European Market Report
Liberalisation and personal opportunities
Following the successful conclusion to its purchase of Innogy, RWE becomes the second largest generator and electricity company in Europe with over 40MW of capacity, the third largest in terms of sales and number 4 in terms of customer numbers with about 20 million. Some indication of the importance of Innogy to RWE comes from the fact that of its 20m customers Innogy will have brought in 7 of the 20 million. What Innogy also provides for RWE - just as Powergen provides similar expertise to E.ON - is the experience of liberalisation, competition and more recently consolidation in the UK market. While German liberalisation has been on-going for some time now, the realistic introduction of competition has been stalled by various regulations and the lack of regulated Third Party Access (TPA) to networks, which have remained in the ownership of companies such as RWE and E.ON, which also have their own retail customers. What Innogy will provide to the RWE group is the necessary experience to make the changes such as supporting TPA which will require the various parts of RWE to make their own success without the support of the parent company. It will result in a set of stronger companies but the background to this will result in there being greater support for full liberalisation of the energy value chain in Germany - and along British lines.
In reporting its latest results RWE produced an improved performance with operating results up 21% on the back of its core businesses delivering improved performance. In electricity, the German market delivered improvements thanks to cost reductions and higher wholesale prices - German wholesale power prices had fallen sharply in recent years. In gas the key changes have been at a strategic level with the recent acquisitions of both the Czech gas industry and Highland Energy, which is active in the upstream sector. RWE also owns 75% of Thyssengas, which is one of Germany's largest long-distance gas companies but after Ruhrgas, which RWE's rival, E.ON, is trying to purchase. In water, Thames Water helped to deliver a 20% increase in RWE's profits and when the acquisition of American Water Works is completed RWE will become the third largest water company in the world. The main bulk of cost-reduction potential is seen to be in the electricity sector - estimated at 90% of the total by RWE. Again this is an area where there has been plenty of experience in the UK! It may be worth noting that RWE is an enormous company despite the downsizing and focussing that it has undertaken in recent years. In the last year it reduced its workforce by some 4% but it still had 156,000 employees. It has made what can only be described as an enlightening statement for a company operating in competitive markets. It states quite clearly that "as in prior years, the company trained far more people than necessary to satisfy its own needs". Presumably it is a training specialist - or there may need to be some further re-focussing of its activities!
For any company or individual aiming to prosper in the European energy utility market there are a small number of companies which are key to the outcome. With all that RWE has been doing it is easy to forget its major rival E.ON but at the same time it is clear that E.ON is not going to allow itself to miss out on opportunities. Its agreement to purchase from Fortum, the Finnish energy group's 27.6% stake in Espoon Sähkö Oyj, a Finnish power supplier, formerly controlled by the local municipality, will give E.ON control when added to its existing 34% stake. It had only purchased its 34% late last year from the city of Espoo. Finland is already a liberalised and competitive power market - and again the experiences will inform E.ON's decisions in other European markets as they liberalise. E.ON already has a significant interest in Scandinavia, where it owns a Swedish business in Sydkraft. The acquisition means that E.ON controls not only a supply business but also a power network, district heating production and distribution facilities. We remain convinced that these types of facilities will need to be fully separated out even within successful companies owning assets across the value chain. We will have to wait to see how these issues develop over coming years.
Norway may not be a member of the EU but its economic agreements with the EU mean that it is impacted by EU competition rules and requirements on State subsidies. Statoil had to extend deadlines for confirming the gas sales contracts from the planned Barents Sea Snoehvit development when it appeared that state subsidies for the $4.6b project could be in violation of Norway's European trade agreements. Preliminary agreements had been reached by several of the field partners to sell LNG to Iberdrola of Spain and EL Paso of the US from 2006. There would also an impact on LNG tankers to be constructed to move the gas to market if the tax regime and support are not resolved rapidly. These developments are all part of the on-going battle between the developers of gas fields across Europe and into Russia about the sort of regime that it is intended to have for gas trading in the liberalisation of Europe. All the big gas producers whether the Russians or Algerians or Shell, ExxonMobil or buyers such as Gaz de France want to see less intervention by the EU. None of these seems to like the idea that the liberalisation of Europe's gas markets will probably mean a major increase in short-term gas contracts and spot trading. In particular there is a marked criticism of the EU for not consulting with producers enough when they opened up the market with the Gas Directive.
