Navigant Research Blog

Europe’s Energy Transition Megatrends and Tipping Points, Part V: Globalisation and Regionalisation of Energy Resources

— September 2, 2016

Oil and Gas ProductionJan Vrins coauthored this post.

In our initial blog on Europe’s energy transition, we discussed seven megatrends that are fundamentally changing how we produce and use power. Here we discuss how the globalisation and regionalisation of energy resources is fundamentally changing the European energy industry.

What’s Happening?

The EU is actively aiming to deliver on Europe’s 2030 climate and energy targets while ensuring security of supply and affordable prices. The EU also seeks to be a world leader in renewable energy. Achieving these goals requires a transformation of Europe’s electricity system. To assist in this transformation, the EU must achieve a balance of meeting consumers’ expectations, delivering benefits from new technologies, and facilitating investments in low-carbon generation while also recognising the interdependence of member states. A critical part of this initiative is connecting isolated national and regional electricity systems to secure supply to help achieve a truly integrated EU-wide energy market—a key enabler for the continent and one that goes well beyond precursors such as Nord Pool. While the United Kingdom’s vote to leave the EU raises a number of questions about future policy, it is too early to say what effect Brexit will have on the United Kingdom’s participation in the EU’s future single energy market. (The United Kingdom has, however, been an enthusiastic proponent of this to date.) What is clear is that a focus on greater levels of interconnection (both offshore and onshore) and energy efficiency will continue to be necessary aspects of EU energy policy—and ones that receive much scrutiny.

To get access to the necessary energy supply and resources, more regions, countries, energy markets, and utilities—including those in Europe—are looking beyond the traditional borders of their energy business and territory.

What’s Driving This Change?

The main drivers behind this globalisation and regionalisation of energy resources are:

  • Access to cheaper natural gas globally
  • Accelerated shift of generation resources to renewables, which requires greater system flexibility to maintain security of supply
  • Economic and political imperatives for energy import and export

Access to Cheap Natural Gas Globally

Driven by a technology breakthrough applied in the field, shale gas has transformed the North American gas market and stands poised to significantly affect the global gas market in the future. On February 24, 2016, for the first time in history, liquefied natural gas (LNG) from North America was exported from the contiguous United States—from the Cheniere Sabine Pass facility in Louisiana—to Europe, a historic moment in the North American gas industry.

Globally diverse sources of natural gas and increased movement of these sources—in the form of LNG by ship—is becoming increasingly prevalent from places far from one another. As Australia, the United States, and Canada follow Qatar with plans to export LNG in large volumes, the global gas market is poised for a renaissance. Although the LNG industry has been a victim of its own success as prices have declined, the growing availability of gas to global markets is set to impact places that never previously had access. This movement is bringing with it the opportunity for new gas-powered industries such as petrochemicals and an increased availability of cleaner gas-fired power generation to people and places around the world.

Extensive European infrastructure for gas transmission, including pipelines and new LNG facilities, is helping ensure that cheap gas will be available in most parts of Europe. There is a lag effect as to how this impacts gas generation development; however, in the short to medium term, it at least underpins gas’ ability to remain a key fuel source for heating, industrial use, and flexible power generation. While the latter use may fly in the face of carbon targets, with questions around new nuclear and other baseload low-carbon generation, the net reduction from replacing coal with gas is still significant and may prove to be at least a convenient bridging arrangement.

Accelerated Shift of Generation Resources to Renewables

In Part III of this series, we discussed the changing generation mix across Europe. Virtually all net growth in recent years has come from renewables. To achieve this while managing the system security of supply requires much greater flexibility in the way the electricity systems are managed across Europe. Flexibility is essential and the key underpinnings of this are interconnection, storage, and demand response. To date, the most prevalent of these has been the rapid growth in interconnection—for example, the import of French nuclear power to support Germany’s solar boom and the HVDC interconnection to enable the United Kingdom and Denmark to rapidly develop their wind generation sector. It can be argued that without access to hydro reserves from Norway and Sweden, neither country would be able to accelerate their current offshore wind program. This interconnectedness is a strength of the European system, but it also means that, in effect, each nation relies on others for their ultimate security of supply. In the future, the impact of storage will complement this and aid renewables integration and system stability. Storage and the ongoing development of demand response will also lead to local regionalisation, whereby markets at a more local level are necessary to deal with increasingly decentralized generation and the local flexibility enabled by smarter metering.

