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ENERGY
2 December 2014 17:15

Climate policy goes commercial: E.ON takes advantage of the new economics of a low carbon energy market

Mat Hope

12.02.14

Mat Hope

02.12.2014 | 5:15pm
EnergyClimate policy goes commercial: E.ON takes advantage of the new economics of a low carbon energy market

German energy company E.ON yesterday announced it was splitting the company in two, “spinning off” its fossil fuel assets. The reason for the move? The European energy market’s trend towards low carbon energy sources and services, and the ever decreasing profitability of fossil fuels, it says.

The move is being hailed as a “watershed moment” for Germany’s ambitious efforts to decarbonise its energy sector.

But why does E.ON think its new model is more profitable? And why aren’t all energy companies doing the same?

Energy transformation

E.ON’s decision to restructure has more to do with a need to do something about its bottom line than environmental concerns. E.ON’s profits fell by 20 per cent over the last 12 months, continuing a long term decline.

That was partly as a consequence of Germany’s ambitious climate and energy policies, known as the Energiewende. Germany aims to get 80 per cent of its electricity from renewable sources by 2050. Currently, it gets about 30 per cent, up from about 15 per cent when the Energiewende was announced in 2010.

Renewables’ rapid expansion has made the wholesale cost of electricity plummet, and put many of Germany’s big utility companies with large stakes in fossil fuels under severe financial pressure.

The German government is also pressing ahead with a plan to phase out nuclear power by 2022. That’s bad news for E.ON, which has a stake in 11 of the country’s nuclear plants.

So E.ON decided to split in two. One part of the company, which will keep the name and branding, will focus on renewables, distributing power, and providing energy efficiency services. The other part will keep E.ON’s non-renewable power plants, and will make new investments in exploring and producing fossil fuels.

Announcing the restructure, E.ON’s CEO said in a press release:

“We are convinced that it’s necessary to respond to dramatically altered global energy markets, technical innovation, and more diverse customer expectations with a bold new beginning. E.ON’s existing broad business model can no longer properly address these new challenges.”

New economics

On the face of it, E.ON’s two new companies have divergent interests. One relies on Germany continuing to support a push for renewables, while the other is betting on continuing demand for fossil fuels. So how can both companies make money?

The new renewables-focused E.ON hopes to attract investment from those that don’t mind getting a lower return over a longer time period in exchange for less risk, such as pension funds.

It will keep most of E.ON’s large debt on its books, but will focus on what many analysts consider safe bets, such as distributing power. Grid operators such as Spain’s Red Electrica, Britain’s National Grid, and Italy’s Terna and Snam are among the most highly valued stocks, Reuters points out.

E.ON will also invest a little under â?¬5 billion in low carbon energy sources in 2015, it says. Renewables typically cost lots to build at the outset, but deliver high profits later as companies sell electricity that is effectively being generated for free.

Such a strategy relies on continued government support for policies which subsidise and promote renewables. Germany’s Energiewende is a 40 year project, and the EU has recently agreed targets to 2030, so political rhetoric suggests this will be the case.

The new fossil-fuel focused company is a riskier bet, but it could make a lot of profit in the short to mid term.

By leaving the new company free of debt, it should be able to take riskier investments in new fossil fuel projects. But the new company will need coal and gas demand to remain robust if it’s to make a profit on these investments.

That seems likely, at least in the short term. As Germany’s energy minister Sigmar Gabriel points out, even if the country gets 80 per cent of its electricity from renewable sources in 2050, the other 20 per cent and most of its heat generation will have to come from fossil fuels.

The fact that the new company will be saddled with E.ON’s nuclear power plants will be of concern to investors, however.

Germany has pledged to phase out nuclear power by 2022. E.ON currently has a stake in six operational nuclear power plants.

E.ON has said the new company will be given funds for decommissioning the plants, reducing the risk for investors in the new company. But recent experience has shown decommissioning is often more expensive than first estimated. That means the new company could effectively become a “bad bank” for E.ON’s nuclear assets, Christoph Podewils, head of communications at thinktank Agora Energiewende says.

So E.ON is hedging its bets. If Europe’s push for renewables continues, the new E.ON will make money. If fossil fuel demand holds firm and it can decommission its nuclear plants on budget, the new company should also turn a profit.

Early signs suggest investors approve of E.ON’s logic. The company’s share price jumped about five per cent shortly after it announced its plan.

Blueprint

E.ON’s restructure has been hailed as a “blueprint” for other companies. But another of Germany’s major utility companies, RWE, today announced that it would not be following suit.

That’s partly because E.ON and RWE have very different investments. E.ON mainly invests in nuclear and gas. The latter two aren’t currently profitable thanks to Germany’s nuclear phase out and a high international gas price.

RWE, in contrast, owns lots of lignite, or brown coal, power plants and mines, which remain profitable in Germany. Lignite provided about 30 per cent of Germany’s electricity in the first 10 months of 2014.

Such investments meant E.ON was in much greater financial strife than RWE. So it made more sense for E.ON to undergo a major corporate restructure than RWE. As Griffin Carpenter, economic modeller for thinktank the New Economics Foundation, puts it:

“E.ON’s finances were the worst. They were in crisis. So in that sense they can afford to be a little bit more visionary.”

Climate policy goes commercial

So does E.ON’s decision to split its assets represent a tipping point for Europe’s big fossil fuel investors? Probably not.

E.ON seems to believe energy companies will increasingly operate in a carbon constrained world, but it’s still hedging its bets. After all, it has restructured to allow it to continue to profit from fossil fuel investments as well as its low carbon portfolio.

But it does show climate policies can have a real impact on the energy market. It’s up to politicians to persuade companies that will continue to be the case, and that investing in fossil fuels is increasingly risky.

Indicating that there is a new global climate deal on the table in Lima this week would be a start. If such signals persist, it’s not impossible that more companies may follow E.ON’s lead.

Main image: Night lights of a big city. Credit: Natali Glado/Shutterstock.com.

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