There have been veiled threats that EU aversion to clauses in long-term contracts regarded by the EU as anti-competitive could impact the future of the industry negatively and eventually result in the appearance of an Opec-style cartel in gas. Certainly there are concerns that if the impact of the actions by the EU and its individual governments on non-EU gas producers results in too difficult a selling environment they could retaliate by reducing supplies to the EU or raising prices to Europe. Effectively everyone is worrying about long-term security of supply at a time when it is clear that increasing proportions of Europe's gas will need to be imported over coming decades. Some commentators believe that the decline in the EU's indigenous gas fields is likely to result in increasing debate about the likelihood of the development of an oligopoly of strong suppliers. Some of the gas-producing arms of the major oil companies continue to believe that the proportion of Europe's gas which is sold on long-term contracts - currently as high as 90% - is likely to remain at similar levels. What surprises us is that the oil markets are able to cope with short-term trading and their major projects are still developed. Gas is essentially no different except for the fact that it can be substituted in theory by other fuels; however, in practice its particular characteristics mean that it has a very secure market base. We remain very optimistic about the many opportunities there will be for us all with the full liberalisation across the value chain of Europe's gas and electricity markets.
Germany's government has further improved the support given to renewable energies by creating improved conditions to support the establishment of power plants for renewables with the expansion of renewables as a central part to their energy policy, according to Environment Minister Jurgen Trittin. The framework being established for further support for renewables assists the establishment of solar plants for warm water generation of heating, biomass heating as well as biomass combined heat and power plants. The funds are generated by Germany's eco tax. Biogas power plants are to receive grants for small - up to 70kW - plants whole the level of support provided for solar power plants has been increased. At another level the renewables industry has made a major impact in Germany by allowing the industry's ailing financial market in new listings to start to show some life. The slowdown in economic activity since the bursting of the technology boom has had a major impact on Germany's Neuer Markt where there had been no new company listing since the middle of last year. Now the first new company to be quoted will be Repower, a Germany wind power company. The demand for shares in this company were 5 times over-subscribed and indicate the extent to which the renewables sector has become a key part of the energy seen - and seen as a future growth star. The major attraction of companies such as Repower is the fact that they are seen by investors as having strong growth potential, good solid management and reasonably priced. Repower was formed from the merger of five green power companies in Germany and had doubled both revenues and profits in the last year. Government support such as that described above can only assist the growth and attractiveness of the renewables sector for employees, companies and investors.
Italy risks energy shortages in three years if it does not urgently move to strengthen its electricity and gas grids, according to Industry Minister Antonio Marzano. Marzano said there was a pressing need to encourage investment to build new electricity networks, regasification plants and pipelines to boost imports from abroad. As part of its actions to liberalise the energy market to competition and in response to the looming shortage crisis, the government has passed a decree to speed up the process for obtaining consents for new power stations. But this has raised fears that Italy could face power shortages as the role of ENEL is reduced and other companies take on a bigger role - without the experience of coping with the Italian bureaucracy. However with companies such as Endesa of Spain and Edison, along with Fiat and Electricite de France taking control of the first two large sales of power station assets sold by ENEL as the latter's share of power generation is reduced to 50%, there is plenty of experience of power production. With demand likely to continue to grow strongly and with a need to increase the role of gas in power production, the concerns of minister Marzano can be understood. It is another example of the changing scene which is producing huge opportunities for those willing to take rapid action - and in this case to bring additional gas imports into Italy.
The third force in the German market?
At a time when all eyes have been on the closing of the purchase by E.ON of Powergen and by RWE of Innogy, there has been relatively little note taken of the Germans' own home market. When Bewag, the utility serving Berlin and East Germany reported its latest results, it was a reminder that there is a major new force in the German market in the form of Vattenfall, the Swedish Government owned electricity company, which has taken control of Bewag - it now owns almost 90% of the shares - following an agreement to purchase the shares in Bewag previously owned by US energy company Mirant. Vattenfall sees Bewag being the third force in the German power market after E.ON and RWE. A major group covering the north and east of Germany is being put together by Vattenfall through its control of Bewag, Hamburg's electricity company , Hamburgishe Electricitaets Werke (HEW), the lignite producer, Lausitzer Braunkohle AG (LAUBAG) and VEAG (Vereinigte Energiewerke AG) which together produces an integrated coal production, electricity generation, electricity network and retail supply business. It will be known as Vattenfall Europe. Bewag is expected to make a major contribution to the integration process involving these companies and will effectively form the backbone of Vattenfall Europe. How this will exactly play out is difficult to foretell since Vattenfall will wish to control the strategic direction.
