Regulated assets could provide UK investment stimulus

Whilst many businesses have been significantly damaged already, the various government stimuli across the globe have gone some way towards averting some of the worst economic effects of the coronavirus pandemic. What industry and businesses need now are clear and consistent policies which set a visible path back to sustainable trading and investment.

Government-led investment in infrastructure is needed not only to improve our public and critical assets, but also to transition to the use of ‘smart’ and low carbon assets which can meet the UK’s 2050 net zero target. In this context, the government could make greater use of the regulated assets we already have to attract continuous investment in a foreseeable pipeline of work by the private sector.

What is regulated asset financing?

Regulated asset financing refers to the use of a regulated ‘public’ asset and its associated income stream to secure private finance. Examples include numerous financings of offshore wind transmission cables and infrastructure and L&G’s financing for Mutual Energy’s Gas to West gas network expansion project in Northern Ireland. On a vastly different scale the Thames Tideway Tunnel, London’s new 25km ‘super sewer’, was used as a regulated asset to secure finance for the project.

In each case, the principle is to use the income stream from customer bills paid for the use of public infrastructure to underpin a financial model which can attract private finance.

Last year, the UK government consulted on the use of a regulated asset base (RAB) model for nuclear projects. The findings from that consultation are awaited. This consultation was originally going to be followed by a consultation on a RAB backed financing model for renewables and low carbon energy generating assets. However, that consultation seems to be on hold. A similar consultation on carbon capture and storage (CCS) ran last year, and the outcomes from that consultation are also awaited.

According to the University of Cambridge Faculty of Economics, both nuclear and CCS projects are ideal candidates for the use of the RAB model. Both types of project “have long lifetimes over which to recover their capital cost, longer than commercial finance would accept without guarantees, in contrast to renewables where off-take contracts have proven sufficient”. Whilst they identify specific benefits of regulated asset financing for projects with these characteristics, there is no reason to limit it to them, as what has previously worked for other assets may no longer be seen as a viable financing structure.

Beyond low carbon energy generation

In the current, very challenging, circumstances as the economy seeks to recover from the impact of Covid-19, it would be hugely encouraging for some of these possible futures to take shape and for new markets to be created. The government can take a bold lead in setting a road map for regulators to implement. While most of the existing examples are in the context of low carbon energy-producing infrastructure, there is no reason why regulated asset financing could not be rolled out to any ‘public’ asset where there is a financeable revenue stream, through a coordinated approach by the government and the applicable regulatory body.

In the water sector, Ofwat has introduced a model called direct procurement for customers (DPC). This model invites investment in new or upgraded infrastructure by the private sector outside of the water companies’ regulated business activities, and uses specific revenue from customer bills to underpin the financing required to build, operate and maintain the new assets.

Two early candidates for DPC projects are United Utilities’ Haweswater Aqueduct Resilience Programme (HARP), upgrading the 109km aqueduct to ensure the resilience of supplies of drinking water to Manchester and the Pennines; and Southern Water’s new Fawley plant, required to address seasonal water shortages in the region. However, there are many more potential projects which may be agreed between Ofwat and the different water companies in England and Wales.

Each DPC project will have to pass Ofwat’s staged approval process, satisfying various control points to confirm that DPC, rather than ‘in house’ delivery by the water company, delivers the best value for customers. The private sector would bid for the project on the basis it raises the finance for the necessary capital expenditure for the construction phase, and customers would only pay for the asset from a set point in the process - normally once the operational phase begins.

During the late 1990s and early 2000s, the UK government created a predictable and consistent pipeline of public projects that attracted a huge amount of private investment. Some of that investment has since attracted its critics, and the search for the perfect delivery model continues - but what that investment programme did was to create a predictable market, which in turn generated a well-organised and committed supply chain of investors, constructors and operators that would be prepared to resource bids energetically. The result was healthy competition, projects achieving financial close and new public assets being built. If this kind of active market could be created for many more regulated asset financed projects, we could motivate an organised response from the private sector.

There is still time for interested parties to get involved in the new stream of DPC projects. HARP is scheduled to hit the market in March 2021, and Southern Water’s proposed DPC project should also take shape in 2021. The outcome of the consultation concerning the RAB for nuclear new build will become clearer in the coming months as will, hopefully, the similar process for CCS.

Hopefully these pathfinders will kick start a new stream of projects based on raising finance against revenue streams from regulated assets. It would also really help to see this happening as an integral part of a wider, clearer government policy, which signposts where the market should place its efforts.