The Energy Transition Fuels Competition in European Utilities

They're going to talk to us about different parts of the value chain, generation, networks and retail and where some of these strategies are different and which ones are actually proving successful. As the energy transition continues full steam ahead, what can we learn from the decisions these European utilities have made. Now, if you want to read this report, it can be found on the Bloomberg terminal at b

NF Go or at BNF dot com. As a quick reminder, BNF does not provide investment or strategy advice, and you can hear a more complete disclaimer at the very end of the show. But now let's speak with Bo and Michael. Bo. Michael, thank you very much for joining today. Thank you, Dana. So today we're going to talk about utilities, specifically European utilities.

And this is a really exciting space at the moment because there are a lot of things that I would say it's safe to say we're looking at maybe they're

changing going forward. But before we dive right into what b anf is so good at, which is talking about the future, let's talk a little bit and lay the groundwork for those out there in you know, podcast land, wondering what specifically we're talking about when we mean utilities, and would you guys kind of break down which part of the utility value chain we are looking at when we're looking at the company profiles, where you stually look

at the utube value chain by separating the upstream, midstream and downstream. And what do we mean by upstream is mainly fossil fuels, thermogeneration and renewable generation, everything that makes power general at the end and midstream we look at transmission and distribution basically all the grids and networks that runs our power. And in the downstream will focus on retail and energy services and also non energy services such

as like telecom, real estate management, insurance and finance. Now all of us are here in London still in lockdown, so we see a path forward. Depending on when you're listening to this, we may or may not yet be permitted to have coffee with somebody outdoors in a park. So my question is what has changed for the European utility space over the past year with COVID nineteen. COVID nineteen has really impacted different parts of utility value in

a different way. We have those field suppliers and generators with exposure to lower power demand and lower power prices and fuel prices, they have been hardest hit, while those units with more regulative returns and residential power retail they have been more protected. Yeah, and I talking more a denis from side of things, in particular energy services, which bowmanshures what we mean by energy services is like installing rooftop TV or storage or electric electric vehicle charge church

chargers our energy efficiency for residential and commercial users. And we kind of saw the acceleration of a trend. We've been seeing that this businesses a lot of comp utilities that invest in the space, but it kind of been a bit maybe a bit slow to find growth. And I think COVID nineteen meant that utilities couldn't get in and install the stuff they cann't get to clients to to sell that, and we've kind of we've seen several utilities perhaps step back from the space centric and energy

being to data data come to mind. Especially COVID nanty has exposed kind of the weaknesses of the coal industry. So we've seen basically all this reduced power demand and reduced a kind of power prices hitting those thermal generators, those coal industry, and meanwhile, renewables have been basically quite protected because they have the great priority and they have been able to secure good prices through like predetermined price agreements such as p p a s power purchase agreements.

So do we think that these changes are here to last? Because you know, this industry doesn't change on a dime in terms of the infrastructure that you build and these p p as that you're signing into the future. So does this mean that these will be lasting impacts? When demand does what we think will actually return pretty you know, aggressively as soon as they start to open up again.

In Gurnal, the thermal producers haven't doing well. It's not just because of COVID nineteen and the reduced power demand,

but also because of the carbon price in Europe. We actually just hit a record high carbon price a few days ago, hitting over four d euros permetrics on and this adds quite a lot of price pressure cost pressure for these So basically the carbon price hits over forty or else prometric town a small and it's quite a big hight compared to seventeen when it was just over five years preton and it takes a ginormous bite into

those carbon intensive coal and lignite generator's margin. And we will continue to say that cold being squeezed out the group by renewables and cheap gas. So this is geographically very split though, because there are some countries that are way more exposed to lignite than others. So which countries are changing the most? Definitely Germany has been one of those that are being hit the most. Also, increasingly we're saying that this is hitting also those Eastern European countries

such as Poland. We will most likely to see like a cold face that is even faster than what has been said in the news at the moment, which then brings me to which companies, So you know, this will probably disproportionately advantage or disadvantage certain companies so which companies have done the best. We have been following this as well, like which companies have been performing better and based on

like the three year return on investing capital. We're seeing that those who have been exposed mostly to the thermal generation like Uniper and r w E, they have been performing less well as those who have more renewable exposures such as like Nail and a bedroller and button Fell for example. Ultimately, the high performers have been those with regulator return whether it's from like grid operations or from renewables. However, there is a caveat about regulator returns is that it

exposes these companies to polish a risk. For example, for European grids that which allowed returns have been falling. There is falling returns for European networks. An example that is off JAM the UK energy regulators have the return on equity transmission network GOT riders can achieve. And we're seeing systemilar trends across Europe, in Spain, Germany, in Scandinavia as well. And I guess in response to that, we're seeing I

