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Politics could push up UK energy investment costs

Sarah McFarlane
Thursday, 21 Nov 2013 | 7:51 AM ET

* Opposition party to freeze energy prices if it wins 2015 election

* Investors could seek higher returns due to political risk

* Credit rating agencies say could downgrade energy companies

* Rating cuts could raise borrowing costs for energy projects

* UK needs 200 bln new energy investment by end of decade

LONDON, Nov 21 (Reuters) - The risk of political intervention in Britain's power market is threatening to push up the cost of UK energy projects at a time when the country desperately needs fresh investment to build new generating capacity.

In September, the opposition Labour Party shocked energy market investors with its plans to freeze energy prices until January 2017 if it wins the 2015 election.

Labour also said it wanted a complete overhaul of the wholesale market, forcing generators to pool their energy so any buyer can access it.

The announcement by party leader Ed Miliband, coupled with a string of big - and deeply unpopular - energy tariff increases from the country's biggest utilities over the autumn, ensures energy will be a prominent issue in parliamentary elections due in 2015.

Latest polls show Labour would come out on top in a public vote.

"The perception of political risk for upstream parts of our business has increased over the last few weeks," said Tony Cocker, chief executive of E.ON UK, one of the "big six" energy companies operating in Britain.

"To me it's not nearly so much (a question of) 'Would we invest?', as 'What's the cost of capital?'," he said at an industry conference last week.

Britain requires 200 billion pounds of investments in its energy market until the end of the decade to replace ageing and polluting plants, or blackouts will arise as demand comes dangerously close to available production capacity.

Roland Vetter, head of research at CF Partners, an advisory, trading and investments firm, estimated that the required return on investments (ROI) for new UK conventional generation is about 10 percent, but that could rise due to perceived political risk.

RISK TO BORROWING COSTS

Credit ratings agencies say increased political risk has also made energy companies vulnerable to rating downgrades.

"The current political and regulatory uncertainty, including the potential for a price freeze or other market interference, has put the UK's safe haven status at risk and might cause us to revise upwards our view of business risk for the UK power sector," said Mark Davidson, a director in the corporate ratings department of Standard & Poor's.

"Ultimately, this could have a ratings impact."

If a company's credit rating falls, it can cost more to borrow money to finance a project.

Ratings agency Moody's said in a note on Thursday that any government move to freeze bills would also increase the perception of political risk and thus the cost of capital, which would be "credit negative".

Shares in Britain's two biggest listed utilities companies SSE and Centrica have lost over 10 percent of their value since Miliband's statement, for fear that their margins could be cut.

"Our analysis reveals the UK utilities, particularly SSE plc (A3 stable) and Centrica plc (A3 stable), to be most at risk of political interference," Moody's said.

NERVOUS FOREIGN INVESTORS

Potential for government intervention could also prompt foreign investors to consider alternative markets to the UK for future investment.

InterGen Europe, which is planning to build two new gas-fired power plants in Britain over the coming years, has two large foreign investors; OTPP (Ontario Teachers' Pension Plan) and China Huaneng Group/Yuedean.

"They'll look around the world and judge which markets and which geographies they feel comfortable investing in," said Mark Somerset, vice president of InterGen Europe.

"For the global investment community, the price freeze announcement has probably made investors a little bit more nervous about the UK."

A recent deal between the government and France's EDF to build a new nuclear plant in Britain included a clause that protected EDF from any political decisions that could threaten the operations of the new plant.

"I can understand if energy companies are suggesting that their investors need a higher return on equity if they're investing in the UK," said Alan White, senior director for Infrastructure and Energy Finance at Lloyds Bank Commercial Banking.

"Whether they be Spanish, German or French, they're all going to be looking across and asking should they be looking at the UK as somewhere that needs a higher return for them to justify to their shareholders the investment that they're being asked to make?"