Bewag has taken control of one of the newly formed energy supply companies which have entered the German supply market. It purchased the 50% in Best Energy from telecoms company, MobilCom; Best Energy has some 100,000 residential and small commercial customers in the German market. Its route to market has been based on sales partnerships with major German companies. In a very difficult market for getting customers to switch supplier the outcome of its approach will have to await the easier regulated Third Party Access to see who the winners will be. The company has been increasing its electricity trading operations which have grown significantly over last year. This is another sign of growing maturity in Europe's energy markets. The precise impact on the German market of having a state-owned company backing an integrated electricity company is not clear. Ensuring that competition reigns will be the preserve of the Regulator when the German Government makes the appointment. Vattenfall is likely to be strong competitor in the supply market with its backing from the Swedish state. It is hardly a surprise, therefore, that RWE saw the need for ownership of K expertise in the competitive supply markets. However, unless Vattenfall is privatised, its ability to make the rapid decisions needed to perform satisfactorily in competitive markets could be a hindrance to it. As full liberalisation is introduced we can expect to see the need for much more restructuring and the clear separation of many of the companies now being pulled into Vattenfall Europe. There will be plenty of chances for many different skills as these changes take place. Let nobody forget that!
Iberdrola, the Spanish power company, is the winning bidder for the purchase of Enron Espana Generacion following approval from a US bankruptcy court. Iberdrola was in competition with several other bidders, including Belgium's Electrabel, which had the opportunity to improve on an earlier offer as a result of a legal protest. The 1200 MW CCGT power plant is unfinished and the price covers various aspects of Enron Espana Generacion's project, including a site at Arcos de la Frontera in Cadiz province, all authorizations, permits as well as generation equipment previously ordered by Enron. The demise of Enron has provided plenty of opportunities for companies across the world. Meanwhile Iberdrola has received in the last month the first cargo of natural gas from a 15-year contract with Italian major ENI. The gas was delivered to the LNG regasification plant near Barcelona as part of the 1.2 billion cubic metres to be delivered annually. The gas will not only feed the growing number of Iberdrola's combined cycle gas turbines but will also be marketed to end-users as the market for natural gas continues to grow strongly in Spain. This is further confirmed by the latest approval by Spain's ministry for the economy for plans by Entergy of the US to build an 800MW gas-fired combined-cycle power plant at Castelnou in Teruel province. This plant should come on stream in 2004 and together with yet another 1200MW proposed by Entergy near Madrid, should help to reduce the power shortages which have been experienced in Spain over the last year.
The Dutch competition authority, NMa, has been considering whether, in considering energy market competition issues such as energy sector mergers, these should be considered in the context of the Dutch electricity market alone or whether in a wider context such as the Benelux region (Belgium, Netherlands and Luxembourg) or even also including the German market. The NMa's conclusion is that for the moment at least the relevant geographic market for the Netherlands is the national market. The reasoning here is that the Dutch electricity market could not be considered part of a larger market because the degree of market opening across the EU varies. It cited a number of conditions which would have to be met including harmonized regulatory structures, harmonization of environmental requirements, subsidies and taxes and a coherent system of tariffs and capacity allocation in cross border trade. This is an interesting pointer for the development of the European market. The smaller countries will inevitably have to be considered in the wider context and it is good that this is now being thought about with a view to action. The outcome of these considerations will have a bearing on future developments in the Dutch market. There is plenty of rumour that a merger between the distributors, Essent and Nuon, is likely. The introduction of full competition in the Dutch market in the next two years will clearly increase pressures on companies and it is almost inevitable that we shall see plenty of merger activity - just as we have seen in Britain. The rules which will need to be applied will affect the supply market - a very competitive market - differently to the network market with its natural monopoly. The Nma will also need to consider the impact of mergers on the gas and electricity markets with these converging as in other countries. Certainly there is to be a growing need for detailed understanding and analysis across both gas and electricity and increasingly across borders.
The final demise of the Dutch gas major, Gasunie, has now been announced casing the CEO, George Verberg, to comment on the "very painful decision". The company was 50% owned by the Dutch government and 25% each by Royal Dutch/Shell and Exxon Mobil. The Dutch Ministry of Economic Affairs has now confirmed plans to aid liberalisation of the gas sector by splitting Gasunie, which was the Dutch equivalent of British Gas in the UK into three units. Since January last year, Gasunie had been split into two divisions: Gastransport Services and Gasunie Trade & Supply. Shell and Exxon would each be given separate gas supply companies under the plans with the Dutch state assuming full control of the gas transmission network to ensure that all new-entrants to the sector gained equal access. This is a different resolution to the British one where regulation ensures equal access to Transco's system for all gas transporters. However, it was also stated that the Dutch economy minister, Annemarie Jorritsma, does not see state ownership of the transmission network as "absolutely necessary for eternity, leaving open a UK private ownership of the gas network. This agreement with Shell and Exxonis expected to be finalised this year and will include a decision on the ownership of the Groningen gas field, one of Europe's largest fields. As a result of existing competition for large customers, Gasunie has lost 35% of its market share - and full competition down to residential customers is expected by January, 2004.
