Infrastructure newsletter - Autumn 2022

Originally published on 7 November 2022

Infrastructure newsletter - Autumn 2022


Welcome to the inaugural edition of the Travers Smith Infrastructure newsletter.

We hope you find this publication an informative and insightful source of information on the developments in the infrastructure market that we are seeing and anticipating from our work across the sector. 

The importance of critical infrastructure has never been greater nor has the impact of change, whether political, legal or technological, for new areas for infrastructure investment. The recent Energy Security Bill is testament to this pace and scope of change, covering wide ranging initiatives, from hydrogen to smart metering and from heat networks to carbon capture. It aims to deliver a cleaner, more affordable and more secure energy system for the long term and seeks to leverage £100 billion of private investment by 2030.

Our experience echoes this drive, with our clients pursuing opportunities across the infrastructure sector.  The opening up of water network ownership, the value of energy data, the rollout of fibre to the home, the uptake of electric vehicles, and the impending arrival of heat pumps in our homes are just a few examples of areas where investors are exploring ways of backing new infrastructure-based solutions to the challenges that we all face. The energy crisis the world is contending with is only likely to further accelerate the need for these solutions and the capital required to support their expansion.

Unlike much of the Growth Plan announced by the UK Government in September, overall investment in infrastructure largely survived in the new Chancellor’s Autumn Statement on 17 November. It remains to be seen how the government’s plans to speed up the delivery of infrastructure projects across the board and facilitate long-term investment play out in reality.

In this edition, we cover:

  • An overview of the year to date
  • Regulatory challenges for infrastructure M&A
  • Core plus and leveraged financing
  • Qualifying asset holding companies
  • Retained EU Law Bill
  • A look ahead to 2023

If you would like to discuss any of the developments we cover in more detail, please get in touch.

Year to date overview

Infrastructure M&A has continued to be very busy during 2022 and has demonstrated a greater resilience than the wider market. Deal activity has remained stable throughout the sector both in the UK and Europe with transactions in the transport, telecommunication and energy transition space gaining a greater significance in contrast with a decrease in renewable transactions.

The uncertainty in pricing caused by macro-economic conditions (including questions on inflation, interest rates, geopolitical conflicts – including the war in Ukraine and disruption of supply chains) and the possible reallocation of assets in portfolios by investors following the downturn in the public equity markets, is likely to decrease the volume and speed of infrastructure M&A. However, even though a slower pace in infrastructure transactions is expected in the near future, we continue to experience a high volume of deal activity.

ESG and energy transition have become part of the agenda globally. This has allowed governments, including in the UK, to create incentives for private investment in such areas. As detailed below, the UK Government has continued to introduce initiatives to reach net zero in the UK by 2050. We continue to see deployment of equity and debt into energy transition such as EV charging, battery storage, district energy and hydrogen. 

Traditionally in a high inflation environment, energy, infrastructure and other real assets can be expected to attract investment due to their softer or harder linkage to inflation. These factors can provide a safe harbour for investors in times of greater uncertainty. It should not be seen as a coincidence that recently a number of core infrastructure mega-funds have been launched and that H1 2022 has set the record for annual fundraising for infrastructure funds.

Considering the cash availability, asset stability and political agenda, we remain optimistic that past the current global turbulence, the sector will remain an attractive value proposition to investors.

Two steps forward, one step back - the road to net zero in UK energy

'Net Zero' has always presented an appealing, if somewhat intangible, vision of a clean, robust and secure energy system supporting an ever more efficient business and residential user base by 2050. But viewed from the current perspective of a society facing steep inflation and a cost-of-living crisis driven by energy prices, which are in turn shaped by and influencing global conflict, all the while still relying heavily on fossil fuels and their consequent toll on the environment and well-being, it feels nothing less than essential. And yet, the road to Net Zero seems more uncertain now than it has been at any time over the last decade.

The rapid expansion and subsequent challenges of renewable subsidies

From a regulatory support perspective, the drive for clean energy got off to a flying start following the turn of the millennium. In the ensuing decade, an almost dizzying array of feed-in-tariffs, renewable obligations, renewable heat incentives, renewable fuel obligations and other incentives drove a surge in uptake and innovation. At that time, the future seemed to be (and perhaps still is) a fully decentralised grid based on the production of energy on an individual, community or local area led basis (rooftop solar; small scale wind turbines; micro anaerobic digestion etc).

