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[00:00:07.930] - David Brett
Welcome to the Investor. Download the podcast about the themes driving markets and the economy now and in the future. I'm your host, David Bret. Energy security and meeting net zero targets remain a big concern for consumers and policymakers. Ambitious targets have been set. And with the war in Ukraine still raging, there's no guarantee that energy prices, which have fallen in recent months, will remain suppressed. Attempting to meet the challenge of providing energy security and meeting net zero targets are companies like electricity generator RWE. As well as helping to keep the lights on, they want to build new facilities that provide cleaner energy, which is secured locally and at lower costs.
[00:01:00.330] - Tom Glover
We've just had a period of some of the highest energy prices and actually renewables and low carbon generation is the way through that.
[00:01:07.450] - David Brett
That's tom Glover, UK Country Chair of RWE.
[00:01:11.230] - Tom Glover
The more investment we get, the more access we get to low carbon, low cost generation. And so we kind of, as an industry, want to get on with it.
[00:01:18.380] - David Brett
The UK's net zero plans are ambitious.
[00:01:21.490] - News clip
The British Government has released a raft of policies today, all aimed at hitting ambitious carbon reduction targets. That means decarbonizing the way we heat our homes. So there's a £450 million pound fund to help people switch from gas boilers to low carbon alternatives like electric heat pumps. Transport is also a big emitter, so the government will invest £620 million pounds in grants for electric vehicles and street charging points, alongside other investments in hydrogen and aviation fuel technologies. And of course, all this electricity we're going to be using has to be clean or there's no point. So the UK has now committed to delivering exactly this by 2035.
[00:02:04.070] - Tom Glover
Okay, you've got in legislation, the economy needs to get to net zero by 2050. That's a legally binding target. Within that, the Committee on Climate Change, the Government are all planning to try and get to a net zero electricity system by 2035. In reality, that's not a legal target, but that's pretty much where everybody's heading and everybody is actually aligned within the UK electricity sector. We all think it's doable and we're all kind of heading that direction, subject to government support and public support.
[00:02:32.660] - David Brett
A big part of that decarbonization process is generating power from clean and renewable sources. And RWE has a big role to play. It is the UK's largest power generator, responsible for 15% of the UK's electricity. All of which will need to be decarbonized if the UK is to meet its targets.
[00:02:52.940] - Tom Glover
About a 15 billion in the UK by 2030 we're planning to invest. That's a lot of capital to deploy as a part of the billion, hundreds of billions that we need to deploy. But our role is to do the offshore wind, to do the onshore wind, to do Solar, one of the largest solar developers as well, but also to kind of decarbonize our current gas fleet.
[00:03:11.930] - David Brett
But that's just the tip of the iceberg. International Energy Agency figures suggest that going forward, post 2035, globally, over a trillion dollars investment a year will be needed to be directed into renewable deployment. And more than that, an equal amount will be needed to support the deployment of renewable generation on the grids to decarbonize the power sector, which enables the decarbonization of the transport sector and longer term, the heating sector. The problem is, just at the time when plans need to be accelerating, that support from policymakers appears to be fading.
[00:03:47.250] - News clip
Now, the UK's climate watchdog has warned the Government that they've been too slow in addressing the challenges of climate change and will need to invest billions of pounds to prepare for the impacts of a warming climate.
[00:04:00.900] - News clip
The UK's International Environment Minister, Zach Goldsmith, has resigned from his position. He has accused the UK Prime Minister, Rishi Sanak, of being uninterested in climate change.
[00:04:11.970] - Tom Glover
I think most people, now, the vast majority of people understand the need to address climate change, but they don't necessarily think it should be done in their backyard. So that is a little bit of a difference of and you need kind of engagement of politicians in that discussion. That honest messaging, you can't have everything. So I think that isn't happening. What's also not happening is... there's a lot of discussion, there's a lot of bodies involved to get this sorted out. And in order to really do it, you need to make it your number one priority. And it's not clear that it's the Government's number one priority at the moment.
[00:04:43.040] - David Brett
The challenges facing decarbonising the UK's energy grid, that's coming up in the next part of the show.