Economic and Political Imperatives

The third driver may be obvious to some but is the most challenging to achieve in practice in many ways. Greater affordability for consumers across Europe is promoted through a more regional approach to energy supply. However, macroeconomic theory and national politics do not always pull in this same direction. It sounds simple for Norway to increase its exports to the United Kingdom via a new interconnector as both countries gain overall; however, if this leads to higher wholesale prices in Norway through a reduced surplus, then consumers may see an impact on their retail price. To date the economic efficiency of Europe’s market coupling has proven a sound platform for rapidly improving the regionalisation of energy resources across the continent while political will has held firm in most respects. Some initiatives such as the North Sea Grid may work on a region-wide basis yet do not translate into a commercial rationale that leads to specific profitable projects for investors. Given the importance of a united energy policy for maintaining affordability and energy security across the continent, this needs to remain a critical area of policy and regulatory attention as 2030 targets come firmly into focus.

So What Does This Mean?

It is worth reminding ourselves of the underlying objectives as defined by Europe’s Energy Union:

  • Electricity systems will become more reliable, with lower risk of blackouts.
  • Money will be saved by reducing the need to build new power stations.
  • Consumers’ increased choice will put downward pressure on household bills.
  • Electricity grids will be able to better manage increasing levels of renewables, particularly variable renewables like wind and solar.

Looking forward, the EU market, national policymakers, and utilities first need to adapt their long-term resource plans and incorporate regional scenarios for power supply, while also building in a rapidly changing fuel resource mix toward renewables and natural gas. Second, they must think outside the box with regard to securing fuel or access to renewables well beyond their traditional territory borders. Third, to effectively develop system plans, the planning processes need to take into account the entire regional transmission system. Regional entities should find a way to bring together players such as distribution network operators, municipalities, and other smaller industry players to ensure their needs are also addressed and more holistic solutions are presented. Finally, to facilitate and enhance emerging market offerings such as enterprise information management, the planning toolkit needs to expand to better address the challenges of large-scale renewables integration across multiple regions.

This post is the sixth in a series in which we discuss each of the power industry megatrends and the impacts (“so what?”) in more detail. Our next blog will be about merging industries and new entrants. Stay tuned.

Learn more about our clients, projects, solution offerings, and team in our Navigant Energy Practice Overview.

 

Europe’s Energy Transition Megatrends and Tipping Points, Part IV: Delivering Shareholder Value through Mergers and Acquisitions, Restructuring, and Divestment

— August 24, 2016

AnalyticsJan Vrins coauthored this post.

In our initial blog on Europe’s energy transition, we discussed seven megatrends that are fundamentally changing how we produce and use power. The increase in merger and acquisition (M&A) and divestment activity is reshaping the utilities industry. Large acquisitions and restructuring maneuvers are happening globally, with some particular impacts on the European utility markets, which we will discuss below.

What’s Happening?

In the search for increased shareholder value and to address policy changes by governments encouraging clean energy, companies are looking at scale, synergies, and reducing exposure to lower-yielding parts of the business. Europe has seen renewables leader DONG Energy become the largest IPO in 2016 with a valuation of approximately €13.5 billion (~$15 billion), and RWE Innogy is slated for its own IPO by year end. E.ON announced it will be separating its more traditional forms of power generation into a new company that is expected to be listed during the second half of 2016. Engie and Centrica are investing billions in new distributed energy resources (DER, which includes distributed generation, energy efficiency, demand response, storage, and more) development and energy services businesses through numerous strategic acquisitions. Even the oil majors are getting back into new energy, making strategic investments well beyond their traditional oil & gas businesses.

What’s Driving This Change?

There is a widely recognised downturn risk, with global growth forecast downward, the impact of the UK referendum, the mature European market, and the growing awareness of the impact of the slowdown of four of the largest emerging economies (China, Russia, Brazil, and South Africa). Despite this, there is evidence of healthy deal flow in the utility sector affecting incumbents and new participants alike. The main drivers behind this are low demand growth (which limits earnings growth), increased carbon reduction policies, changing customer demands, the growth of DER, and the attractiveness of the steady returns from regulated assets in the sector.

But it goes further than that. With the emergence of the Energy Cloud driving a broad and deep digitalization of the industry, utilities, manufacturers, technology companies, and others are looking for ways to retain their customers, improve their market position, and grow earnings. They are targeting a completely new market of technologies and services, including DER, building-to-grid, electric transportation, smart cities, the Internet of Things (IoT), and transactive energy, which Navigant has estimated will generate $1.3 trillion in new annual industry revenue by 2030. The European energy transition in many ways is leading the way globally, and we see the following acquisition, new venture, and divestiture scenarios playing out across the industry.

