Sailing through choppy waters
As the credit crunch bites, the implications for the power industry during the economic slump are uncertain. A new report suggests that the sector will suffer from project delays, cancellations and a lack of investment, but urges governments and utilities to maintain their plans for zero carbon generation.
BY TIM PROBERT
On the surface, the power industry appears to be one of the stronger sectors of a global economy in the clutch of a sharp downturn. While oil and gas prices have dropped off significantly, the emergence of carbon credits, emissions regulations, government subsidies and other incentives still offer the power industry some interesting opportunities.
However, the sector remains highly capital intensive, meaning that the credit crunch is having a major impact on prospects for new power infrastructure investment. The financial crisis has hit the outlook for investment in three ways: it has raised the cost of funding, it has cut the price of electricity and it has dampened expectations of future demand.
In the spring of 2007 Italian utility Enel raised the required capital for its €42.5bn ($55bn) acquisition of Spain's Endesa in just two hours. In November, it was reported that EDF, 85 per cent owned by the French government, was still yet to conclude the syndication of its loan for the £12.5bn ($19bn) acquisition of nuclear generator British Energy. When credit was cheap, reported the Financial Times, utilities were paying as little as 0.15 percentage points more than government bonds for their money. For Iberdrola of Spain, the spread had rose to 3.5 percentage points by November.
The falling profitability of utilities due to these rising finance costs and falling electricity prices (as oil & gas prices plunged) has had a big impact on their share prices. Despite the common perception that utilities are 'safe harbour' investments during a slump, utilities' share prices have taken a major tumble. Over the past year EDF has dipped 53 per cent, while Germany's E.ON is down 49 per cent.
The consequence of this, concludes a report released last month, European Energy Markets Observatory, by French consultancy Capgemini, is that "the credit crunch should short-circuit the investment cycle, leading to a lack of generation capacities and infrastructures. It will very likely delay the needed investments in infrastructure to replace aging plants and to build the necessary new plants and electrical lines.
"The credit crunch will very likely slow down renewable projects and some nuclear investments, consequently raising carbon dioxide emissions owing to increased output from fossil fuelled plants."
A fall in tax revenues will force governments to tighten their belts, said the report, with financial subsidies to renewable projects a likely casualty – as has happened in Spain in October by limiting its incentives to solar power. Such decisions could cripple the growth of renewables, especially wind and solar, which were heavily reliant on subsidy to be financially competitive even before the price of crude oil collapsed.
Capgemini expects the credit crunch to trigger a heightened period of market consolidation (even if it does makes big acquisitions more difficult to finance), with companies enjoying a solid balance sheet and cash in the bank buying up weaker and/or younger market participants.
The report also predicts increasing government intervention in the energy market to protect citizens' purchasing power by taking measures such as price capping, as announced by Belgium in October. This view is shared by New Energy Finance's chief executive Michael Liebrich, who wrote in a recent note that utilities could end up taking some of the burden for making up fiscal deficits.
He wrote: "Governments exposed to the wrath of voters are unlikely to want to saddle them with extra income taxes, if they can help it. Instead, they may go for a softer target – the fossil fuel energy industry."
The Capgemini report says utilities will have to quickly adapt to the new landscape by thriving towards operational excellence. It stated: "This means that they will have to streamline their internal processes, simplify their organizations and increase their reactivity while continuously benchmarking their results with the 'best in class'."
Others are less pessimistic for the power industry's prospects during the downturn. David Johnson, Managing Director for global energy of consultants Proviti, authors of the Global Financial Crisis Bulletin – Impact of the Current Financial Crisis on the Energy and Utilities Industry, said: "As investors seek safe investments, we believe that the energy markets will remain attractive. However, higher costs for debt and the greater use of equity funding will definitely increase overall project costs and necessary returns."
Johnson expects most of the investment in the power industry will focus on nuclear facilities, alternative energy sources, transmission lines and retrofits to reduce carbon emissions on existing facilities. He said: "Many of these plants will regulated and cost recovery will be reasonably assured, but they still need to be financed. Tightness in the capital markets could put a considerable hitch in the industry's ability to keep pace."
However, says Johnson, even if a recession dampens the demand for electricity to some degree, substantial investments will be required. "These investments take an average of three to ten years to build, so short-term factors will not have much influence. But reduced consumption levels could have a significant long-term economic impact on the affected regions."
And as for after the crisis? Well, Capgemini, which estimates that Europe needs to invest €1 trillion ($1.3 trillion) in power and gas infrastructure over 25 years, says that Europe is likely to have a "difficult wake-up call" once the recession is over if essential investments are delayed.
"Without a vigorous investment programme, Europe's security of energy supply would be threatened. Utilities and governments should maintain their investment plans in zero carbon generation," Capgemini concluded. With new jobs, energy security and carbon mitigation up for grabs, it is hard to disagree with this supposition.
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