However, the subsidies came to be seen by decision makers as expensive and complex. They were also long term (20 or more years), which was effective in providing investor certainty but is now presenting challenges. Perceptions of what is 'green' can change over time - as seen in the recent scrutiny of the sustainability credentials of wood biomass at Drax power station, which provides 12% of the UK's renewable power and receives around £500 million of Renewable Obligation subsidy a year. In addition, when wholesale prices rise sharply, suddenly highly profitable generators continuing to receive subsidy can present political difficulties (hence the government now engaging with those generators in the hope of restructuring subsidies). Finally, the storage solutions and grid (including smart) capabilities required to make this small-scale renewable revolution work to its fullest potential haven't yet caught up, for a variety of reasons.  As renewable technology has matured and cheapened, government has therefore eased off the regulatory accelerator pedal in recent years. The hope was that there was enough momentum for the market to carry energy production in the UK through to a Net Zero future.

A possible weakening in regulatory resolve?

The momentum towards cleaner energy seems to have now stalled slightly. The government instead seems to be increasing its emphasis on pragmatism and the role of oil and gas as a transition fuel. This seems intended to foster a sense of stability – for the grid, but also for a market made up of various actors (including the government) with an economic interest in the continued exploitation of oil and gas resources. Hence, we see:

  • the British Energy Security Strategy, released in April 2022, declaring that "Net Zero is a smooth transition, not an immediate extinction for oil and gas" and establishing the snappily titled 'Gas and Oil New Project Regulatory Accelerators' to support and facilitate the development of new oil and gas projects;

  • the recent government announcement of a new oil and gas licensing round, which is expected to deliver 100 new licences for extraction of fossil fuels from the North Sea;

  • as mentioned in the introduction, the September 2022 Growth Plan announcing an independent review on how Net Zero can be delivered "while maximising economic growth and investment, supporting energy security, and minimising the costs borne by businesses and consumers" – pointedly noting that the 2022 economic climate is rather different to that in 2021 when the more unequivocal Net Zero Strategy was published (but not highlighting that the strategy was successfully challenged recently by environmental NGOs for lack of detailed plans to achieve Net Zero); and

  • the consolidation and protection of existing imports of LNG from countries such as Norway and Qatar.

Which is not to say the UK government is committing itself to a fossil fuel future. Net Zero remains a legally binding target and a policy commitment. There is also the possibility to off-set some of the impact of future oil and gas exploitation through the development of carbon capture and storage (although the government's track record of supporting the development in this area is spotty at best). And funding is still being made available for the pursuit of cleaner forms of gas, via hydrogen pilots and development (see Update on the Low Carbon Hydrogen Business Model in this newsletter) and through the new Green Gas Support Scheme (effectively the successor to the non-domestic Renewable Heat Incentive) to support biomethane.

Big infrastructure and big unknowns

How to square all of this with Net Zero? Well, it feels like the government is putting many of its chips back on big infrastructure – particularly nuclear and offshore wind. These offer large baseloads of low carbon power. Nuclear has various difficulties (e.g. reliance on overseas technology; dealing with long term environmental impact of waste; safety concerns). Wind also gives rise to some concerns (including impact to bird and marine life). But both also share notoriously long and complex consenting processes (not least due to the aforementioned environmental risks) – which have been getting slower over the last decade. Hence the government proposes to streamline the planning and consenting process for larger (in England, above 50MW onshore and above 100MW offshore) generation projects via a new Planning and Infrastructure Bill. It is not yet clear what this will consist of, but the forthcoming removal of EU laws from the statute book (see Retained EU Law (Revocation and Reform) Bill in this newsletter) creates certain opportunities - with speculation rife that government may be intending to pare back the Environmental Impact Assessment process. Naturally this has NGOs concerned that the government would effectively be trading carbon for biodiversity. In addition to planning reform, the annex to the government's Growth Plan contained a non-exhaustive list of infrastructure projects to be "accelerated as fast as possible" with construction targeted to begin before the end of 2023 (including the Sizewell C nuclear power station and seven offshore wind groups of projects). However, the Autumn Statement rowed back on the specifics of that list, while insisting that the government remains committed to accelerating delivery of projects “across its infrastructure portfolio”. Speculation is inevitably rife that some major projects may be delayed, or even axed.

