- Major support policies for rapid decarbonization--such as "Fit For 55" in Europe and a potential $3.5 trillion U.S. clean energy framework proposed by President Biden--represent a significant investment opportunity for electric utilities.
- However, recent inflation in the cost of renewables production could stall growth if it endures and challenges the 40% cost decline anticipated over the next decade. For 2021, S&P Global Platts Analytics forecasts a rise in costs of 10% for solar photovoltaic plants, 8% for onshore wind projects, and 4% for offshore wind projects.
- We also see rising policy risk for power producers, given that energy affordability issues or blackout risks could materialize if the rollout of new renewables and power storage capacity isn't aligned with the decommissioning of coal and nuclear plants.
- Oil and gas players will also contend with accelerating the transformation of their portfolio toward lower-carbon power sources.
To reach carbon neutrality by 2050, the EU and U.S. target significant decarbonization of their energy sectors by 2030 and 2035, respectively. This will require massive step-ups in investment and annual renewable capacity. In the EU, for instance, annual renewable production additions would need to roughly double this decade, according to the European Commission's modelling work. To help their economies manage this shift, governments are introducing major support policies--such as the European Commission's "Fit For 55" package in Europe and the Biden Administration's potential $3.5 trillion clean energy framework in the U.S.
These conditions present utilities with significant opportunities to scale up their renewable capacity, but S&P Global Ratings also notes a number of risks on the horizon for power producers. Meanwhile, we expect oil and gas producers will face headwinds as they expedite the transformation of their generation portfolios toward less-carbon-intensive power sources amid mounting environmental, social, and governance concerns.
Renewables Require A Huge Ramp-Up While Facing New Hurdles
S&P Global Ratings Analysts: Pierre Georges, Sector Lead, EMEA Utilities, and Aneesh Prabhu, Sector Lead, North America Unregulated Power
S&P Global Platts Analytics Analyst: Bruno Brunetti, Head of Low Carbon Electricity
The European Commission's "Fit for 55" package targets accelerating decarbonization in the EU by 2030 while creating 10 million tons per year of green hydrogen supplies. To achieve this, Europe will need to add between 45 gigawatts (GW) to 55GW of renewable capacity per year this decade (20GW-30GW per year for solar and 25GW for wind) up from 30GW added in 2020 (20GW of solar and 10GW of wind). Similarly, President Biden's U.S. clean energy framework, which targets fully decarbonizing the national power market by 2035, would require annual renewable capacities doubling to 30GW per year over 2021-2025 (from 15GW in 2020) and doubling again to 60GW over 2026-2030. While government support packages will facilitate this major shift, we see a number of challenges ahead for renewables.
Cost inflation could threaten the pace of renewables growth
Renewable energy production costs are showing their first deviation from the expected long-term decline of about 40% on average by 2030. S&P Global Platts Analytics estimates that commissioning costs for solar photovoltaic plants will increase up to 10% this year, and that the cost of offshore and onshore wind projects will rise 4% and 8%, respectively, by the end of 2021. The increases stem from higher prices of raw materials--such as copper, aluminium, and steel--that are used for solar and wind plants, and are causing setbacks to both manufacturing and new-build activity. Additionally, bottlenecks in shipping are contributing to the high-cost environment by making it more difficult to procure materials. If the surge endures, it could throw into question the anticipated gradual decline in production costs and slow the pace of growth.
Record high energy prices may weaken policy support
Furthermore, spiking gas, carbon, and power prices, particularly in Europe, are putting social challenges, such as energy affordability, in the spotlight (see "The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update," published Sept. 17, 2021, on RatingsDirect). Although coal is increasingly being retired as part of the energy mix in Europe and the U.S., utilization of the residual operational coal capacity is increasing at a time when decarbonization efforts are stepping up. While initiatives such as "Fit for 55" in Europe and the Biden's clean-energy plan in the U.S. support decarbonization, the social implications of rising power prices could result in waning political support and give way to political and social backlash. As such, we see policy risks as on the rise for power producers.
Supply chain reliability and revenue prospects add uncertainty
Meanwhile, renewables supply chains are already struggling to keep up with the required pace of development. Also revenue cannibalization risks, that is the exposure to power prices in the absence of regulatory floor prices or long-term power purchase agreements, remain a concern for renewable power plants in the longer term. This is because power market fundamentals will alter substantially if and when zero-marginal-cost renewables become the dominant price setters, even if current short-term power prices clearly provide a great incentive to build plants.
