Delivering progress through quality

The evolution of the energy debate: what next?January 2015

Contents

Foreword 4

Introduction 5

Market overview: key developments 6

General election 2015 12

Commentators 14

What next? 16

Conclusion 17

Moving forward 18

Bibliography 19

In a sector that is constantly changing, so are we.

Foreword

Adam Lovell Editor, Yorkshire Business Insider

Welcome to Watson Burton’s energy sector report 2014/15, I am very honoured to have been asked to introduce this publication to you. Earlier this year, Watson Burton was one of the headline sponsors for our Invest Humber Energy Breakfast. The event brought together business leaders from across the UK to debate how the Humber region could build upon the optimism and confidence generated by the vast swathes of private sector investment across the last year. But it’s not just the Humber region, nor even Yorkshire, which is seeing increasing developments in the energy sector. Across the UK, businesses and organisations are reaping the benefits of a changing landscape in the energy sector.

As renewable power accounts for an even greater share of our electricity needs year on year, together with a greater focus on the wider energy mix, it is easy to see why the UK, and in particular the north of England, is marked out as a prime strategic hub in the global renewables industry. Businesses of all sizes are preparing to capitalise on a resurgent energy industry, the future is certainly shaping up to offer increasingly attractive opportunities.

Our breakfast seminar tackled a range of topics which are addressed in this report, including leadership, skills, education and the need for a commitment from investors.  It is pleasing to see companies like Watson Burton – as specialist advisors to supply chain companies – put itself and its energy team into the debate, enabling knowledgeable and responsive support to businesses both already in the sector, and those trying to break into it.

Businesses of all sizes are preparing to capitalise on a resurgent energy industry, the future is certainly shaping up to offer increasingly attractive opportunities.

IntroductionThis report presents a follow-up to Watson Burton’s energy sector report 2013/14. This year, we consider the evolution of the energy debate, and ask the all-important question – what next?

The Energy Act 2013 came into force to establish a legislative framework to deliver secure, affordable and low carbon energy. This coupled with the UK government’s aim to reduce carbon emissions by 80% on 1990 levels by 2050 has seen renewable power generation gain a strong foothold as part of the energy mix.

Whilst energy strategy can often be used as a civil football by political parties, it is clear that the three elements of the ‘energy trilemma’ (security of supply, reduction in emissions and affordability for the consumer) are a matter of national importance.

Since our previous report, the past 12 months has seen significant investment in energy developments across the UK. It is an exciting time for businesses involved in the sector, and an exciting time for those of us that are involved in the supply chain.

Interestingly, five years ago the conversation would have centred on the need for decisions and action. Remarkably, current debates seem to prioritise logistics and practicalities.

Watson Burton is proud to be pushing forward the evolution of the energy debate. This document presents key developments in the market, examines practical issues surrounding the current industry and looks at the potential impact of the general election in 2015.

At the end of this report we outline some ‘next steps’ which we will be facilitating. If you are interested in being involved, please contact me directly.

Christopher GrahamPartner and head of energy at Watson Burton LLPchristopher.graham@watsonburton.com

0845 901 2033

5

Wind

The 2014 State of the Industry report by RenewableUK in October showed that the wind industry is now a key contributor to the energy mix. Out of the 14.9% of the electricity generated by renewables in the UK, onshore and offshore wind accounts for just over half. Wind energy is playing a key part in helping the UK government to realise its goals of shifting to a low carbon economy, but at the same time continues to remain vulnerable to dramatic shifts in government legislation.

More than 15,000 people now work directly for the wind industry across a wide range of professions.

October 2014 was a record-breaking month for wind energy, which hit a record high providing 24% of the UK’s electricity needs on 20th October. A new peak half-hour was also broken numerous times with a high of 8,100MW, enough to power the equivalent of 17 million homes at the time of generation.

Official statistics from RenewableUK’s report show that wind power generated more than nuclear for 11 full days during October.

Key developmentsLast year we produced our energy sector report 2013/14, which presented a range of statistics for the energy mix. This market overview examines key developments in the 12 months since then, in:

RenewablesThe general trend in the electricity mix, is a decline in the use of fossil fuels such as coal and oil, but a rise in the use of wind and solar and other renewables, such as hydro, bioenergy and landfill gas, for generating electricity.