Beyond this, the hope is apparently that various new technological solutions will unlock the Net Zero future. Further pilot and development funding is being made available to carbon capture and storage, hydrogen and nuclear fusion projects. The concern is (as is perhaps seen in the stalled development of carbon capture and storage) that these types of new technologies and ways of working require more systemic change, support and regulatory reform to truly be effective, rather than sporadic project support. It is beginning to feel like the 'two steps forward, one step back' approach seen in policy to date may need to become a more determined and focused march forwards.

The future of heating

At present, heating buildings accounts for some 21% of all UK carbon emissions and will need to remain a key area of focus for the UK government if it is to achieve its target of net zero greenhouse gas emissions by 2050.

The task however is huge and, at present, less than 5% of heating used in UK homes comes from low-carbon sources and these, and any other new low carbon, technologies will need to attract investment of over £250 billion to fully decarbonise homes, according to the Climate Change Committee. Put another way, the UK Research Energy Centre projected back in 2020 that one million homes will need to be retrofitted every year for the following 30 years to meet the net zero target by 2050.

The plan to achieve this is currently based on three low carbon technologies, namely:

(i) Heat networks;

(ii) Heat pumps; and

(iii) Hydrogen. 

Taking each of these in turn, what is the current state of play?

(i) Heat networks – also known as district heating, heat networks take heat from a central source and deliver it to multiple domestic or non-domestic buildings. It currently accounts for 480,000 customers or 2% of heat demand in the UK and is targeted to deliver around 19% by 2050 if the UK is to meet its carbon targets. The new Energy Security Bill introduces a regulatory framework to enable heat zoning in England – this is envisaged to require heat networks developed within zones to meet a low carbon requirement and also for certain buildings, principally new buildings and those with communal heating, within zones to connect to a heat network within a specific timeframe. From a consumer perspective, Ofgem's role as regulator will expand to cover heat networks, so that consumers are ensured a fair price and reliable supply of heat. Heat network developers will also be allowed to access powers equivalent to those for gas and electricity so that heat networks can be built out more quickly and cost effectively. 

(ii) Heat pumps – the UK is some way behind other countries in Europe and North America when it comes to the use of heat pumps for hot water and heating households. The government's plan to bridge this gap is to replace old gas boilers with low-carbon heat pumps and install 600,000 of them a year by 2028. In addition, all new heating systems from 2025 will not be allowed to connect to the gas network. There are however a number of challenges ahead – the age of housing stock and need for external space to house a pump, the cost of replacing radiators and pipework to accommodate a heat pump's lower temperature and the cost of the pump itself.  Given these challenges, it is likely that the new build market will be the initial focus for heat pump roll-out.

(iii) Hydrogen – still the new kid on the block, there are hopes that hydrogen could provide a credible and clean alternative to heat pumps in heating homes. However, some doubt has recently been cast on the viability of hydrogen for heating our homes, given the likely high cost and need for technical alterations including in-home pipework. Nevertheless, it remains a potential part of the future mix of heating solutions of the future and five hydrogen projects feature on the list of priority infrastructure projects in the UK Government's recent Growth Plan. See below for our update on the Low Carbon Hydrogen Business Model.

Regulatory challenges for infrastructure M&A: a brave new world?

The age of government and regulator interventionism in M&A transactions, much-discussed for several years, seems to have arrived. Whilst competition regulators have sought to expand their jurisdiction to investigate transactions that previously escaped scrutiny, governments and the European Commission (EC) have also become increasingly concerned about the public interest implications of inward investment, particularly in sectors of core importance to national security or civil society.    

Perhaps one of the biggest shake-ups of the UK's regulatory landscape in recent years is the introduction of the UK's National Security & Investment Act (NSI Act). The regime focuses on the risk of a deal to the UK's national security, but unlike other 'foreign direct investment' regimes, does not only apply to deals involving a foreign investor: it focuses on the activities of the target relevant to national security. Whilst 'national security' is undefined, several sectors within the UK's Critical National Infrastructure may well also be considered important to national security (e.g. energy, communications, transport, health and water).

