In this space we will regularly review new publications – to keep you abreast of what is going in energy markets – and hopefully save you some time. This first installment of our Review Service discusses four recent reports that deal with the manifold problems in the (European) electricity sector. They even offer some advice – but not much.
Photo: azza bazoo
European Power Utilities under Pressure
This report focuses on “how the electricity majors are dealing with the changing investment climate in the EU power sector”. The fact that European energy companies are facing a “challenging environment” is well known by now. The author describes some of the measures and strategies the big-7 European power producers are taking to cope with these challenges.
The report contains a comparison of some “key indicators” that are suggestive in their own right. For example, Eon had by far the largest revenues in 2012 (€143 billion) – twice as much as number four EDF – but EDF had larger net profits (€3.2 billion versus €2.2 billion). Enel had the third largest revenues (€85 billion), but the lowest net profit (€0.87 billion). The smallest of the big-7, Vattenfall, with just €19.2 billion in revenues, managed to bring in a hefty net profit of almost €2 billion – more than RWE, Enel and GdF-Suez, and almost as much as Eon.
Combined revenues of the seven firms grew from €282 billion in 2007 to €502 billion in 2012, mainly as a result of acquisitions and increased trading activities. On the other hand, total net income declined over the same period from €26 billion to €14 billion, clearly showing the pressure on profit margins. The companies try to cope with these difficult market circumstances mainly by restructuring, divesting assets as well as expanding beyond the EU into new markets, notes the author. Vattenfall, for example, has divested activities in the Netherlands, Belgium, Germany, Finland and Poland. GDF Suez has sold assets in Italy, France and Belgium.
GdF Suez is by far the most diversified of the EU power majors, notes the report, and continues to develop its LNG and energy services operations outside of the EU. But the others are also pinning their hopes on new markets. Eon has assets in Russia and has set up joint ventures in Brazil and Turkey. Enel spends more than half of its CAPEX on power generation in the Americas, partly through its Spanish subsidiary Endesa. Iberdrola is also looking at the Americas. RWE focuses on Turkey, South Eastern Europe and Poland. EDF has nuclear facilities in the US and China, hydropower plants in Brazil and Laos and wind power parks in the US and Canada. Vattenfall is the only one which does not seem willing or able to expand outside the EU. Incidentally, as the author notes, the reverse is also happening: companies from outside the EU are increasingly interested in acquiring assets here – see for example the Chinese takeovers in Protugal.
When it comes to renewables, the report notes that “wind is the renewable energy source of choice among the power majors” (if we exclude hydropower). They also tend to favour biomass, which they can use in coal plants.
A crisis in UK energy policy
Liberum Capital, A Crisis in UK Energy Policy Looks Inevitable (April 30, 2013)
This is a very hard-hitting report, which got quite a bit of publicity in the UK when it came out at the end of April. If you missed it, read on. The authors – analysts Peter Atherton and Guillaume Redgwell of the European Equity Research department of London-based financial services and investment company Liberum Capital – argue that “successive UK governments have grossly underestimated the engineering, financial, and economic challenges posed by the drive to de-carbonise the electricity sector by 2030. Far too much is being asked of the power sector, which is taking on the burden of climate change policy for the whole economy.”
Both EU and UK policymakers, says this report, are far too ambitious in their climate policies. UK policy “requires the power sector to migrate from a largely fossil-fuel based system to one overwhelmingly based upon renewable and nuclear capacity” in the space of some 17 years. The share of renewables in electricity generation is to grow from 10% to 35% in just 7 years. “This would be one of the biggest industrial transformations in British history”, say the authors. They do not believe it can be done.
The two analysts note that “To deliver its policy goals the government requires utility companies (and third party investors) to build assets that are fundamentally not economic, often in technologies that are still far from robust or mature.” To make sure that the companies deliver on the goals, the government is proposing far-reaching interventions in the market, in effect amounting to “the effective renationalisation of the investment decision process in the power sector. It is now the government, not private companies, who will decide what power stations get built, when, where, and using what technology. The role of the power companies is reduced to acting as a facilitator for DECC decisions.”
