- Some European households pay up to three times more than their U.S. counterparts for electricity relative to their disposable income and we therefore believe customer affordability is more at risk for European utilities compared to their U.S. peers.
- Europe's environmental policies aim at reconciling ambitious energy transition and containing the cost of energy. Yet maintaining a balance between higher transition costs and power price affordability is challenging and especially because we expect European power bills will even further increase over the next three years.
- Political intervention could take the form of fiscal reforms that would alleviate pressure on the consumer or through the recouping of utility profits that would adversely affect a utility's credit measures.
- As a result, we view the European electric utilities as having relatively higher exposure to social and political risks than the U.S. utilities, which we believe are better positioned to absorb rising costs associated with the energy transformation and decarbonization.
- Our report focuses on the electricity bill burden for consumers and not the entire energy mix that would also include a customer's natural gas bill, the split of which can vary highly between European countries. While we recognize that this research may not tell the entire energy story and is not meant to draw conclusions between individual European countries, we believe that our underlying conclusions of higher affordability risks for European households on average compared to the U.S. remain valid.
How The Two Regions Differ
Higher power prices in Europe imply increased social and political risk
The recent increase in commodity prices that brought higher electricity bills for European utility customers has accelerated the affordability debate. European wholesale prices have risen on average by more than 100% in Europe over the last 12 months and S&P Global Ratings believes power prices will continue to increase in 2022-2023 as supply tightens. Furthermore, we expect that supply will constrict further as Europe's more ambitious environmental targets accelerate the closure of thermal and nuclear baseload generation, which renewables cannot fully replace over the coming three years, leading to greater weather-related price volatility in the interim (The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update, Sept. 17, 2021).
In the face of higher customer electric utility bills, European governments have implemented various policies to address affordability. While some of these initiatives may help over the near term, given the rising cost of energy transition, which will be a key pillar of European climate policies applied at national level, we expect social risks will remain an elevated and a longer-term risk for European utilities relative to U.S. utilities.
While U.S. utility credit quality has been pressured because of environmental and governance credit risks (Industry Top Trends Update: Regulated Utilities North America, July 15, 2021), bill affordability or social risks have not yet meaningfully affected credit quality. We believe the primary reasons are that the U.S. electric customer bill represents a significantly lower percentage of household disposable income compared to Europe and U.S. commodity prices have been considerably less volatile than seen in Europe.
The Electric Bill In Europe Weighs More On Households Than It Does In The U.S.
While U.S. and European electricity utility bills are about the same, with the typical European electricity bill costing about 2% less than the average U.S. electricity bill (chart 1), relative to affordability, the European electricity bill is about twice as expensive compared to the U.S., because it represents a significantly higher portion of disposable income. Please note that this report focuses on the electricity bill burden for consumers and not the entire energy mix that would also include a customer's natural gas bill, the split of which can vary highly between European countries. While we recognize that this research may not tell the entire energy story and is not meant to draw conclusions between individual European countries, we believe that our underlying conclusions of higher affordability risks for European households on average compared to the U.S. remain valid.
As such, we believe, the European electric utility bill exerts a relatively higher social pressure on European households compared to U.S. households. On average, we estimate that U.S. households spend about 2.4% of their median net disposable income on their electricity bills. This is about a third of what Spanish consumers spend on their electricity bill (8.4%) and roughly half of the average of our selected Western European countries (5.7%) (chart 2). In our view, U.S. utilities are in a better position than their European counterparts to manage potential social risks that may occur as the industry continues to navigate through the energy transformation of reducing their carbon footprint.
The cost per kWh in Europe is considerably higher than in the U.S.
The cost of electricity for the seven Western European countries we selected for this report on € per kWh is about €0.32 or nearly 3x that of the U.S. (€0.11) (chart 3).
While this difference is striking, we believe that most of the variance is primarily due to European taxes that can account for as much of 60% the utility electric bill (chart 8).
Higher consumption in the U.S. offsets its lower cost per kWh than in Europe
Electricity consumption is much higher in the U.S. While Europe's cost per kWh is about 3x as high as in the U.S., the customer bill is ultimately about the same because U.S. electricity consumption is about 2.5x higher than our selected Western European countries (chart 4). Overall, we view Europe's higher cost per kWh as offset by the higher electricity consumption in the U.S. and we believe the primary reason that the U.S. customer bill is relatively more affordable is because of the higher disposable income in the U.S.