Coordinated regulatory action

Under the NSI Act, the UK Government expects its Investment Security Unit (ISU) to review approximately 1000-1850 notifications per year (although the number actually received is slightly below that).  Acquisitions in 17 mandatory sectors (including e.g. energy, communications and transport) require clearance from the ISU prior to closing.    

Inevitably, a number of these cases will also be reviewed through a competition lens.  Since the untangling of the UK's merger control regime from the EU's "one stop shop", transactions may fall for parallel 'merger control' review by both the EC and the UK Competition & Markets Authority (CMA). Deals may also need to be notified to the national competition authorities of other countries.

Regulation of foreign investments in Europe appears only set to increase, with the Commission now also set to introduce another new notification regime for M&A deals that have been facilitated by 'foreign' (i.e. non-EU) subsidies: the 'Foreign Subsidies Regulation'. That regime is set to come into force mid-2023.

Expansive jurisdictional reach

Merger control regulators around the world have become focused on the extent to which they should be able to expand their jurisdictional thresholds to review, in particular, acquisitions of disruptive nascent or start-up businesses by large firms potentially seeking to protect their incumbent position (so-called "killer acquisitions").  

An example of the EC's willingness to apply an expansionist approach is Illumina's acquisition of GRAIL, a healthcare company developing cancer detection tests. Despite GRAIL not having generated any turnover in Europe (and therefore not meeting the financial thresholds for notification under the EU Merger Regulation), six Member States referred the deal to the EC for review. The transaction has now been prohibited by the EC.

The CMA considers that its very flexible jurisdictional test is an advantage of the UK merger control regime, enabling it to review transactions which could not be investigated in other countries. However, an expansive approach to that test comes at the price of legal certainty for parties, who risk having their deals subject to a UK merger control review, even post-closing. 

Procedural issues

The need to navigate parallel reviews, across a range of issues, inevitably risks a more complicated coordination task for parties, potentially impacting the timeline to closing and key terms such as financing.

This is exacerbated by the fact that different regimes operate different timetables and trigger points (e.g. remedies may be accepted at Phase I in a CMA merger control review, whereas in a UK national security review, a full assessment - akin to a 'Phase II' - is required before remedies can be accepted).

In the merger control sphere, a significant implication of the UK's voluntary regime is that it has the power, almost always used in post-closing reviews, to impose a hold separate order (known as an initial enforcement order, or IEO), requiring the target business to be operated entirely separately from the buyer. The CMA has imposed significant fines for breaches of IEOs (Facebook was recently fined £50.5 million in the Facebook/Giphy case).  For international transactions, the CMA's starting point is that an IEO applies globally, such that, to begin with, all parts of the parties' businesses will be subject to the IEO.

Deal documents should therefore cater for all relevant processes, with appropriate gap periods. Approaches to regulators should be coordinated so far as possible in order to manage deal timetables and, when planning for acquisitions with a UK dimension, parties should carefully consider whether there might be a realistic basis for the CMA and/or ISU to take jurisdiction (and whether any associated 'clawback' protections need to be included in deal documents).

Key takeaways

The trend for parallel review across merger control and public interest matters is set to increase and continue throughout 2022 and beyond.

However, greater scrutiny does not necessarily imply a greater number of adverse regulatory outcomes for deals. The UK government has emphasised that only a small minority of deals are likely to be blocked on national security grounds (the two blocks to date relate to the UK defence sector and acquirors with Chinese links). In merger control, currently at least, the more expansive jurisdiction of regulators around the world is not obviously leading to materially greater numbers of prohibitions.

Even as the regulatory landscape becomes more challenging, strategic investments will be achievable for well-prepared, adaptable teams, with a clear eye to the policy context in which their deals are taking place.

Core-plus infrastructure

As the private infrastructure market has continued to evolve into a wider range of “core-plus” and “value-add” infrastructure investments, there is a continued crossover of investment opportunities that are attractive both to private equity (PE) funds and infrastructure funds, particularly in areas such as social infrastructure and TMT.  

As a result of this interchangeability in PE/infrastructure ownership across certain assets, we are increasingly seeing, in the core-plus/value-add infrastructure debt market, infrastructure investors wanting to benefit from the flexibility in debt terms that PE funds have been able to obtain for similar assets.

