European governments have ambitiously raised targets for the energy transition, aiming for a net-zero carbon economy by 2050. In turn, there has been a significant push towards renewables and other low-carbon energy solutions. As Pierre Georges, Sector Lead for EMEA Utilities at S&P Global Ratings, explains, utilities that are aligned with these objectives are set to perform better over the coming decade
Prospects for European utilities have generally improved over the past year, with policymakers elevating the continent’s decarbonisation ambitions and the energy transition becoming a pillar of the economic recovery strategy post-COVID-19. Here, utilities have a singular role to play, with many having prepared themselves for a greener economy over the past decade.
Despite this, not all European utilities have been able to accelerate this transformation due to political, geographic or system constraints. As such, there has been a divergence across the sector in companies’ ability to effectively seize the investment opportunities offered by new European policies.
Improving financing conditions
European utilities started to accelerate their transformation in 2016, when power prices crashed as a result of lower commodity prices due to the development of U.S. shale gas – stepping back from merchant-based and fossil fuel generation and growing into cheaper, longer-term contracted renewables. By creating more defensive profiles, this process addressed growing environmental concerns and led to a withdrawal from the most polluting energy sources.
Since, investments in renewables and power networks have continued to increase and will benefit from this growth in the years to come. Additionally, there are advantageous conditions stemming from
European funds facilitating the energy transition, while the European Central Bank (ECB) favours sustainable finance transactions in its buy-back program. With an increasing investor appetite for sustainable and green capital, it is European utilities seem set to benefit from attractive conditions more than other sectors.
Poised to enter an investment supercycle, S&P Global Ratings expects capital investment in utilities will surge, leading to balance sheets becoming stretched in order to effectively seize these opportunities. Yet as investments progress, business risk profiles are expected to gradually strengthen. As a result, risks will be manageable and credit conditions will gradually improve – with ratings upside contingent on whether utilities have a well-established and diversified asset base and a solid track record to execute their pipeline.
Championing the energy transition
As the industry continues on its path towards net-zero, the utilities sector is seeing the emergence of energy transition champions that should be able to deliver superior growth of secured cash flow for the coming decade – largely stemming from the regulated, asset-based growth of electricity networks, as well as long-term contracted earnings from relatively young renewable asset portfolios.
Indeed, large investments are being made in electricity networks, not least to accompany the growth of renewables, strengthening both efficiency and resilience. In turn, for operators, the associated costs should remain manageable thanks to the greater integration of automation and digitalisation.
Moreover, despite the increasingly competitive landcape for renewables, electricity networks are in good stead to benefit from their current positioning ahead of the curve in the energy transition. This is notably thanks to the experience and expertise they have gained in recent years – which takes time to build – and the scale they have reached in the renewables space, which allows them to better seize opportunities. Of course, all these strengths are further supported by a convergence of forces, including market demand, policymakers, regulators and investors.
Uncertainty prevails for coal, gas and nuclear
Despite a predominantly positive outlook for the sector, utilities exposed to coal, gas and nuclear assets face greater risks than those with heavier reliance on renewables. Indeed, European utilities are becoming more willing to shut down their fossil fuel assets as environmental, social and governance (ESG) pressures mount, and the economics become weaker for European coal and lignite assets.
For gas, the situation is complex. While carbonised gas will likely remain a key European energy source for decades, a decline looks inevitable, and as such, investments in new gas-fired power plants are becoming more difficult to come by. Meanwhile, the role of nuclear in Europe remains unresolved, with no decision about the position of this low-carbon technology, which bears other risks such as safety and waste management.
It is clear that decarbonisation remains a priority for the sector, while demand for green energy continues to grow among industrials. As early movers in the renewables space, European utilities will maintain some degree of competitiveness, while investment opportunities will likely increase and, in turn, create space for new market entrants. Moving forward, it will be those most exposed to renewables and power networks that will perform best, while those less aligned with a net-zero carbon economy will face continued uncertainty.
Pierre Georges is sector lead for EMEA Utilities at S&P Global Ratings.