U.S. household income is the key reason for affordability. The U.S. after-tax disposable household income is about 2x higher than our selected Western European countries (chart 6). We believe that these underlying economic differences between Europe and the U.S. increase the social risks on the European utilities relative to the U.S. utilities. However, we recognize some limitations to the after-tax disposable income comparisons. Much of the difference in the after-tax disposable household income between Europe and the U.S. reflects the considerable higher taxes paid by Europeans. As a result, Europeans typically enjoy higher social benefits that could include health care and schooling.
Europe is not homogeneous and electricity bills weigh most on Spanish households
In Europe, the electricity bill burden for households is uneven from country to country. The fluctuating rates between the countries reflect differences in the use of natural gas as a percentage of the total energy mix, the level of renewable penetration, and the difference in the gross domestic product (GDP) per household.
From the countries we've selected for this review, Spanish households are the most vulnerable to increasing pressure on their electricity bills, followed by France and then Sweden. The elevated electricity bills in France correlate to greater consumption related to heating given the higher penetration of electric heating in France than for European peers. According to France's Environment & Energy Management Agency, 34% of residential and collective housing were electrically heated as of 2018. In Sweden, the high electricity bill in absolute terms is correlated with higher weather-driven consumption.
While we recognize that just analyzing the electric utility bill does not tell the entire energy story, we believe that the relative ranking of electricity bill burden provides a valuable estimate of countries with the highest social awareness on affordability especially considering the growing drive to reach net zero by 2050. In Italy, the Netherlands, and the U.K., the use of natural gas as a percentage of the total energy mix is high. Based on the International Energy Agency's 2019 data, natural gas use in these countries represents 36%-40% of the total energy mix. As such, natural gas customer bills in these countries represent a sizable share of their annual energy bill and we estimate the heavy utilization of natural gas for heating in these countries contributes to gas bills that are higher than electricity bills. Therefore, although electricity bills for customers in the Netherlands, Italy, and the U.K. account for the lowest percentage of disposable income from our selected Western European countries, we believe utilities in these countries could also face social risks when incorporating the full energy bill of both electric and natural gas.
In the U.S., with regard to the affordability of the electric bill (chart 2), significant variances between the 10 states we've selected for this report exist, but the differences are not nearly as drastic as seen in Europe. For our selected U.S. states, California's electric bill is most affordable, accounting for just 2% of disposable household income. Conversely, West Virginia's electric bill was least affordable, accounting for 3.7% of disposable household income. While West Virginia's electric bill accounted for about 40% more of disposable income compared to California, West Virginia's electric bill was still relatively more affordable than six of the seven selected Western European countries analyzed.
The spotlight on affordability could translate into adverse regulatory measures for utilities
We believe that European utilities are confronted with a higher risk of political intervention, in the context of the current commodity spike and potentially higher electricity prices that could last for the longer term. Political intervention could be in the form of fiscal reforms that are neutral to utilities' credit quality or could result in clawback measures that could be more detrimental to a utility's credit quality. Because taxes represent up to 60% of the European electric bill (chart 8), fiscal reforms would be a conceivable means to reduce the burden on the customer bill. However, the degree of political intervention is uncertain and even more uncertainty exists for countries such as France that are facing near-term presidential elections in 2022.
Spain is the most emblematic case with strong political response to rising power prices and the adoption of adverse regulatory measures for utilities. The Spanish government aims at clawing back from Spanish power producers an estimated €3.2 billion over 2021-2022 (Spain's Plan To Claw Back Billions From Utilities Could Stunt Renewables Growth, Sept. 29, 2021). Specifically, the clawback mechanism on gas prices, implemented in a Royal Decree Law and thus already into force, will constitute pure loss on earnings for all Spanish power producers since they have already hedged 100% of their production for 2021 and 2022 at materially lower prices than those on the post markets. The financial impact of these clawback measures, although material, did not negatively affect the credit quality of these utilities because the measures remain only temporary, lasting through March 31, 2022.
Conversely, governments in Europe have chosen fiscal reforms, instead of recouping utility profits as done in Spain, to contain the increase in the energy bill.