Renewables accounted for 53.7TWh, or 14.9% of electricity generated in the UK in 2013. This is 3.6% higher than 2012 when renewables accounted for 41.2TWh. Overall energy (not just electricity) generated from renewables increased by 30% between 2012 and 2013.

Market overview

TWh: Major energy production or consumption is often expressed as terawatt-hours (TWh) for a given period that is often a calendar year or financial year. One terawatt-hour is equal to a sustained power of approximately 114 megawatts for a period of one year.

Renewable Electricity Generation, TWh

1990 2000 2010 2012 2013

Onshore wind - 0.9 7.1 12.1 17.0

Offshore wind - - 3.0 7.5 11.4

Solar PV - - - 1.4 2.0

Hydro 5.2 5.1 3.6 5.3 4.7

Landfill Gas 0.1 2.2 5.0 5.2 5.2

Other Bioenergy 0.5 1.7 7.0 9.8 13.3

Total Renewables 5.8 9.9 25.8 41.2 53.7

2000 2005 2010 20130

10

20

30

40

50

60

Electricity generation from renewable since 2000

Cont

ribut

ion

of re

new

able

s so

urce

sto

ele

ctric

ity g

ener

ated

(TW

h)

Offshore Wind Onshore Wind Solar PV Other Bioenergy

Landfill Gas Total Hydro

Note: Hydro bar includes shoreline wave/tidal (0.006 TWh in 2013)

• Renewables• Gas & Fracking

• Oil • Nuclear

Market overview

Bioenergy

Electricity generated from bioenergy increased by 24%, reflecting a UK government policy change which has encouraged coal plants to convert to burning biomass. Drax, based in Selby, North Yorkshire, is one of the main importers of biomass in the UK after it secured financing to enable a £700million investment plan to convert three out of six of its generating units exclusively to burning biomass rather than coal.

This development in policy has seen a huge increase in wood pellet exports from North America, however, according to a report from the Institute for European Environmental Policy (IEEP), there is a significant time lag between the carbon debt created when trees are felled to be burnt for energy, and the carbon reductions that fully grown trees planted in replacement will bring.

Solar PV

Electricity generation from Solar PV was up in 2013 by 51% on 2012 levels. This was largely down to the Feed in Tariff (FIT) scheme, which replaced the government grants for solar panels. Whilst the previous grant scheme only covered a minor percentage of the cost, FIT allows users to recover the full cost of installation, typically in less than a decade, as well as a return on investment of between 8-12%. On the domestic front, a recent study by the University of Durham as part of the Customer-Led Network Revolution (CLNR) project found that UK consumers with Solar PV technology are often too focused on the financial benefits of selling the electricity they generate back to the grid, when they could be using more of the power they generate to reduce their own energy bills.

7

The CLNR project and The Smart Grid Solution

The increased uptake of low carbon technologies such as electric vehicles and heat transfer pumps are central to plans by the UK government to reduce carbon emissions by 80% by 2050. However, UK electricity networks were not designed to support the increased demands.

The CLNR project, which is part of Northern Powergrid Limited, predicts that by 2030 there could be up to 10 million electric vehicles in use by UK consumers. If all of these users charged their vehicles at the end of the working day, the existing electricity network infrastructure would have to double in size to cope with this demand alone.

Northern Powergrid Limited is currently trialling new network technologies with the aim of creating a ‘smarter’ power grid which optimises power distribution and facilitates energy storage.

Gas and FrackingOne third of UK energy demand is met by gas. In 2012, around 25% of the gas used in the UK was to produce electricity, 23% by industry, 12% by services and 40% in cooking and heating. The government has forecast that with reduced coal usage over the next 15 years, gas from all sources will help to fill the gap alongside renewable and nuclear generated electricity.

In the past decade, North Sea production has declined to such an extent that by 2025 the UK expects to import close to 70% of the gas we consume, based on the assumption that it does not develop shale production.

The current government is in favour of developing the shale gas industry in the UK, on the basis that the country should build up its own gas reserves, reducing a reliance on gas imports in the future.

However the fracking technique which is used to extract shale gas has been a topic of much debate, in particular, the widespread public concern about the health and environmental impacts, with fears that the process could cause earthquakes, water contamination and air pollution.

