Investing in the future of the electricity industry: opportunities, obstacles and preferences

12 December 2007

Speaking at the EURELECTRIC conference on Financing the Future of the Electricity Industry on 3 December, Johannes Mayer of Austrian regulatory body E-Control focussed on the question whether investment in the electricity industry is being held back by regulation. He gave a simple answer: yes. Mr Mayer then proceeded to qualify the answer by looking at different aspects of the question.

On the one hand, allowable returns negotiated by network companies with the national regulators are providing "quite impressive margins" and there is no evidence that regulated tariffs are hampering necessary reinforcement of the transmission networks. On the other hand companies are facing a rather unstable legislative framework, with a third package of energy liberalisation measures now on the table within a period of just over ten years. Great uncertainty surrounds the implementation of cross-border markets, where - once the requisite degree of liquidity is achieved - arbitrage opportunities may lead to lower profit margins, explained Mr Mayer. However the single biggest hurdle to investment continues to be the permitting and authorisation procedures for both power plants - especially coal-fired, nuclear and run-of-river hydro and high voltage wires. Mr Mayer argued that there must be proper nation-level coordination to establish priority projects and streamline the procedures in order to ensure that they can be built.

Regarding market development, Mr Mayer said the final goal must be a transparent European market in electricity based on a working legal framework that does not require adjustments and special treatment through case law. At the moment there are no clear rules for integrating the markets and ad hoc measures are in place in various countries to try to counter public distrust of the energy market and energy companies. Such anomalies as regulated prices for customers also tend to undermine the retail market, he pointed out. Proper open competition must be the aim, he concluded.


"Investing is always a gamble", and a person's attitude to risk is largely a matter of statistics and psychology, Henri-Alain Bonte of French-based bank Paribas reminded the audience. The basic question for the electricity industry today is what to build, how much and when, given the long-life of capital assets and high sunk costs, in a context of increasing competition and changing structures, against a background of global environmental concerns. Moreover, the traditional forecasting methods are strong in analysing historical trends, but weak in predicting events-based shocks to the system.

Mr Bonte pointed out that market liberalisation brought in by the 1996 EU directive has not been implemented in a homogeneous fashion across the European Union. Nor have forward power prices been a good predictor of future spot prices. Electricity producer prices will probably converge, towards around €60/MWh by 2015, based on a $55/barrel oil price and a CO2 price of €20/tonne, he predicted, but differences are likely to remain between the "continental plate" and the peripheral markets.

Mr Bonte underlined that "politics is the key" to all future outcomes. Will nuclear power plants be allowed to extend their operating lives from the standard 40 years to 60 or even 80, he asked rhetorically, as such national decisions will affect company equity values. What decisions will be reached on the Emissions Trading scheme that will determine the price of carbon dioxide? Will gas be able to de-link from the oil price and be indexed to coal? Will there be sufficient investment in Russia's gas potential? Will liquefied natural gas (LNG) provide the required flexibility? And can coal-fired power generation survive? For the risk averse, ways to reduce risk include investing in a portfolio of plants based on the fuel mix in that region, investing in regulated segments such as networks or supported renewable energies and maintaining the capacity to swap output at need, Mr Bonte told the audience.

Samer Mansour of Rabobank International looked at the long-term challenges facing the electricity industry, based on the three main pillars of reliability, sustainability and affordability. The latest EU targets for renewable energy sources (RES) - to reach 20%, or even 30% of total power consumption by 2020 - are extremely challenging, as new RES currently accounts for only 7% of installed capacity, with large hydro accounting for a further 19%. Given the wide variation in national endowments, "creativity will be required" to meet the targets, he suggested, arguing that "reliable electricity will still very much depend on conventional technology for the foreseeable future", a widely underestimated fact. Mr Mansour argued that a realistic figure for new build in Europe to 2012 is about 80 gigawattts. However, China is building several times this figure, helping to drive up the price of steel, copper and other materials used in building power plants and constraining power plant equipment supplier capacity. Concluding, Mr Mansour argued that technological developments - such as carbon capture and storage and decentralised power production with smarter grids - will be required to "optimise the balance between sustainability, reliability and affordability". However, a one-size-fits-all approach will be hard to achieve, he told the audience.

David Long of UBS Global Asset Management pointed out that since early 2003, the EU utilities sector has shown a stunning performance on the stock markets, producing a 400% return to investors and outperforming the market by nearly 190% over the period. Utilities are traditionally "defensive" stocks, with a profile similar to bonds, and that still largely applies to regulated activities such as networks but since liberalisation, this has been less true for the sector as a whole. Mr Long explained that stock price growth has been partly driven by rising oil, gas and coal prices, which feed into power prices, and also by the pass-through of the carbon price from the Emissions Trading Scheme. There has also been significant mergers and acquisitions activity. There is a fair amount of new investment taking place at the moment, fuelled by current high profits, strong balance sheets, low cost of capital and opportunities for cross-subsidisation from low-marginal-cost plant by larger, mixed-technology electricity companies, he told the audience.

Looking forward, Mr Long pointed to the need for 80-130 GW of new generation capacity, 60% of which he said would be for renewable energy, with 40% thermal generation. However, there was still a significant risk of cyclical overcapacity, he warned, especially for nuclear and coal plants with CCS, and very little price-visibility, while at present gas-fired CCGT plants provide greater flexibility and lower risk. Assessing the implications for Europe's future investment needs, Mr Long argued for policies that will set a framework to encourage investment in base-load plant needed to ensure supply security foster CO2 mitigation. We should stop weighting the market in favour of CCGTs. He argued that concentration is a good thing for investment and that breaking companies up would tend to discourage investors. However, the situation around nuclear power needs to be clearer, in terms of policy and planning. We need long-term targets for CO2 abatement and for RES targets and subsidies, while tariff regimes which distort the market should be phased out, he advised.

During the question and answer session, Mr Long said that a lot has changed in the past five years. Electricity company balance sheets are now much stronger are they are now able to invest where appropriate. However "this is a cyclical world, so don't rely on things staying the same. Electricity prices have been historically high and financing costs low. So perhaps one should start being conservative now", he suggested.

All speakers agreed on the importance of CO2 in energy policy and business decisions. Mr Mayer predicted that "CO2 will increase the correlation between electricity prices, even if there is no actual interconnection between borders. However, there is not enough reliable price-indication for efficient allocation of capacity," he warned.

All speakers agreed that there are no opportunities to finance carbon capture and storage at the present time. CCS needs financing and support for R&D and demonstration. "When the technology is ready, the banks will come in", Mr Bonte told the audience. 

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