Infrastructure finance partner Ben Thompson’s chapter Core-Plus Infrastructure and Leveraged Financing: The Continued Convergence of Terms in The International Comparative Legal Guide - Lending & Secured Finance 2022, sets out some of those terms that we are seeing more commonly being sought by infrastructure funds for the debt financing of their assets, which traditionally would have been more commonly seen in the PE/leveraged buyout (LBO) debt market.

Read the full chapter.

A closer look: Qualifying asset holding company regime

In April 2022 the UK introduced a new tax efficient vehicle: the qualifying asset holding company (“QAHC”, generally being pronounced “quack” in the market). This new regime provides a simplified basis of taxation, and a host of generous tax benefits (both for the QAHC and its investors), which should allow the UK to compete as a go-to jurisdiction for holding companies.

Please see our briefing from March, which provides a simplified overview of the tax benefits and consequences of QAHCs, exploring how they will benefit infrastructure funds and investors and commenting on how QAHCs compare with Luxembourg's offering.

It is understood that HMRC is trying to improve the regime and we have been engaged with
them on a number of deficiencies within the rules. Indeed, since the introduction of the QAHC regime in April, there have already been amendments to make access to the regime easier for funds in corporate form and for other fund structures, and there are additional changes expected next year. It is generally encouraging to see that HMRC is responding to feedback from taxpayers to make improvements to the new QAHC regime, including making the regime more accessible.

Retained EU Law (Revocation and Reform) Bill

The Government is proposing a wide-ranging reform of retained EU law.  For many businesses, the most significant point to be aware of is the proposal for a large proportion of retained EU legislation to be revoked at the end of 2023, unless expressly preserved by Ministers.  This creates the risk of another Brexit-related cliff-edge for business, as it may not be clear which measures are being allowed to expire until close to the initial deadline.  From an infrastructure perspective, a wide range of measures relating to the environment would – in theory at least – be at risk of revocation, although recent press reports suggest that the Government may be rethinking its approach to at least some aspects of the Bill. In combination with the Government's Growth Plan which includes proposals to streamline processes and expedite approvals for some energy and infrastructure projects, developers may see this as good news in the short term at least, if they can handle the inherent uncertainty that it brings.

Other proposed changes

In addition to the so-called "sunsetting" provisions relating to much retained EU legislation, the Bill will also:

  • Give Ministers extensive new powers to amend or revoke retained EU law swiftly, with only limited Parliamentary scrutiny;

  • Reverse the current approach to conflicts between retained EU law and domestic law;

  • Remove general principles of EU law, including the requirement for courts to interpret retained EU law in accordance with those principles; and

  • Introduce new measures designed to make it easier for UK courts to depart from retained EU case law.

Our briefing examines the Bill in more detail and discusses whether it will help to drive growth (e.g. through deregulatory measures) or just create further uncertainty for business.  We also look at some potential examples of EU-derived measures which might be considered candidates for revocation under the Bill, should it become law.  For an explanation of the current position on retained EU law, see our detailed guide.

Looking forward: what can we expect from 2023?

Autumn Statement

On 17 November, the Chancellor Jeremy Hunt announced his Autumn Statement (accompanied by an economic forecast from the OBR). Please see our briefing on some of the key measures announced, which includes reductions in the income tax additional rate threshold, the dividends allowance and capital gains tax exempt amount, a "rebalancing" of R&D rates, and confirmation that the Government will go ahead with its implementation of OECD BEPS Pillar 2. Measures announced which are of particular interest to the infrastructure-space include:

Windfall taxes

The Chancellor extended the Energy Profits Levy (which was announced at the end of May 2022) to the end of March 2028 and increased the rate from 25% to 35% with effect from 1 January 2023. In addition, a new, temporary 45% levy on electricity generators was introduced. Please see below for further information on UK windfall taxes.

Investment Zones

In September's Growth Plan (as announced as part of the "mini-budget"), the then Chancellor, Kwasi Kwarteng, announced the introduction of a package of measures focussing on driving increased investment, including plans for new "Investment Zones". As originally planned, Investment Zones would have provided generous local tax reliefs beyond those introduced in relation to freeports in 2021. However, following the Autumn Statement, we now understand that the Investment Zones proposals will be refocussed to focus on a limited number of "the highest potential knowledge-intensive growth clusters". The first clusters are to be announced in the coming months.