New regulations and changes to the law are currently being considered by the House of Lords as part of the Infrastructure Bill. If successful, changes to trespass laws will mean that fracking companies could have the right to operate below properties without the need for permission from the landowner or homeowner.

Part 5 of the Infrastructure Bill had its second Commons reading in December and contains a number of proposals to assist with shale gas extraction. Perhaps most notable are proposals that could allow operators access to ‘deep-level’ land (i.e. below 300m) without the need to agree terms with the land owner, along with a voluntary community payment scheme of £20,000 for each horizontal well that extends by more than 200 metres laterally, where this and other proposed rights are exercised. Some of the detail behind Part 5 is yet to be determined,

but the proposals will not be welcomed by everyone, least of all existing mineral owners with interests that lie below 300m. Clarity over access rights and the subject of subterranean trespass can only be a good thing however, if the UK’s fracking industry is to progress. This in itself will not seem like good news to those opposed to fracking in principle, but with other global economies already exploiting this new form of energy generation, we welcome the decisive action by government to make the law clearer. All of this assumes that the Bill makes it through Parliament and doesn’t end up in the tangle of the May election.

Comment from Libbie Henderson, Partner, Watson Burton

Oil Production of crude oil from the UK’s North Sea fields decreased by 9% between 2012 and 2013. Overall UK production fell to around a quarter lower than in 2000.

Following the closure of the Coryton refinery in Essex in 2012, the UK now has seven refineries that produced 64.7 million tonnes of product in 2013. Production loss from the closure of Coryton in 2012 has not been made up by other refineries. The fall in production means that the UK has become a net importer of petroleum for the first time since 1984, the year of the miner’s strike.

Transport is likely to remain heavily dependent on oil for the next 10 years. A 2014 report by the Department of Energy and Climate Change (DECC) examined transport energy consumption by type of transport:

The chart (left) from the DECC shows an increase in energy consumption by the transport sector between 1970 and 2007, and subsequently the fall in recent years, which has primarily been attributed to the downturn in economy. The latter falling trend is attributed to less people using cars for leisure purposes, and also the increased efficiency in fuel consumption of new cars.

1970 1975 1980 1985 1990 1995 2000 2005 2013

Rail Road

Water Air0

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Mill

ion

tonn

es o

f oil

equi

vale

nt (m

toe)

The UK now has seven refineries that produced 64.7 million tonnes of product in 2013

9

NuclearIn 2013, the nuclear share of electricity generation was unchanged at 18%.

Nuclear has been part of the UK’s energy mix for the past 50 years, however most existing nuclear power stations are scheduled to close by 2023.

Net Capacity(MW)

Number of operating reactors

Published lifetime

Magnox - NDA

Wylfa 490 1 1971-2014

Advanced Gas Cooled Reactor (AGR) - EDF

Hinkley Point B 880 2 1976-2023

Hunterson B 890 2 1976-2023

Heysham 1 1,155 2 1983-2019

Dungeness B 1,040 2 1983-2018

Hartlepool 1,180 2 1983-2019

Heysham 2 1,220 2 1988-2023

Torness 1,185 2 1988-2023

Pressurised Water Reactor (PWR) - EDF

Sizewell B 1,198 1 1995-2035

Total net capacity and number of operating reactors

9,238 16

Closed nuclear power plants (all Magnox power stations)

Capacity(MW)

Number of reactors

Lifetime

Berkeley 276 2 1962-1989

Hunterson A 300 2 1964-1989

Trawsfynydd 390 2 1965-1991

Dounreay Fast Reactor 234 2 1976-1994

Hinkley Point A 470 2 1965-2000

Bradwell 246 2 1962-2002

Calder Hall 200 2 1956-2003

Chapelcross 200 2 1959-2004

Sizewell A 420 2 1966-2006

Dungeness A 450 2 1965-2006

Oldbury 434 2 1967-2012

Table of past and present UK nuclear reactors

The current government has a vision of the UK nuclear industry becoming a global leader.

If this is achieved, the UK supply chain will be in a position to supply to major nuclear developers, reactor vendors and operators in both domestic and global nuclear markets.

Existing plans to develop new nuclear power generators include:

Hitachi Ltd: Up to three new nuclear reactors at Wylfa on Anglesey and Oldbury in South Gloucestershire.

EDF Energy: Four new nuclear reactors at Hinkley Point in Somerset and Sizewell in Suffolk.

