Environmental consultancy in a cash-strapped market

With the UK government poised to announce the deepest spending cuts in decades and investors wary of parting with their cash, the UK looks set to remain a difficult market for environmental consultancies. Geraint Roberts reports

At a recent parliamentary reception held by the Aldersgate Group – a coalition of “progressive” businesses, NGOs and individuals that lobbies for more ambitious environmental standards as the route to achieving economic growth and international competitiveness – the new energy and climate change secretary, Chris Huhne, offered his views. Huhne told his audience that “the prime minister is totally committed to the low carbon agenda”. Drawing parallels between the current economic downturn and the depression of the early 1930s, Huhne said he was “convinced we stand on the edge of a revolution in our industrial structure. The period of growth in the 1930s was one of the highest in UK history, spurred by growth in new areas such as light industry and electrical appliances”.

Many people in the audience appeared to agree with him. Supporting Huhne’s argument is the fact that several key policies that could play a role in sparking a low carbon economic boom were put in place prior to recession. These include the climate change act, the EU renewables directive and an increasing focus on improving UK energy security. None of these is going away, but how will the need to cut the budget deficit affect them and the pace of growth of low carbon and environmental services? The picture is a complicated one and is likely to remain so for some time.

There is no better example of the complications that have – and will continue to – come as the new government seeks to slim the deficit than July’s confused announcement about the end of the building schools for the future (BSF) programme. While no one in consultancy circles thought BSF would proceed at the spending levels set by Labour, it is clearly a sign of things to come that the new government has cut deeply and has calculated cumulative savings of £7.5 billion through the cancelling of more than 700 school building projects.

One major BSF player, Carillion, was sanguine in response. It said the BSF cuts were in line with its own plan to reduce the size of its UK construction business, adding that in the medium term public sector cuts in other areas may create new opportunities for its largest business, support services. “As we move through 2011 and into 2012 we expect to benefit from an acceleration in outsourcing by central and local government organisations as they come under increasing pressure to achieve the 25% reduction in spending announced in the UK Government’s Emergency Budget”, noted Carillion.

While it is true that the age of austerity may offer some environmental consultancies the chance to seize new opportunities to provide outsourced services to clients, analyst David Brockton of Execution Noble warns against expecting too much from this market. “Austerity measures should prompt an increase in outsourcing to the benefit of many constituents of the support services sector,” he agrees. “However, it is our view that tougher contractual terms and greater competitive pressures will limit margin gains. We further believe that this structural shift will act to accelerate the commoditisation of the UK outsourcing market.” The type of businesses likely to benefit most from any growth in outsourcing will be those who “operate in markets where barriers to entry are high or where a sustainable position of scale or technical expertise has been built”.

In addition to loud headlines about the cancellation of high-profile, national spending programmes such as BSF, there have been less-publicised announcements that do not bode well for the UK environmental market. Abolition of the Sustainable Development Commission and the Royal Commission on Environmental Pollution may not affect directly the revenue streams of very many environmental consultancies, but it clarified one issue: the coalition government may say that climate change and environmental sustainability are a priority, but that doesn’t mean they will be spared cutbacks (Environment Analyst, 22-Jul-10). Also announced in July was £34 million trimmed from a range of “low carbon technology” funds managed by the Department of Energy and Climate Change. Areas affected include development funds for bio-energy and deep geotheral energy, grants for offshore wind capital investment, funding for central government’s own take-up of low carbon technology, technology trials run by the Energy Savings Trust, and the activities of the Carbon Trust.

The full impact of the government’s budget cutting programme will not begin to be worked out fully until 20 October, when details of the comprehensive spending review for the period to 2014/15 are published. June’s emergency budget introduced £32 billion extra in public sector spending cuts by 2014/15, on top of the £52 billion already outlined in March’s budget. October’s spending review announcement will reveal far more, in particular, which government programmes face the chop or significant cutbacks for the foreseeable future. With widespread media reporting of the government’s demand that almost all government departments identify how they would reduce spending by 25% - 40%, no one is any longer in doubt that austerity lies ahead. Public expenditure will be a massive £83 billion a year lower by 2014/15 than it would have been if departmental expenditure remained constant in real terms.

An immediate freeze on “unnecessary” spending on consultancy, advertising and new ICT is being overseen by the Cabinet Office’s efficiency and reform group. “Absolute priority” will be given to capital spending on projects the government judges to offer “a significant economic return to the country”. Here, transport – traditionally, a department that bears much of the pain during periods of lower spending – could fare better than usual, since many transport projects can be shown to meet the national economic return test. Transport secretary Philip Hammond says he continues to support Crossrail and the proposed new high-speed rail project, High Speed 2. Also of note is the coalition agreement’s inclusion of a promise to “mandate” a national recharging network for electric and plug-in hybrid vehicles. Nevertheless, some transport projects will be cut, with the A14 improvement scheme already cancelled.

Uncertainty breeds paralysis

With so much uncertainty it is no surprise that the threat of cuts has had a significant impact on environmental consultancies, says SKM Enviros’ head of marketing, Nigel Clark. “As a sector we are used to a period of limbo with project commissioning either side of a national election, but this year that period of uncertainty looks like being far longer than usual. Although there is nervousness surrounding a deregulation agenda that might accompany spending cuts, there are also strong legal drivers in place, so delivery will remain a challenge. However, it is clear that government departments, agencies and local authorities will find it harder to engage consultancies to support delivery as long as the spending picture is unclear”.