Utilities Acquiring Other Utility Companies or Assets

A combination of falling deal value in Europe and rising deal value in other parts of the world resulted in a decline in European utilities’ share of the of the global mergers and acquisitions (M&A) deal market over the last 4 years. A large part of this was due to European acquisition targets being in short supply, being less attractive when coupled with the policy constraints faced by many European power utility companies, and the US government’s clampdown on cross-border tax inversion deals.

Utility M&A Deals 2012-2016

GajanBlogTable

(Source: Mergermarket)

However, there has been targeted activity driven by a renewed search for international growth and synergy savings. Enel Green Power (EGP) in January 2016 took the first step into the German renewables market with the acquisition of a majority share in Erdwärme Oberland (EO), a company that specialises in the development of geothermal projects. In addition, Iberdrola made a $4.4 billion acquisition of UIL Holdings in the United States, which is the most notable outbound move by a European utility for expanding outside Europe, and MET Group made an acquisition of Repower’s energy supply operations in Romania as part of its expansion along the value chain. We do see large-scale M&A increasing again after this year once divestitures and IPOs have stabilized and the overall investment climate in Europe becomes more favourable.

Institutional Investors and Private Infrastructure Funds Acquiring Utility Companies

Institutional investors’ search for steady yields remains undiminished across the world. The steady, long-term returns available from regulated assets in the power utilities sector are attractive to investors, particularly in today’s low interest environment. Institutional investors, especially cash-rich private equity funds from the Far East and China, are moving into generation, where in previous year the interest was based in network assets.

We have also seen an increasing number of investment yield vehicles and holding companies designed to give Middle Eastern investors in particular access to portfolios of longer term contracted assets, with the renewables sector being a particular focus. A number of the largest deals announced in 2016 fall into this category, with 16 deals worth a total of $4 billion in the first quarter. The most notable of these were Beijing Enterprises Holdings’ acquisition of German energy-from-waste company EEW Energy for $1.6 billion, ISQ Global Infrastructure Fund’s $1.1 billion acquisition of Viridian Group, and Danish pension provider PKA and Kirkbi A/S’s acquisition of 50% of DONG Energy’s UK offshore wind farm project for $1 billion.

Divestitures and IPOs

Divestment of non-core assets to focus on capital projects and growth through acquisitions will be the likely source of restructuring activity in Europe in 2016. The number of divestments marks the highest half-year deal count since 2003, according to figures published by Mergermarket. DONG Energy’s intended divestment of its oil & gas pipelines and review of its exploration & production business will be a significant deal in this respect. This deal would represent a milestone in unbundling one of Europe’s largest power utilities.

Other landmark deals include RWE’s separation of its renewable power generation and distribution business into Innogy and selling a 10% stake through an IPO later in the year. The company intends to use the funding from the IPO to increase its capital expenditure in renewable energy and trends of the energy world of tomorrow. There’s also E.ON’s separation of its conventional power business into a separate entity called Uniper, which is expected to be listed in 2016. While developments both were in response to Germany’s drive to develop more renewable power capacity at the expense of more conventional coal and gas-fired plants and to close its nuclear stations, all big utility companies in the major European markets are reviewing their portfolios in response to the decarbonization drive and to optimise their balance sheets. In the UK, National Grid’s intent to dispose of a majority stake in its gas distribution business is likely to attract considerable interest from a range of institutional funds. Similarly, competition is likely for OMV Group’s planned sale of up to a 49% minority stake in Gas Connect Austria.

Utilities Buying Energy Technology Companies

Globally, we see more technology companies being acquired by utilities with acquisitions of renewables, energy storage companies, and DER. In a recent cross-border transaction, French utility giant Engie took a majority stake in Green Charge Networks. In Europe, this trend is distorted by the size of the deals falling below the radar; many of the deals are small to midsize in nature or joint ventures and tend to focus on beyond-the-meter service offerings, energy storage solutions, and other disruptive technologies. In March 2016, Ecova, a leading US energy company, acquired Power Efficiency Ltd., a leading European energy procurement and carbon reduction service provider. In late 2015, E.ON signed an agreement with Samsung to develop a business model for targeting applications for lithium ion batteries in selected markets. Earlier that year, E.ON sold its Italian solar operations to private infrastructure fund F2i SGR as it exited the Italian solar market. F2i subsequently signed an agreement with EGP to form a joint venture to boost the development of solar PV in Italy. In that same year, EGP opened its first solar power plants combined with battery storage facilities with technology partner General Electric.