Risk of intermittent supply will need to be addressed
Renewables like wind and solar cannot produce energy around the clock, and given thinning spare capacity margins and extreme weather events, we see an increasing risk of blackouts and need for dispatchable power--that is power sources that can be turned on and off on demand. As such, intermittency risk will become another key factor to look at when it comes to the renewable energy market's growth prospects. To mitigate this risk and meet net-zero ambitions, renewables growth will need to be accompanied by solutions that boost system reliability (batteries/power storage, transmission upgrades, demand-side response, carbon capture, utilization and storage, as well as hydrogen in the very long term). As the share of intermittent generation increases, carbon-free dispatchable power will become even more relevant, including nuclear
'Fit For 55' Supports European Utilities' Energy Transformation
Analyst: Pierre Georges, Sector Lead, EMEA Utilities
A Closer Look At 'Fit For 55'
The European Commission's "Fit For 55" package aims to bring the EU's climate, energy, transport and taxation policies in line with its goal of cutting greenhouse gas emissions by at least 55% by 2030 (compared with 1990). The plan includes a range of regulatory and sectoral targets, incentives for creating technological disruption, and other policy instruments to decarbonize the economy and enable change at the consumer level.
To achieve this, the package relies on four distinct pillars:
- Higher carbon pricing in the EU through the extension of the existing Emissions Trading System market to include the shipping sector;
- Wider sectoral decarbonization targets;
- An increase in the production and use of low-carbon fuels in the building and mobility sectors; and
- A focus on the mobilization of funds to stimulate innovation and mitigate social impact.
The "Fit For 55" package demonstrates that the EU has chosen to pursue decarbonization by dramatically shifting its energy mix (see chart 1). Under the plan, electrification would increase to 30% of the final energy demand by 2030 and 57% by 2050, from just 25% today. As such, we expect significant growth in demand for electricity, primarily from 2030, which will likely support high power prices in the long run. That said, forecasting power prices remains extremely tricky, given that by 2030 two-thirds of generation may come from zero- or low-marginal-cost renewables, which could actually depress the average power price.
To support this growth, investments will need to significantly pick up--both in terms of producing renewables and on the network side to connect and distribute this new capacity. In addition, investment in the infrastructure that will accompany low-carbon mobility--such as charging stations and network abilities--will need to see a considerable boost to support these developments.
We see the European utilities sector as already in a phase of high innovation, and expect this will intensify as the world looks for new ways to transform and lower the costs of the energy transition. We anticipate the "Fit for 55" package will support utilities by providing clearer policies on how and where to invest in the energy transition. Additionally, we expect to see an increase in equity raising and hybrid capital to support investments. As such, while we expect to see a significant mobilization of capital, we currently do not anticipate credit quality deteriorating for this sector.
U.S. Regulated Utilities Grapple With Weak Financials And High Spending Needs
Analysts: Gabe Grosberg, Sector Lead, North America Regulated Power; David Bodek, Sector Lead, U.S. Public Power; and Michael Ferguson, Analytical Manager Sustainable Finance Americas
The State Of U.S. Energy Policy
The Biden Administration has made its intention to promote the energy transition clear, declaring commitment to a series of ambitious targets, including carbon neutrality for the electricity sector by 2035 and for the entire country by 2050. President Biden's $3.5 trillion plan, which will be put to vote soon in the Senate, and should boost investments in power grids further.
This spending bill is in addition to the recently announced $1.0 trillion Bipartisan Infrastructure Framework that focuses on rebuilding roads, bridges, outdated water infrastructure and public transport, and broadband access to address social inequalities. The infrastructure plan also seeks to increase the resilience of transmission infrastructure in the wake of February's Hurricane Uri and other extreme weather events, which are becoming more frequent and severe due to climate change. Additionally, given the Biden Administration's targets for electric vehicle (EV) development-–which would see EV's make up 50% of all new cars sold in the U.S. by 2030-–we expect the infrastructure framework will focus, at least in part, on investment in EV charging infrastructure (3%).
These policy initiatives occur at a time when U.S. investor-owned utilities have already stepped up capital expenditure pertaining to the energy transition. Spending for regulated electric, gas, and water utilities stood at an all-time high of more than $160 billion in 2020 (see chart 2). This continues to shrink entities' financial cushions, which already were low and partly explain why about 30% of our ratings on U.S. regulated utilities carry a negative outlook. To offset some of these rising credit risks, utilities have issued common equity, hybrid instruments, sold minority interests in in their subsidiaries, and sold noncore assets, including the recent sale of many higher-risk midstream assets.