Clark acknowledges the possibility of increased outsourcing to environmental consultancies by some public sector bodies, but he adds that “inevitably the devil will be in the detail and it might be as much a question of ‘when’ as ‘if’. Once budgets are clearer, departments will need a period to assess how they will achieve the demanded cuts and continue to deliver their agenda. That will inevitably include changing priorities, shifting timescales and different delivery models.”

From Clark’s perspective, “the important thing for consultants will be to stay close to their clients, not run away while they are not spending, and help in the process of identifying how departments can do more with less. Relationships, client understanding and innovative ideas will become more relevant, rather than less.”

Last month, Atkins warned that deficit cutting would lead to many delayed and cancelled projects, yet at the same time consultancies are likely to face “more complex engineering challenges, as clients put greater emphasis on planning and design disciplines to achieve maximum value for their infrastructure programmes”. It’s a case of consultancies having to summon up the strength and expertise to offer clients more despite there being less cash to go around.

An issue for some environmental consultancies is the extent to which in recent years they have become dependent on work from quangos and other central government-funded bodies and programmes. The government has already announced it is pushing ahead with plans to abolish the Infrastructure Planning Commission and the regional development agencies (RDAs), although in both cases some of the activities of the soon-to-be-disbanded organisations will be taken on by new bodies. Needless to say, there are concerns that doing away with regional spatial strategies, along with other, recent announcements about relaxation of various planning regulations, could create a strategic planning gap that would make advances toward a lower-carbon economy significantly more difficult.

Meanwhile, the Carbon Trust, along with the Energy Technologies Institute (ETI) and the low carbon unit of the Technology Strategy Board (TSB), plus six government funds, are likely to be subsumed into a new green investment bank (Environment Analyst, 01-Jul-10). Public bodies such as the Environment Agency, Natural England, the Waste Resources and Action Programme (Wrap) and the new Marine Management Organisation are all expected to have their budgets cut.

“Consultancies that have grown on public sector and quango contracts will find life changing significantly,” comments WSP director David Symons. “Having said that, the challenge of cutting carbon and delivering a sustainable economy has not gone away. Our sector will need to find new, commercial ways of helping the public sector deliver on these goals. There will be less straight consultancy contracts, but more opportunities to construct partnerships and develop innovative commercial propositions. These will focus more around gainshare agreements, guaranteeing operational cost savings and real commercial value”.

Skills brain drain

The squeeze on public bodies’ budgets will put pressure on staffing levels as well as capital funding. The Treasury predicts that 500,000 – 600,000 jobs will go in the public sector over the next five years, while other voices, such as the Chartered Institute of Personnel and Development, are predicting greater numbers of job losses. During the recession of the early 1990s, when budget cuts were lower than those now being planned, the public sector workforce shrank by approximately 600,000. Whichever estimate is proved right in the end, staff losses from public sector teams with which environmental consultancies liaise will create delay, confusion and add to the pressure on those who remain. In response, many public sector bodies may narrow their remits, curtail activities and, of course, look for alternative sources of funding.

In a recent speech, Wrap chair Peter Stone said budget cuts are already forcing his organisation to focus on fewer priorities and look to leverage more from partners, while Environment Agency chief executive Paul Leinster has said that future investment in flood defences will require greater contribution from the communities set to benefit from such schemes and from local businesses.

There is no escaping the fact that a massive drop in public sector investment looks set to coincide with the need to spend £200 billion by 2020 – according to the government’s own estimates – to shift the UK economy toward a low-carbon energy base. The investment needed to achieve such a transition can be found, insists Tom Burke, former adviser to three environment secretaries and a founding director of thinktank E3G.

“The transition is affordable,” Burke told his audience at the same Aldersgate Group event at which Chris Huhne spoke. “It won’t wreck the economy, but it will wreck some business models. For example, if electric vehicles take off, demand for petrol will disappear. You will also get an enormous number of new jobs – for example, for work retrofitting homes – but they won’t be for the same people, using the same skills and they won’t be acceptable politically unless the government explains how it’s going to manage it. Some infrastructure projects, such as upgrading of electricity transmission networks, might be paid for by the private sector, but for advancements in riskier areas, like carbon capture and storage and electric vehicle networks “you’ll need public investment”, says Burke.

The two main financial instruments the government appears to be pinning its hopes on are transformation of the climate change levy into a carbon floor price and the creation of a green investment bank. Burke suggests that the former would be a neat way for the government to get round the problem of ruling out government subsidies for new nuclear, while quietly acknowledging that the cost of building new reactors is too great for the private sector to shoulder alone.

Everyone agrees that the success – or failure – of a new green investment bank will depend on its capitalisation. “The Aldersgate Group has called for £2 billion from the government, but I don’t think that’s enough,” says Burke. “The government must look at products like green ISAs and green bonds, and think this through all the way.” Chris Stubbs, director with WSP Environment & Energy has described the volume of investment, some £2.2 billion, that the new bank may be in a position to dish out as “a drop in the ocean compared to the levels which will be required”.

In addition to floating a figure of £2.2 billion, a report issued by the Conservative-appointed green investment bank commission also considered novel ways the bank could raise money, such as green bonds and green ISAs as well as a direct levy on energy bills, diverting revenue from the sale of EU emissions trading scheme allowances, and the sale of government assets. However, with the Treasury looking at those very same sources to cover spending and structural debt reduction, the bank is expected to face stiff competition.

All this leaves consultancies facing a longer period of uncertainty than they are used to after a change of government and the strong likelihood of volatility and tough times for some time to come. With questions growing again about the possibility of a “double dip” recession, consultancies will be keeping their ears to Whitehall’s ground as they seek to judge when it’s time to take cover and when it’s time to take advantage of opportunities during this new age of austerity.