The world of Europe’s utilities after 2020: Where do we go from here?
Although gas and electricity demand have not collapsed to the same degree as oil demand as the world reacts to the public health imperatives of COVID-19, Europe's gas and power utilities still face transformational changes in the landscape that will require them to adapt their business strategies.
IHS Markit has identified six major themes to help make sense of the impact on European utilities of the societal and economic response to COVID-19.
- Impact of lower electricity demand is concentrated disproportionately on thermal generation. The decline in electricity demand has from 5% to 20% depending on the severity of lockdown restrictions. Lower power prices affect all generation but the impact on operating hours is concentrated in the thermal plants that make up the residual load. When demand for electricity falls, the residual load and call on thermal generation decrease along with a decline in power prices. A wild card is however the increasing maintenance levels of nuclear power plants, which could partly offset the impact of lower demand
- Variable exposure to regulated returns relative to merchant returns. Overall, European utilities claim to derive about 60% of their EBITDA from regulated businesses or contracted prices (via FITs or CFDs) for renewable output—but beneath this weighted average there is significant variation. Regulated and contracted businesses are relative safe havens, whereas merchant activities will be more exposed to risks from the current environment, with different segments and geographies facing different levels of risk. Past hedging positions will also be crucial to offset or compound losses in the spot market.
- Uncertainty over handling of customer non-payment. With discussion of explicit payment holidays for utility customers on the agenda—and with some unplanned non-payment of utility bills likely given the economic crisis—the mechanisms for burden-sharing between utilities and governments will need to be defined on the fly.
- Geographical focus/spread. Renewable asset ownership with contracted prices seems to be the safest business in this environment since it is more isolated from the demand impact. However, geographic diversification is key to diluting the risk of regulatory backlash and exceptional levels of COVID-19 demand impact. The financial impact on any individual European utility will depend as well on its geographical focus or spread.
- New levels of counterparty risk. Even utilities that are reasonably confident about the structure of their overall exposure may face uncertainty over the financial strength of some commercial counterparties—large customers, equipment or service suppliers, and counterparties in trades and forward hedged positions. Small retailers may be particularly at risk of default - on both thermal and renewable generation.
- Energy transition and the green agenda. Last, but far from least, are questions about the impact of the response to COVID-19 on the policy and business approach to the energy transition and the climate policy agenda. In Europe, the pressure of the climate agenda is likely to be sustained, regardless of the short-, medium-, or even long-term effects of the COVID-19 pandemic. Reduced demand is likely to help countries in meeting 2020 RED and GHG emissions targets but the structural impact on meeting REDII and other 2030 targets remains as yet unclear.
From a political point of view, it is clear that many utility players are too big to fail. Electricity supply is obviously of systemic importance—visibly so at present because of the frontline role of hospitals. But the disaggregated nature of today's utility business in Europe makes it far from clear whether any particular company can rely on a government bailout, in cases where financial circumstances may make this necessary.
Learn more about the IHS Markit research on European gas and power.
Posted 27 April 2020
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