The global economic crisis has hit all industries, but the power industry has the real benefit of being a key driver in worldwide efforts to create ‘green collar’ jobs and reduce carbon emissions. PricewaterhouseCoopers’ 2009 global utilities survey, subtitled ‘A World Beyond Recession’, looks at the impact of the seismic events of the past year and what lies ahead for the power industry.

Tim Probert, Deputy Editor

Regulation, regulation, regulation. Regulation is one of the buzzwords of 2009. Who would have thought so in 2007? In those far off days, politicians hubristically claimed that economic crises were a thing of the past, that economic cycles were no more, that the days of boom followed by inevitable bust were over.

In the European power industry, utilities fell over themselves to pay top dollar to acquire competitors, aggressively building up their empires to survive in a brave new dog-eat-dog world of a sector liberalized by European Union (EU) directives. This prospect of seemingly never-ending economic growth suggested that the good times for a resurgent power sector would never stop and OEMs had the full order books to reflect that sentiment.

Contrast that with 2009. As RWE president and CEO Juergen Grossman, puts it, people “now question the entire banking system and are second guessing the fundamental principles of the market economy. State intervention in the economy has become the order of the day.”

Of course, for the power industry, this is not necessarily such a bad thing. All over the world, political leaders extol the virtues of going green. Green technology, green manufacturing and ‘green collar’ jobs are on the lips of virtually every finance and industry minister trying to improve their respective country’s economic situation.

But what does the industry itself feel about this? Well, PricewaterhouseCoopers (PwC), which interviewed 69 senior power utility executives from 65 utility companies for its 2009 Global Utilities Survey, found that while the credit crunch has impacted utilities’ forecasts for future electricity demand, the very business of power requires them to stretch their horizons beyond any short-term difficulties and invest in new plant for when happy days are here again.

However, the financial crisis has tightened the availability of capital. Debt-laden governments have also tightened their belts, dampening the outlook for future subsidy for green energy. Summing up the report Manfred Wiegand, PwC’s Global Utilities Leader, said: “Companies face a delicate balancing act. They need to make the adjustments necessary to steer through the changed economic and financial environment but also maintain a long-term horizon.”

The world was already in a power capacity slump before the economic crisis, and if investment plans are not maintained, PwC can only expect reduced reserve margins in the future. As the global recession recedes, this capacity shortfall will lead to higher price spikes and greater competition for limited supplies. The 2009 report, subtitled ‘A World Beyond Recession’, therefore, looked beyond the economic downturn to the time horizons that are important for long-term energy planning.

Rising cost of capital

Of primary concern to utilities, however, is the current market environment for investment in new plant, and understandably so. The survey found that the downturn has cast considerable doubt on whether investment will come forward in a timely manner to keep pace with future demand for power and climate change targets. Two-thirds (67 per cent) of the survey respondents reported that a shortage of capital is having a high or very high impact on their activities.

The debt markets remain open to most utility companies, but at a higher cost. For example, the spreads (to benchmark curve) on utility corporate bonds issued by European utility companies in late 2008 and 2009 increased by more than twofold from 2007. Similarly, the margins on loans have risen dramatically in the last 12 months and tenors are substantially shorter than seen in recent years, with seven years now being considered long.

When it comes to raising funds through equity, the PwC survey found that the heightened risk perceived in capital markets has also been reflected in higher estimates for the equity market risk premium (EMRP).

The cost of equity has risen for utility companies relative to previous years; in particular there has been a significant increase in financing costs for any short-term capital requirements.

It is possible for utility companies to raise equity through rights issues, said PwC, but the timing and perception of the issue can affect cost and success. In such an environment, investments in energy efficiency and renewable energy may be lower than previously expected, investments with low upfront costs will be preferred to highly capital-intensive ones and plant retirements may be delayed.

Retirements are expected to reduce the short-term need for new capacity but reduced capital project construction levels and a slowing of renewable energy development could have a significant long-term impact when energy demand picks up.

