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This Is What the Utility Death Spiral Looks Like

This Is What the Utility Death Spiral Looks Like thumbnail

In Germany, utility revenues are spiraling down the rabbit hole. Will American power companies follow?

The German mega-utility RWE provided another dismal reminder today of the painful transition European power companies are undergoing.

According to 2013 financial results, the utility lost more than $3.8 billion last year as it cycled down unprofitable fossil fuel plants due to sliding wholesale prices. The yearly loss is actually quite historic; it’s RWE’s first since 1949 when the German Republic was formed.

This follows poor earnings news from Vattenfall, a Swedish utility with the second-biggest generation portfolio in Germany, which saw $2.3 billion in losses in 2013 due to this same “fundamental structural change” in the electricity market.

The problem is well documented: high penetrations of renewables with legal priority over fossil fuels are driving down wholesale market prices — sometimes causing them to go negative — and quickly eroding the value of coal and natural gas plants. At the same time, Germany’s energy consumption continues to fall while renewable energy development rises.

RWE’s CEO Peter Terium called it “the worst structural crisis in the history of energy supply.”

To make matters worse for utilities, their commercial and industrial customers are increasingly trying to separate themselves from the grid to avoid government fees levied to pay for renewable energy expansion. According to the Wall Street Journal, 16 percent of German companies are now energy self-sufficient — a 50 percent increase from just a year ago. Another 23 percent of businesses say they plan to become energy self-sufficient in the near future.

It’s a real-world example of the “death spiral” that the industry has so far only considered in theory: as grid maintenance costs go up and the capital cost of renewable energy moves down, more customers will be encouraged to leave the grid. In turn, that pushes grid costs even higher for the remainder of customers, who then have even more incentive to become self-sufficient. Meanwhile, utilities are stuck with a growing pile of stranded assets.

When unveiling today’s dismal earnings, RWE’s Terium admitted the utility had invested too heavily in fossil fuel plants at a time when it should have been thinking about renewables: “I grant we have made mistakes. We were late entering into the renewables market — possibly too late.”

As power company executives collectively gnash their teeth, green energy advocates are praising the tumultuous shift these utilities are enduring. Although both sides disagree on the ultimate value of the outcome, the underlying situation is undebatable: Germany is in the midst of a massive “structural” change that is ripping gaping holes in the traditional utility business model. And now the cash is bleeding faster than ever.

In a shareholder document from last September, the German utility EnBW illustrated how bad the bleeding has gotten. EnBW has the fourth-biggest generation pipeline in the country, and has been forced to make a serious shift in its own strategy.

The first graph shows how far forward prices for conventional power plant generation have plummeted since 2011. As the profitability of fossil fuel plants continues to fall, EnBW concluded in a strategy document that it needs to “develop new business models…without delay.”

EnBW offered another snapshot of how bad things are getting for utilities. These two graphs show the gross margins from coal plants (clean dark spread) and gas-fired plants (clean spark spread) after accounting for fuel purchasing and carbon allowances. Both have taken a serious hit, but natural gas has fared worse as fuel costs remain high and market prices for power fall.

Do these graphs remind you of anything?

Europe’s biggest utilities are falling down a rabbit hole and could soon find themselves swimming in a pool of their own tears. Many of them already are.

Over the last five years, the top twenty utilities in Europe have lost half their value. Recent poor financial results, stranded assets and mass selloffs of power plants highlight how tough things have gotten for power providers. But there are signs of change.

In its own strategy document, EnBW made a simple declaration about its future: “Conventional business models of larger power supply companies no longer work.”

By 2020, the utility plans to cut its electricity generation and trading business by around 80 percent. It will try to make up for the decline by investing further in wind power, transmission and distribution projects to connect renewables, and by working on the consumer level to implement services like home automation.

Ben Kellison, GTM Research’s senior grid analyst, said EnBW’s approach “provides a window into one possible path in which the value of energy trading and peaker plants systematically erodes, pushing large utilities into more service-oriented work.”

RWE is also headed in this direction. That utility, which is Germany’s second-biggest, said last fall that it was planning to divest many of its large-scale fossil fuel plants and implement a “prosumer” business model to help integrate renewables projects. These emergency declarations are the only way some big power companies can ensure their future.

