Heavy on the levy

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Neil Woodford 14 July 2015 Est. reading: 4 min read

As we have previously discussed, budgets tend to be built on consistently optimistic assumptions about growth and inflation. That remains the case in last week’s budget but it did at least contain some bold, commendable initiatives which should be helpful in moving towards the Government’s improbable objective of eliminating the budget deficit.

There was, however, one element of the budget which has caused us some frustration and disappointment – the decision to abolish the Climate Change Levy exemption for renewable energy – and has compelled me to write a letter to the Government to outline my concerns.

By way of background, the Climate Change Levy was introduced in 2001 with the aim of helping to reduce the UK’s carbon emissions. Renewable energy producers were, until last week, exempt from the levy – quite rightly, one may assume, seeing that they are helping to deliver the same objective.

I understand that the Treasury has an unenviable task ahead, trying to fix our broken public finances – it needs all the help it can get in this pursuit. I can also understand why the Treasury feels the need to work on an ill-thought through renewables subsidy regime, which has delivered some poor outcomes. It has become expensive, with consumers ultimately paying the price through higher energy bills. Energy companies, meanwhile, have been demonised despite several competition enquiries concluding that the market is fair. The net result of Government policy and numerous competition enquiries is a situation where there is nowhere near enough investment in new generation capacity. The UK has an energy system that is dangerously lopsided, because the renewable subsidy regime has favoured excessive investment in expensive, unreliable generation capacity and completely disincentivised further fossil fuel investment.

Abolishing the Climate Change Levy exemption for renewable energy does not solve any of these problems. It does, however, carry some profound consequences for individual companies and, more importantly, for future investment behaviour.

We are, on behalf of our shareholders, major shareholders in Drax, a company which has transformed itself from Europe’s largest (polluting) coal-fired power station to Europe’s largest renewable energy project.

The Drax transformation has been a large, ambitious and pioneering project. As such, it has involved a great deal of risk. Nevertheless, we were supportive of management’s plans but recognised there would be a need for Government support for the project to ensure that risk capital would be rewarded with an appropriately attractive long-term return. Alongside, Dorothy Thompson, chief executive of Drax, I met several ministers and civil servants in an intensive lobbying campaign aimed to get the project off the ground with the deserved level of support, both political and financial.

Having achieved this support and the necessary Government commitments, investment in the project commenced with considerable capital being deployed. To date, in net present value terms, the transformation project has cost approximately £1bn of investors’ money. That capital was committed by shareholders as a result of the long-term commitment from Government to allow an appropriately attractive long-term return.

The project has been a rare British engineering success story. Drax has fulfilled its side of the bargain, managing the project to time and to budget, delivering a strategically important asset for the UK economy. The Government has been delivered an enormous source of cheap renewable and dispatchable (i.e. where output is reliable and can be adjusted to meet demand – other sources of renewable energy, by the way, such as wind and solar, are not dispatchable!) energy.

By contrast, the Government has, in abolishing the Climate Change Levy, gone back on its commitment. Not for the first time (Drax has taken the Government to court in the past for trying to walk away from other forms of biomass subsidy commitment), it has pulled the rug from underneath the feet of Drax and its shareholders.

Whilst this is immensely disappointing and frustrating to us as investors in Drax, the broader implications of this move are even more disturbing. This latest example of back-pedalling demonstrates that Government believes that policy can be amended to suit changing political priorities without due consideration of the implications for the wider economy or, in particular, private capital funded infrastructure projects.

I have to conclude that the Government has either failed to understand the implications of this policy change or wilfully ignored the interests of capital providers in this vital industry. Long-term capital projects need consistency that extends way beyond the length of a political cycle.

Government should be working in partnership with the private sector and the investment community, to deliver positive long-term outcomes for the UK economy and indeed the environment. Yet, in this particular instance, it is probable that Drax’s shareholders would have been better off if the company had simply continued to generate power by burning coal.

If Government cannot be trusted to fulfil its long-term commitments then it will have to accept that it cannot rely on support from institutional investors. That would not be a good outcome for the UK economy.

What are the risks?

  • The value of the fund and any income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The annual management charge is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the fund’s volatility and increase the level of indirect charges to which the fund is exposed
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of investments to decrease or increase
  • The fund may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund, and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

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