And where the government advances, private investors do well to retreat, says the report. The authors warn investors that to put money into UK energy companies at this moment is a risky proposition, in particular because of the political exposure the companies – especially the big six: Centrica, SSE, Eon, RWE, EDF and Iberdrola/Scottish Power – are facing. “Given the hostile rhetoric that utility companies face from across the political spectrum on bills and their profits today, it takes quite a leap of faith to believe that future governments will steadfastly defend the sort of bill and profit increases that policy will require. Political risk is bound to rise sharply in the UK energy space in the coming years as the inherent implausibility and contradictory nature of the policy goals are exposed by events.”
They conclude that “a crisis in UK energy policy looks increasingly likely and therefore utility companies and investors would be prudent in limiting their future exposure”. It’s not a message that policymakers in London or Brussels will want to hear.
Towards a sustainable market model
Jens Büchner, Remco Frenken, Towards a Sustainable Market Model (April 2013, study commissioned by TSO Tennet)
Whereas Liberum Capital looks at the electricity market from a solidly financial perspective, this report is clearly written by two energy specialists. Frenken works for UMS Group, an international management consulting firm for the utilities sector, Büchner is Managing Director of E-Bridge Consulting, another specialised energy consultancy. The authors are not the first to note that the European electricity market has been thrown out of balance in recent years. “The current electricity industry framework is designed around large scale fossil generation whereas the new energy world is centered around renewables”, they note. “This leads to strange price signals, instability and increasing discussion within society over the unplanned side effects of the ongoing energy transition (tax & levies increase, perceived market distortion and doubts whether the security of supply is guaranteed in the long run).”
Their analysis is different in that it goes into quite a bit of depth. They identify in detail (though in highly condensed form) what “the real problems” are “for the relevant stakeholders in the current framework”. They discuss what the big issues are for conventional generators, renewable generators, infrastructure companies and system operators, and they even include that oft-forgotten group: the consumers.
For example, with regard to small consumers, they note that their energy bills consist of “an increasing amount of socialized costs”, their bills are getting higher “without many possibilities to influence it”, they face an “increasing risk of fuel poverty” and are “increasingly aware of the costs associated with the energy transition”. As a consequence, they are looking for “ways to avoid levies and taxes by installing their own generation” (solar, micro-CHP), which results in the “remaining” grid customers having to pay even higher taxes and levies”.
Their conclusions are not very hopeful: 1) the market share of “the market” is decreasing; 2) renewables will always depend on subsidies (because when the wind blows and the sun shines, prices drop, at the very moments when wind and solar production are at their highest); 3) investment in conventional generation will not be attracted; 4) the contribution of market parties to security of supply is not incentivized 5) the need for back-up power is not part of the current market design; 6) there is an increasing amount of socialized cost; 7) there are no locational signals to smooth the problem of lagging grid expansion and 8) the single European energy market is jeopardized by diverging (national) repair actions. Are you still there?
They then raise a number of interesting FAQs to which they give some intriguing answers. For example, how does the CO2 market relate to renewable subsidies? Their answer is that even higher CO2 prices would not impact the market value of renewables and they would not give a higher incentive to traditional generation to take up the backup role. “There is simply no appropriate link between CO2 prices and renewable subsidies: the more renewables there are, the more subsidy is needed, but the lower the CO2 price.” Therefore, the authors are “convinced that the CO2 market in its current form has no reason to exist”.
They conclude from their analysis that the “current market model is not robust for the new energy world” and a new one is needed. Here, however, the story ends. Although they note that “the problem will not solve itself”, they, unfortunately, stop short of offering solutions for the current conundrum the European energy market is facing. Any takers out there?
Finally, if you work in the plagued electricity sector and you want to get even more depressed, don’t forget to check out this report: Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business, published in January 2013 by the Edison Electric Institute in the US and written by Peter Kind of Energy Infrastructure Advocates. We have already discussed it on our website here. The report looks at how certain “disruptive challenges” could wreck the traditional utility model altogether. Or is this the “new market model” the electricity market needs?