NuGeneration: Up to 3.6GW of new nuclear capacity at Moorside, near Sellafield. Eight further sites across England and Wales have been assessed to find out if the social, economic and other benefits outweigh the health detriment of ionising radiation.

HartlepoolSellafield*

Heysham

Wylfa

Trawsfynyndd

Chapelcross

TornessHunterston

Berkeley

OldburyHinkley Point

Dungeness

Bradwell

SizewellEngland

Scotland

Confirmed new sites

Sites currently generating

Shut-down sites

11

Nuclear energy is a highly emotive subject, particularly since the 2011 tsunami-sparked catastrophe at the Fukushima nuclear plant in Japan. The negative public perception of the industry has inevitably been exacerbated by the disaster. This sapping of confidence has played a significant role in the international energy market, particularly in Europe where there has been a shift to green energy away from nuclear power and fossil fuels.

Given the contribution to our energy supply made by nuclear power stations, we in the UK are forced to acknowledge that they are coming to the end of their natural lives, and whilst plans have been put in place to

replace them up to 2035, we must plan to either develop updated nuclear technology or find a reliable alternative.

During the third quarter of 2014, the UK saw the temporary closure of two nuclear power stations; Heysham 1 and Hartlepool which were taken offline due to a series of discovered faults. EDF Energy revealed that these power stations were likely to be out of action until the end of the year, with a potential electricity generation shortage on the horizon as a result. To combat this possibility, National Grid promptly began to explore options around sourcing from other suppliers. Perhaps this will be one of the triggers for further action as we look to alternative solutions.

Comment from Tracy Hall, Partner at Watson Burton

Conservatives:• Pledge to end subsidies for offshore wind• Support for fracking via the Infrastructure Bill • Former environment secretary Owen Paterson MP is

calling to scrap the 2008 Climate Change Act which ties Britain into stringent targets to reduce the use of fossil fuels, should be suspended until other countries agree to take similar measures

• The party is currently considering a manifesto to rule out any new onshore wind farms after those in the planning system are built

Liberal Democrats:• Have been open-minded and abandoned their

opposition to nuclear power, admitting that “it has a role to play in securing energy supplies and cutting carbon emissions”

• Pledge to plant 1 million trees• Pledge to enforce a 5p plastic bag charge• Pledge to create 200,000 green jobs

Labour:• Pledge to freeze gas and electricity bills until 2017• Pledge to fix the energy market, increasing competition

and transparency• Includes the introduction of a new tariff structure so that

customers can easily compare prices• Pledge to abolish Ofgem and replace with a new

energy watchdog• Pledge to unlock investment in clean energy by setting

a firm 2030 decarbonisation target and give the Green Investment Bank more power

Green Party:• Say no to nuclear and fracking • Pledge to speed up adoption of renewables• Improve home insulation

The 2015 general election will have a significant impact on the energy industry, with current parties using their respective energy strategies as a political football.

General election 2015

Electricity Market Reform (EMR)Security of supply is at the forefront of the UK government’s energy strategy. The Electricity Market Reform (EMR) will transform the UK electricity sector to enable low-carbon generation to effectively mix with traditional fossil-fuel generation. This will deliver a cleaner and more sustainable energy mix, whilst minimising costs for consumers in the future.

The 3 main aims of EMR are to:

• De-carbonise electricity generation• Provide a sustainable and secure electricity supply• Minimise costs to UK consumers

EMR will use Contracts for Difference and the Capacity Market to attract the investment needed to change the current electricity market infrastructure.

Contracts for Difference (CFD)

CFDs aim to help stabilise fluctuating energy prices for low-carbon generation technologies, by guaranteeing a ‘strike price’. Covering all low-carbon generation (including renewables and nuclear) CFDs provide generators with a variable top-up rate if market prices are lower than agreed; and must pay back any charges over and above the strike rate.

According to government, this stabilisation should allow investment to come forward at a lower cost of capital and therefore at a lower cost to consumers.

Capacity Market

Given the fluctuating nature of the electricity supply market, the capacity market is designed to ensure that there is sufficient investment in reliable capacity, leading to an improved security of supply.

The capacity market provides a steady and predictable revenue stream to new and existing electricity suppliers, in return for which they must be available and producing when needed, or face penalties.

