As liberalization takes hold in Europe, German utilities are coming out of their corners fighting. The latest development is a proposed merger of VEW and RWE,to form a company ready to take on any contender in the European utility war.
More than a year ago, the German government decided to fully open up its electricity market without any transitional periods and, broadly speaking, without any regulation of ‘stranded costs’. This measure, which goes well beyond the requirements of the European single market electricity directive, heralded a new era in the German energy market. Change will be driven by few market makers in the European energy market. RWE will be one of them.
Even now it is clear that Germany is one of the pace-setters in the development of competition in the European electricity market. Competition is rapidly hotting up in Europe’s largest national electricity market; a market with consumption in excess of 500 billion kWh and power generation capacity of 116 000 MW:
- Regional demarcations in the market that were previously carved in stone have for some time been no longer valid
- Instead, a large number of new operators are entering the market. Starting with foreign energy suppliers and followed by IPPs, they include brokers and traders, not to mention banks and other investors
- Suppliers are competing not only for large industrial and commercial customers; competition has already reached the level of small commercial consumers and households
- The intensive competition has already led to large price reductions; industrial consumers are benefiting from price reductions of up to 40 per cent; and private customers, too, are receiving offers of significantly lower prices.
Numerous competitive forces are responsible for this dynamic change. In Germany alone, there is surplus generation capacity of 10 000 MW, which is available at marginal cost. In Europe as a whole, power plant surplus capacity totals 40 000 MW, and given the advanced state of liberalization and Germany’s central location, this surplus capacity will be pushing its way into the domestic market.
Moreover, in spite of the existing overcapacity, more plants are being built, mostly combined cycle power plants. The driving force behind this, besides the low investment costs and the high degree of flexibility in the use of gas-fired power plants, is provided by the import prices of gas, which are currently especially favourable.
In addition, the demand side is creating considerable pressure on prices. Given that German industrial electricity prices are in some cases 30 to 40 per cent higher than the level prevailing in major European competing markets, German consumers are urgently seeking cheaper alternatives. The transformation from a seller’s to a buyer’s market is clear to see.
And, finally, the introduction of price indices as well as the creation of electricity trading exchanges are also fostering competition in the German market.
A quiet revolution
For the German electrical utilities, this development is resulting in a fundamental change in the market. The previously closed value-added chain, from power generation through distribution to sale, is breaking up. The market and competition are affecting every level of the value-added chain and are thus resulting in the creation of a multitude of new products. The markets for electricity and gas are growing together. The previously defined domestic energy market is becoming a European energy market.
The electrical utilities must come up with new answers to this revolutionary situation. The strategic business areas must be redefined by addressing the following questions:
- What should be the company’s market mission, and which customer needs should it be satisfying?
- How should the company’s relevant market be defined – on a national, European or global scale?
To operate successfully in the competitive arena, clearly defined strategic businesses are needed. And corporate policy must be rigorously aligned and instituted to reflect them.
The critical factors for success in the competitive environment have changed. For tomorrow’s winners, top-quality performance in the following areas will be decisive:
Price leadership: Price and cost leadership are the most important competitive advantages. Every single activity must be carried out at the highest possible level of efficiency, and economies of scale must be exploited consistently.
Optimization of sales and marketing: Horizontal synergies must be exploited comprehensively through concentration and coordination of customer contacts, transfer of know-how, and optimized use of distribution resources. This will allow us to address customer requirements more specifically and to make better use of our existing customer base through cross-selling.
Astute risk management: Access to a broad mix of primary energies, a well-balanced upstream, generation and conversion portfolio, and a good spread of international activities facilitate the spreading of risk, risk hedging, and use of arbitrage.
Vision and strategy
RWE has already found answers to the above questions, and is approaching the competition in the energy market with a fundamental realignment of its strategy. It no longer sees itself as a conglomerate, but instead intends to concentrate on its core business. Energy and energy-related services will be at the heart of future activities.
As RWE’s vision states: “In the converging European energy market we will be a leading provider of energy and energy-related services (multi energy/multi utility) and will expand this position internationally. To this end, we will focus consistently on the needs of our customers and will use all our strengths with determination. We will excel at all value chain levels critical to success. Our corporate concept comprises supplementary business segments which create value and add to the overall strength of our company.”
In order to realise this vision, RWE will pursue a multi-utility, multi-energy strategy combined with focused internationalization. As a multi-energy corporation, it can exploit arbitrage opportunities on the fuel side, and can minimize price risks. As a multi-utility, it is in a position to provide its customers with the widest possible range of services, from electricity, gas and heat, through facility management, to water, wastewater and waste management services. Thanks to this ‘one-stop-shop’ approach, it aims to increase the value of its services to customers as well as make use of active cross-selling.
And finally, as margins on the German market are declining, ‘going international’ is a must for any company that wishes to maintain and increase its return on investment in the medium and long term. Commitments in the energy business in the world’s growth regions not only offer attractive opportunities in terms of returns and growth. They also enable the corporation to diversify its income-related risk through geographical spread of activities.
