European energy markets in crisis

Fabien Roques, FTI Compass Lexecon & University Paris Dauphine

ESADE – The Global Annual Energy Meeting

Madrid – 24 November 2014

FTI Consulting overview

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History & scale

Global reach Services

Overview

Global business advisory firm

Dedicated to helping organisations protect

and enhance enterprise value

Content

Context for the current crisis of the European energy industry

Policy issues: the lack of consistency of Europe’s energy policy framework

Market issues: electricity markets do not send appropriate price signals

Conclusion and way forward: the need for a new model

3

Context for the current crisis of the European

energy industry

4

Electricity demand: a lost decade

5

Index of historical consumption (base 100 in 2006)

Several countries have not recovered

yet the pre-crisis consumption level:

■Double dip recessions in Italy and

Spain

■Stabilisation in France and

Germany

■Eastern Europe continues to grow

6

Solar and wind capacity additions reduced “residual

demand” for thermal plants

0

1

2

3

4

5

6

7

8

9

10

2006 2007 2008 2009 2010 2011 2012 2013

Solar capacity additions

Germany Spain France UK Italy

0

1

1

2

2

3

3

2006 2007 2008 2009 2010 2011 2012 2013

Onshore wind capacity additions

Germany Spain France UK Italy

GW/year GW/year

Source : Eurobserv'er

7

Utilization rates of gas plants have fallen

dramatically

Theoretical utilization rate of a 56% efficiency CCGT

Monthly percentage of hours for which the spot price is superior to the CCGT SRMC

Yearly percentage of hours for which the spot price is superior to the CCGT SRMC

Source: ICE CO2 EU ETS future, For germany NCG gas price, for Spain, PEG Sud + transit costs estimated from

CNE, starting Jan 2013, gas tax included.

UK Spain

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

01

/01

/20

10

01

/04

/20

10

01

/07

/20

10

01

/10

/20

10

01

/01

/20

11

01

/04

/20

11

01

/07

/20

11

01

/10

/20

11

01

/01

/20

12

01

/04

/20

12

01

/07

/20

12

01

/10

/20

12

01

/01

/20

13

01

/04

/20

13

01

/07

/20

13

01

/10

/20

13

01

/01

/20

14

01

/04

/20

14

01

/07

/20

14

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

01/0

1/2

010

01/0

4/2

010

01/0

7/2

010

01/1

0/2

010

01/0

1/2

011

01/0

4/2

011

01/0

7/2

011

01/1

0/2

011

01/0

1/2

012

01/0

4/2

012

01/0

7/2

012

01/1

0/2

012

01/0

1/2

013

01/0

4/2

013

01/0

7/2

013

01/1

0/2

013

01/0

1/2

014

01/0

4/2

014

01/0

7/2

014

European utilities fight for survival as their

profitability has fallen and debt has increased

European utilities are in a weak financial situation as they enter into a massive investment

cycle

8

12.3

10.3 10.5

8.9

7.6 7.78.3 7.8

7.3 7.26.7 6.4

0%

2%

4%

6%

8%

10%

12%

14%

2007 2008 2009 2010 2011 2012

ROCE WACCSource: IHS CERA, Industry.

EPD_SR_0213

0

50

100

150

200

250

300

2000 2002 2004 2006 2008 2010 2012E

UR

Billio

n (n

om

ina

l)

Source: IHS CERA.

EPD_SR_0213

Net debt evolution of 10 largest

European utilities (billion Euros)

Return on capital employed (ROCE) and

weighted average cost of capital (WACC) for 10

largest European utilities (2007-2012)

Policy issues: the lack of consistency of Europe’s

energy policy framework

9

• 1996 & 2003: 1st and 2nd Directives

concentrate on creating integrated

competitive power & gas markets

• 2008: Green legislative package sets

2020 targets

• 2012-2013: Debate on 2030 targets

highlights change in priorities:

• European Commission Green Paper

(COM(2013) 169 final) - “A 2030 framework

for climate and energy policies”

• “One of the fundamental objectives of EU

energy policy is to ensure …. competitive

domestic and international energy markets

and prices which are internationally

competitive and represent affordable energy

for final consumers“

Environmental

sustainability

Competitiveness

and affordability

European energy policy: the need for a consistent

framework that addresses trade offs

10

Competitiveness

Green agendaSecurity of

supply

Infrastructure development is lagging behind

ENSTO-E 10 2012 Investment Plan calls

for two- to threefold increase in the rate

of infrastructure investment:

■58 GW of new interconnection in Europe

by 2022.

■104bn of investments over 2012-22.

However, slow progress to date as

critical infrastructures face repeated

delays:

■Progress slowed down by a range of

factors: local opposition, political and

regulatory barriers.

