Companies in the energy sector are surprisingly resilient in the face of a broad range of challenges. For evidence, you need look no further than the IR Magazine Continental Europe Investor Perception Study 2006/2007, which canvassed the opinions of buy-side and sell-side analysts and portfolio managers. Respondents were asked to rate which sectors they were most optimistic about in terms of stock market performance over the next twelve to 18 months – and the energy sector came second only to the financial sector.
Some attribute the solid growth predictions to anticipated demand from emerging industrial economies. But the business of energy generation is not immune to risk and not all analysts expect this growth to go on indefinitely. One buy-side analyst based in the Netherlands was not inclined to comment far into the future, predicting only that ‘industrial energy will do well in the short term, particularly because of production for China and India.’
The past few years have brought a significant period of evolution across the global energy industry. The liberalization of markets and the increased internationalization of utilities firms furthered cross-border mergers and acquisitions. And M&A activity across global gas, electricity and water companies in terms of value rose to an all-time high of almost $300 bn in 2006, according to data from Thomson Financial.
Political fallout
‘The growing influence of national oil companies and their internationalization is bringing politics into play much more,’ observes Will Rowley, director of analytical services at London and Houston, Texas-based energy data company Infield Systems. He thinks the new-look energy landscape makes relationships between national governments even more salient. Recent events in Venezuela and Bolivia back up Rowley’s position. In May 2006 Bolivia’s president took the unprecedented step of seizing the energy sector and putting it under state control. He gave foreign energy companies operating in the country just six months to sell at least 51 percent of their holdings back to the state.
In Venezuela, meanwhile, President Hugo Chavez has expressed a desire to nationalize Electricidad de Caracas, which is owned by US-based AES.
The market has become more interdependent with Chinese, Brazilian and Indian energy companies operating in Africa, Norwegian companies eying the Gulf of Mexico and Russian energy giant Gazprom looking to expand its presence worldwide. ‘National oil companies are getting involved a lot more and this is making it harder for the big operators to position themselves,’ notes Rowley.
With all this activity, some IROs fear the market is in danger of overheating. ‘Last year was reaching the absolute peak in terms of the size of cross-border transactions,’ says Ingo Alphéus from RWE in Germany. He believes increasingly large amounts of pension fund money in need of a safe home helped spur the market. ‘Some of these safe havens are infrastructure funds and they are coming to the market to look for assets,’ he adds. ‘Repaired balance sheets of utilities, low interest rates and private equity have also fueled M&A.’
Value for money
Uncertainty is an issue for IROs everywhere and the energy sector is no different. ‘It used to be the case that if rumors circulated we were just on the side of the potential acquirer. Now even big names like ours are part of the rumor mill,’ says Alphéus. ‘One investor summed it up as: If you’re not sitting at the table, you’re probably on the menu.’
In the context of all this consolidation, the IRO’s job becomes much more about reassuring investors that they are getting value for money from M&A ventures. ‘Our investors are primarily concerned with capital discipline and cost management,’ says Barbara Kuncic, head of IR at Austria’s largest industrial company, OMV. Since the oil and gas group has been involved in high-profile M&A activity in central Europe, Kuncic says shareholders have been focusing their attentions on pushing for a rapid restructuring of various operations.
Some predict further integration due to increased efforts by EU member states, but Rowley doubts the current spate of activity is sustainable. ‘In terms of oil companies and operators, there’s room for a bit more consolidation, but not much,’ he says, arguing that the structural costs facing energy companies are posing a real challenge. ‘Oil prices are down compared with this time last year and everyone is having real issues about the cost of getting things done,’ he adds. For example, Petrobras, the Brazilian oil giant, has increased its capital budget by 66 percent – and as much as 44 percent of that increase is solely down to increased costs.
Rowley feels the increase in costs across the supply chain is having a negative impact on the sector. ‘It means the profitability of the oil companies is starting to be squeezed and a lot of the firms we work with are worried,’ he says. His sentiment was echoed in part by a buy-side analyst from Spain who last year told investor perception study researchers: ‘Although there’s good news on oil prices, returns are decreasing.’
Other uncertainties in the sector include the possibility of legislation to break up large-scale companies that control distribution networks. Even after the regulators in Brussels announced they planned to break up all European energy suppliers also active in managing networks such as grids and pipelines, the market barely seemed to notice. RWE’s shares even gained on the news.
One explanation is that investors simply don’t take such threats seriously. ‘I think the Germans and French will resist any breakup as it will curtail their ability to compete effectively in the marketplace,’ Rowley says. He points out that European companies involved in electricity or gas will have to compete against Gazprom in the Russian market. ‘I don’t think politicians will let it happen because the likes of E.ON and RWE will say we can’t negotiate with Gazprom if this kind of regulation comes into play,’ he explains.
Alphéus finds the unpredictability of future regulation in the energy sector another factor that makes his job more taxing. ‘Ultimately, there are lots of political processes going on that increase uncertainty in the eyes of our investors,’ he says. A climate of change
It’s hard to pick up a newspaper these days without reading yet another grim headline prophesying the disastrous potential consequences of climate change.
Some argue that the way in which the sector responds to climate change issues will largely determine the long-term fate of many energy companies. A recent report produced by Sustainable Asset Management (SAM) and the World Wide Fund for Nature (WWF) argues that companies’ value ‘could be at considerable risk in a future with stricter laws restricting carbon emissions.’
‘In a world where carbon emissions will become expensive, utilities need to keep an eye on the long-term value of their company,’ warns Björn Tore Urdal of SAM Group. In a similar vein, a study published by Lehman Brothers entitled ‘The business of climate change: challenges and opportunities’, argues that ‘while climate change may be gradual, asset prices will on occasion move sharply, when new evidence reaches the market or policies change.’
The report concludes from this that ‘businesses are likely to be affected both by climate change itself and by policies to address it through regulatory exposure, competitive exposure and reputational – including litigational – exposure.’ In short, the authors suggest that the more companies preempt future political developments, the more successful they will be.
The early signs, however, are that many investors are unmoved by such issues. Energy companies are expanding fast and analyst sentiment on the bigger firms remains buoyant, despite the new risks. And although many of the companies are devoting more resources to renewable energy programs, progress remains slow.
RWE has announced plans to commission a larger-scale, almost carbon-free power plant in 2014 but that is not soon enough for some. Matthias Kopp from the WWF actually shows some sympathy for the sector. ‘Utilities firms are clearly right in saying CO2 is not the only thing driving decisions,’ he notes. But he believes ‘the future of regulation is going to be tighter and more restrictive, so investors should be questioning companies and managers should be able to give satisfactory answers.’
One thing is for sure, however. The energy sector will remain an exciting area in which to do business and invest for the foreseeable future. What happens to the various companies involved will largely be determined by how well they prepare for – and explain – the future risks and uncertainties.
