What does Eon’s change in corporate strategy and Gazprom’s decision not to build South Stream have in common? Quite a lot. Both decisions are responses to the increasing speed in which Europe is moving towards a low-carbon society. Both are also bold and risky decisions for the two companies involved. The rest of us probably need not be (too) concerned, writes Energy Post editor Karel Beckman.
On Monday two bombshells dropped on the European energy market. Eon, Germany’s largest energy company (with revenues of €36.8 billion last year), announced a major strategic change, saying it will henceforth focus on renewables, distribution networks and “customer solutions”. At the same time, it will divest its conventional power generation (and power trading) business, which will be subsumed in a separate entity and sold off.
Very shortly afterwards, Russian President Putin had another characteristically straightforward announcement to make: the South Stream pipeline will not be built. Period. Well, it might be diverted to Turkey, but that’s not clear yet.
These two landmark decisions – which will both have a huge impact on European energy markets in the years to come – may seem totally unrelated. Yet they stem from the same underlying cause: the deep changes that are taking place in the European energy sector. In particular, the transition Europe is making towards a low-carbon society.
Eon’s new corporate strategy
In the case of Eon, this is obvious. The company sees little growth potential in its ‘conventional’ coal, nuclear and gas fired power plants. Instead, it will focus on three main areas: renewable energy, distribution networks and customer solutions.
The renewable energy activities currently generate revenues of €2.436 billion and make up 11% of the company’s power production. The portfolio is structured as follows (2013 figures):
- 48% (4855 MW) hydropower , 54% (15.7 TWh) output
- 37% (3694 MW) onshore wind, 35% (10.3 TWh) output
- 7% (688 MW) offshore wind, 7% (2.2 TWh) output
- 8% (783 MW) biomass, 3% (0.9 TWh) output
- 1% (62 MW) solar PV/CSP, 0% (0.1 TWh) output
The assets are in the US (23%), Germany (23%), the UK (15%), Denmark and Sweden (19%), Italy (9%), Spain (9%) and some small assets in France, Portugal and Poland. Eon has said it will place “particular emphasis on expanding its wind business in Europe and other selected target markets”. It also wants to “strengthen its solar power business”.
Eon also owns over a million kilometres of power grids, some 40% in Germany, 20% in Turkey, 14% in Sweden. The company says it wants to “upgrade its energy distribution networks in Europe” and “make them smarter”. From the financial statements provided by Eon (see the next two links below) it is not clear what the revenues and profits are of this division.
In its retail business, Eon has 33 million customers, including 7.7 million in the UK and 6.1 million in Germany. This year is actually the first time in many years the number of its German customers has grown, the company notes. Interestingly, Eon also wants to actively partner with cleantech start-ups in Europe and North America and position itself as “a pioneer in innovative, customer-oriented solutions”.
The “new company” that Eon will set apart will include its nuclear power stations (which are to be phased out in Germany) as well as its coal-fired and gas-fired power stations. What are the shares of the various types of generation? In the presentation of the new strategy given to investors Eon provides no details. This overview on Eon’s website has more information.
All in all, Eon has 370 power stations at 300 locations throughout Europe with a total capacity of 40 GW. This includes:
- about 20% (8200 MW) in nuclear capacity in Germany and Sweden, producing 56 TWh in 2013
- 45% (18200 MW) steam (coal-fired) capacity in Germany, UK, Sweden, France, Netherlands, Belgium, Italy and Spain, producing 70 TWh in 2013
- and 34% (13700 MW) gas-fired (CCGT) capacity in Germany, UK, Sweden, Italy, Spain, Netherlands, Hungary and Slovakia, producing just 20 TWh in 2013 (the low output figure shows that the gas-fired power plants are running at low capacity, because of the high gas prices compared to coal)
Reasons and risks
The reason for the new strategy is obvious: the stormy growth of renewable energy, above all in Germany, has killed the growth potential of the conventional generation business. And this is not likely to change in most of Eon’s core markets. Other countries in Europe, such as the UK, are following down Germany’s path. The EU has set ambitious CO2 emission reduction targets. In the US a similar scenario is unfolding. The opportunities in nuclear are limited and the company has already made a decision not to pursue those. Coal-fired power is under pressure. Gas-fired power is running at a loss.
With the costs of wind and solar power still on a downward path, carbon capture and storage (CCS) expensive and unpopular, the pressure for an ambitious climate agreement ever stronger, Eon’s conventional power business seems to offer little growth potential.
Eon’s move has a number of attractive features. It clearly separates the new from the old business, which will give both companies a clear focus. The old business, which is hampered by to-be-phased out nuclear assets, loss-making gas power plants and unpopular coal power, will not be able to drag down the new. The new business can dedicate itself wholeheartedly to making the transition to a low-carbon future.
Eon also has the advantage of being the first mover. Its great rival RWE earlier announced a similar strategy, but it does not go as far as separating its conventional power generation assets. RWE and the smaller German power producer ENBW have more political shareholders (local authorities) than Eon, so for them it may be more difficult to make a similar move.
But there are also risks to Eon’s move. German commentators have pointed out that the “new company” will look very much like a “bad bank”. Eon denies this, and it is true that in particular the company’s strong natural gas portfolio, including pipelines, long-term contracts and storage capacity, combined with its trading business, could become a healthy business if CO2 prices move in the right direction for gas. But Eon also notes that this “solid, independent company (…) will safeguard security of supply for the (energy) transformation”, which seems to suggest that the government cannot afford to let it fall down. It will lead to pressure on policymakers in Germany to take it under their wings.
