Welcome to the euro zone
Two months from now will see the introduction of the euro. Energy companies and utilities have made serious investment in preparation for this, and will see some fairly fundamental changes to their business as economic, monetary and political union deepens across Europe.
Never mind January 1, 2000; the next big hurdle for any business active in Europe is January 1, 1999 – also known as E-day. Like it or not, European Monetary Union (EMU) is imminent, and the new currency – the euro – will become part of everyday business life for many.
If all goes to plan, the euro will encourage cross-border trade within the European Union (EU) through the elimination of currency exchange costs and risks, increased price transparency and the creation of a stable financial environment. If all goes to plan, the euro will be guaranteed by a new and independent European Central Bank, and will create a semi-unified economy of a size to rival the USA.
But unfortunately, there is no plan. EMU has no precedent to follow, and has been hailed as one of the biggest economic experiments ever attempted. No-one can really predict what the long-term impacts will be, for EMU will bring together not only monetary policy across Europe, but also more sensitive areas such as taxation. Sceptics are concerned that such a large economy will be ungovernable.
Eurosceptics insist that the risks of monetary union far outweigh the benefits. They could, of course, be right, but they are in a minority. Most seem to welcome the euro and the opportunities it will bring, in spite of all the preparations needed.
If there is one known factor about the introduction of the euro, it is probably that preparation is the key to success. Companies have invested millions in a huge logistical exercise to update their accounting ledgers, billing systems, taxation, legal and IT systems to cope with the new currency and to prepare for any eventuality.
“We are considering all kinds of impacts in order to manage our liability and exposure,” says Antonio Casolaro of Italian utility Enel, which has worked with the commission set up by the Italian Treasury Ministry to analyse the implications of the euro. Casolaro, responsible for financial planning, adds: “We have followed their instructions and appointed an internal group to prepare for January 1 1999”.
But at least there is time for preparation, even now. Although the euro becomes a currency at the beginning of 1999 for non-cash transactions, there will be a transition period before national currencies are withdrawn in 2002. During this transition, companies will be able to operate in both euros and other currencies. “For billing purposes, Enel will allow the customer to receive the amount in two currencies, Italian Lira and euros,” says Casolaro.
Siemens is in a similar position. At the beginning of 1999, the company will be able to conduct all its external business in euros, and is hoping to persuade its customers and suppliers to be able to do the same. From October 1999, it will convert all its accounts and records and adopt the euro as its official currency.
A smooth transition will come at a price, however. Siemens has estimated that between 1999 and 2002, its conversion costs will exceed DM100 million ($60 million), mostly on data processing. The company has spent the past two years finalising its preparation in areas such as accounting, treasury, purchasing human resources and data processing. It has estimated, however, that the investment it has made will pay for itself within three years through savings made by use of the euro.
The impact of the euro will also be far reaching in geographic terms. Eleven EU countries have opted to adopt monetary union – the UK, Denmark and Sweden have opted out and Greece did not qualify. Any company, be it from Europe or further afield, doing business with a company based in one of these 11 countries will need the capability to transact in euros.
USA-based Enron began examining its needs around two years ago, and the importance of the euro to its operations is clear. “We have an internal EMU project underway which will manage the introduction of the euro on January 1,” says Paul Chivers, Enron`s vice president for European finance and treasury. “A full assessment and impact study has been carried out in respect of the effects that we`ve been able to identify.” He adds: “We have also launched an internet site to communicate these issues to personnel.”
“The driver for the EMU project has been spearheaded in Europe,” states Chivers. “But being a US business, such a fundamental change is clearly going to be of interest in the USA.” From next year, any business Enron undertakes in Europe will be done in euros. “Ultimately we are a US company and so we will need to translate any euro exposure into US dollars,” says Chivers.
Monetary union will therefore have a considerable impact at a strategic, fundamental level as well as on day-to-day business operations. In particular, it is expected to accelerate the integration of European markets and intensify competition through improved price transparency.
Stiff competition already exists between power equipment dealers and suppliers, and has resulted in a number of mergers and acquisitions. The euro is likely to intensify this competition, leading to further consolidation among retailers already struggling to make a profit. Performance and cost will become even more important.
Utilities will also feel the effects of greater price transparency, especially as the electricity and gas markets liberalize in the coming months. Enel`s Casolaro explains: “It will be easier to compare prices and this means that the euro will be an incentive to competition.”
This will have a significant impact on European utilities. Energy prices within the EU vary widely, with the highest price being over five times that of the lowest price. This fact has been partly masked by the use of different currencies, so a single currency will add transparency to energy prices. Cost-conscious customers will be fast to pick up on any price differentials across Europe and approach new suppliers as soon as liberalization permits.
It is worth noting that the European Commission (EC) now believes that 60 per cent of the EU electricity market will be liberalized by 1999, well ahead of the official timetable. Utilities and consumers unprepared for monetary union will thus be at a competitive disadvantage.
Customer service is therefore likely to grow in importance and this includes providing the customer with seamless billing in two currencies throughout the transition period. Expansion into other sectors, such as telecoms and water, could also be crucial to compete with the emergence of the multi-utility.
While Italy`s electricity sector has not yet undergone liberalization, the government will determine the new structure of the industry by February 1999. The Italian power sector is characterized by a high cost of generation and cross subsidies, factors which could put Enel at a disadvantage in a liberalized market. Enel, however, is preparing for liberalization, and wants to maintain its leadership status.
“Enel is actively preparing to compete in the new environment,” comments Casolaro. The company, which generates just over 60 per cent of Italy`s power demand, is actively pursuing a number of joint venture operations to compete effectively in the deregulated energy markets of Italy and the EU. These joint ventures with leading energy companies such as Eni and Enron should help Enel to offset these problems.
Perhaps the biggest impact of the euro on all players in the European energy market will be reduced foreign exchange costs. More than half of Siemens` sales and expenses are currently generated in the 11-country euro-zone, and the company has estimated that it expects to make savings of tens of millions of German marks each year.
Enel believes that it will also make significant savings this way. “Certainly the euro will reduce the costs of hedging and the problem of currency exposure,” says Casolaro. “We have been obliged to buy hedging derivatives just to control our exposure to other European currencies, and when the euro starts, we will be able to reduce these costs.”
Similarly, Enron will be able to reduce the number of currencies which it deals in by six, making savings and improving efficiency.
Smaller differences in interest rates will also bring savings, and companies will need fewer bank accounts and will be able to streamline financial management.
The euro will also bring opportunities for utilities and other players in the European energy markets in the area of financing and capital investment. The EU will become one large capital market, the second largest in the world after the USA, replacing the fragmented national markets that currently exist.
This consolidation will also bring increased transparency and liquidity, and fundraising for infrastructure projects such as power plants will be more efficient.
Enel sees this larger and more efficient market as an opportunity for increasing its investor base. Last September, Enel successfully issued a 1 billion Eurobond targeted at foreign institutional investors which has become a benchmark. Explaining the significance of this move Casolaro says: “We will receive the benefit of a larger market…and enlarge the potential investor base to European dimensions.”
Figure 1. Domestic electricity prices across the European Union vary considerably. Source: Electricity Association
Figure 2. EU industrial electricity prices. Source: Electricity Association