities. We do this by creating an open forum where peers can exchange insights, share leading practices, and access the latest KPMG expert knowledge.

Join today for access to the latest thought leadership and webcasts.

www.kpmginstitutes.com/industries/energy

www.kpmg.com/uk/powerandutilities

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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POWER & UTILITIES UPDATE – EDITION 1