In this article, part of a series in which we cover commodities, energy, shipping and technology, media and telecom, we look at the energy sector and asses the sources of volatility and uncertainty it faces.
Energy sector: structural changes underway
The health of the energy sector, which encompasses a wide range of industries including oil and gas, coal and renewables, as well as associated network infrastructure and technology, is closely linked to GDP growth. Historically, when growth slows, energy consumption falls, which has subsequent impacts for companies in the sector. The low growth environment of the post-crisis period has been no exception.
However, during this long period of economic uncertainty, companies in the energy sector have faced an unprecedented range of additional challenges: the scale of the change in the industry’s fortunes is reflected in the €104 billion write down of assets by Europe’s 12 biggest energy companies over the past six years, €30 billion of which occurred in the past year, according to analysts at Jefferies. “The list of challenges facing the industry is enormous and the problems are only likely to get tougher,” explains Alexander Alting Von Geusau, head of utilities at ING Wholesale Banking.
A plethora of problems
While the energy sector has some distinct dynamics, it is inextricably linked to the broader commodity market. “As global growth has slowed, there has also been a steep fall in commodity prices, which has had a knock-on effect for energy producers,” says Alting Von Geusau. “In some markets, such as the US, price falls have been deepened by the emergence of new sources of supply, such as shale gas. This has had wider implications, with US coal being exported to Europe at extremely low prices.”
Meanwhile, government intervention and regulation have increased. The energy sector has always been tightly regulated given its critical economic and social role. However, in recent years governments across Europe have significantly increased their intervention in the market in order to promote renewables – through the provision of feed-in-tariffs, for example – and reduce carbon emissions from other traditional fuels, such as coal, through carbon pricing and other mechanisms. As well as disrupting the market, in many countries the provision of subsidiaries for renewables has created over-supply, which reduces prices.
Other government interventions have had equally dramatic repercussions. Among the most notable is the surprise decision by the German government, in the wake of the Fukushima disaster in Japan, to close the country’s nuclear power stations by 2022. Traditional generators operating these plants face high costs for decommissioning.
As if the energy industry’s challenges were not great enough, companies in the sector must also contend with a fundamental shift in how the energy industry operates. “The nature of the sector is changing dramatically, as energy efficiency measures are implemented and the ‘internet of things’ and new technologies play an even greater role,” says Alting Von Geusau. “There is a move towards small-scale, decentralised generation, the use of smart meters, which will facilitate greater understanding of customer behaviour, and increased storage capacity. These changes will increase supply, reduce demand and result in further disruption for traditional generators.”
Alting Von Geusau says that energy companies are trying to change their business models by moving into renewables, becoming more customer-centric, and focusing on selling gadgets to help people reduce energy use. “Some are also following the example of the technology world and buying up new, more innovative competitors. However, as the nature of the energy industry changes, the barriers to competition will fall: any company with a strong customer base can sell energy and storage: if traditional utilities can’t adapt quickly enough they will be overtaken. The most important factor for success will be customer engagement and technology adoption: are companies prepared for the connected, mobile and smart customer?”
These fundamental shifts in the energy sector are changing how it is perceived by investors and, in some instances, are making it harder for companies to raise capital. “Historically, the energy sector has been seen as a haven of stability with predictable, regulated cashflows,” says Alting Von Geusau. “Given greater uncertainty, investors are now shying away from traditional generators and instead are favouring renewable-focussed companies, which are subsidised and have clear, regulated income streams. Certain renewable technologies such as solar PV have achieved grid parity in many regions and will not require subsidies going forward. Similarly, network operators, which will become more important in a decentralised generation market, are also seen as attractive.”