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Portfolio shake-up for Europe's energy majors

EUROPE: Falling wholesale power prices and environmental pressures are making the big European energy companies reconsider their portfolios. But whether that means a stronger focus on renewables depends on their home market and ownership structure.

Cheap lignite… Coal is still king for Germany's RWE. It's 2.2GW Neurath power station was built in 2011
Cheap lignite… Coal is still king for Germany's RWE. It's 2.2GW Neurath power station was built in 2011

The expansion of ever cheaper renewable electricity generation combined with some 60GW overcapacity of fossil and nuclear power stations in Europe is driving down the market price of power. Prices are now at a level that makes it increasingly difficult for conventional power stations to operate profitably.

Europe's major energy companies are reacting in different ways to the new challenges. Germany's E.on has made the decision to split renewables from conventional activities, while CEZ of the Czech Republic is strengthening its focus on purely conventional generation. France's EDF is to set up an asset management partnership to gather funds from institutional and private investors for renewables investment.

A close look at energy companies' development policies reveals that whether and how much they choose to turn to renewables depends heavily on their market circumstances and obligations.

Among the energy majors, the most dramatic reaction has probably been E.on's decision, announced last November, to split off its conventional generation, global energy trading, and fossil-fuel exploration and production units into a separate, independent company, which is also responsible for delivering funds for the company's nuclear dismantling and decommissioning when required.

This will leave E.on itself with renewables, distribution networks and customer-services activities - and the main responsibility for E.on's current substantial debts, reported at €17.75 billion at the end of September 2014.

E.on's move may have been driven not by an eagerness to improve the rate of expansion of renewables activities - its climate and renewables division was already pursuing renewables projects - but by the need to guarantee that its €14.6 billion in provisions for nuclear-power station closures and waste disposal can be made available earlier than had been expected following the German government's 2011 decision, in the wake of the Fukushima nuclear disaster in Japan, to phase-out nuclear power to 2022. Germany's upper house, the Bundesrat, explicitly called on the government last October to check whether the total of €36 billion that German energy companies with nuclear activities say they have allocated for nuclear decommissioning "actually exist and are sufficient".

Cheap coal benefits

German rival RWE has shown no inclination yet to follow E.on's lead and hive off its RWE Innogy renewables division from its conventional generation activities. But its German power station portfolio includes 10.3GW of lignite capacity fuelled with cheap lignite coal from its own opencast mines, making it look better able to cope with low wholesale electricity prices. At current levels, CO2 emissions certificate prices need to rise up to tenfold, to EUR50-60 per tonne, before gas generation in Germany starts to become competitive with lignite, says German lignite federation Debriv.

With a similar generation mix to RWE, the Czech Republic's major energy company, CEZ (owned 69% by the Czech State), is not planning a swing to more wind or other renewables. On the contrary, a CEZ November 2014 company presentation showed a stagnation of its total renewables capacity. Although the company owns the biggest onshore wind farm in Europe, the 600MW Fantanele-Cogealac project in Romania, CEZ is forecasting 1.3GW of renewable capacity between 2015 and 2025, mainly outside the Czech Republic, compared with 0.7GW in 2013.

Like RWE, CEZ has a strong lignite base. Of its 12.63GW of generating capacity in the Czech Republic, 5.4GW is lignite fired and 73% of its lignite needs are supplied from local lignite opencast mines owned by its subsidiary SD, the largest mining company in the country. CEZ also has 800MW of coal-fired plants and 4.3GW of nuclear power, along with 2GW of hydroelectric and pumped-storage power plants, but just 133MW of renewable energy sources in its home country: two wind farms with total installed capacity of 8MW and 13 solar farms totalling 125.2MW.

Asked in December about its policy or target for renewable energy within the Czech Republic, the company merely said: "We are currently in the phase of searching for suitable opportunities." The company added that the rapid development of renewable-energy sources makes heavier demands on subsidies, which results in growth of the regulated components of the electricity price or an excessive burden on many countries' budgets. CEZ stopped providing support for new installed renewables at the end of 2013.

The group's strategic priorities, updated in autumn 2014, make no mention of renewables. It aims "to be among the best in operation of traditional power facilities and pro-actively respond to the challenges of the 21st century, including offering customers a wide range of products and services addressing their energy needs". This includes expansion of decentralised power generation in the form of small fossil-fuel fired combined heat and power plants.

Emissions dispensation

CEZ's policy of continued reliance on conventional energies is partly explained by CO2 emissions-trading dispensations for countries whose economic performance is below the EU average - which help the economics of the company's lignite and coal operations. As CEZ explained in a November 2014 presentation, the European Commission approved a measure in December 2012 allowing the CEZ group to get up to a total of 70.2 million tonnes of free CO2 emission allowances spread over the period 2013-2019 in exchange for investments to reduce greenhouse gas emissions. Further, the key parameters of the EU emissions trading system after 2020 allows countries with a GDP per capita below 60% of the EU average - such as the Czech Republic - to opt to give free allowances to energy companies in exchange for investments of up to 40% of the auctioned amount.