The German experience is just the beginning of a long, tumultuous shift for the broader utility sector. But it highlights the question: will American utilities soon deal with the same issues? With much lower penetrations of distributed renewables and less aggressive promotion laws, the U.S. power sector won’t face the same kind of violent death spiral in the near term. But the same forces driving change in Europe are starting to raise concerns within the utility sector here.

There’s a scene in Alice’s Adventures in Wonderland when the Mock Turtle and the Gryphon ask about Alice’s exploits. She replies: “It’s no use going back to yesterday, because I was a different person then.”

That may be how some utilities in Europe are feeling now — finally reaching the point of no return where looking back is not an option.

American utilities have the benefit of learning from that first-mover experience. Will they use it to land safely in a wonderland of distributed generation and consumer empowerment? Or will they fall down the rabbit hole, not knowing where they’re headed until its too late?

Those are the questions we’ll be asking at Greentech Media’s Grid Edge Live conference this summer. Come join us.

Greentech Media

11 Comments on "This Is What the Utility Death Spiral Looks Like"

  1. Davy, Hermann, MO on Mon, 31st Mar 2014 11:32 am 

    Interesting article and one we should ponder as Americans. I feel the part to ponder is the part not spoken. What happens when there is a financial correction and or contraction? In Germany you have utilities that are unhealthy business operations. Part of this poor performance is their own doing by not planning for a changed environment but the government played a part also. I wonder how effective the wholesale market is. Are we in a new environment that needs a new way to buy and sell power? A financial corrections is only going to make these numbers worse because there will be a further decrease in demand. The article mentions grid maintenance is going up. The further AltE market penetration proceeds the more that will be asked of the grid. Yet, Utilities are being hammered now how will they be able to invest in new assets when they have so many stranded assets currently? I have read here and elsewhere that renewable energy cost are moving down and this is great. Yet, this is not going to last. The nature of the renewable industry manufacturing is one of complex manufacturing, expensive inputs, and high embedded energy. The renewable industry right now has hit a sweet spot of economies of scale, government support, and good market position. China has driven the unit costs down by a huge overcapacity being built out in their orgy of growth. This is overcapacity will not last and prices will drift up with China’s debt unwind. At some point if the financial environment turns to a higher cost of money and less available capital this renewable sweet spot will quickly change. Society still has a large bills to pay for built out AltE resources. AltE paybacks are generally 7 to 10 years. The stranded asset issue is troubling. It represent a large investment lost. Not only lost but with a cost of maintenance and dismantling. How many of these costs can society afford in a situation of overall diminishing returns? The predicaments and problems are multiplying for society. Everywhere we look there is funding and cost issues. The one bright spot in Germany is the self sufficiency of their industry at 16% with 23% more heading that way. I find this as the key to the future. Having a significant amount assets off the grid and dispersed. Yet, there is still a huge portion of the population remaining on a sick grid. How long can we push this envelope when we are seeing a trend towards increased costs, decreased funding, and deteriorating existing infrastructure? The number one aspect of modern society is electricity and transport fuels. Both of these vital parts of modern society and are in trouble. Is AltE making us more vulnerable or less, both I suspect.

  2. Makati1 on Mon, 31st Mar 2014 1:21 pm 

    I foresee that, in the near future, Americans will begin to realize that they do not need all of the electric they use when the choice is between electric and eating. When the use drops and there is no way for electric power plants to pay for themselves, a lot of things will change. I learned this quickly when my electric went from $0.09/KWh in PA to $0.28/KWh in Makati.

  3. Arthur on Mon, 31st Mar 2014 2:00 pm 

    The problem is well documented: high penetrations of renewables with legal priority over fossil fuels are driving down wholesale market prices — sometimes causing them to go negative — and quickly eroding the value of coal and natural gas plants. At the same time, Germany’s energy consumption continues to fall while renewable energy development rises.

    This of course if good news.

    Same problem in Holland. We have brand new gas fueled power stations that are not operating enough hours to pay back for themselves because of all the influx from renewable energy from our German neighbors.

    En onze gascentrales, goed voor 60 procent van onze stroomopwekking, draaien op halve kracht. Reden? De aardgasprijs is te hoog en duurzame stroom uit Duitsland en Noorwegen is heel goedkoop.

    NG power stations can generate 60% of Dutch electricity, but are only operating 50% of the time. Reason: NG is too expensive and renewable energy from Germany and Norway is very cheap (if available).

    Luxury problem. Renewable energy is taking over before we run out of gas. That’s why it is very difficult to be a doomer for the long term, at least as energy supply is concerned.

