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European renewables sector faces rising merchant risk, consolidation in 2019

Q2: U.S. Solar and Wind Power by the Numbers

Essential Energy Insights - September 17, 2020

Essential Energy Insights September 2020

Rate case activity slips, COVID-19 proceedings remain at the forefront in August


European renewables sector faces rising merchant risk, consolidation in 2019

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Ørsted's 659-MW Walney Extension wind farm in the U.K., the largest operating offshore wind park in the world.
Source: MHI Vestas Offshore Wind

The biggest European utilities will continue to pour billions into their renewable businesses in the year ahead to gain an edge in a maturing sector, as large asset swaps and acquisitions are set to reshuffle the landscape at the top of the industry.

Analysts say the renewables industry will become more competitive as costs are driven down by auctions in many countries, ramping up the pressure by removing quasi-regulated revenues and replacing them with merchant risk.

"We expect Western Europe to be the region with the highest share of renewable energy, forecast at 27% of the total primary energy mix in 2026, and to report solid growth in this 10-year period, driven by political support and decreasing costs," Fitch Ratings said in a recent report. "Utilities will need to diversify development plans, sources of funding and continue to improve their knowledge and expertise in order to adapt."

Companies have been gearing up for the future by concentrating on core business areas. Recent years have seen Denmark's Ørsted A/S reinvent itself by focusing almost exclusively on offshore wind, making the company a pioneer with one of the cleanest generation portfolios in the world.

After separating their conventional and renewable generation, German utilities E.ON SE and RWE AG expect to complete an asset swap this year that will leave one company with a network and supply business and the other with one of the largest generation fleets in Europe.

And other companies across the sector also continue to budget a large share of their expenditures for renewable energy.

Renewables investment

With the importance of sustainability rising among customers, that drive toward more renewables increasingly comes from outside the boardroom, according to some executives.

Italy's Enel SpA plans to spend over 40% of its €27.5 billion planned gross capital expenditures for 2019-2021 on renewables, CEO Francesco Starace told investors in November.

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A solar farm on the Isle of Wight in the U.K.
Source: Lightsource BP

Renewables already made up 45% of Enel's power portfolio at the end of 2018; the company wants to be carbon neutral by 2050.

"In markets where we have an integrated presence, namely Italy, Spain, Chile and Brazil, decarbonizing our generation fleet is not only a support for our [own] CO2 reduction targets, but it's just a good business idea," Starace said. "We see an increasing demand from our commercial and industrial customer base for renewable energy being supplied to them."

The European Union agreed last year to raise its binding target for renewable energy from 27% to 32% of final energy consumption by 2030. To meet this, member countries will have to propose their own national objectives and detail how to get there, which will help give companies a clear perspective for investments.

The U.K. has already said it plans to add up to 2 GW a year of offshore wind capacity through the 2020s; Germany and the Netherlands also have ambitious targets. Although the environment for land-based renewables is more challenging in some countries, many are also investing in onshore wind and solar.

In the first nine months of 2018, Iberdrola SA spent 34% of its net investments on renewables, surpassed only by its networks business. Between this year and 2022, the company will use over €10 billion to grow its renewables segment, mostly by investing in onshore and offshore wind, but also solar and hydro projects, according to its investment plan.

The company's U.K. subsidiary, Scottish Power, also inked a £702 million deal to sell gas and hydro assets to British generator Drax Group PLC this year. This will make it the first vertically integrated energy major in the U.K. to shed all of its fossil generation assets. "We are leaving carbon generation behind for a renewable future powered by cheaper green energy," said the company's CEO, Keith Anderson.

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Marching to the merchant drum

The renewables sector is maturing in Europe, with subsidies expiring and many countries switching to centralized tenders to drive down prices. This naturally reduces returns for utilities and other investors, Fitch notes. "Competition in the industry is rising, due to more companies vying for business, falling component costs, and less generous incentives," the report said.

As a result of their increasing exposure to merchant prices because of this transition, power generators have stepped up their activity in signing long-term power purchase agreements in order to lock in revenue, in addition to the legacy support schemes still available.

"We continue to focus ... on the execution of our organic growth, securing long-term contracts," Antonio Mexia, CEO of EDP - Energias de Portugal SA, said during a 2018 third-quarter earnings presentation. "EDP Renewables have currently secured 3.4 [GW] of PPAs and feed-in tariffs for new wind and solar capacity to be commissioned over the next years," he said. EDP has signed such contracts in the U.S., Europe, Canada and Brazil.

In addition to solar and onshore wind, which have seen the use of corporate PPAs increase in several countries amid dramatic cost reductions, merchant offshore wind projects are also expected to become more common in several jurisdictions.

Ørsted, one of the biggest players in that segment, only recently raised its target for offshore wind farm installations to 15 GW by 2025 and said it plans to invest approximately $30 billion in renewables by then. A significant share of that growth, however, will likely be outside of Europe.

Along with Ørsted, the newly consolidated RWE will have the most exposure to renewables among European utilities overall, according to Fitch. That business segment will represent approximately 90% and 50% of the companies' consolidated EBITDA, respectively, the firm projects.

Scaling up quickly will remain essential for all of the largest utilities if they want to compete successfully in the renewables business, Fitch said. "All these companies have ambitious, clearly defined organic growth targets," the analysts said. "And even though non-organic growth and consolidation is not explicit in their public plans, we view this as likely."

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Takeover season

Regulators will likely judge not just the one but two blockbuster acquisitions in 2019, involving two of the largest renewable portfolios in the sector.

E.ON and RWE expect to get the sign-off from the European Commission for their split-up of RWE subsidiary Innogy SE in the summer, RWE CFO Markus Krebber told journalists in November 2018. Under the €40 billion deal, RWE will receive the renewables assets of both E.ON and Innogy while E.ON will absorb the rest of Innogy and become focused on regulated energy networks and retail customers.

The new RWE should have an installed capacity of 8.6 GW, including approximately 6 GW of onshore and 2 GW of offshore wind, according to Fitch, and become the third-largest renewable operator in Europe behind Iberdrola and Enel. It plans to invest approximately €1.5 billion annually in the renewables segment following the deal.

Another potential acquisition could also see parts of EDP Renováveis, the Madrid-headquartered onshore wind powerhouse, put on the block. In June, Chinese state-owned China Three Gorges Corp. made a €9 billion takeover offer for EDPR parent company EDP, of which it is already the largest shareholder.

To pre-empt concerns from regulators, CTG has been sounding out European utilities' interest in buying EDP's and EDPR's renewables business in the U.S., according to sources cited by Reuters.

EDP's board rejected the initial share offer as too low, and CTG is seeking regulatory approval from competition authorities in Europe as well, where it could run into hurdles because of other Chinese state investments in Portugal, including in power grid operator REN - Redes Energéticas Nacionais SGPS S.A.

"There are clear signals that CTG is doing the work in the context of the offer," Mexia told investors in November 2018, adding that he expected to be able to update the market on the bid's progress in the first quarter of 2019. The Brazilian competition watchdog had already given its approval and EU regulators had been prenotified, he said.