By Gerard Wynn
LONDON May 3 (Reuters) - Policymakers around the world are turning to the private sector to finance a massive expansion of electric grids and Britain's experience in funding offshore wind projects holds lessons on consumers over-paying as a result of competitive tenders.
Countries globally are seeking to expand transmission capacity, to connect more remote renewable power; link networks across wider areas to boost stability; and in emerging economies draw more customers to the grid.
The International Energy Agency estimates some $7.2 trillion of grid investment is needed globally through 2035, in its latest World Energy Outlook, which is comparable with that required in power generation.
Grid investment requires government intervention, given its massive scale and non-market public benefits for example to boost security of supply or cut carbon emissions.
Policymakers are turning to private sector finance, funded by levies on consumer electricity bills, against a backdrop of tight fiscal policy, and to pension funds in particular given a pullback in bank lending and a perceived fit with their long-term liabilities.
The U.S. Mid-Atlantic and Midwest electric grid operator PJM Interconnection this week opened a new process to allow utility and non-utility competitors to propose how to meet power system needs in specific areas.
That competitive approach was prompted by the U.S. Federal Energy Regulatory Commission's (FERC) Order 1000, which allows operators to use bidding to solicit investment in big projects.
Britain has lessons on how to avoid over-payment by consumers after criticisms of its regime for public contracts for offshore wind transmission.
UK OFFSHORE WIND
Britain is hoping offshore wind will supply a large portion of its low-carbon electricity commitments under European Union renewable energy targets in 2020.
As of the end of 2011, the country had installed 1.8 gigawatts (GW), up 37 percent on the previous year, according to statistics from the Department for Energy and Climate Change (DECC).
DECC's "UK Renewable Energy Roadmap" in July 2011 forecasts a "central range" for 11-18 GW by 2020. (See Chart 1)
Britain's National Audit Office estimates the associated undersea cables would require investment of 8 billion pounds ($12.4 billion) through 2020.
To raise the required funds, Britain has implemented a competitive licensing regime where investors bid for ownership of the cable connection.
Bids are based on annual revenue requests which reflect their estimated cost of financing the cable acquisition or construction plus operation and maintenance.
Costs are ultimately passed to consumers through the grid operator National Grid via electric utilities and wind farms which pay for transmission. (See Chart 2)
That contrasts with most EU countries which have left responsibility for connection to the grid operator, as in Germany where disputes over liabilities arising from late cable construction have held up development.
EU rules require separate ownership of generation and transmission assets, meaning offshore wind farms cannot own the subsea cable.
Chart 1: (page 45)
Chart 2: (page 17)
Chart 3: (page 22)
Chart 4: (page 12)
Advisory firm KPMG last December published a detailed review of the British regime for investors, "Offshore Transmission: An Investor Perspective", commissioned by the regulator Ofgem.
KPMG pointed out the low risk and particular benefits, for example compared with onshore transmission investments and public-private partnership projects (PPP).
"The evidence to date suggests that OFTOs (Offshore Transmission Owners) offer strong returns relative to comparable asset classes with similar risk profiles," it said, in comments which perhaps should have alerted the regulator that the scheme was too generous to investors.
KPMG noted attractions including: a 20-year, inflation-linked revenue stream; rewards for over-performance; penalties for under-performance capped at 10 percent of revenues; and zero exposure to the wind farm's performance (no construction risk).
The scheme has transferred risk to consumers who will be left nursing the full cost if a wind farm fails, is barely used, or if inflation spikes.
The aim appeared to be to attract competitive bids by capping risk.
The tenders have attracted a range of bids but the KPMG study shows that just two firms (Blue Transmission and Transmission Capital Partners) have won nine out of 11 tenders as of last December, for assets worth 1.36 billion pounds. (See Chart 3)
The idea of full inflation index-linking was to entice pension funds which seek revenue streams to match their rising liabilities.
As of December, the UK regime had attracted some pension fund investment directly or indirectly: AMP Capital is an Australian pension provider while some of the other equity sponsors have pension fund investors.
But full index linking was over-generous, according to the National Audit Office (NAO), which advises on value for money in public spending, given that the main ownership cost is financing which is fixed from the outset. (Chart 4)
Returns achieved in early projects were up to 11 percent, exceeding PPP projects, according to the NAO report published last June, "Offshore electricity transmission: a new model for delivering infrastructure".
Parliament's public finance advisors, the Public Accounts Committee (PAC), was more critical.
"The terms of the transmission licences awarded so far appear heavily skewed towards attracting investors rather than securing a good deal for consumers," it concluded in a report in January.
It suggested possible changes which will provide a check list for similar regimes to deliver value for investors while not demanding consumers bear all the risk.
These included: higher penalties for under-performance; shorter licensing periods than 20 years; alternatives to full index linking such as flat or partially indexed revenues; transparency about actual returns; and a claw-back process to share gains where these were excessive.