Building an offshore electricity network may be the biggest infrastructure project the UK has seen since the building of the railways. It will transport 15% of the UK’s electricity supply within a few years and, in the longer term, will connect the UK, Germany and the Netherlands in a new North Sea grid. The commercial framework designed to stimulate the building of this network (OFTO) has just been subject to a highly critical report by the Public Accounts Committee.
The committee concluded that the first four OFTO licences were bad value for money for a number of reasons including:
- Revenues are fixed for 20 years without review, regardless of whether assets are being fully used.
- The penalties for not delivering are considered to be too low – they are limited to 10% of expected revenues in any one year.
- Any profits from refinancing on better terms are kept by the OFTO and not shared with government.
Taken in isolation these sound like fundamental concerns and, indeed, the UK could have chosen a much simpler system in which National Grid builds and operates the system. But it didn’t. It chose a system designed to encourage competition and the paradox is that, within the OFTO framework, the committee’s recommendations are actually likely to increase costs to consumers. Perceiving higher political risk, investors will raise the cost of capital. This illustrates a common problem for policy makers: the trade-off between flexibility for government and certainty for investors. The current system is weighted to investor certainty, but this is deliberate. Investors are not yet used to financing the offshore grid and are nervous about the risks. The case for increasing regulator flexibility will be stronger once we have a more mature market, but to do it now would risk stalling the programme.
Unfortunately the committee’s report does not take the early stage of the construction cycle into account, and neither does it follow through its own logic by proposing an alternative regime. UK infrastructure procurement could be smarter, but fundamentally changing the model at this point is not a wise choice. The good news is that the early UK investment is stimulating a strong offshore wind industry, and we are already generating more power at sea than any other nation on earth.