    The reason why there so many NG power stations in the Netherlands is because:
    a) Holland has the largest gas field in Europe and 9th in the world (at least once)
    b) Holland is at the crossroads of all sorts of pipelines as well as electricity grid
    c) Location near the sea with abundant cooling water for power stations:

    Typical situation in the north of the Netherlands, with power station at the sea board. Structure running into the sea is the electricity cable connection with Norway, the longest in the world, used to pump water up into basins high in the Norwegian mountains or to deliver hydro energy back to the Nethelands.

  4. Boat on Mon, 31st Mar 2014 2:47 pm 

    A hook up/maintenance fee will be charged for those who want the grid to be a back up.

    Just like American roads that are maintained by gasoline taxes will be switched to taxing miles driven so hybrids and electric cars pay their share of the infrastructure. Nothing but common sense and fairness at play.

  5. Plantagenet on Mon, 31st Mar 2014 3:55 pm 

    Germany is dependent on Russian NG and huge government subsidies for RE.

    What could possibly go wrong?

  6. bobinget on Mon, 31st Mar 2014 4:30 pm 

    “If ya can’t beat em, join”

    A new model designed expressly for utilities;

    Almost weekly new hybrid power plants, solar and fossil fuel, are being announced.

    General Electric just bought electric storage technology
    which promises to completely eliminate the fossil fuel component giving alt. power greater base potential.

  7. bobinget on Mon, 31st Mar 2014 7:06 pm 

    Credit: Reuters/Brian Snyder
    (Reuters) – GE Energy Financial Services, the General Electric Co (GE.N) arm that funds energy infrastructure projects, said on Friday it was planning to invest in a solar power project in Setouchi, Japan.

    The Nikkei had reported earlier that GE would contribute about 10-20 billion yen to the project and take a majority stake in the plant’s operating company set up by Tokyo-based Kuni Umi Asset Management.

    The 230,000-kilowatt plant, which will mark GE’s entry into the Japanese solar market, would be the country’s biggest plant with twice the output of the biggest domestic solar projects now in the works, the Japanese business daily reported.

    Solar companies are benefiting from power subsidies in Japan, which is banking on solar power to help meet the shortfall in supply after the Fukushima disaster in 2011 shattered public confidence in nuclear energy.

    The plant, which will start operating in 2018 in Setouchi in Okayama Prefecture, is expected to cost around 80 billion yen ($776 million), the daily reported.

    While a spokesman from GE Energy Financial Services confirmed the equity investment, he declined to provide details, saying the company was “still discussing details within the project team.”

    “Because documents about this project have been publicly disclosed by the Setouchi municipal assembly, we can confirm that if certain conditions are met, GE plans to invest in the solar power project,” GE Energy Financial Services spokesman Andy Katell told Reuters.

    Katell said GE Energy Financial Services holds equity investments in six solar power projects in the United States and Europe, totaling more than 800,000 kilowatts.

    (Reporting by Ankit Ajmera and Sayantani Ghosh in Bangalore; Editing by Maju Samuel)

  8. bobinget on Mon, 31st Mar 2014 7:15 pm 

    One other report had GE ‘running’ the plant.

    Oddly, this investment may cause GE to lose its top credit rating.
    It seems banksters are unconvinced solar & wind power
    will adequately replace nukes for Japanese industry.
    As we also know, Banksters are never wrong.

    Strictly a guess here because Japan and China are as joined at the hip as are GE and First Solar, a mix of Chinese and Japanese panels will be selected.

    First Solar has more experience with these huge projects. We will see.

  9. Stilgar Wilcox on Mon, 31st Mar 2014 8:25 pm 

    It’s pretty simple math that as more people and businesses supply their own electrical supply via renewables, utility company profits are going to drop. At some point the private utility co. needs to be taken over by the govt. to insure the continued transition to renewables.

    What’s at stake, is if the transition to renewables gets derailed in Germany, then that doesn’t bode well for other countries trying to do the same. Whatever glitches occur along the way have be ironed out, or we’re stuck with FF.

  10. Kenz300 on Mon, 31st Mar 2014 11:28 pm 

    Decentralized, local energy production will replace the old and tired centralized energy production model.

    Utilities need to get on board or get left behind.

  11. Makati1 on Tue, 1st Apr 2014 2:33 am 

    So, you are advocating communism in the US? Government takeover of all ‘necessary’ corporations? Interesting!

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