INSIGHTS AND OPINIONS FROM BARINGA PARTNERS

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Baringa analysis of European wholesale power markets (March 2020) Our market reports provide a comprehensive overview of European power markets together with forward looking projections for wholesale power prices, capacity market prices, and renewable incentives. These reports are available as individual prproducts or annual subscriptions to keep you up to date with our latest view on market developments and price evolution.

For our March 2020 update, this includes dedicated Covid-19 sensitivities that explore the interplay between the trajectory of the virus, the effectiveness of the interventions that European Governments take in order to halt the spspread of the virus, and the potential implications for the European economy and the power sector more specifically.

The key outlook issue is whether the expected economic contraction in the near term due to Covid-19 becomes a longer-lasting downturn or not.

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In the coming weeks we will be exploring additional sensitivities to the scenarios described above, including for example the impact of relaxing existing environmental objectives as a response to a long-lasting economic downturn (structural shock with policy shift).

For more information you can contact us via: enquiries@baringa.com

In addition to our standard “Low Commodities” and “High Commodities” scenarios, the March 2020 update includes:

This scenario assumes that the economic impaThis scenario assumes that the economic impact of Covid-19 is sharper and longer-lasting, and that the financial system suffers significant distress, akin to the global financial crisis of 2008-2009. This leads to a structural change in the growth outlook for the European economy throughout the 2020s, and recovery only begins from Q3 2021 onwards;

Q1 2020 Baringa Reference Case with structural shock:

The Q1 2020 Baringa Reference Case assumes a very sharp but relatively brief contraction in the European economy followed by gradual recovery from Q4 2020 onwards as the spread of the virus is contained and confidence progressively returns. As a As a result, this scenario assumes the medium-to-long term economic effects of Covid-19 are relatively limited;

Q1 2020 Baringa Reference Case (transitory shock):

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Commodity prices:

SlSlowing global trade flows due to reduced consumption and a sharp reduction in travel demand has resulted in a drop in commodity indices to multi-decade lows. For the oil market in particular, this has coincided with a further supply-side shock pertaining to the so-called “price war” between OPEC (chiefly Saudi Arabia and UAE) and Russia. In the context of the Covid-19 epidemic, commodity-dependent economies are particularly exposed given that falling commodity prices instantly put a strain on public finances just as the burden of coping with a public-health crisis is likely to increase.

This is liThis is likely to lead to oil and gas companies scaling down their operations and investment budgets, especially the marginal players (from a production cost perspective) such as shale operators in the US as well as some offshore exploration and production players. Note that lower shale oil production would also have an impact on natural gas markets given that natural gas is often seen as a “byproduct” by some exploration and production companies that target the most oil-rich wells in order to boost internal rates of return.

NatuNatural gas and coal prices have the strongest impact on wholesale power prices in Europe. It is therefore important to note here that there was significant pressure on natural gas prices in Europe even before the Covid-19 epidemic due to a combination of continued high levels of Liquefied Natural Gas (LNG) supply, softer than anticipated Asian LNG demand, resolution of the Russian/Ukraine gas transit stand-off, and high European gas storage levels.

EUA carbon prices:

The expected reduction in economic activity (particularly in the industrial sector) and reduced travel demand will lead to a reduction in carbon emissions in the short term, thereby also lowering European Union Allowance (EUA) carbon prices. In addition, an increased focus on remote and smart working could also serve to embed habits that help to curb carbon emissions in the long term. The trajectory for EUA carbon prices post post Covid-19, however, will continue to strongly depend on energy policy objectives in addition to the more fundamental supply/demand considerations.

The Covid-19 epidemic represents a large and unexpected supply and demand shock for the global economy and as a result it can also have wide-ranging impacts on European power markets. Below we describe some of the more pertaining potential impacts.

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Potential impacts of Covid-19 on European power

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Electricity demand

EleElectricity demand patterns in Europe have changed with the introduction of Government interventions and a rise in the working population working from home. As more people stay at home, the shape of electricity demand whilst these measures are in place resembles more consumption during weekends. In particular, electricity demand from commercial and industrial sectors has declined, whilst demand from the residential sector has increased.

WWe have analysed data from European Transmission System Operators (TSOs) which demonstrate that, as countries have introduced social distancing measures to reduce the spread of Covid-19, a significant decline has been observed in overall electricity demand levels, along with a change in consumption profiles.

IItaly, the European country that was firstly and most severely affected by the epidemic, has been in a state of lockdown since the 9th of March and saw a 5-10% reduction in daytime power demand in its first week, then followed by a reduction of as much as 25% the week after. Spain has witnessed consequences of similar levels of severity as Italy, albeit with a slight time delay; it entered a state of lockdown on the 15th of March and only by the middle of that week the load starts dropping by as much as 25%. France has also seen a also seen a reduction of up to 15-20% in daytime consumption during the week commencing the 16th of March.

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In GB, electricity demand has not yet been severely affected, since the epidemic started later in the country and the Government only enforced strict lockdown measures on March 23rd. There is still a 5-10% reduction in daytime electricity demand, which can also in part be attributed to milder temperatures through March. Germany’s demand has also not seen a drastic reduction so far; as Bavaria, the first German federal state to introduce a full lockdown, has only done so since the 20th of March. CoConversely for Netherlands, electricity demand levels have reduced significantly combined with a considerable distortion of the demand shape.