- France introduced a "price shield" for both natural gas and electricity, meaning that any tariff increase will be limited to 12% and 4%, respectively, over the next 12 months. For electric bills, the tax rebate will offset the higher costs, temporarily reducing potential social risks. France has also granted to about 5.8 million eligible households an extraordinary €100 top-up in Cheque Energie to be paid in December 2021 (plus €150 on average) effectively reducing the tax burden for lower income households and lowered the VAT to 5% from 20%.
- Italy's government has allocated €3 billion to cut households' energy bills by about 30%. It will also inject €700 million from the sale of CO2 allowances, transfer into the state budget the proceeds of tax on renewables of about €1.8 billion, reduce VAT (totaling about €500 million), and extend social tariffs by about €450 million to be split between electricity and natural gas bills.
- In the U.K., the steep rise in energy costs will most likely be passed on to customers through the standard variable tariffs, i.e., the default energy tariffs, despite the energy price cap mechanism on retail suppliers, which sets a limit on the amount that suppliers can charge more vulnerable customers. We believe that the October price cap reset and the imposition of an industry levy to absorb the burden of failed suppliers will challenge household energy affordability, particularly as supportive government measures, such as furlough, end. (The Energy Price Crisis: Examining The Impact On U.K.Suppliers, Sept. 30, 2021).
Energy transition translates to higher bills in both Europe and the U.S.
Most European governments are committed to transitioning to a net zero economy. We expect that to complete this transformation the industry will still require billions of Euros of incremental private and public investments, part of which will be passed through to the final consumers. That in turn, also raises affordability concerns on households. For the integrated utilities we rate, we expect aggregate annual investments to gradually increase to about €130 billion by 2023, from about €100 billion in 2020 (chart 9). We anticipate utilities will pass some of these rising expenditures to electricity consumers in the form of increased network costs and sustained power prices by significant growth in demand. While we recognize that higher carbon revenues received by the countries will finance part of these investments, we expect that these investments will lead to a higher electric customer bill. To address potentially elevated social risks, governments will have to determine the appropriate cost sharing between consumers, taxpayers, and state budgets. In our view, alleviating taxes from the energy bill by passing it to a general tax may be a difficult political decision at a time when governments still aim to boost economic recovery post-pandemic.
The recent creation of a social fund envisaged at the European level by the Fit for 55 package could alleviate pressure on more vulnerable households by redistributing energy efficiency savings on the path to net zero (Fit for 55: The Gains (And Pains) For European Utilities, Sept. 29, 2021). However, this remains a proposal and details are missing, including the magnitude of the plan and whether the effectiveness of such a social fund would mitigate the impact on countries with the highest social risks.
Across the U.S., we expect annual capital spending for regulated electric and natural gas utilities to grow by about 4% over the 2020-2024 period which is somewhat lower than the 7% annual growth rate over the prior decade (chart 10). Overall, we expect that over the next three years, the industry's capital spending will increase to more than $160 billion from its current $147 billion.
As explained above, we believe U.S. utilities are in a better position to handle social risks compared to European utilities because electricity bills in the U.S. represent a a much smaller percentage of disposable income. However, even U.S. utilities will need to take steps to reduce a possible sudden increase to the customer bill partially related to the high capital cost of energy transformation. This will include reducing other costs to the customer bill, including operation and maintenance costs or fuel-related costs. If U.S. utilities continue to use technologies and renewable energy to reduce the overall impact to the customer bill and maintain customer bill growth at a level consistently below inflation, they should be in a better position to handle the costs of potential social risks.
- The Energy Price Crisis: Examining The Impact On U.K. Suppliers, Sept. 30, 2021
- Fit for 55: The Gains (And Pains) For European Utilities, Sept. 29, 2021
- Spain's Plan To Claw Back Billions From Utilities Could Stunt Renewables Growth, Sept 29, 2021
- The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update, Sept.17, 2021
- Industry Top Trends Update: Regulated Utilities North America, July 15, 2021
This report does not constitute a rating action.
|Primary Credit Analysts:||Gabe Grosberg, New York + 1 (212) 438 6043;|
|Claire Mauduit-Le Clercq, Paris + 33 14 420 7201;|
|Research Contributors:||Federico Loreti, Paris + 33140752509;|
|Minni Zhang, New York;|
|Research Assistant:||Jesal K Gandhi, Mumbai|
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