guess the the European Utilities Expanded Site of Europe. I guess Latin America has been one of the main targets there and they'll is it wants to expand, it's it's gris business there. Energy bought TAG Brazilian networks company, and eber Droll as well is also expanding its business in Brazil and the US, and it's really where it caes its growth in networks and not in its European businesses. So really, when we're talking about European utilities, in many

respects we're talking about global utilities. Would you say that that is the strategy of the majority of the utilities in Europe is to be looking for expansion areas either in South America you know, typically very much linked to those in Iberia, right the utilities that operate there, or is that just you know, the select few. There is definitely a strong interest in South America. For example, both and Nell and I Padrola are strongly there. They are

attracted by the demand, strong demand. That is, they're also attracted by some of the supportive policy regimes that are in place, and also by that there's still potential to grow quite strongly the renewable generation in those markets. At the moment. The good point there is expansion in Latin America. However, the sub companies are not expanding and if anything, they are actually reducing their geographic coverage. And I think Centrica

is probably the biggest stories we saw there. Centrica had a energy business in North America, Direct Energy, which they sold to Energy Energy later in twenty twenty, and I guess the goal of Centrica now is to really consolidate this business and reduces focus down to just its home markets of the UK and Ireland. And essentially we're the only company doing this either Energy they have and it's quite a big strategy change, and part of that is

to reduce the number of countries that they operation. Okay, so then we are really truly talking about Europe here. So since we are talking about Europe and we're looking at certain countries maybe decarbonizing faster than others, depending upon how their grids are currently set up, I wanted to know is there still a strong case for integration. We have seen kind of some signs of vertical integral being

not as avantageous structure anymore. We saw Eon and r w E swapping their assets are double A focus is now in upstream while Ion is specialized in downstream. We also saw Ovote buying SSS retail Arm, which kind of raises the question whether the generation retail era is coming to an end after this deal, the majority of UK customers are now served by retailers with no generation, which was not the case twenty years ago where the almost nine was served by generator retailers. And there are easy

kind of two groups of reasons. The pull reason from this integrated structure is that the skills to run a successful business is not that much. There's like little overlap between generation arm and retail arm. And then the ultimately the main argument why are many companies have chosen the integrated structure is the physical hedge, which means that you have one buy empower and one selling power and then

you can match the volumes with each other. But it's becoming less important because of kind of the ongoing evolution of financial hedge and tools that it's providing this generator's options that are more flexible than coupling their generation with retail. They basically have now so many different financial instruments like pp A, forwards and future which can all do what

the retail coupling did and maybe better. And also the field switching and increasing renewables are really making this hedging more difficult than before. And there's also the push element here that customers are wanting more today and utilities are exploring quite a lot like how can they do this? How can they satisfy their customers? But there have them been really a winning strategy. So by consolidating and having a larger customer base, this could help them to scale

up faster. Now for a very short break, stay with us for right now, Let's say, okay, we've talked about retail. Let's throw the metaphorical car in reverse and let's head back up the value chain to networks, and let's talk about networks. What do you see and what should we watch for anyone when it comes to networks. So, as you say grid companies looking to grow abroad in Latin America, we said, the other big trend you see in networks is the adoption of digital technologies, so getting more smart

meters in the grid. But that's where the smart meters

live exactly. So that's probably a great use for smart meters for network comperies to see what's going on in their grids and being able to respond to that more quickly and just gathering that data, integrating that with other data streams from some stations they have on the grid, and using all that to understand where you know, predictive maintenance on their grid, you know, reducing those operating costs, while at the same time perhaps employing digital or software

solutions such as local flexibility markets, which we recovering other research, which would allow these network companies to reduce the capital they're investing, so they might have brings that their building as well. So while the returns are falling, I think the target now for within your free to Lose is to try and get their costs down as much as they can. And which companies or utilities are doing this

the best right now? So sorry, so and I will It's okay, it's a very short answer, but I'LL are investing very heavily in the digital space. Yeah, and it's not only the quality of the grids, but also the quantity. Because of the uptake of the huge amount of renewable capacity, we will also need a lot more networks to connect them. So we're expecting that just more grids will come online.

And these big utilities in Padrola and now they have already made a big commitment to expand their grids in Padrolla said that they were invest almost thirty billion euros to kind of increase it almost two hundred by which is quite a big uptake from their existing base and throwing the car in reverse yet one more time. So

let's go back to generation. So you mentioned that we'renewables were an indicator actually, well not an indicator, but that we did see some correlation between success recently and the amount of existing renewables that people actually had as a part of their portfolio. And the question is what are the opportunities and what are the things to watch in

the generation side. We talked a little bit earlier about how renewables for some of these companies, the ones that actually had a lot of exposure there did pretty well recently. And do you see that as continuing to be a trend. Yes, definitely. The business case for renewables are definitely there. The cost of the technology is falling and climate policy is supporting it. And also it's important to think what are the future gaps and industrial decarbonization will be a big thing, a