A similar story can be observed for Belgium, Norway, Sweden, Portugal, Ireland (SEM), Greece, Poland, Finland and Denmark which are all presented below:

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Supply chain and project development:

Globally, the Globally, the Covid-19 epidemic has impacted the sourcing and supply chains across the power industry. Equipment suppliers are operating at reduced capacity, borders are closed in some countries and project developers are observing logistical delays and delivery bottlenecks. These delays could cause some developers to miss the deployment deadlines in auction schemes and therefore face financial penalties. There could also be impact in participation volumes in upcoming auctions because developers are unable to bid on time.

Risk Risk for negative price events and curtailment of renewables:

LLower electricity demand levels have led to oversupply situations being observed, particularly in markets that are driven by the availability of energy (such as the hydro-dominated Scandinavian market) rather than capacity (most markets with high levels of thermal capacity). This increases the risk for negative price events and curtailment of renewable generators. For some renewable generators operating under existing support schemes, these risks could be more material than lower wholesale market price levels.

AAvailability rates for power stations and network infrastructure:

RRelated to the point above, the Covid-19 epidemic constitutes an immediate threat on sensitive strategic infrastructure. Operation and maintenance of equipment in the power sector relies on a limited resource pool of specialised technicians and engineers and, whilst safety measures have been put in place to ensure continuity of operations and some technologies already operate largely autonomously (such as wind and solar farms and new battery storage and gas peaking plants), the Covid-19 epidemic could lead to reduced availability rates for large thermal power stations and transmission and distribution netdistribution network infrastructure. The risk could be higher for highly specialised sectors such as the nuclear industry.

Energy policy and environmental objectives:

The Covid-19 epidemic could fuel political nationalism and carbon-intensive stimulus measures in some European countries if policy makers and businesses turn their attention to short term economic stimulus packages rather than longer term clean energy infrastructure.

With respect to procurement of electricity generated by renewable energy sources by Governments or large corporates, this could have a short-term impact by halting administrative procurement functions, or a longer-term impact by either (1) dampening economic activity and electricity demand to a point where less new-build capacity is required; or (2) potentially even leading to a cancellation of renewable auctions and/or long-term renewable PPA (Power Purchase Agreement) procurement exercises.

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At the other end of the spectrum, it is also possible that European Governments and the European Commission use any economic stimulus measures enacted in response to the Covid-19 epidemic to accelerate the transition to a green economy (such as the European Green Deal for example). It is widely anticipated for example that industries like aviation and auto manufacturing will require Government support and it is possible that this support may come with strict requirements on reducing emissions and investing more in clean energy ininfrastructure.

Electric vehicles and heat pumps:

Electrification of the heat and transport sectors will be required if European countries are to meet their long-term carbon objectives. For EVs, the economic impacts of Covid-19, falling oil (and carbon) prices and lower government subsidies may reduce EV demand as consumers favour petrol cars. The EV market also relies on global sourcing for its core technology, the EV batteries. Car manufacturers, who are already suffering from a collapse in car sales, may thetherefore respond by revisiting their manufacturing strategies. The Covid-19 epidemic provides manufacturers with an opportunity to take dramatic longer-term actions, such as reducing production capacity by closing manufacturing plants, and it is not yet clear whether that presents a threat or an opportunity for the EV industry. Partly, this will also depend on any economic stimulus measures enacted by Governments in response to the epidemic.

Availability of capital and the overall energy infrastructure investment environment:

Depending on the duration and extent of the Covid-19 disruption and the speed and efficiency of Gof Government response measures, the most material impact of the crisis on banks and other systemically important financial institutions may be higher credit losses due to the economic downturn. Some central banks in Europe have already responded by cutting interest rates, thereby reducing the cost of short-term borrowing. Central banks have also announced stimulus measures, including measures to encourage banks to lend more to small and medium-size businesses. However, unless confidence returns to the sector, the availability of capital for long-term infrastructure investments may be impacted. In recent years, the success of some pusuccess of some pure-play renewable developers in particular has been driven by a capital recycling model and hence if capital is not recycled quickly and efficiently in the sector, this could have an impact on future levels of new-build capacity.

It is also important to consider what impact (if any) Covid-19 may have in terms of longer term changes in market sentiment towards the energy infrastructure asset class more widely. There is a possibility for example that investment in clean tech infrastructure could increase if investors perceive these assets as a better bet over the long term compared to asset classes that hthat have been particularly impacted by Covid-19 – noting also their relative stability (especially for contracted assets) and lower correlation with capital markets.

A key theme that is also emerging is the enlarged role that Governments are likely to play following the crisis. This is because the loss of income incurred by the private sector, and any debt raised to fill the gap, is expected to eventually be absorbed (at least partially) by Government balance sheets. Higher public debt levels are likely to become an important feature of the European economy atleast in the short-to-medium term, and how European Governments put their balance sheets to use and channel to use and channel funds to the economy will have profound implications also for the energy infrastructure sector. Finally, given the present levels of interest rates in Europe, such an increase in Government debt may not significantly add to its servicing costs today however over the longer term it will also depend on future interest rate levels and the willingness of lenders to maintain these debt levels.