By Roshan Madawela
With only months remaining before most of Europe’s national currencies will be permanently replaced by the Euro, PEi looks at its implications for the region’s power industry and on prospects for developing a single electricity market.
On new years day 1999, the Euro arrived on the scene, diminishing most of Europe’s other currencies to a transitional and diminished existence. With the exception of Britain, Denmark, Sweden and Greece, the remaining 11 financial centres of Europe adopted the Euro as their unique currency.
The move resulted in the formation of the world’s second most traded currency. The Euro-zone accounts for 20 per cent of global economic output, comparable to the US. From the start, euro-critics argued that economic and monetary union (EMU) along with the single currency was an economically neutral event. The optimists still maintain that it will unleash a dynamic corporate environment with lower prices and more competition facilitating a single electricity market.
When the Euro became the currency for 11 European Union (EU) Member States (Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, Netherlands, Austria, Portugal and Finland), their national currencies became ‘non-decimal’ sub-units of the Euro with conversion rates between each of them and the Euro irrevocably fixed. By June 1999, the European Council adopted Greece into the single currency and set the conversion rate between the Euro and the drachma.
The transition was accompanied by a single monetary policy for the Euro-zone. New government debt was issued in the Euro, and many financial markets switched to the Euro. The period between 1 January 1999 and 31 December 2001 has been declared as the transition period for the orderly changeover to the Euro by the whole economy. The European Central Bank (ECB) has launched a publicity drive, which is set to reach its peak in September, to boost confidence in the currency ahead of the issue of notes and coins, scheduled for 1 January 2002. Later this year, we can expect banks and large retailers to be front-loaded with Euro hard currency.
The period between 1 January 2002 and 28 February 2002 will be a dual circulation period where all scriptural transactions will be denominated in the Euro while national banknotes and currencies start being withdrawn. A complete changeover is to take place in public administration. At the end of this period, national banknotes and coins will enter the realm of collectibles.
As a world leader in the production of power generation machinery and technology, the region’s exports reach energy markets within Europe and across the globe.
In this regard the Euro should conduce competition in line with EU objectives, which in theory, will lead to a better allocation of resources. Increased competition can also increase choice among customers, giving them the option to choose between the cheapest, cleanest or best supplier. Debatably, economies of scale lead to lower electricity prices, cutting the costs of production and raising the competitiveness of exports.
Also worth noting is that EMU is taking place in a global climate where power grid interconnections across national borders are on the rise. Objectives such as keeping emergency backup, sharing access capacity and spinning reserve that force transmission companies to extend unproductive power lines, have boosted calls for cross border trade and fuelled the drive to establish a single electricity market.
Labour market mobility and the transferability of specialist staff across borders is also likely to benefit from a single currency. The environment could also benefit, as it would be easier to implement treaties and impose penalties relating to environmental protection and to promote green energy generation.
The Euro zone in 2001
Many of the challenges that apply to power firms operating in the Euro-zone, whether they are utilities, equipment manufacturers or project developers, will also hold true for firms in the non-Euro countries. Essentially, companies will need to alter their IT system and decide whether to re-use, replace or upgrade existing software prior to the January 2002 changeover.
During the transition period firms will need to consider three main aspects in relation to IT:
- Systems-related requirements for meeting legal directives governing the use of the Euro
- System-related requirements for processing business transactions during the dual circulation period
- Technical requirements for the process of changing to Euro units.
EU regulations set out how conversion between denominations will be made and how rounding procedures should be applied. Transactions in either direction are required to be based on the same official exchange rate with the inverse exchange rates not permitted. Software will need to ensure that the correct rates are used where participating currencies are exchanged via the Euro. Therefore, each system that carries out any currency processing will need to be reviewed and algorithm routines will have to be modified in line with Euro regulations.
Population, share of world GDP and world trade
Companies will also need to process purchase orders, sales orders, and invoices in the Euro during the transition period. Where a company has made an early transition it will need to convert tax returns back to the national currency denomination where the local tax authorities are still working in non-Euro. Thus, a multi-currency capability of a system is a prerequisite for processing business during the transition.
IT infrastructures for most companies have become increasingly elaborate with PCs, mainframes, and networks operating in conjunction with group-wide networks. Given the complexity, what is needed is an integrated solution that embraces all software components and reduces the number of individual changes to be made to existing programs and interfaces.
For smaller companies with small amounts of data, it may be best to change the account currency at the year-end, to offer a clean break. Special attention would only be required by those items still open at the year-end and long-term forecasts. Larger firms will need to consider whether all their programs enable them to specify the currency for each years accounts. Most businesses will therefore need to make a large number of changes.
A spokesperson for Enel, the Italian utility, has said that adopting its computer and information systems to the Euro cost five billion lire ($2.32 million), which was booked in the company’s 2000 results. Enel estimates that the whole Euro conversion programme, which began a few years ago, will require a total investment of 20 billion lire. The conversion programme is expected to be completed by the middle of this year.
In addition to the IT challenges outlined above, the introduction of the Euro is also likely to have serious strategic affects on the way business is conducted. Competitive circumstances could change and all businesses will need to review their pricing strategies in order to avoid putting their futures at risk.