As to the renewables business, this is now just good for 6.6% of revenues and 11% of production volume. There is little growth potential in hydropower. Eon seems to want to expand mainly in offshore wind, which is costly and heavily subsidised, and in onshore wind, which has natural limits. In solar, Eon has virtually no presence at all yet.
And what about the distribution networks? Eon has this to say in its press release: its new strategy “represents an important and attractive opportunity [!] for regulators and policymakers as well. Eon is clearly separating power and gas production and trading from its end-customer businesses, thereby making both even more transparent for regulators.”
Apparently, the company regards its distribution networks as part of its “end-customer business”, but there is a clear difference between retail activities and power distribution. The latter is a regulated business. In some countries (e.g. the Netherlands) private companies are not even allowed to own distribution networks. It is quite unclear how regulators and policymakers will look at this “opportunity” that Eon is providing them with.
On a visit to Ankara on Monday (1 December), Russian President Vladimir Putin made an announcement every bit as surprising and significant as Eon’s change in strategy. The $40 billion project, which was supposed to bring 63 bcm (billion cubic metres) of natural gas to Europe, will not be built.
Russia currently exports some 165 bcm of gas to Europe annually. Gazprom has said that the South Stream pipeline would bring one-third “new” gas. Two-thirds of its capacity would divert gas from Ukraine to the new route (through the Black Sea, into Bulgaria, Serbia, Hungary, Slovenia and Italy as well as to Austria). (See more background information in this recent article by Bulgarian ambassador Peter Poptchev.)
Putin said in Ankara that he cancelled South Stream because “the stance of the European Commission was counterproductive. In fact, the European Commission not only provided no help in implementation of [the South Stream pipeline], but … obstacles were crated to its implementation. Well, if Europe doesn’t want it implemented, it won’t be implemented.”
The problem for Gazprom is that construction in the Black Sea has to begin, but the company has no permission yet from Bulgaria to enter that country. Investing hundreds of millions of dollars into the pipeline, which would have to stop when it reaches Bulgarian waters, is “just absurd, I hope everybody understands that,” said Putin.
Putin made it appear as if his decision will hurt Europe and benefit other markets. He said the Russian gas “will be retargeted to other regions of the world, which will be achieved, among other things, through the promotion and accelerated implementation of projects involving liquefied natural gas We’ll be promoting other markets and Europe won’t receive those volumes, at least not from Russia. We believe that it doesn’t meet the economic interests of Europe and it harms our cooperation. But such is the choice of our European friends.”
However, as has been pointed out by many analysts, the reality is that South Stream has always been mostly a political project, directed against Ukraine and meant to ensure diversification of routes into Europe both for Gazprom as supplier and Europe as buyer. Its commercial viability has been doubtful from the start – but even more so in recent years, since the economic crisis hit and gas demand in Europe has stagnated.
And there is another reason why the prospects for increased gas exports do not look promising: indeed, the transition to a low-carbon economy that the EU is pursuing. See Eon’s new strategy: Eon – which has traditionally been one of the largest, if not the largest, buyer of Russian gas – is divesting its gas power business for this very same reason.
Does Europe need to be concerned by Putin’s decision? Not really. For one thing, it does not change the current supply situation. As to the future, the EU is already following a strategy of diversification of sources, which seems fairly successful. As top US policymakers and analysts pointed out at a recent conference in Istanbul, Europe is actually in a better position now than it was a few years ago when it comes to the gas market.
As Carlos Pascual, Fellow and Senior Research Scholar at the Global Energy Policy Center, Columbia University, and a former ambassador to Ukraine and Mexico, put it: “Europe has made a massive investment in LNG infrastructure. It has also made a massive investment in interconnecting pipelines. It has introduced legislation, the third Energy Package, that does not let any party own supply, transport and distribution. As a result, a competitive gas market in Europe has emerged that has driven down prices and has forced Gazprom to renegotiate contracts.”
Jason Bordoff, Professor and Director of the Center on Global Energy Policy at Columbia University, noted that the European gas market has become much more competitive: “the share of gas-to-gas pricing in the European market has jumped from 10-15% five years ago to 50% today.” He also said that once the US starts exporting LNG, which is certain to happen in the near future, the outlook for the European market will be even better.
In addition, at that same conference, Joe Murphy, Vice-President Southern Corridor at oil company BP, gave a presentation about the progress the Southern Corridor is making. This new pipeline system will bring 16 bcm of additional, new gas supplies from Azerbaijan into Europe in just a few years from now. The full capacity of the pipeline is 30 bcm.
In other words, Putin’s decision is merely a confirmation of current market trends: future growth in gas demand will come from Asia, not Europe. In that light, the South Stream pipeline does not make economic sense. Putin is taking a long-term risk, however, by scrapping South Stream: he will continue to be strongly dependent on Ukrainian transit if he wants to continue to sell gas into Europe. In the short term, this may be a problem for European security of supply. In the longer term, it may be a bigger problem for Russia’s security of demand.
In November 2013, we published an article by solar pioneer Peter F. Varadi, “The future of the large German utilities: it’s already here“, in which the author predicted what would happen in Germany first of all. Among other things, he wrote: “The situation which the large German utilities are facing is very similar to what was happening in the telephone business which similarly to the electric utilities also started with central stations connected to customers by wires and was also a monopolistic situation which was regulated by localities and governments. Same way as the utilities, it was a regulated, stable and profitable business. The emerging cell (mobile) phones which were not connected to the local central station by wire, but could be used anywhere in the world, became a fast growing, and importantly, an unregulated business, where profit is limited only by competitors.”