Investment in Infrastructure and the UK Infrastructure Bank

The Chancellor confirmed that he will not cut capital budgets for the next two years and will maintain them in cash terms for the next three years, which will see £600bn of planned public investment in major infrastructure projects. These projects include HS2, Northern Powerhouse Rail, the NHS hospitals programme and Project Gigabit. There was confirmation that the second round of the Levelling Up Fund will allocate at lease £1.7bn to priority local infrastructure projects (successful bids will be announced by the end of the year). Hunt also confirmed that plans for a nuclear power facility at Sizewell C will go ahead as planned which, according to the Chancellor, will help to secure the Country's goal of reaching net zero by 2050 and decarbonising the Country's power system by 2023.

In addition, the Government is placing the UK Infrastructure Bank on a statutory footing. The UK Infrastructure Bank was established in June 2021 and provides finance to the private sector and local government for infrastructure projects. It will also provide advice to local governments on infrastructure projects and financing. The Treasury provided the UK Infrastructure bank with an initial £22bn of funding for its first five years.

Solvency II reforms

The Government also published its consultation response setting out its proposed reforms of Solvency II. These include changes which would allow insurers to invest significantly more in long-term productive assets such as infrastructure.

UK windfall taxes

At the end of May 2022, the then Chancellor Rishi Sunak announced a new temporary windfall tax on oil and gas profits which is intended to be used to fund energy grants to households (the "Energy Profits Levy"). As originally announced, the Energy Profits Levy was a 25% levy on profits of oil and gas companies operating in the UK and the UK Continental Shelf and was legislated for in the Energy (Oil and Gas) Profits Levy Act which came into force on 26 May 2022. However, in the Autumn Statement, the now Chancellor Jeremy Hunt announced that the rate will increase from 25% to 35% from 1 January 2023. The Energy Profits Levy had been due to end at the end of December 2025, but will now stay in force until the end of March 2028.

The extended Energy Profits Levy will increase the headline rate of tax on those oil and gas profits from 40% (prior to the introduction of the Energy Profits Levy earlier this year) to 75%. However, to encourage companies to reinvest their profits into UK oil and gas extraction, the existing cash value of the levy's investment allowance will be broadly maintained.  The investment allowance is a 'super deduction' style of relief which gives a taxpayer a c.£91 tax saving for every £100 of qualifying investment made in the UK and was announced alongside the Energy Profit's Levy in May.  The cash value of the investment allowance is calculated by reference to the headline energy profits levy rate - to maintain an equivalent c.£91 saving per £100 invested, the investment allowance will be reduced to 29% (from the 80% allowance announced in May in respect of the 25% levy rate) for all qualifying investment besides decarbonisation expenditure.  The investment allowance will remain at 80% for decarbonisation expenditure giving a c.£109 tax saving for every £100 invested in decarbonisation. The investment allowance is available on capital, operating or leasing expenditure which is incurred for the purpose of oil-related activities, however, financing costs and decommissioning costs will not qualify for the allowance.

The Chancellor announced the introduction of a new, temporary Electricity Generator Levy ("EGL"), which will come into force on 1 January 2023 and end on 31 March 2028. The EGL is a temporary 45% tax on "Exceptional Generation Receipts" from UK electricity generation, which will bring the headline rate of tax to 70% on such receipts. Broadly, Exceptional Generation Receipts are those above a benchmark price per megawatt hour of electricity (currently £75 £/MWH). The tax will be limited to generators with in-scope output exceeding 100GWh across the qualifying period and will only apply to, largely, corporate groups that undertake electricity generation in the UK and are either connected to a national grid or connected to local distribution networks. The EGL will also apply to groups generating electricity from nuclear, renewable and biomass sources who are benefitting from a significant increase in the price received for their output without a corresponding increase in the costs of generation.

New air, water and other Environment Act 2021 targets

The Environment Act 2021 was not accompanied by much fanfare when (after years of delays) it finally became law in late 2021. This was in part because, whilst the Act establishes some important regulatory principles and concepts, it often leaves the more devilish detail to later legislation.   