13

These are challenging times for governments when it comes to energy strategy. The difficulties are all the harder because political posturing can sometimes get in the way and over-complicate matters. The issue of cross-border politics playing a role in the security of energy supply (or more accurately, the lack of security of supply) is an example of this.

The UK government’s strategy is built on three broad priorities: security of supply; reduction in emissions; and affordability for the consumer. Parties should work together to agree on a stable energy policy which will allow UK businesses operating in the sector to forecast and budget. With increased security of the market, those involved in the supply chain will be able to invest in the UK energy industry with confidence.

The need to reduce emissions and the desire to have affordable energy are inevitably interlinked. Energy from fossil fuels has been historically cheap to produce and we can all understand the need to develop carbon capture and storage technologies to ensure compliance with European Union emissions regulations. Anticipating the need to develop these technologies to stay ahead of the curve is not always a political priority, however.

There is arguably a lack of a political will to provide a short to medium-term place for coal and other fossil fuels in our energy strategy, which means that we are losing the ability to use these fuels as bridging sources of energy as we move towards greener and more reliable  technologies. This leads to uncertainty over medium to long-term supply, short-term pricing for the consumer and fairly substantial price increases, which is already placing some domestic consumers in fuel poverty.

Energy and politics don’t mix – Tracy Hall, Partner, Watson Burton

The National College of Onshore Oil and Gas will continue the north east’s legacy of developing skilled people and attracting companies keen to invest in, and utilise the region’s workforce. It will also support the north east’s excellent supply chain, which has the ability to meet the requirements of the emerging onshore oil and gas industry.

Investors need to think long-term, and devote attention and capital to specialist education in order to ensure that a skilled workforce will be able to meet the growing needs of businesses in the energy sector. Developers should consider building relationships with schools, colleges and universities to cultivate specialist courses which ensure students will graduate with the skills and experience they need to work in the energy industry.

Rather than working hard to attract individuals from outside of a region, it is also important to support and nurture existing talent. LEPs, businesses and universities should work together to provide opportunities in regions so that individuals can have successful and fruitful careers without moving to London or other major cities.

George Rafferty, Chief Executive, NOF Energy

John Laverick, Director, Turner & Townsend

Carol Stanfield, Assistant Director, UK Commission for Employment and Skills

Commentators

Aggressive marketing of areas such as Hull and Humber is vital in order to put developing regions on the map in the eyes of the government and other key decision makers. This will lead to increased investment in transport and logistics to strengthen the region’s position on a national level, and attract talent from outside of the region.

Training providers and LEPs should look to make it easier for companies to invest in areas which are fast-developing in the energy market. If a business is looking to invest in a particular region, such as Humber, it needs to know that there is a skilled workforce which can be easily accessed.

The energy sector is an important contributor to the north east economy.  To sustain growth we need continued investment to nurture our future engineers.  The industry needs to develop and form stronger relationships with the educational institutions and this has been one of the key factors to our success, ensuring that not only do we have a suitably qualified workforce but we retain the talent within the north east.

David Mcloughlin, Group MD, Spencer Group

Jonathan Chapman, Director of Strategy and Business Development, Balfour Beatty

Phillip Fleetham, Recruitment Manager, Fabricom Offshore Services

15

In the north of England alone, investment in energy projects is reaching £multi-million levels, with the announcement of government approval for the £450m Marine Energy Park by Able UK in Hull and a further £multi-million investment by companies such as Siemens, Vivergo Fuels and Reckitt Benckiser.

More than 6,100 jobs in the energy industry are expected to be created both directly and indirectly in the Hull and Humber region alone in the next five years, so businesses will need to attract and retain talent in order to realise potential and meet demand from investors. With development planned in energy hubs across the UK, it is vital that plans are put in place now to ensure that businesses will have access to an ample and skilled workforce.

LeadershipThe need for strong and effective leadership across a range of levels is evident. At the highest level, the UK government needs to fully engage with the energy sector, and develop a long-term plan, taking into account all elements of the energy mix, and supporting businesses on a regional basis.

The UK’s current government strategy is built on three broad priorities: security of supply, reduction in emissions and affordability for the consumer. Current leaders should look to reinforce the view that energy security should be a matter of national interest, which is not subjected to short-term political influence.