[00:04:47.790] - Announcer
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[00:04:55.790] - David Brett
Other than the political discord, sufficient network capacity and timely grid connections are the two other major barriers to deploying low carbon generation, according to many, including Glover. Current peak power demand in the UK is about 50 to 55 gigawatts. That's expected to double by 2035. But there's plenty waiting in a queue to be connected to the grid.
[00:05:20.910] - Tom Glover
I mean, there is over 300 gigawatts of projects in the queue and even in the most ambitious growth estimate of electrification, that seems a little bit too much. So providing the power needed through clean energy sources shouldn't be an issue. However, connecting those power sources to the grid is. Some estimates put the wait times to connect these low carbon energy projects to the electricity grid up to 14 years, which takes them beyond the UK's 2035 target. Perhaps gallingly. 70% of those schemes never connect to the grid at all. And more than half of those projects in the queue have had to wait five years or more to be offered a connection date.
[00:06:02.070] - Tom Glover
And if you just look at the pipeline on everybody's projects, we're looking at three to five years delay on almost all projects, whether that be solar, CCUS or offshore. Purely because of grid deployment. So that's three to five years. You're waiting for those billions of pounds of investment, you're waiting for those lower power prices, you're waiting to decarbonise.
[00:06:20.260] - David Brett
CCUS is carbon capture and underground storage, which involves capturing carbon dioxide at emissions sources, transporting and then storing or burying it in a suitable deep underground location. However, back to Grid connection, whose wait times have been described as a national scandal and the greatest obstacle on the path to net zero, according to Nick Windsor, Electricity Networks Commissioner, in a review of the UK's Grid system. National Grid, which is the UK's major grid operator, has come up with a five point plan to speed up connections. Part of that plan is to get a large proportion of those 70% of projects that will never connect to the grid out of the queue with no penalties. But Glover also believes investors have a big role to play too.
[00:07:13.370] - Tom Glover
The best person to determine whether a project is good or not is the person who owns the project. They know whether it's a good project, they know if it's in a windy location, they know whether it's big enough to get to low capital and so there, you know, how much they're prepared to pay to keep that project going. So we would call for higher and earlier liabilities for Grid to self sort the queue, but we would also look at a more commercial approach and can you buy or sell or trade grid connection in the queue? So we'd look at that and also we would think we should look more option at like sharing connections.
[00:07:46.460] - David Brett
While sorting the connection queue is a top priority, glover believes a stronger message needs to be sent from the government to keep everyone on track.
[00:07:54.730] - Tom Glover
Now, I think it has to start, it starts with the government and it starts with messaging that decarbonisation is the challenge of our age and getting to the climate change. And we do have to take compromises, so we have to accept we're going to need to build some stuff, whether that be wires or wind farms or solar farms, as we need to get the public to understand it's better to build that stuff than have climate change. That's kind of like the kind of political messaging that will enable us then to do the planning reform and allow us to basically get better planning rules to enable us to build more wires and do more wind farms, do more solar farms. And then when you've got that kind of sorted, then we need the government framework and the market framework to keep on going so we can roll it out economically, so that it's not only economic for us to invest, it's also cheap for the consumers.
[00:08:39.740] - David Brett
And once the framework is in place and the public understands that the infrastructure needs to be built because it makes sense cost wise, security wise, and because of climate issues, glover says the industry and policymakers need to attack the problem, like the government and telecoms firms did with broadband.
[00:08:57.430] - Tom Glover
There's so many studies now available that building grid is almost a no brainer, right, because almost every study says building grid is much better than constraint costs. So actually, the way I always put it, it's really simple. I kind of go, you did broadband. When we did broadband, we decided everybody wants to get ultra fast. We didn't look at individuals and go, oh, Mrs Smith's 80, she's not going to use it. We just went, right, we're going to give everybody ultra fast. Well broadband and that technology is only good if you've got good electricity systems. And so the electricity system is the underpinning of the whole economy. And so, really, we should basically think about, like, broadband and just say we want ultra high capacity network everywhere. And I think that's probably going to be pretty much a no regrets option.