A good example of this is environmental targets. The Act requires that at least one target be set by the government in relation to air, water, biodiversity, resource efficiency and waste reduction, fine particulate matter (PM2.5) and species abundance. Beyond requiring that the targets were to be laid out in separate regulations by 31 October 2022, and that certain consultation steps be followed, the Act leaves it to the government to determine what those targets should be.

The government consulted on proposed targets earlier this year and is still considering feedback. See here for more detail on the proposals, which include:

  • reducing exposure to the most harmful air pollutant to human health – PM2.5 – by over a third compared to 2018 levels;

  • halving landfill and incineration waste by 2042; and

  • a legally binding target for species abundance by 2030, with a requirement to increase species populations by 10% by 2042.

The reception to these was not especially warm. Many called for more ambitious targets – including in the much contested area of air quality (where the targets fall below current recommendations of the World Health Organisation, which the government does not consider achievable). The targets won't themselves directly bind energy and infrastructure developers – but they will influence decision makers in the planning and consenting phases, and lead to stricter scrutiny of, for example, biodiversity, water and air impacts of any new development. On 28 October, just three days before the deadline set by the Environment Act, the new Secretary of State for the Environment, Food and Rural Affairs, Thérèse Coffey, announced that DEFRA would not be able to meet the deadline, citing, in summary, an excess of information to review. It is not currently clear when the Government will adopt the targets, beyond that this will be "as soon as practicable". 

Of more direct impact to new developments may be a change brought about by the Environment Act 2021 a little further down the road. The Act amends planning legislation (from a date to be confirmed, but expected to be November 2023) to require permissions in England to be subject to a new pre-commencement condition requiring a 'biodiversity gain plan' for the permitted development. That plan must in turn ensure the biodiversity value attributable to a development exceeds the pre-development biodiversity value of the onsite habitat by 10% (although this could be delivered via off-site works; or potentially through the purchase of 'biodiversity credits' from a yet to be detailed government scheme). The idea that new projects should not only not harm biodiversity, but in fact positively contribute to it, could present a significant change of mindset of policy makers. Any major projects targeting planning permission in a year or more from now need to take this into account.

Update on the Low Carbon Hydrogen Business Model

As detailed elsewhere in this newsletter, hydrogen is seen as key to the UK's energy independence and carbon reduction targets. However, the challenge in building an entire hydrogen economy from scratch is a significant one.

The government is therefore funding various hydrogen pilot and development programmes, as detailed in its Hydrogen Strategy (here, with a 2022 update available here), to test the viability of mass production and use of hydrogen as flexible energy for power, heat and transport. Earlier this year, the government doubled its original target of 5GW of low-carbon hydrogen production capacity by 2030 to 10GW. It also launched its Hydrogen Investor Roadmap in April 2022 – essentially a marketing campaign to attract investment into the area, which details various timings and revenue support mechanisms.

One element of that state support is the 'Hydrogen Business Model' ("HBM"), which will provide revenue support to facilitate investment in new low carbon hydrogen production. The HBM will initially focus on electrolytic and carbon capture, usage and storage enabled hydrogen production. The government is proposing a Contracts for Difference ("CfD") style variable support mechanism for the HBM – effectively guaranteeing producers a 'strike price' (which will allow them to recover their costs plus a reasonable return), with the government backed contract counterparty then taking the risk/reward of higher and lower market pricing. Initial details of the proposal were laid out in the government's response to a consultation earlier this year (including indicative heads of terms) here. However, there is considerable complexity to how this would work in practice – for example, in the absence of the ability to easily benchmark pricing (unlike CfDs there is no existing wholesale market to provide a transparent reference price) there is a particular need to ensure producers are incentivised to maximise return.

Government is working with the Low Carbon Contracts Company (the counterparty for CfDs) to develop the more detailed HBM terms. Based on the Hydrogen Strategy, Government had intended to finalise the HBM through further consultation in late 2022 - although it is now anticipated this could slip to early 2023.

