Figure 1: EU27 energy generation by type (TWh)
Source:ENTSO-E, March 2024
Energy-intensive industries, namely cement, iron and steel, also showed a year-on-year drop of 7%. Conversely, the aviation industry showed a jump of 10% year-on-year as passenger numbers continue to rise after Covid-193. However, the overall contribution to emissions from aviation is low at just 4% for 2023, according to Bloomberg estimates (Figure 2).
Figure 2: EU emissions shrink as renewables ramp up
Source: European Union Transaction Log. BloombergNEF.
The EC states that ETS emissions are now 47% below 2005 levels and are on track to achieve a 2030 target of -62%.
Why does this mean for us as investors?
We have a preference for issuers in the Utilities sector that demonstrate stability in earnings – these are typically regulated transmission and distribution grid owners and operators. Across Europe these assets are reporting material increases in demands for connection to their networks from renewable generation plants. This requires a jump in costs and capex needs. Large, regulated electricity transmission owners such as Eurogrid, TenneT, Elia and Amprion, based in Germany, the Netherlands and Belgium, expect year-on-year annual capex spend increases for FY24 by approximately 80% for the German grids and in excess of 100% for the Belgian assets.
The capex increases and consequent debt-funding needs highlight the importance of defensive characteristics in regulated assets. The operating and financial profiles of regulated electricity and transmission players must demonstrate the following key mitigants to these increasing demands:
- Stability of earnings as regulatory mechanisms protect critical infrastructure from cyclical risks such as volume, commodity, cost inflation and the cost of funding
- Higher connection demand and consequent capex needs will earn an appropriate regulatory return to encourage investment
- Grids are critical infrastructure that increasingly see more regulatory and political support to meet green targets. Permitting timeframes of, historically, seven to eight years are being compressed as states increasingly intervene in local authority planning procedures.
- Capex needs will result in an increase in bond issuance making these players more prominent in bond indices
Do we rule out integrated issuers such as Iberdrola4?
Stability of earnings is a growing feature of the integrated issuers that are skewed towards renewables such as wind and solar. Among the integrated players within green generation, the quality of earnings derived from renewable generation is improving. This comes as wind and solar are increasingly underpinned by power purchase agreements or other forms of contracted earnings, with the demand side keen to secure supply at fixed prices. The mix of contracted and regulated earnings is growing, up to 70%-80% for our preferred issuers.
While hydro remains a mainly merchant activity, and therefore dependent on commodity trends, we consider factors such as state ownership and strategic support, such as the Norwegian state-owned generation player Statkraft.
Project risks related to renewables growth, however, remain a challenge – as demonstrated by Orsted earlier this year5. This proved to be a company-specific issue. We focus on issuers that demonstrate conservative risk strategies and are able to allocate risks to project suppliers, combined with a commitment to strong balance sheets.