■One third of the ENTSO-E “Projects of

Pan-European Significance” have

experienced delays.

11

Evolution in the timing of interconnection completions, and

causes of delay or cancellations (ENTSO-E TYNDP of 2010

vs. 2012)

Source: ENTSO-E ten year network development plans, 2012 and 2010.

Renewables represent a rising share of

consumers’ electricity bills

12

Evolution of the share of renewables support schemes share in

domestic consumer retail prices (2009-2012)

Source: European Commission “Energy prices and costs report”, Accompanying the Commincation from

the EC Energy prices and costs in Europe

The European carbon market: need for a structural

reform to address overlap with RES policies

The ETS has become a “residual market”

■RES and energy efficiency policies are the

prime drivers of investments.

■ETS prices well below the implied

switching price btw. coal & gas generation

(about 40€/tCO2).

The decisive step for the future

credibility of the ETS is the structural

reform that the EC has started

discussing:

■Need for a supply adjustment mechanism

that is transparent and based on

predetermined simple rules

13

ETS carbon price and coal-gas switching

implied carbon price

Source: FTI analysis

€/ton CO2

-20

-10

0

10

20

30

40

50

60

Ju

n-0

5

Ja

n-0

6

Au

g-0

6

Mar-

07

Oct-

07

May

-08

Dec-0

8

Ju

l-09

Feb

-10

Sep

-10

Ap

r-11

No

v-1

1

Ju

n-1

2

Ja

n-1

3

Au

g-1

3

CO2 price CO2 break-even price

Market issues: electricity markets do not send

appropriate price signals

14

Current European electricity markets remain

incomplete

Adequate price signals are lacking to provide the right operational and investment

incentives to market participants:

■both on a very short time frame – within day or within the last hour

■and on a long time frame to trigger investments

Forwardmarket

Spot Market

IntradayTrade

Capacity

Energy

Balancing

services

Years

ahead

Months

ahead

Day ahead

(h-24) IntradayReal

time

Product

type

Time

Forwardmarket

h-1

Primary, secondary, tertiary reserves

Forward contracting

Spot market

Historical

focus

Need for reform & integrationReform &

integration

15

Renewables need to be integrated into electricity markets

Lack of coordination between national

approaches leads to suboptimal deployment

of renewables, increasing costs for

consumers.

Support policies need to evolve to integrate

RES into power markets

In the long term, the depressive effect of

RES on power prices represents a structural

issue

16

R. Haas, Ch. Panzer, G. Resch, M. Ragwitz, G. Reece, A. Held. A Historical

Review of Promotion Strategies for Electricity from Renewable Energy

Sources in EU Countries, Renewable and Sustainable Energy Reviews,

volume 15, issue 2, pp. 1003 – 1034 (2011).

Type of renewables support policy by country

Capacity mechanisms need to be coordinated

17

Spain

Discussions for

reform of capacity

payment

Italy

2014: Implementation

of market

for Reliability Options

France

2014: implementation of

capacity obligation on

suppliers and backstop

auction

Germany

Implementation of transitory

“redispatch / winter

reserve”, discussions on

capacity market

United Kingdom

2014: implementation of

capacity market with

centralized auction

Capacity market Strategic reserveCapacity payment

Ongoing reforms / discussions

mark a shift toward market

based capacity mechanisms

France, Italian, and United

Kindom reforms share

common structural (and

permanent) approach

Significant differences remain

in the design of the different

capacity markets

This could introduce further

distortions in energy markets

…

And calls for some European

guidelines on harmonization

and coordination of these

mechanisms

Belgium

Strategic reserve

/ tender for new

plant

Conclusion and way forward: the need for a new

model

18

Conclusions

A set of objectives does not make a consistent energy policy

■The lack of consistency in the different policy objectives is the root cause of many the

regulatory and policy uncertainty that hampers investment.

■The debate on the 2030 targets has not addressed the key trade offs between competitiveness

an costs, environmental objectives, and security of supply.

European power markets need a deep reform to adapt to change in policy priorities and

international context

■It is critical to complete the sequence of electricity markets with the missing elements in both

the short term and in the long term

■Experience on other continents (Latin America, Ontario, etc.) demonstrates how the functioning

of competitive and well developed electricity markets can be enhanced through the judicious

use of long term contracts.

Governance issues need to be addressed and regional approaches are a promising way

forward

■National and European levels of governance are obsolete

■Coordination mechanisms need to be strengthened to reduce risk and support investment

19

Merci pour votre attention

20

Fabien Roques

Senior Vice President

FTI - COMPASS LEXECON

froques@compasslexecon.

com

Fabien Roques

Professeur Associé

Université Paris Dauphine

fabien.roques@dauphine.fr