Prohibition on continuing to let commercial properties with an EPC rating of "F" or "G" (from Apr 2023)

The Minimum Energy Efficiency Regulations 2015 ("MEES") are intended to reduce harmful emissions from the built environment, with a view to achieving net zero by 2050. The MEES regime refers to the rating that a property was given in its energy performance certificate ("EPC").  From April 2018, landlords of qualifying commercial properties have been unable to grant a new lease of a property that scores F or G unless one of the following exemptions apply and have been registered on the PRS Exemptions Register:

  • all the relevant energy efficiency improvements for the property have been made (or there are none that can be made) and the property remains sub-standard;

  • third party consent to carry out the works is required and has not been obtained. This is a five year exemption;

  • the landlord has obtained a report from a RICS-registered independent surveyor advising that the installation of specific energy efficiency measures would reduce the market value of the property by more than five per cent. This is also a five year exemption;

  • the landlord has only recently become a landlord, in one of the circumstances set out in the Regulations. This exemption lasts for just six months;

  • a recommended energy efficiency measure is not considered to be a relevant measure where it is cavity wall insulation, external wall insulation or internal wall insulation (for external walls), and the landlord has obtained written expert advice indicating that the measure is not appropriate for the property due to its potential negative impact on the fabric or structure of the property. This exemption last for five years; or

  • the expected value of savings on energy bills that the recommended relevant energy efficiency improvements are expected to achieve over a period of seven years is less than the cost of carrying out the works. This exemption lasts for five years.

Some properties do not require an EPC and therefore fall outside the regime, including:

  • any properties outside England and Wales;

  • any properties let under a licence rather than a lease, or under a lease with a term of either under six months or over 99 years; and

  • temporary buildings, agricultural buildings, those of under 50 sq m, workshops with low energy demand or buildings that are about to be demolished, and listed buildings/ those in conservation areas if the energy-related alterations would unacceptably alter their character or appearance.

From 1 April 2023, these rules will start to apply to existing leases. This means that landlords must not continue to let a sub-standard property to existing tenants (even where there has been no tenancy renewal, extension or indeed new tenancy) or to new tenants, unless one of the exemptions above apply. The rules are complex but there is some Government guidance to assist.

Landlords and tenants of commercial premises affected by this change (and their respective investors/funders) will be concerned to check the terms of their relevant leases to determine who between them is to pick up the cost of making the necessary improvements. When it comes to altering commercial premises, landlords are increasingly sensitive about the effect of any works on the energy efficiency of their buildings and tenants should expect to provide increasingly detailed information on how their fit out, occupation and use of commercial premises affects energy performance.

A lease granted or continued in breach of these rules is still legally valid but the landlord risks enforcement action including fines and "naming and shaming" by means of the publication of the details of the breach.

Expiry of gas hedging contracts

Last year

Broadly speaking, smaller challengers in the market were able to offer lower prices than their more established competitors and therefore capture customers by hedging less or none of their output and thereby avoiding the generally higher forward commodity prices. With the sharp rise in prices, those companies who had chosen not to hedge their exposure saw their cost of wholesale supply skyrocket and, constrained by energy price caps, they were unable to pass on the costs and collapsed. In parallel, the established players who had hedged sufficiently were able to ride out the price rises and even gain market share by taking on the customers of their collapsed competitors.

Looking ahead

The energy price cap increased by 54% in April 2022 with a further increase in January 2023 which would (in the absence of government support) see a typical household bill rise to £4,279 per year. A variety of government assistance packages have been unveiled, focussing primarily on ensuring consumers are able to pay their energy bills over winter 2022 to 2023, albeit pared back slightly in the Autumn Statement. If wholesale prices follow their recent trajectory and continue to climb, further increases to the price cap (and therefore, at least in the short term, the effective level of government subsidy) are inevitable. This, combined with Ofgem's decision to adjust the cap every three months instead of every six, is expected to make it less likely that further energy suppliers will collapse, particularly now that those with the least cautious hedging positions have already fallen by the wayside.

However, even the best hedged suppliers will begin to feel the effects of higher prices as futures contracts roll off and replacements are required. With high gas prices showing no signs of falling any time soon, the price of these replacement futures has also risen. Whilst they will be protected by the energy price cap increases, we are yet to see what the long-term impact of this may be in the market. It does notably introduce the possibility of energy suppliers accelerating their shift to renewable sources, with the investment required to do this looking relatively less expensive in a market where high gas prices remain the norm.

Should you have any questions about energy hedging arrangements, please do contact our Derivatives & Structured Products team.

Source: Domestic energy prices - House of Commons Library (

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