Meanwhile, S&P Global Ratings' outlook on not-for-profit public power and electric cooperative utilities remains stable overall, bearing in mind their ownership and ability to pass through costs. Costs have so far been manageable as coal retirements pave the way for a move to gas, and purchase power agreements with wind and solar offtakers are taking place at a measured pace.
Over the next decade, we expect the pace of coal retirements will accelerate in the U.S. In the past decade, the power industry was able to reduce its carbon emissions by about 25% because coal closures were primarily replaced by natural gas-fired generation, which emits about half the carbon of coal. Over the next decade, we expect that power industry's carbon emissions will reduce by about 40% as coal plants will be mostly replaced with renewables and batteries. While we expect some increase in natural gas-fired generation, this increase will be modest, in our view, and used primarily to bridge any fuel gaps.
The Oil And Gas Sectors Reckon With Net-Zero Prospects
Analysts: Thomas Watters, Sector Lead, US Oil & Gas, Elena Anankina, Lead Analyst, EMEA Utilities, and Simon Redmond, Sector Lead, EMEA Oil & Gas
Europe is leading the charge in transforming ambitious net-zero goals into specific plans with measurable implications. As part of the "Fit for 55" package, which outlines the EU's future energy policy, the European Commission published its plans for a carbon border adjustment mechanism in July 2021. Some oil and gas majors, including BP and Eni, have taken note and declared their intention to become energy companies rather than just oil and gas companies, by moving to broader strategies and setting targets to increase the share of renewables in their portfolio.
In the U.S., oil and gas majors are now making similar commitments to reduce greenhouse gases. Companies such as Chevron and Exxon Mobil, for instance, are focusing on carbon sequestration to reduce their carbon footprint. Even small, independent producers have begun including dedicated carbon emission sections in their investor presentations, outlining the actions they are taking to reduce their carbon footprints.
The transition is gathering pace, but brings headwinds for oil and gas producers. In many cases, this has prompted increased consolidation, with merger and acquisition activity ramping up across the sector, especially for independent U.S. producers. Relentless investor demands to reduce debt, generate free cash flow, and return profits in the form of dividends or share purchases are also contributing to consolidation pressure.
And while developed markets put their decarbonization strategies into action, many emerging markets will continue to rely on hydrocarbons to sustain economic growth. Globally, roughly 800 million people do not yet have access to electricity. The energy transition also needs to take their demands for affordable power into account.
- Airports Face A Long Delay To Global Air Traffic Recovery, Sept. 24, 2021
- The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update, Sept. 17, 2021
- Keeping The Lights On: U.S. Utilities’ Exposure To Physical Climate Risks, Sept. 16, 2021
- A Bipartisan Infrastructure Framework Emerges To Address Social Disparities, Aug. 3, 2021
- Updated Activity Estimates For U.S. Transportation Infrastructure Show Recovery For Air Travel Demand Accelerating And Public Transit Lagging, July 29, 2021
- The Energy Transition: ESG Concerns Are Starting To Present Capital Market Challenges To North American Energy Companies, June 14, 2021
- The ESG Winds Of Change Could Become A Tempest For Global Oil And Gas Producers, June 2, 2021
- Europe's 2021 Air Passenger Traffic Likely To Stall At 30%-50% Of 2019 Level, Feb. 18, 2021
This report does not constitute a rating action.
|S&P Global Ratings:||Pierre Georges, Paris + 33 14 420 6735;|
|Aneesh Prabhu, CFA, FRM, New York + 1 (212) 438 1285;|
|Gabe Grosberg, New York + 1 (212) 438 6043;|
|David N Bodek, New York + 1 (212) 438 7969;|
|Michael T Ferguson, CFA, CPA, New York + 1 (212) 438 7670;|
|Simon Redmond, London + 44 20 7176 3683;|
|Thomas A Watters, New York + 1 (212) 438 7818;|
|Elena Anankina, CFA, Moscow + 7 49 5783 4130;|
|Massimo Schiavo, Paris + 33 14 420 6718;|
|Karl Nietvelt, Paris + 33 14 420 6751;|
|Contributor:||Bruno Brunetti, S&P Global Platts Analytics, New York +1 (212) 438 9112;|
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