Partner & Director
Russia’s invasion of Ukraine transformed the outlook for global energy markets and for the power and utilities (P&U) sector in particular. In July 2022, we surveyed P&U investors to understand their expectations. The survey was representative of a group that invests worldwide and has more than $1 trillion in assets under management. Their holdings span a range of companies, including developers of power assets, independent power producers, regulated utilities, trading and distribution companies, and retail energy providers.
This recent survey was a follow-up to a similar one we conducted in the third quarter of 2021. With so many recent changes on the global scene, the new data enable us to understand what’s changed since last year and what hasn’t.
Four messages stand out. First, investors continue to look to the P&U sector for growth; dividends are not the primary focus. Since the war, however, investors are anticipating much higher volatility; consequentially, they are looking for measures to safeguard their investments. Second, they believe strongly that the war is accelerating the energy transition to renewables. Third, they still see P&U assets as undervalued, even though they have been performing far above market averages in the last year. Finally, investors are requesting more clarity from the companies they invest in, as well as from regulators. And they are increasingly willing to engage actively with the boards of the companies in which they are invested.
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Closer analysis of the results of the new survey indicates that the war’s impact on the sector has significantly increased uncertainty for investors and the industry as a whole. But the overall sentiment is that the industry will thrive and that P&U companies can benefit from the anticipated disruptions of the coming decade.
Unsurprisingly, respondents to the new survey said they expect greater volatility in both short- and medium-term energy prices. Compared to the previous survey, the percentage of respondents who said energy prices would increase rose substantially. In fact, since the war began, short-term prices have surged far more than what investors said they had anticipated, suggesting that they expect the current price increase of more than 175% in Europe to be short-lived. Still, investors expect to see higher power prices than a year ago for both the mid and long term.
This helps explain why investors also feel that a period of far greater uncertainty and volatility for companies lies ahead. They have become more cautious and believe that the need for P&U players to preserve liquidity has become far more important. This indicator rose by two thirds since the prior survey, whereas all other key success factors remained essentially unchanged. Improving their cash positions would allow companies to pursue all options in the face of sudden market changes. Similarly, the expected thresholds for investment returns (or hurdle rates) have come down since the last survey.
An environment of uncertainty often drives the desire to double down on the established and reliable. Today’s P&U investors think differently. Three-quarters of investors—and especially those focused on Europe—say the war has and will continue to accelerate the move to new forms of power generation. On one hand, it’s no surprise that investors see the need for oil in the short term, given the current crisis in the energy markets. But on the other, the number of investors who say we are already past peak oil has decreased; more now expect that peak oil and peak gas will arrive in this decade. These results suggest that the energy transition will happen more quickly than previously thought, bringing with it even more turbulence and volatility than expected.
Investors also want to hold themselves accountable: nearly three quarters of investors have committed to or are considering net zero goals, a 6% increase since the previous survey. At the same time, however, fewer investors now say they’ve blacklisted coal assets from their portfolios—suggesting that they have become more flexible in the face of rising energy prices and growing concerns about energy security, and are hedging their bets.
Given investors’ expectations for a faster energy transition, they also recognize that there will be even less time for P&U companies to build their climate-friendly portfolios organically. Consequently, 70% of investors want to see companies focus on M&A as they move through the transition, which again will lead to more volatility.
Given the energy transition outlook and the current atmosphere of uncertainty, investors are understandably eager to gain more clarity into how companies are planning to navigate these changes. As a result, they expect both companies and regulators to provide guidance on their plans for the transition, and they are increasingly willing to engage to promote clarity and shape the agenda. The number of respondents who see themselves becoming more active and involved with management teams on ESG goals has increased from 48% to 53% since the war began.
Industry players would be wise to take this as a warning, but also as an opportunity. Companies that clearly state their long-term plans and goals for the transition and define their transition roadmap, including specific deliverables for each milestone, can gain a competitive advantage. Moreover, including governments and the public at large as stakeholders in industry efforts to reduce emissions and mitigate the effects of climate change will be key. And in light of the war in Ukraine’s impact on the sector, companies must also become more willing to take a public stance on a variety of geopolitical and social issues.
Our total shareholder return (TSR) research shows that in the four years preceding last year’s survey, only 22% of the top 50 P&U players (weighted by revenue) performed better than the median S&P 500 company. But in the year leading up to July 2022, that figure rose to 68%, reflecting the market’s bullish view of the sector. Yet investors continue to believe P&U companies are undervalued, especially developers and trading and distribution companies. This perception among investors—and the fact that 90% of respondents believe companies should invest in green technologies to grow—provides further evidence of a significant uplift in M&A transactions in the short term.
Investor optimism is also suggested by the general decline in hurdle rates for every type of P&U-related investment, indicating very high pressure to deploy funds. Investors expect the lowest hurdle rates for at-scale green technologies—notably wind, solar, and hydro—as well as infrastructure, including grid, district cooling, and gas pipelines. And the perceived risk of emerging technologies such as carbon capture, utilization and storage, green hydrogen, and e-fuels has decreased significantly, resulting in hurdle rates between 2.5% and 3.3% lower than prior to the war.
If there is a single takeaway from the results of our recent P&U investor surveys, it is that the war in Ukraine has added momentum to the energy transition and the opportunities that it will bring to the sector.
To capture those opportunities, however, P&U companies must maneuver in a world of higher prices, increasing volatility, higher scrutiny, and greater uncertainty—a degree of agility that is not a typical strength of the sector. Governments and banks also must step up with the structures and investment needed to develop and scale up the innovative technologies that will help push through the transition.
It is to be hoped that the war in Ukraine will end soon, and that related factors roiling energy markets and the power and utilities sector will subside. Yet the need to prepare for the energy transition will only become more pressing. Now is the time to act on the insights gained from the survey.