[00:09:41.180] - David Brett
However, increasing costs is causing havoc for industry players. Shares in the world's largest offshore wind company, Orsted, tumbled by nearly a quarter after it said it may have to write down the value of its US portfolio by nearly 2 billion pounds. The Danish firm's issues include soaring costs in its supply chain, echoing problems cited by Swedish rival Vattenfall, which suspended a giant British offshore wind farm project off the coast of Norfolk last month. Compounding issues for the clean energy rollout is a reduction in UK government subsidies, which is making the industry less attractive for investors. That impacted the number of bids in the most recent auction for offshore wind licences, which resulted in no offshore wind project bids being accepted.
[00:10:31.730] - Tom Glover
We have seen an increase in project costs of somewhere between 20 and 40%, driven by a variety of factors, whether that be inflation, whether it be commodity prices, supply chain prices, general unavailability, the fact that a lot of the OEMs aren't making money and therefore need to at some point start making money. So we have seen that 20% to 40% increase. We've actually seen a reduction in what's called the administered strike price, or the maximum price you can bid in offshore wind. So the two things don't match. The industry has been very vocal to the government about this and said, this is a problem and that's not good for the offshore wind industry.
[00:11:08.990] - David Brett
But the UK's connection issues and the lack of strong leadership on clean energy adoption from the government is impacting the country's attractiveness to investors, which is further inhibiting the clean energy rollout.
[00:11:20.690] - Tom Glover
One or two years ago, we kind of put the UK as best in class, the best place to put RWE investment, I would say it's gradually moving down the table, it's still top table. It's a great place to invest, the UK generally in terms of investment rating and say the place to do business, regulatory framework, principle of grandfathering, et cetera. So it's generally a great place to do business. It's just going down the table a little bit. And that's a combination of a few things. There's a lot of government interventions like the electricity generators levy, things in the energy bill that hang over our business, the uncertainty about future legislation and policy through the review of electricity market arrangements, these are all uncertainties that sit in our business. Meanwhile, they're kind of like the competitors. So under the EU Green deal, under the Inflation Reduction Act in the USA, they're giving more and more incentives to go. And it is a global competition because the supply chain is squeezed.
[00:12:14.690] - David Brett
What that means for investors investing in the clean energy sector, that's coming up in the final part of the show with fund manager Ashley Thomas.
[00:12:23.720] - Announcer
Get in touch with us by email at firstname.lastname@example.org or visit our website schroders.com/theinvestordownload.
[00:12:35.540] - David Brett
So Ashley, welcome back to the show. I know this subject is close to your heart. It's something you're really enthusiastic about, but I just want to pick up on the very last point that Tom made. How concerned should we be that the UK seems to be falling down that league table of countries that you might want to invest in in the clean energy projects?
[00:12:56.210] - Ashley Thomas
Well, you have to give credit to the UK for what it's achieved to date. It's decarbonized its power sector faster and to a greater degree than many of its European counterparts, in part because it's developed a leading offshore wind market and its contract for difference subsidy regime was reviewed as a gold standard when it was introduced back in 2014. However, life moves on. Other countries catch up. In the most recent Renewable Energy Country Attractiveness Index, it's the United States and Germany that are at the top of the table, with the UK in fourth place, and it used to be in third place last year. And for hydrogen, the UK has fallen six places from second to 8th over the past two years in the Energy Network's International Hydrogen Progress Index, with again the US and Germany improving their ranking. In addition to potentially impacting the pace of decarbonisation, there's a potential cost, whether it's in the opportunity to establish leadership in new industries such as carbon capture and storage, or if there's policy uncertainty or issues with the regulatory framework in a higher cost of capital being applied which can feed through to the end costs for consumers.
[00:14:16.050] - Ashley Thomas
We're recording this show a few days before the result of the UK's annual CFD Renewable Auction, Auction round five. And given the government's ceiling price doesn't really reflect the increase in costs that offshore wind projects have recently experienced, I suspect it's unlikely that many large projects will progress in this round, which may then have an impact on the UK supply chain.
[00:14:40.390] - David Brett
Yeah, that seems a bit of a shame, really. It seems almost like a snowballing effect, especially when you mentioned Germany and the US. The US have just had the inflation reduction act. Germany is obviously part of the EU. The EU's got the green deal. Is there any way that the UK compete with those sorts of legislation, or should we be doing something similar in the UK?