Visions for growth
The multi-utility approach is not new to RWE. Already today, it is basically a multi-utility company through its activities in the fields of electricity, gas, water, environmental services and petroleum. The new vision has the purpose of further boosting the added value of the company by making consistent use of its strengths. It has already reached important milestones on this road.
RWE introduced a new return-on-capital concept as a decisive tool for optimizing portfolios. In future, the company will only consider those business segments as core business segments whose Return on Invested Capital (ROIC) are constantly above the cost of capital required by the market. We aim at increasing our ROIC employed from today’s 11.5 per cent to an ambitious 15 per cent by 2002/2003.
Moreover, RWE is implementing the most drastic cost-cutting programme in the company’s history in the Energy, Mining and Raw Materials divisions. Since 1992/1993, it managed to achieve cost reductions of Euro 1.1 billion annually. In the next five years, additional cost savings of over Euro 1.3 billion will follow.
With a market share of 2.3 per cent, RWE is one of the leading providers in a highly fragmented European multi-utility/multi-energy market. The 14 largest companies generate no more than 30 per cent of European sales, while several thousand medium- and small-sized companies serve 70 per cent of the market. This extreme polypolistic market structure will not survive in competition. Instead, in addition to many local and regional players, a good handful of companies operating on a European level will emerge.
RWE wants to become one of the leading providers in this European market with a share of 10-15 per cent in 2010. This means that RWE has to more than quadruple its current sales about Euro 20.9 million in the multi-energy/multi-utility market.
It is obvious that RWE can only achieve this ambitious growth objective if it grows externally and if the globalization of the group reaches a different magnitude than in the past. This is why RWE is going to strengthen its performance capacity by acquisitions.
A first step down this road is a merger of RWE and VEW AG, which in terms of sales is the sixth largest electricity utility and fourth largest gas utility in Germany. On October 21, 1999, the Supervisory Boards of both companies resolved to examine a merger and to start negotiations to this effect. The merger would create one of the most powerful multi-utility/multi-energy companies in the German and European market; the new company would have a cost savings potential of Euro 700 million. Moreover, RWE is bidding for a stake of 34.01 per cent in Energieversorgung Baden-W
Within the next years, RWE plans to invest Euro 25-30 billion. A considerable share of external growth is to be achieved in other European countries, and the company wants to increase the share that foreign sales have in overall business from presently 27 per cent to approximately 50 per cent by 2010.
One major focus of RWE’s energy commitments are the emerging markets of central and eastern Europe because the company expects healthy profits there on a mid-term basis. It already has several cooperative ventures and interests in Poland, Croatia and the Czech Republic and supplies more than 40 per cent of electricity requirements in Hungary. And RWE will expand these activities as privatization of eastern Europe’s energy markets proceeds.
Another focus surely lies in strengthening the market position in Western Europe. RWE is already present on the electricity markets in Switzerland, Luxembourg, Belgium, Spain and Portugal. It plans to use these commitments as a basis for extending its energy activities on this part of the continent.
The market is in a state of flux. The race for the best positions has begun. Therefore, RWE is implementing its vision on the basis of the existing structures and organizations pragmatically and without delay.
The multi-utility (MU) activities in RWE are pooled in the Multi-Utility Center where this business is advanced strategically and operationally. This unit is independent within the organization and is provided with strong success incentives. It develops the Group-wide MU marketing strategy, coordinates the sales of MU products and defines the MU globalization strategy.
Moreover, the MU Center advances specific MU projects. It develops customized solutions for selected key accounts to provide complete supplies of electricity, gas, water, fuel oil and district heat. On a group-wide level, it coordinates sales and marketing systems, creates sales partnerships and supports the search and development of potentials for cross-selling. Finally, it is responsible for tapping the markets of attractive European metropolises and regions with the ’10 Metropolis Multi-Utility Program’.
With a second project house, the Multi-Energy House, RWE is pursuing the development of a concept to integrate trading activities. RWE is not only Germany’s largest electricity trader but also the largest coal trader worldwide and number two in global uranium trading. It wants to pool these activities with gas and oil trading with a targeted approach and use them to market integrated services to customers and to benefit from economies of scale and synergies. The establishment of RWE Energy Trading Ltd., London, is an important step. It trades electricity in its physical form as well as energy derivatives for price hedging and will play a leading role in the expanding energy trading market in Europe.
Against the background of the fundamental changes in European energy markets, specific added-value concepts are a key factor for energy utilities when it comes to operating successfully in the future marketplace. According to our calculations, the European utility market will only grow slightly from today’s Euro 500 billion to Euro 520-550 billion in 2010. However, the structure of the market will change substantially. The market shares of water and gas will grow and the significance of energy-related services will increase.
RWE is geared up to meet the challenges ahead. Its multi-utility/multi-energy strategy has a forward-looking position in the market and the company is determined to use the opportunities provided by the opening of the European markets.