30 Jul 10 Eddie's Blog Global

Funding Europe’s future

Last week in this column I spoke about the Supergrid and how it will bring revolutionary change to Europe in terms of the free trade of electricity, security of supply, clean sustainable energy and so on. That it will create a leading global position for Europe in the transition to a low carbon economy.

What I didn’t speak about was how this vast energy network will be financed.

The first question is how much will it cost. By 2050 Europe will need 50% of its energy from wind. The majority of this will be offshore. This means that somewhere between one million and 1.6 million Megawatts of offshore wind will have to be installed over the next forty years.

The total investment will be around £3 trillion and that is just the wind farms alone. Even if cost efficiencies and reductions mean 50% savings on this estimate, it is still a gigantic investment. It is however gigantic only when considered as an absolute figure.  If we were to build our 2050 electricity generation requirement with fossil fired and nuclear the cost would be in the region of £1.6 trillion.  However with the investment in fossil-fired plant you still have to pay for the fuel.  The cost of this fuel if it were based on oil at $200/barrel would be £1.6 trillion per annum.  Renewables substitute fixed cost for variable cost.

The Supergrid, with its HVDC cables and Supernodes which will transport the electricity to the customer, will cost another £600 to 800 billion. 

Barriers to investment

So how do we unlock the cash to fund this continental, bulk power resource at a time when Europe is slowly pulling itself out of the depths of recession?

The first point to be made is that the money does not have to be found today or tomorrow.  However, before anyone commits to investing, the framework for getting paid has to be proposed and agreed.

Right now  there’s a huge amount of regulatory and policy uncertainty.  The money will flow when the risks are identified, and the rewards are tailored to take the risks into account.  Just as wind and solar were incentivised to get them going, the early builders of, for instance, the first leg of the Supergrid, should be allowed, and be clearly seen to be making good money from the investment.

It’s about creating investor confidence in the immense opportunity this transition presents. There is nothing better to encourage investment than seeing the early mover do very well.

One key word is long-term. The long-term should flow from the short term in a seamless manner. There’s an intense debate taking place in the UK right now about the merits of a FIT (feed-in tariff) versus a ROC (renewable obligation certificate). This transition, if it is to come, must be managed so that confidence is not damaged and activity does not grind to a halt in the meantime. There’s a belief that by choosing the correct one, the proverbial investment gates will open and investor confidence will magically appear. I’m not so sure.

These support schemes have a vital role to play, but they are instruments with a specific task. We need something more fundamental.


It’s about setting out a clear vision for a low carbon Europe. And that vision must come from the top. Europe’s governments need to show the world that they are entirely committed to leading the global transition to sustainability. The first step is to translate that vision into ambitious targets, which is in turn supported by long-term policy and transparent regulations. This is where the short-term incentives come into their own. And incentives/arrangements upon which investments are justified must not be retroactively changed. That is worse than no incentive at all.

Chris Huhne recently called for a ten percent reduction to Europe’s 2020 emissions target – going from a reduction of 20 per cent to a reduction of 30 per cent. Backed by his German and French counterparts he said the global race to a sustainable low-carbon economy has begun and our economic competitors are not hanging back.  He rightly pointed out that the private sector will deliver the investment which will build this low-carbon future and moving to a more ambitious 30 per cent CO2 reduction target will provide greater certainty and predictability for investors – so that they can see the case to invest. Very correctly he is focusing explicitly on what it takes to get money into this space including the supply chain companies, who along with developers are the first to be faced with this investment decision.

The logic for the increased target becomes even more compelling when you consider the cost implications. Because of reduced emissions in the recession, the annual costs in 2020 of meeting the current 20 per cent target comes down from €70 billion to €48 billion. A move up to 30 per cent is now estimated to cost only an extra €11bn.

So much for costs, what about the benefits that are supposed to flow from this investment? The estimates here are usually cast in terms of the cost of not investing. Delayed action is expensive. The IEA estimates that every year of delayed investment in low carbon energy sources costs €300-400 billion at the global level. And this is based on the assumption that oil will cost US$88 a barrel in 2020. US$88 a barrel!

Would you invest in a business whose success depends on oil being US$88 a barrel in two or five years, never mind ten years from now?

As an investor, I have put my money on renewables. Rising oil prices will lower the opportunity costs of reaching these targets and the direct economic impacts of hitting the 30 per cent target by 2020 can actually turn positive. Stern took the wider view and his conclusion was the whole thing was an investment no-brainer.  Chris Huhne pointed out that when oil reaches US$130/b the transition to a 30 per cent reduction in CO2 emission pays for itself. 

With wind in Northern Europe the fuel source is free. The more wind we deploy, the less fossil fuels we need to import and burn, the less supply and price risk the customer is exposed to, and  the cheaper our electricity becomes.

Swapping uncertainty for certainty

With the Supergrid, Europe will swap the uncertainty of a fossil fuel future for the certainties of secure, clean and ultimately cheaper electricity.

In a fossil fuel future, the risks to electricity supply are geo-political, physical, environmental and economic. The risks include the malign or perverse policies of energy-rich neighbours, and in an extreme scenario, the threat of resource wars and all that this entails.

We are swapping political, economic and environmental risks for a set of new risks associated with the weather. The Supergrid, because of its length, spanning as it will 5,000km, smoothes out local variations in wind output.  So weather risks are hugely minimised.

As the offshore wind industry evolves, investors will become more confident with the technology. Until that happens the bond market has a significant role to play in bridging the gap between investor confidence and the deep pools of cash needed.  The Moyle interconnector between Northern Ireland and Scotland is a good example. It was funded entirely by debt in the form of credit enhanced bonds. Because credit enhanced bonds are guaranteed by the government, there is no perceived risk by investors – their cash flows are guaranteed. The route mooted by OfGem for funding the investment in Smart Grid is to levy electricity consumers’ bills – the people who will benefit from the investment. This is an alternative source of credit enhancement for bonds funding Supergrid and any other necessary investment in our electricity infrastructure. It is the customer who will pay so it behoves policy makers to organise matters for maximum efficiency in delivering that infrastructure.

So to summarise, I believe Europe’s governments need to come together, create and adopt a united energy vision. It needs to be ambitious, it needs to be as integrated as the electricity system it is facilitating, and it needs to happen fast.  As we’re languishing in the slow lane, China and India are starting to take first place in a race we once led.