Risk controls set to red alert

The economic recession and the financial crisis have heightened the energy trading risks that utility companies must manage. Liquidity in the market is a major concern. Eighty-six per cent of respondents indicated that reduced liquidity in energy trading markets was having an impact on their companies, with 60 per cent of all respondents rating this impact as high or very high.

Customer credit risk was also identified by PwC as an area of major concern and 90 per cent of respondents reported a high or very high impact of increased sales and retail credit risk. Companies are mindful of the risks of going into liquidation, defaulting on payments, bargaining over delivery or simply shutting down plants and requiring less supply.

Technology the key to growth

The power utilities industry has come off the back of a series of record-breaking years for mergers and acquisitions activity. Inorganic growth has been the order of the day for many companies, particularly in Europe, as companies sought to acquire scale and presence across territories.

Now, many of the busiest M&A players are concentrating on bedding down their acquisitions and delivering the synergies they are seeking. The constrained availability of finance will also inhibit deal activity and, until that situation is eased, there is unlikely to be a revival in deal values. However, some players will be less constrained than others by the financial markets. Transformational large transactions cannot be ruled out but the main activity is likely to be at lower value levels, and with an emphasis on individual assets as well as corporate assets.


Answers to PwC’s 2009 utilities survey question, ‘Organic growth: Where are you looking to make new investments?’
Click here to enlarge image

Certainly the underlying drivers of consolidation, supply security and capitalization remain in place, and will create increasing pent-up deal demand. M&A remains a key route for acquiring new customers, securing supply and demand balance in power, the acquisition of new capabilities and delivering scale.

Most encouragingly, however, the survey said that technology will be the key to future growth and competitive advantage. The importance of technology for key developments, such as energy efficiency and the expansion of nuclear power, has led many survey respondents to pinpoint power equipment and technology companies as a more significant competitive threat than even direct competition in the retail market by other utility company home market rivals.

Only 14 per cent of survey respondents viewed equipment and technology companies as no threat and 35 per cent identified them as a strong or very strong threat. ‘New entrant’ technologies, being invested in by companies with strong balance sheets, are a threat to companies with older and less efficient coal and gas generation. Among the important technologies currently being introduced, for example, are very efficient combined-cycle gas turbines (CCGTs) that have a thermal efficiency of well over 50 per cent. Early CCGTs sometimes had an efficiency of only 40 per cent with limits on their flexibility. Further, supercritical coal technology uses high pressures and high temperatures to achieve thermal efficiency of above 40 per cent (compared to mid-30s for most existing coal fired generation). These are cleaner, as well as more efficient, power generation technologies.

Looking ahead, the potential for stand-alone or distributed local off-grid generation may also provide opportunities for power equipment and technology companies to play a more visible role with end-consumers in the future power landscape.

THE GROWTH OF ENERGY EFFICIENCY

The introduction of new energy efficient technology is seen as a key enabler to major improvements in energy efficiency. Subsidy of energy efficiency equipment is also seen as important.

However, unless prioritised by governments as part of stimulus programmes, the potential for substantial subsidy schemes is likely to be restricted because of the pressures on the public spending in many countries as a result of the cost of the various bail out and stimulus measures.

Smart metering, which helps individual users to better monitor and control the way they use energy, is viewed as playing a key role by American and Asia-Pacific respondents although, in Europe, despite the EU mandating an 80 per cent roll-out of smart metering by 2020, only a minority of respondents saw it as important.

European utilities appear sceptical about the ability of smart metering to deliver major improvements in energy efficiency. Smart metering in Europe is mainly predicated on other gains such as firm monthly bills, back and front office cost savings and improvements in outage management. In contrast, smart metering in North America and many Asia-Pacific countries offers greater ‘demand response’ advantages due to the very high summer air conditioning loads.

