How is the government getting on with its negotiations with electricity generators to lower the wholesale price of energy? These negotiations, in case anyone has forgotten amid the current chaotic state of policymaking, were an absolute priority a month ago.
Kwasi Kwarteng, in his last weeks as business secretary, got the show rolling by warming up nuclear and renewables firms to expect a switch to new 15-year fixed-price contracts at below current wholesale prices. The case for reform, voluntary or otherwise, was almost unanswerable. Many of these generators – the ones operating under old-style incentives to encourage investment in solar, wind and biomass projects – are the accidental beneficiaries of sky-high gas prices. New contractual terms were, in effect, the government’s alternative to a windfall tax.
The ambition became a firm policy on 8 September, when Liz Truss announced the government’s two-year “energy price guarantee” for households. New electricity supply contracts, it was argued, would make the guarantee more affordable for the public purse. A new energy supply taskforce was established within the business department to hammer down the details and seemed to get off to a flyer. The chief executive of Centrica, owner of a 20% stake in the UK’s nuclear fleet, declared he wanted his company to be the first to sign a new-style contract. EdF, owner of the other 80%, followed. The mood music was excellent.
And now? The tone is very different. “Talks are stuck,” says one renewables industry source. “Discussions are taking place, but not the hard yards of an actual negotiation,” says another. Meanwhile, the FT reports that the government is threatening the relevant energy firms with a cap on their revenues unless they agree a voluntary deal. Nobody seems happy.
One complication is that generators sell their output a year or more in advance, so their windfall profits have yet to arrive; the former chancellor Rishi Sunak (remember him?) encountered the same issue when contemplating an extension to his North Sea windfall tax and gave up. Another is that “renewable obligations certificates” – the incentive mechanism – roll off over varying periods. Another is that, logically, new contracts would have to be designed on a fuel-by-fuel, or even project-by-project, basis. It ain’t straightforward.
But the underlying dynamic is that the government needs to get something in place. As long as the gas prices remain high, delay only benefits the generators. The European Union, note, is streets ahead with its revenue cap, which is really a form of windfall tax. One assumes the UK government, despite its reported rhetoric, would loathe to go down that route since it would represent another U-turn. But it is starting to look like the simplest model.
It might be helpful if the new business secretary, Jacob Rees-Mogg, spent less time talking about fracking, which may never happen, and more time on today’s pressing issue. If negotiations with the power firms are to succeed, it needs to happen soon.
Regulators need to take a look at all things LDI
Legal & General’s trading update on Tuesday could be roughly summarised as: “We’re fine. All this stuff about pension funds and LDI, or liability-driven investment, is like water off a duck’s back for us.”
As far it goes, it’s a fair stance. L&G is the biggest player in the LDI market in the UK. But, as the statement was at pains to say, its formal role is one of agent. The FTSE 100 insurer manages portfolios on behalf of pension fund clients – and it was some of those clients who had to post extra collateral to support LDI funds when gilt yields spiked before the Bank of England’s intervention last week. L&G itself has no balance sheet exposure.
Jolly good, and the accompanying healthy numbers on the group’s cash and capital position reinforced the message of resilience. The shares gained 6%.
The nagging doubt, though, concerns the long-term impact of the LDI drama. Jefferies’ analysts earlier this week raised the idea that “the biggest risk for L&G is that this crisis has discredited the firm’s risk management abilities”. In short, the optimal collateral levels that L&G had been recommending to clients may be seen to have been too skimpy. That risk, if it materialises in the form of pension funds switching out of LDI arrangements, will clearly be a slow burn.
More immediately, regulators will surely want to take a look at all things LDI. If “a material risk to the UK financial stability” – the Bank’s words – suddenly appears, there are usually consequences. None may ultimately affect L&G, but it’s too soon to say.