big thing to watch. Electrification will definitely boost renewables, so there will be business case there and there will be also a business case to kind of in those newer technologies to decarbonize those hard to embate sectors like the aluminum and cement. A lot of utilities have already jumped into like a development of hydrogen ccs, and it will be interesting to see like what kind of business strategy

will actually be the winning one in those areas. And another thing be interesting to watch is the flexibility, which will be a key challenge as we have more uptake of renewables, So the question will be how do we kind of address all these challenges. Companies will definitely want to be involved in this, and there will be also a market design challenge for kind of making all this piece come together. And then how about even further back to the fossil fuel part of things, because really, let's

go as far upstream as possible. Now we're already talking about how renewables are going to help with decarbonization, but presumably there is still just quite a bit within the fossil fuel space that has yet to transition to something else, or may never transition to something else. How do you see that changing, I guess or maybe not in the next year. The story for coal is quite straightforward now as we're also expecting the carbon to go up as

with a renewable uptake. The cold story is that it will be faced out just by looking at the economics, not even taking into account like those cold face out policies. But the bigger question is is gas. What will happen to gas? Right now? There is still a business case for gas because of the volatility of renewables and the need for balancing the grid and most utilities in Europe they have already committed to net zero, but at the moment gas is still profitable and it's a money maker

for them. So how to face out gas will be a bigger question for them to kind of get to their actual net zero commitment. So what are some of the companies again from the business models, So who are the utilities that are doing the best in the space an upstream? We have seen that it's the renewable majors

that have been done. The BA asked, So we have an l in Padrola and E d F what the fall they are all kind of doing similarly well when we look at like the return on the investing capital and are there any outliers here across the utility space comprehensively. We're seeing certain trends and certain sub segments, but are there any outliers which just don't seem to be doing the things that the others are. So one company made one energy major Energy didn't five years ago, didn't take

the same route as an l or Jola. It preferred to go down an energy services rout and and since you does intend, they've acquired about nineteen companies in this energy services space as energy storage companies, energy efficiency generation, and on site generation. Last year they decided against that strategy. They've replot of course they are going to spin out the energy part of the energy services business and take them cash raised from that and invest into developing renewables

and building as their grids business as well. So there were companies who maybe took a different tax and now we see them reverting course and going to the same route dash an l aber droller that they pursued so successfully in the upstream. Maybe one company that comes to mind is for Tomb while kind of other companies they've been more invested in how to dicarbonize their generation protfolio.

For to instead, their generation portfolio was quite low carbon, but instead of going more or expanding their low carbon They went and bought Uniper who had higher carbon intensity

than they did, so that was an interesting development. But I guess what they are really betting on is that there will be a tighter power market and while coal and nuclear plants retire and the gas production from growing and ends, there will be a really tight power market where like gas plants that Uniper has a lot and hydro they will have a huge advantage in that case. So we've talked about a lot of successful business models and a lot of successful businesses on the show, keeping

it really quite upbeat. But I want to know about how competitive this space is and what we see happening in the future. I mean, is it is it a crowded market? That it is definitely. We have been seen quite a lot of new entrants in this market, especially from oil and gas sector. There is a huge gap between kind of now and reaching the Paris Agreement, so there is space as well, but it definitely getting more competitive.

And example of that is what we saw with the U k C Bed auction where we saw a record high level of bidding from oil and gas sector. From BP and in theF both of the oil and gas

and utilities have their advantages. And it's good to notice that even though maybe oil and gas have a lot of money, but utilities they have advantage in um their experience of developing assets and building looss renewable projects and also their existing pipeline is invaluable and those factors have been built over the years and it may give them an edge over this oil majors coming into the power sector. But what also Shells mentioned earlier that they have big

trading desks and ability to manage big offshore projects. This could help them kind of to manage those merchant risks that we see in a power sector and manage those unsubsidized revenue risks. And all the gas majors in their focus isn't just on the upstream in renewable development. We're actually seeing a lot of activity from shell in particular in the downstream space. So show has acquired energy retail

businesses in Australia. In the UK they about battery storage companies that's on and in Germany they have but four separate electric vehicle charging companies total has bought SAFT an

array of ev charging companies itself. So oil and cast companies are chargeting both the upstream the generation side as well as the downstream on the retail side, and Shell only recently announced that they want to double the amount of electricity that they sell to customers by With that, that's what to watch when we sit down to do the next look at these utilities and their company profiles.

This may be a very different conversation with a lot more energy companies involved in a bigger way going forward. And with that, Michael both, thank you so much for your insights today and great having you on the show. Thank you, Thank you. Ny. This episode of Switched On was edited by Rex Warner who Grace Stook Media. Bloombergin e F is a service provided by Bloomberg Finance LP

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