A development we are seeing in the United States that has yet to make its way to Europe is the acquisition and investment of analytics companies by utilities in an effort to adapt to the increasingly complex distributed energy environment. A recent example is the $20 million investment in AutoGrid Systems from Energy Impact Partners, a utility group that includes Southern Company, Xcel Energy, Oncor, National Grid, and Envision Ventures.

Oil Majors Diversifying into the Sector through Acquisitions

When Chatham House warned oil majors that they must transform their business or face a short and brutal end, no one expected the ensuing events. There were always signs that oil & gas majors were moving into the power market for their resource production, with Gazprom being the most notable until now with its $4 billion purchase of Moscow Integrated Power Company in 2013. With Shell and Total now diversifying their portfolios into the local carbon and cleantech markets, the landscape has genuinely changed. We see oil & gas majors making investments in renewables, DER, transportation, smart infrastructure and cities, and energy management.

In the first half of 2016, Total acquired Lampiris, a renewable power vendor based out of Belgium, for $225 million, as well as battery maker Saft for $1.1 billion. Total has a stated ambition to be the top renewable and electricity player within 20 years; the company previously acquired a majority stake in solar company SunPower, and in April announced the creation of a Gas, Renewables and Power division. Shortly after, Shell, Europe’s largest oil giant, established a new division called New Energies to invest in renewables and low carbon power generation. With close to $2 billion in capital investment already attached to this business and an estimated $200 million in annual funding, the company has ambitious plans to be at the leading edge of the transition to lower carbon economies.

Manufacturers or (Energy) Technology Companies Acquiring Other Manufacturers and (Energy) Technology Companies

Globally, this category has seen significant activity with solar companies acquiring other solar companies, solar companies merging with energy storage companies, and even technology companies buying other technology companies. In the United States, from Google buying Nest to Oracle buying Opower, there is an acute interest to be part of the momentum, and companies are looking for unique and differentiating technologies and capabilities to stay ahead of the competition. In Europe, we see a tremendous number of new companies coming into the energy space, selling new and innovative energy technology products and services. This is expected to be the growth area for the volume of deals, with a significant amount of investment pouring into newer, greener ways of producing, managing, and using power. Europe is at the beginning of a greentech groundswell, and IKEA is leading the way with a pledge to invest $650 million (on top of its earlier investment of $1.6 billion) into cleantech energy projects.

So What Does This All Mean?

Our advice to utility companies is threefold. Your landscape is changing rapidly, and technology improvements and new participants in the market are forcing the pace of this change to unfamiliar territory. If you take the “low regret cost” option, you will end up with stranded assets as new entrants will innovate, provide utility products and services, and gain market share. Think out of the box on how to diversify your revenue streams from new products and services along the value chain, as well as complementary products. Look beyond your comfort zones into emerging markets and form partnerships with local incumbents.

Your customers today can become your competitors tomorrow (as seen with IKEA), or they could seek to be energy self-sufficient, as seen in Apple’s search for European sites with renewable energy sources to power its data centers. This emerging trend with customers using the grid infrastructure to buy and sell power (i.e., transactive energy) where the traditional utility companies are required to maintain the infrastructure has the real risk of forcing you down the low ROI direction. If you are not proactive in forming strategic partnerships with non-traditional participants to explore opportunities, however insignificant and tangential it may seem in your current environment, you will become a reserve source of energy rather than a primary one.

The transition from fossil fuels to a low carbon mix due to technologies and market players will transform the sector from what it looks like today. Embrace green technology—your customers and your stakeholders are. If you do not, then you will lose customers who opt for newer, greener technologies as they change their strategy to meet their own customers’ desires for low carbon energy consumption.

Balancing today’s business with tomorrow’s opportunities is key. Thinking through strategy and future case scenarios will help you understand the opportunities and threats. Existing planning horizons and tools, such as strategic plans and integrated resource plans, are insufficient. A more agile strategic planning approach is needed to pinpoint the trends, opportunities, and threats, and to introduce new technologies and business models successfully to address market and customer needs. Our latest white paper, Navigating the Energy Transformation, offers a framework for approaching strategic planning within an industry facing historic transformation, outlining five steps industry participants should follow to prepare their organisations to maneuver around disruption and capture value in the Energy Cloud. Navigant can help clients understand the impacts of the many industry changes in their business and develop and implement a Strategic Identity and Growth Plan (10-15 years), as well as an agile Energy Cloud Playbook (6-12 months) that will help you navigate a path forward and take control of your future.

This blog is the fourth in a series discussing how industry megatrends will play out across Europe as well as at the regional and country level. Our next blog will be about the globalisation of energy resources. Stay tuned.

Learn more about our clients, projects, solution offerings, and team at Navigant Energy Practice Overview.

 

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