Other measures that were identified as playing a role in delivering efficiency gains included regulation of the energy performance of buildings and distributed generation. By placing power generation close to the end user, distributed generation could play a part in reducing energy lost in transmission and distribution systems.

Nuclear power expansion

Nuclear power is undergoing a renaissance as more governments change their policy stance on new nuclear expansion. In February 2009, Sweden announced it will allow the construction of nuclear power stations, ending a ban imposed after a 1980 referendum. Italy has followed suit and the UK has already announced a programme of growth in its nuclear plants. This revival of nuclear power is reflected in 59 per cent of respondents worldwide anticipating that nuclear power would have a significant impact in their market.

More than half of these felt that it will have a high or very high impact. Indeed, some respondents go further and believe that nuclear power should be given preference over renewable energy in reducing carbon dioxide (CO2) emissions although their views are nearly balanced by those who would prioritise renewable over nuclear power.

ENERGY AND climate change

Asked if the economic recession would slow down responses to climate change, 51 per cent felt that it would have a high or very high impact on a likely slowing of responses, and 28 per cent felt that it would have a medium impact. Only 21 per cent thought it unlikely that the recession would slow climate change responses.

PwC also tested respondent views about the political will behind climate change action by asking whether high energy prices would deter governments from increasing utility company environmental obligations. More respondents (40 per cent) felt that high energy prices would dilute environmentalism than disagreed with this view (30 per cent). The remainder were undecided.

Respondents from Asia-Pacific, Middle East and African countries were most likely to see a direct trade-off between energy prices and environmentalism – 50 per cent of Asia-Pacific respondents and 54 per cent of Middle East and African respondents believe that higher prices would soften policy requirements.

Call for clarity

The importance of governments delivering greater clarity and developing an effective framework for the development of cleaner energy is highlighted by survey responses to a series of statements about renewable energy and cleaner energy investment decisions.

Nearly three-fifths of respondents (59 per cent) feel that their renewable energy investment programmes are being affected by the lack of clarity from governments on renewable energy targets and financial support for renewable energy. There were, however, strong regional variations in responses, with European respondents much happier with the renewables policy framework. The EU has committed to a 20 per cent target of renewable energy by 2020. Negotiations are taking place to translate that overall target into individual country targets. Such negotiations will prove the testing ground for how far the EU target can be realized.

In Europe, much of RWE’s focus is on seeking a more certain long-term policy context. “Political decisions in the field of energy policy have a significant impact on the options available to the RWE Group to reduce CO2 emissions sustainably”, says RWE.

As a utility with a significant proportion of coal-burning generation, RWE is likely to be a key player in the development of carbon capture and storage (CCS) technology but stresses that CCS needs more support from government: “We welcome the rules for the promotion of CCS power plants. However, the planned subsidy is unlikely to be sufficient to realize the ten to 12 demonstration plants envisaged by the EU. This will require further subsidies from the member states”.

A different kind of power sector

Looking further ahead, BC Hydro’s Bob Elton foresees a world where the traditional model of large grid supply is turned on its head. He points to two key trends that will force change.

“In developed countries, it is becoming increasingly difficult to build large infrastructure projects, whether that is power plant or transmission lines. Each one is getting more challenging and that will put a premium on demand-side management and distributed generation”.

UrbaniZation is another key trend influencing a future where distributed energy plays more of a role. Elton points out: “In 1800 only three per cent of the world’s population lived in urban areas, by 1950 it was 30 per cent and by 2007 it was just short of 50 per cent. By 2050 it is projected to be 67 per cent. Cities will have to become increasingly self-sufficient”.

“Distributed power sources will mean the grid will be the back-up service and not the primary means of delivery in the future” predicts Elton. Distributed generation and a revolution in demand-side management will, in turn, demand different approaches by utility companies.

“If you are an integrated company then you’ll need to decide early on what kind of role you want to take in this new energy world. It will require new relationships with customers. Individual customers and communities of customers will be much more involved in developing their own solutions and companies will need to be very good at partnering and facilitating that”.