Scottish Northern Ireland Pipeline
The downsides of Northern Ireland’s unique political set-up are well documented, but the existence of such a small state that was isolated from major markets for a long time creates another problem – high energy prices, writes Aaron Woolner.
Unlike the rest of the UK, Northern Ireland did not even have access to gas supplies until the early 1990s when British Gas acquired the Ballylumford power station – supplier of 50 per cent of the province’s power – and promptly converted it from oil to gas. This added impetus to the drive to establish a secure supply of gas.
This took off in 1996 when Premier Transmission – then operating as Premier Transco – constructed the Scottish Northern Ireland Pipeline (SNIP) that links the gas fields of Scotland to the province.
But this late take-up and gas, and the lack of economies of scale from such a small market resulted in an energy market that was under-developed and, more importantly, over-priced.
According to Ofreg – the province’s energy regulator – Northern Ireland’s geography and distance from a grid has two major negative effects on the local economy:industry suffers from competitive disadvantage domestic customers have the highest level of energy poverty in the UK
While it is clearly impossible to bring the province geographically closer to the rest of the UK, and steps being taken towards creating an all-Ireland energy market are moving at a snail's pace, Ofreg needed to find another way to reduce the province’s energy costs and firm up its supply guarantees.
When Premier Transmission put SNIP up for sale late last year, Ofreg elected to throw its weight behind the efforts of Team Northern Ireland - a consortium led by former Mirror Group chief exec David Montgomery - to add SNIP to its growing power portfolio through its Northern Ireland Energy Holdings (NIEH) vehicle.
Team Northern Ireland was established in 2002 by a group local of business professionals to promote the renewal of Northern Ireland’s economic infrastructure in the face of the unique challenges faced by the province’s energy market.
In order to do this, the parties set-up a not-for-profit ownership of the gas infrastructure which resulted in a radical overhaul of the provinces gas charging mechanism – postalisation – and holds out the tantalising hope that structures of this kind can be rolled out across the UK and bring down cost of gas for all the country’s consumers, and for CCGT power production through lower gas prices.
Though not a complete one-off, the absence of equity in financing the pipeline was unusual, but -according to Paul Rowan, director at David Wilde Project Finance which advised Team North Ireland on the acquisition - it was not without precedent.
‘Like Moyle [the interconnector between Scotland and Northern Ireland], it is a 100 per cent debt structure and is also a mutualisation,’ he says, ‘although there is no equity cushion for debt providers to fall back-on it absence is unusual but not unheard of in the UK.’
‘Other successful transactions carried out on this basis include Wales Water, Network Rail, as well as the Moyle interconnector,’ he added.
This is possible, says Geoff Knight, director at Royal Bank of Canada Capital Markets, who advised Premier Transmission on the issue, because although SNIP is an oil and gas asset, that is not the way it is treated by the market.
‘This is effectively a utility rather than an oil and gas facility – it has got a long-term licence and guaranteed payments – this was reflected by the strong appetite by investors for the issue,’ says Knight. ‘We compared all the possible structures, and bond financing provided the best value for consumers for this kind of asset.'
How this form of financing provides best value for consumers is illustrated by Tim Travers, senior managing director international and global utilities for FGIC, which provided the monoline insurance for this issue.
‘When the previous owners – BG and Keyspan – had hold on the pipeline it was 40 per cent debt financed,’ says Travers, ‘with the cost of equity roughly 12 per cent a year, and the cost of debt around 6 per cent. This gave a weighted average cost of capital of around 9 per cent.
‘But on the other hand, if you make the deal 100 per cent debt financed, with a wrap, then you can bring the total cost of capital to 5.2 per cent - a significant saving on the previous arrangement.'
The geography of Northern Ireland not only provided one of the main drivers for the refinancing of SNIP, it also gave a headache to those trying to come up with a fair way of charging for the gas transported along the pipeline - postalisation.
Unlike the majority of utilities which bill on a ‘true cost’ basis – where the consumer furthest from where the gas is delivered pays a higher price than one living on its doorstep – with postalisation everyone pays the same, flat fee.
‘Postalisation gives you a way to pass on a cost on a uniform basis and is integral to the regulatory construct,’ says Travers. ’It shifts the burden from gas rate payers to electricity rate payers.’
This, Travers explains, is possible because SNIP delivers the gas that supplies 75 per cent of the electricity in the province the postalised gas cost can then be embedded within the electricity charge.
The FGIC team responsible for providing the wrap had to pick its way carefully in order to ensure the best return for Northern Ireland’s consumers through the bond issue.
Unlike a merchant facility, the price SNIP can charge for transporting gas is dependent on the regulator, rather than prevalent market forces - an issue which, if not handled correctly, could have threatened the top grade status needed to keep interest rates down.
‘This forced us to focus on the regulatory risk,’ says Travers. ‘With no equity component there was no headroom with the deal. What we had to do was to make sure we had full cost recovery in order to mitigate against this risk’
Another problem facing the insurers is SNIP throughput dependence. If for some reason consumption went down then revenues would naturally follow them south and produce liquidity issues further down the line. A solution had to be found and within a timeframe that would fall before the annual rate setting.
The solution was to build extra liquidity into the transaction to mitigate this timing issue and hedge against any unforeseen costs in the early life of the mutualisation
‘To circumvent these issues there were two full years of debt service imbedded in the transactions – typically you might expect 6 months to a year – giving the sensitivity in this case of the asset to the gas flows. This was neccessary in order to get the rating that was so important to the issuers,’ says Travers.
With Ofreg claiming the Moyle issue generated savings of around US$1.5m a year and SNIP expected to be US$45m cheaper over its lifetime than an equity based financing, there would appear to be scope to replicate its success onto a wider scale on the UK mainland and Rowan was cautiously optimistic that this is possible.
‘It could be implemented outside of Northern Ireland – it is just a neat way of ensuring a common tariff across the province, if there was political will it should not be problem.’ He said.
But Rowan’s caveat is important - as with the Moyle transaction, the SNIP financing was dependent on the all the parties involved singing from the same hymn sheet.
This point was echoed by Knight who is less convinced of the potential for mutualisations being rolled-out across the UK.
‘There is a possibility that this template could be used in Wales and Scotland, in water and other utility developments,’ he said. But without a change in regulatory attitude it is unlikely to be used in England. It is essentially an Ireland-centric model for development.’