“Vertical disintegration” sounds not entirely unlike the “conscious uncoupling” euphemism used by celebs Gwyneth Paltrow and Chris Martin to describe what those unfamiliar with New Age wisdom may instead refer to as a split-up or divorce. Indeed, splitting up is precisely what vertical disintegration also implies. In the UK energy context, it means companies no longer being able to own both the supply arms, which sell power to consumers, and the generation units, which own the power plants.
The issue is topical because of UK energy regulator Ofgem’s announcement last week that it intended to place a market investigation of the sector in the hands of the Competition and Markets Authority (CMA). In a statement, Ofgem said it hoped the investigation – prompted by claims of consumer mistreatment at the hands of the “big six” energy companies – would “once and for all clear the air” and “complement our reforms for a simpler, clearer and fairer energy market”.
Some of the “big six” appeared happy with this outcome (remembering, of course that appearances can be deceptive). E.ON UK chief executive Tony Cocker, for example, said the investigation was “the only way to restore full public confidence to the energy sector and depoliticise the whole issue”.
Vertical disintegration, meanwhile, was addressed by fellow big six firm SSE in a timely announcement that it would split its retail and wholesale activities just a day before the Ofgem referral (together with a promise to freeze household energy prices until January 2016).
For infrastructure investors with an appetite for generation assets, the prospect of vertical disintegration in theory presents both opportunity and threat. If the energy companies conclude that they will be forced to sell generation assets, many of them may end up in the portfolios of funds and institutions. But it may take some time before the assets change hands – before which, there would likely be a fallow period in which the energy companies (and would-be fund/institutional co-investors) may well shy away from investing in assets they won’t get to hold for the long term.
Looking more broadly at the impact of the referral on investor sentiment, it seems bound to have a negative effect on the perception of regulatory risk. Sources canvassed by Infrastructure Investor say this risk is being factored into pricing today to an extent not seen before in the UK. Added to the protracted implementation of electricity market reforms arising from the 2012-2013 Energy Bill, the status of the UK as an investment “safe haven” for core infrastructure investors appears increasingly questionable.
Further uncertainty surrounds what will happen if the May 2015 general election delivers a Labour government committed to a 20-month energy price freeze and hinting strongly at the abolition of Ofgem and its replacement with a new regulatory structure. One question occupying minds is whether Labour would wait for the CMA review findings to be published (expected in 2016) before pressing ahead with their own plans.
For the coalition government trying to balance the promotion of investment and supply security with the need to address consumer anger over rising prices, Ofgem’s latest move is unlikely to provide a squaring of the circle. “The inquiry will not be a magic bullet to deal with the conflicting agendas pulling the government in different directions,” Mark Jones, a partner in law firm Hogan Lovells’ antitrust, competition and economic regulation practice, told us recently.
Call it uncoupling, disintegration or another word of your choice: the strains on the relationship between investors and the UK energy industry are becoming increasingly evident.