[00:15:02.050] - Ashley Thomas
It's impossible for the UK to compete with the scale of the Inflation Reduction Act. I think we also have to recognise the UK is ahead of the US in its decarbonisation journey. However, if we compare the UK with Europe, I think there's been a difference in how the carbon tax revenues have been utilised, with an element of those funds directly contributing to schemes in the EU, such as the Innovation or Modernisation Fund, where there isn't any direct hypothecation for the UK Emission Trading Scheme revenues. I think one of the most powerful tools the UK government could produce would be stability and certainty. In general, the cost of capital has increased as risk free rates have increased. That's been a global effect. But if uncertainty adds an additional layer to the cost of capital, it could shift where capital is being deployed or impact the cost benefit analysis of policy changes.
[00:16:02.310] - David Brett
You mentioned the UK was ahead of the US in its decarbonisation journey. Does that mean, along with, obviously, the Inflation Reduction Act, does that mean that you, as an investor in the net zero theme, does that mean you're casting your eye abroad and away from the UK more and more?
[00:16:19.850] - Ashley Thomas
The decarbonisation theme is global, and given the size of the market and stimulus from IRA, there is a lot of focus on the USA. IRA itself has had a more limited impact on the integrated utilities than on pureplay renewable developers, although there is still similar support on their renewable pipelines, hydrogen and CCS projects. However, I think IRA will place increased focus on the need to invest in the US transmission system. In the US, it's only grown by one to 2% over the past few years, but this pace needs to at least double going forward. There's a Princeton report that suggests that up to 80% of the potential decarbonization benefits of IRA in 2030 could be lost unless the investment in transmission materially picks up. We also discussed the relative attractiveness of the UK earlier. One of the attractive elements is the inflation linked or real return framework, but this is also replicated in countries such as Italy, France and a number of Latin American markets.
[00:17:33.830] - David Brett
And you say that the decarbonisation theme is global. How has this theme affected the way that investors... Because usually from an investor's point of view, utilities can be said to be quite boring, they're just stable give a certain return. Has anything changed now with all this net zero targets?
[00:17:52.240] - Ashley Thomas
Well, I think stable, dependability does have attractive characteristics in itself, but you're right, the sector is viewed as a bond proxy, so with other cash flows that are discounted back, there's sensitivity to risk free rates as they rise. However, for regulated companies, this does eventually get reflected in higher allowed returns. I think the two key factors that result from net zero targets are firstly, a step up in the rate of investment and therefore asset based growth, historically, from low single digit growth to high single digit or even double digit growth. And secondly, a recognition of their role in supporting climate change mitigation or adaptation, which is being recognised in the reporting of their taxonomy alignment, particularly the proportion of their investment, which is aligned with, say, the EU taxonomy of sustainable activities.
[00:18:55.200] - David Brett
Okay, so I mean, just to sum things up, we have seen some negativity around the UK, but from what you're saying, it's actually not all as bad as maybe some of the headlines we've seen in the papers over the recent few weeks and months make it out to be.
[00:19:07.390] - Ashley Thomas
Yeah, I think broadly, the framework is still a top ten framework for investing in low carbon technology. However, other countries have accelerated their position and I think particularly for long term investors, a degree of policy stability and certainty would be welcomed.
[00:19:30.400] - David Brett
Excellent Ashley Thomas, thanks so much again for joining us.
[00:19:33.030] - Ashley Thomas
Thank you, David.
[00:19:35.190] - David Brett
Well, that was the show. We very much hope you enjoyed it. If you want to find out more, please head to Schroders.com/insights and we're endeavouring to record as many of these shows in the studio on video. And if you want to watch them in their full, unabridged version, then go to Schroder's YouTube channel. If you want to get in touch with us, it's Schroder's email@example.com. And remember, you can listen, subscribe and review the investor download wherever you get your podcasts. New shows drop every Thursday at 05:00 p.m. UK time. But above all, keep safe and go well. Cheers.
[00:20:11.490] - Announcer
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested. Past performance is not a guide to future performance. The information is not an offer, solicitation or recommendation of any funds, services or products, or to adopt any investment strategy.