Cheap lignite generation remains buoyant despite the pressures of very low wholesale market prices, but nuclear power may be reaching the limits of its economic advantage. In France, even the powerful majority state-owned EDF is being challenged by low wholesale electricity prices that could wobble its nuclear business case.

EDF is 84.58% owned by the French state. Its nuclear generation from 58 reactors totalling 63.2GW, amounted to 403.7TWh in 2013, or 73.3% of France's total power generation of 551TWh. On the face of it, EDF's future has been shaped by France's new energy transition for green growth bill that was passed in October 2014. The five "clear and voluntary objectives" of the bill include a measure in which nuclear - and therefore EDF's dominance - is reduced from 75% of national electricity generation to 50% by 2025. The 2025 target conveniently coincides with the likely closure of a number of nuclear plants reaching 40-50 years of operation. Around 4.5GW of EDF's nuclear plants were commissioned in the 1970s, and a further 24.5GW in the early 1980s.

But if regulated payments for EDF's nuclear power are reduced or abolished, and wholesale prices remain low, or if a nuclear incident shakes public faith in the sector, the company may regret not having moved faster with energy transition. Certainly, French nuclear electricity no longer looks cheap. The World Nuclear Association (WNA) said last November that the cost of French nuclear power generation "is indicated by the national energy regulator (CRE) setting the price at which EDF's electricity is sold to competing distributors".

Regulated nuclear tariff

In 2014, the price for this regulated access to nuclear power, known as Arenh price, was €42/MWh. CRE proposed an increase to €44 in 2015, €R46 in 2016 and €48 in 2017 "to allow EDF to recover costs of plant upgrades, which it puts at EUR55 billion to extend all 58 reactor lifetimes by ten years", said the WNA.

But the weighted base-load day-ahead auction price of power in France was below €42/MWh in all but two months in 2014 (October and December), according to energy analyst Spider-Energy, making the regulated access tariff look expensive even at its current rate.

As to the future, Czech group CEZ has predicted that its forward hedge prices for base load in the European market over the seven years to 2021 will only rise above €42/MWh once, in 2020, and do not rise above €39.5/MWh in the four years to 2018.

In this light, the French government's move in November to freeze the Arenh price at €42/MWh to mid-2015 looks unsurprising. Adding to the uncertainty, the draft decree for setting the new price on 1 July is currently under review by the European Commission.

The Arenh limit of 100TWh per year has not been reached since the system began in 2011, and in future retailers could shun it, preferring to buy cheaper power from the wholesale market. No longer able to rely on a fixed price for up to a quarter of its nuclear generation, EDF may find a substantial chunk of its nuclear generation is too expensive to find a market.

With potential nuclear closures on the cards earlier than expected for economic reasons, which, in turn could mean having to mobilise decommissioning provisions sooner than anticipated, EDF seems slow in building up a renewables portfolio.

Third way

One answer, avoiding a new burden on EDF's own balance sheet, was last October's creation of a joint venture with asset-management company Amundi. The joint venture will raise funds from institutional and retail investors and, on behalf of third parties, manage funds intended to finance projects relating to energy transition.

The fund-raising goal is €1.5 billion, divided between renewable energy, such as wind power, photovoltaic and small hydro, and energy-saving strategies in the business-to-business sector, including electro intensive industries.

Assuming half is allocated to renewables and the equity represents 30% of overall investment, the asset management venture could trigger a first wave of renewables investment totalling €2.5 billion. If all this went on onshore wind, being the cheapest form of renewables, it could result in around 2.5GW of new wind capacity in France, generating roughly 5.5TWh per year.

But this is equivalent to only around 5% of the up to 100TWh of historical nuclear electricity sales that will be lost to EDF if the regulated cost-covering price is higher than the market price. If for economic, safety, security or other reason, EDF must close nuclear reactors faster than planned, its renewables portfolio will be too small to allow the company to maintain anything close to its current market power.

Whether energy companies switch to renewables generation like E.on, or aim to rely completely on conventional fossil fuels in their home market, like CEZ, or place almost all their eggs in one energy basket as EDF is doing with its nuclear fleet may partly reflect ownership structure. State-owned CEZ and EDF apparently see less need to swiftly reposition themselves compared with investor-owned energy supplier E.on.

But if market forces are allowed to unfold over the coming years, including substantial closures of surplus capacity and stronger interconnection of national markets, changes of policy could have to be drawn up and implemented faster than some companies find comfortable.

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