Ring fence review: energy networks call for input
Background and context
Summary
This section outlines why the licence conditions were created and the potential risks we need to review.
Background
The ring fence licence conditions were introduced in the 1990s after the energy industry was privatised. It was then adapted for electricity and gas networks licences in 2000.
The licence conditions were produced so that network companies have the financial and operational resources needed to meet their obligations. So far, these have been a broadly effective part of the regulatory framework.
However, we consider it necessary to review and strengthen the licence conditions to reflect changes both in the corporate structures of network companies and in the economic landscape in which they operate.
Risk areas
There are several areas of potential risk to the ring fence which need to be considered in our review. These are:
- changes in corporate structures
- financial engineering
- challenges in other sectors
Changes in corporate structures
When the ring fence licence conditions were first introduced, network companies were listed as Public Limited Companies with strict transparency requirements.
Many of the networks have since been acquired by private equity or large conglomerates. This means they are no longer subject to the same level of scrutiny.
Such a change in ownership could result in too much influence from a smaller number of controlling parties over the vital infrastructure that the network companies operate. This may lead to poor outcomes for the consumer.
Financial engineering
The corporate structures of energy network companies have become more complex as holding companies above the network company, such as Midco and Holdco are used to raise debt on behalf of the group.
Holding companies have control over them and influence decisions made by the network companies.
There is a risk that high levels of Midco or Holdco debt may negatively impact decision making. This may also impact the financial resilience of the network company, particularly where they are required to pay dividends for example.
Challenges in other sectors
Thames Water Utilities Limited (Thames) has suffered financial difficulties recently. This has resulted in a higher cost of debt for Thames compared to other water and energy companies.
If a network company were to get into financial distress, this would most likely increase its cost of borrowing and could also impact other companies within the energy sector.
Each of these challenges pose a risk to the effectiveness of the ring fence and may expose the network company to the riskier activities of the group that it sits within. This could ultimately harm consumers.