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.