Senior Partner & Managing Director, Vice Chairman, Energy Practice
Only the Nimble Will Thrive
The European energy markets are undergoing structural changes that will permanently transform the power-generation and power-retail landscape. After more than 20 years of relative stability, the markets are being reshaped by three main forces:
In recent years, power demand has fallen significantly in many of the major European countries. For example, electricity demand fell by 7.5 percent in the U.K. from 2007 through 2012, according to National Grid. (See Exhibit 1.) Across the EU-27 countries, total electricity demand fell by 1.7 percent from 2007 through 2011 (the most recent year for which EU-27 data are available), according to Eurelectric.
The primary cause of the fall in demand was the global credit crisis and the ensuing European sovereign-debt crisis. Although the worst is now over for most countries, power demand may remain below precrisis levels for many years to come. For example, 2020 electricity consumption in the U.K. and Germany is expected to be below 2012 levels by 0.2 percent and 0.6 percent, respectively, according to Eurelectric. Economic growth, the main driver of demand, is weak; the European Commission forecasts growth of only 0.1 percent for the Eurozone in 2013.
The falloff in electric-power demand has coincided with an increase in renewable-energy capacity across Europe. Wind power capacity grew from 56 gigawatts (GW) at the end of 2007 to well over 100 GW by the end of 2012, according to the European Wind Energy Association (EWEA). Solar-photovoltaic (PV) capacity grew from 5 GW to approximately 70 GW over that time period, the European Photovoltaic Industry Association (EPIA) reported.
The decrease in demand coupled with the significant increase in installed capacity has resulted in excess capacity in several countries, affecting the traditional supply-demand balance and wholesale-power-market dynamics. At the same time, this new capacity does not fully contribute to an increase in the security of the supply given the intermittent nature of wind and solar power.
In parallel, unit energy costs have continued to rise, driven by multiple factors that vary by market. The following are the six major drivers:
Emerging and relatively inexpensive shale gas has been suggested as the solution to Europe’s rising-energy-cost problem. However, shale gas has had no direct impact on European gas prices to date: Europe does not yet have a significant hydraulic fracturing, or “fracking,” industry, and there are significant doubts about the environmental feasibility of large-scale shale-gas production in Europe. Moreover, factor costs such as land rights are likely to make shale gas production in Europe much more expensive than it is in the U.S.
The biggest opportunity for less expensive energy may come if and when new gas contracts that delink gas prices from oil prices are negotiated. However, given the economic implications of lower export prices for gas-producing nations, European natural-gas importers would face many rounds of tough negotiations with their trading partners.
At the same time that demand is falling and costs are rising, new energy options are emerging that allow consumers to partially or completely disintermediate the traditional value-chain players. Cost reductions in solar PV mean that distributed generation and self-consumption are now more attractive economically for some consumers—for example, residential customers in parts of Italy have been able to save on energy costs as a result of this new source. New demand-response technologies such as Voltalis’s BluePod4 are winning tens of thousands of customers. Smarter control systems are enabling businesses to reshape their power demand, saving money on consumption and ancillary items such as grid fees.
The net result of these changes will be a permanent transformation of the energy landscape. This new landscape will be more complex, more volatile, and more fragile. It will raise costs for consumers and increase risk levels for power companies.
While the rate of change has so far been gradual, we expect it to accelerate as other market participants react to these changes in the landscape.
Several national governments are accelerating energy-efficiency measures as a way to offset rising unit costs for power while also reducing carbon emissions. Germany plans to increase its efforts to provide free energy-saving advice to low-income households. U.K. politicians are introducing new energy-efficiency policies in an effort to reduce levels of “fuel poverty”—the condition in which people who spend more than 10 percent of their income on fuel live. The number of U.K. households in fuel poverty rose from 2 million in 2004 to nearly 5 million in 2010, according to the U.K. Department of Energy & Climate Change.
Consumers are also changing their behavior, in some cases producing their own energy and becoming “prosumers.” For example, Ikea is developing a portfolio of clean-energy generation to supply all its stores with low-carbon, fixed-price electricity, and GlaxoSmithKline is investing in technologies such as wind and tidal power to serve some of its manufacturing sites.
Public- and private-grid operators are not standing still. Those with regions that border on the North Sea have come together to investigate the merits of an offshore-grid network, and new interconnections are already planned between Germany, Denmark, the U.K., and Norway. Better land-based interconnections between Germany and its neighbors have already contributed to a significant drop in prices in Germany’s balancing market. Smart meters and smart grids are being rolled out in several countries, with the aim of managing supply-and-demand patterns at the local grid level.
Given the many challenges that European power companies will face in the coming years, how can they best prepare to compete and thrive in this changing landscape?
At the core of any plan of action is a sound strategic outlook, built on a range of possible scenarios rather than a single view of the future. Companies need to recognize that, given the nature of the changes in the European power landscape, awaiting a return to past patterns is not an option. Companies’ plans should also integrate potential “black swan” events that could further accelerate change, such as a major nuclear incident or a regional grid failure. Energy companies can also learn from other industries that have experienced similar levels of change, such as banking, telecommunications, and media.
With the uncertainties inherent in the future energy landscape and the growing importance of being nimble, companies must enhance their ability to adapt. There are three ways to do this:
In addition to increasing their adaptability, companies may need to review their corporate structures in order to bridge the risk-return gap. Among the options that should be considered are mergers and acquisitions, joint ventures, and divestments. More radical options such as separating “good” businesses from “poor” businesses may even be necessary to renew investor confidence, as has been the case for some of the banks hardest hit by the global credit crisis.
The European power-generation and power-retail landscape is being fundamentally reshaped as demand falls, costs rise, and new energy options emerge. The result of these changes will be an energy landscape that is more complex, volatile, and fragile in the medium term, one where consumers will face higher costs and energy companies will face higher risks. Power companies that recognize this and reshape their business models to become more adaptable are likely to not only survive but thrive.