An official of ABB in Norway, which has opted out of the Euro, spoke in favour of single currency saying that “it would reduce fluctuation and strengthen the pricing strategy for 30 per cent of the firm’s market” which is accounted for by the Euro zone.
For many large players such as Siemens, the favoured approach has been to launch the changes early, enabling the option to trade in Euros from the start of the transition period. To achieve the goals, the company set up an internal working party to address the issues of the European Monetary Union.
The working party examined technical and organizational aspects of adaptation procedures, questions of strategy, and the need for external and internal communications in order to prepare workable solutions. It was recognized early on that accounting and the adaptation of information systems were key areas affected by the introduction of the new currency. Early implementation of Euro changes enabled Siemens to accept transactions in their customer’s preferred currency.
The exchange rate benefit to companies will depend on their location. For the national currencies that are currently stable, the effect may be minimal, with possible gains to be made on the currency conversion cost saving. A representative at ABB claimed that “the new currency will only have a secondary effect on investment decissions and cross border deals as they are determined by supply and demand changes”. However, he added that “taking the exchange risk out will reduce risk and encourage investment”. The weaker currencies might have more benefits where the new currency is more stable than the old. A spokesperson for Enel recently claimed that “the Euro has certainly had a positive effect for the firm. The lire, had there not been the Euro, would probably have been weaker against the dollar than the Euro, so Enel’s fuel costs would have been higher”. He added that “the Euro has probably brought Enel a saving in fuel costs”.
Risks for companies
If a company is unable to trade in Euros after the deadline, it will not be able to trade legally. EU legislation does not make provisions for any agreements or contracts in the former national currency as the units will cease to be legal tender after the deadline. Scriptural transactions, banking system transactions and payment card transactions will all ceases in national currencies.
Many states will make legal requirements for internal audit to be made in Euros. Where a company fails to adhere to the set procedures, it will cause the national authority to reject returns and therefore increase the risk of incurring the legal penalties for late filing. In some states it will be a legal requirement for all official documentation to be maintained in the Euro even where the files relate to periods prior to 31 December 2001. Similarly, all VAT returns will need to be filed in the Euro after the deadline date.
Advisors, accountants and auditors should warn management of the risks of overload which is likely to effect business, both internally and externally. As evidence suggests that many companies have been leaving it until the end of 2001, we can expect delays and bottlenecks to occur in software suppliers and the banking system which could suffer from a sudden increase in activity.
A company that is seen to be ill-prepared and has therefore placed itself in a risky position could be refused finance from banks. Last minute rescues would require additional staff and extra telephone lines. Also, given that the introduction of the Euro is a foreseeable event, normal professional indemnity insurance cover may not provide protection against loss.
A single power market
For energy utilities operating in the Euro-zone, the introduction of the Euro should be viewed in the context of the drive to introduce a single electricity market. Electricity supply in Europe has traditionally been based on monopoly production with separate national markets. With the exception of a few countries, competition in the production and trade of electricity became the norm and not the exception only as of 19 February 1999. The Directive concerning common rules of the internal market in electricity was adopted by the Council of Ministers on 19 December 1996 and entered into force two months later.
European domestic electricity prices, pence/kWh
The three energy policy objectives of the EU have been set out as: increased competitiveness, improved environmental protection and greater security of energy supply. Prices for electricity vary considerably across the Member States due to distortions in the competitive conditions across the Euro-zone. Policy makers claim that an interconnected market requires less reserve capacity which is expensive. The extent to which the Euro launch at the end of the year could speed up cross-border electricity remains debatable. As one official at Enel said, “cross-border trades with France, for example, have been at fixed Euro exchange rates since the beginning of 1999 so there is no impact of significance in that area”.
The new Euro currency could also facilitate the EU objective of unbundling the energy sector accounts, increasing transparency in the operation of electricity undertakings. It could help to stamp out cross-subsidies, and will enable regulators to ensure that the owners of essential infrastructure do not charge excessive prices by increasing transaction transparency.
The extent of the Euro’s impact on the energy sector will depend on a number of factors which include: consumer and investor confidence in the new currency, success of the commission in getting states to comply with regulations, how individual firms react and the global economic environment.
Despite some concerns on the global economic outlook, European power exporters can expect to benefit from growing demand for energy production across the world such as Asia and America as well as an enlarged European market. Possible dangers to the industry could arise where individual states refuse to comply with EU regulations, leading to uncertainty in the sector, causing distortions in the market and preventing the formation of a single electricity market. Recently, the EU threatened to take France to court over its failure to introduce legislation to liberalize its gas markets.
The European Central Bank recently admitted that low exchange rates have undermined public confidence in the Euro. Perhaps the appearance of hard currency next year will have the effect of reassuring the public that the new currency is here to stay.
The Euro has more credibility among the financial markets and banks illustrated by the fact that long-term interest rates have remained fairly low. Given fair weather in the external factors, what remains is for individual companies to take heed and make swift changes to their internal systems and/or pricing strategies before the deadline if they have not already done so. Slow movers are not likely to grasp any rewards.