At a mid-level, there is a call for entrepreneurs and business leaders to collaborate in order to organise and support investment, and drive other businesses in the sector to over-achieve and inspire.

At entry level, regions involved in the energy sector should work hard to retain and nurture top-class talent, in order to strengthen the workforce offering, and cultivate leaders of the future.

Skills and EducationWith a skills shortage in engineering sectors across the board, schools, colleges and universities should look to collaborate with businesses in the sector to ensure that students will graduate with the knowledge and skills they need to succeed in the industry.

In the north east, Nissan provided local colleges with cars and machinery to ensure than when students leave the college, they graduate as a Nissan apprentice, ready and able to hit the ground running without further training.

Businesses want to know that when they invest in a region they will have easy and quick access to a skilled and talented workforce. In order for this to happen, it is vital that businesses also commit to investing in people.

The Teesside region is currently leading the way, with a government announcement that Redcar & Cleveland College will be part of a £multi-million national training hub that will produce the next generation of oil and gas specialists.

With no official launch date set, the National College of Onshore Oil and Gas will be the first specialist training centre in the UK, with the aim of producing the next generation of oil and gas specialists, and also upskilling existing workers – both in the UK and overseas – as part of a wider drive to improve the country’s competitiveness in the sector.

What next?

More than 6,100 jobs in the energy industry are expected to be created both directly and indirectly in the Hull and Humber region alone in the next five years.

17

The UK’s energy mix has not changed greatly over the previous 12 months, but the heavily politicised nature of ‘the energy debate’ means that the discussion surrounding the renewable energy industry will undoubtedly become more heated as the general election approaches.

Away from all of the political debate, those of us involved in the supply chain must remain focussed on the tremendous opportunities available if we are to maximise our potential.This report has highlighted the need for a progressive dialogue between businesses in the energy industry, suppliers, education providers and government. There is no easy answer.

We must engage with government at a local and national level to inspire leadership and long-term commitment to the UK’s energy mix - beyond politics - so that the UK leads and does not just follow other economies in delivering sustainable energy solutions.

SMEs in the energy sector and those involved in the supply chain, need to be given the confidence to make substantial long-term investments.

The UK already has a skills crisis in the energy industry and it is up to us to connect with the schools, colleges and universities, to ensure that they are training our workforce to get us back on track, and tackle our energy trilemma head on.

Watson Burton has its roots firmly planted in this industry and on the back of this report, our energy debate last year, and the Invest Humber debate last October, we intend to bring together business leaders, politicians and those involved in education, to ensure that we drive home the message of the need for education and upskilling, starting with a focussed event in 2015.

The UK’s energy market is evolving as we speak. We all need to get ready for change and meaningfully accept the challenge, today.

Conclusion

In spring 2015, following the Invest Humber energy debate, our Leeds office will be hosting a round table event, to identify some of the next steps. We will then be hosting an event in the north east where we plan to bring together colleges, universities, training providers, businesses and suppliers to discuss action plans for the energy sector in the north.

The discussion will be focussed around SMEs involved in the energy market and its supply chain. In particular we will focus on how businesses will be able to take advantage of emerging opportunities in the sector – including access to talent – without being left behind.

We will also examine how political developments such as Electricity Market Reform (EMR) and fracking will affect the market, and in what ways businesses should prepare to adapt to changes within the fast-paced energy sector.

To send us your feedback on this report, or to register your interest in attending either of these future events, please contact laura.kingston@watsonburton.com

Moving Forward

The discussion will be focussed around SMEs involved in the energy market and its supply chain.

19

• Department of Energy and Climate Change - ECUK (2014) report

• Department of Energy and Climate Change - Special feature: Renewable Energy in 2013

• Department of Energy and Climate Change - UK Energy in Brief 2014

• Digest of UK Energy Statistics 2013

• Mint UK

• National Grid Winter Outlook 2014/15

• Practical Law

• Utility Week

• Yorkshire Business Insider

• Westlaw UK

• www.building.co.uk

• www.cuadrillresources.com

• www.dur.ac.uk

• www.gov.uk

• www.greenparty.org.uk/values/energy.html

• www.labour.org.uk/issues/detail/energy

• www.networkrevolution.co.uk

• www.renewableuk.com

• www.conservatives.com

• www.libdems.org.uk

Bibliography

watsonburton.com