Time for a new approach to political and regulatory uncertainty and risk in the energy and water sectors

Uncertainty and risk relating to fairness and the environment are not new in the UK energy and water sectors.However, new challenges faced by the sectors demand a fundamental rethink of today's treatment and handling of both – be this by government, regulators, company managements and/or their investors.

This is not simply about a nationalization challenge.Rather, it is the critical need to understand the full range of uncertainties and risks that arise in our dynamic, digital and interconnected world.

Sustainability First's new discussion paper provides an early insight into our work on mapping political and regulatory uncertainty and risk as it relates to fairness and the environment in energy and water. This paper forms part of our new major three-year Fair for the Future project, which sets out to rethink and reframe the debate around fairness and the environment in the sectors and asks how best we can understand and mitigate new risks and uncertainties in the 'disrupted' world of the 21st century.

Through our risk-mapping work, we seek to help enable energy and water companies, policymakers, and regulators to demonstrate a more coherent approach to risk in a radically changing and shifting environment. We want to develop a more comprehensive framework for thinking about risk and uncertainty, a common language for dealing with risk, and in the process, a 'democratisation' of debates around fairness and the environment.

As a starting point, the Fair for the Future project has analysed risk and uncertainty from the perspective of 'conventional politics'. 'Risk' and 'uncertainty', however, are not the same thing. Whereas risk may be determined reasonably objectively and therefore be used to drive markets, uncertainty occurs where expectations are less stable and consistent.Where this leads to eroding consumer trust, dwindling engagement, and reduced investor confidence, it can increase pressure on the cost of capital, and in turn act as a 'dead-weight' on customers' energy and water bills.

In his working note for the discussion paper on the economics of political and regulatory uncertainty, Professor George Yarrow unpicks this distinction between risk and uncertainty and highlights some clear public interest implications. When there are no clear or meaningful consequences for those whose conduct goes against established patterns of expectations, mistrust can be exacerbated. If this mistrust leads to a reduction in the capacity to co-ordinate and carry out social and economic activities, he notes, "the performance of the whole system suffers".

Risk in the energy and water sectors is of course nothing new.However, our second working note in the discussion paper on the apparatus of government and regulation highlights that there has been a significant 'trend increase' and a fundamental generational shift, not seen since the privatization and restructuring of the 1990s. The continuing fallout from the 2008 financial crisis, the 2016 EU referendum, and the fourth industrial revolution – among other factors – pose significant challenges to the energy and water sectors and have together led to a renewed interest in nationalisation and local-level/devolved approaches. The note proposes a typology of risks, sets out some of the industries' key players, and considers some potential political risk triggers.

The third working note in the paper provides an overview of political and regulatory risk from the perspective of capital markets. It outlines both the types of public infrastructure assets and the types of investors in these assets. Risk is usually seen to be more of an issue for equity investors than debt investors.Equity markets actually thrive on risk, which can be analysed and priced effectively, unlike uncertainty, that cannot. The note then examines some of the differences between public and private markets and different types of owners, noting the fact that the vast bulk of UK electricity, gas and water networks are now owned by private side investors who are largely based overseas.Analysing the implications resulting from the often complex and highly leveraged private ownership of UK energy and water networks, it also touches on the debate over public sector versus private ownership.

Sustainability First's discussion paper will be the first in a series on this theme. While this paper covers the 'conventional' means for appraising and handling risk, we recognise that the world is changing.As we move towards digitisation and a more dynamic consumer environment, companies should embrace disruption in order to influence and more proactively address future risks. Issues of fairness ought not be discussed within a narrow and technocratic framework only in terms of capex and cost of capital; rather, the discussion ought to be opened up to consider how changes in consumer lived experience, wider civil society and the media can shape risk.

This is why we are developing an Uncertainty and risk-mapping framework for fairness and the environment, which we hope will serve as a comprehensive, coherent, and flexible framework for use by energy and water companies, government, regulators, markets, and civil society. We will be publishing a second paper on risk in early 2019, moving beyond 'conventional politics' to focus on the shifting sentiment and changes underpinning the 'politics of the disrupted world'.

Our work on risk will be integrated into a separate but parallel Fair for the Future workstream in which we will iteratively be testing with key stakeholders the 'Sustainable Licence to Operate' strawman that we will publish shortly. In doing so, as this discussion paper concludes, "we hope to see companies become more confident in developing their own future-facing agendas for both fairness and the environment."