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Transcript of Global investment patterns in the electricity industry © Utility Consultants Ltd 2003 Prepared by...
Global investment patterns in the electricity industry
© Utility Consultants Ltd 2003
Prepared by Utility Consultants Ltd
www.utilityconsultants.co.nz
Disclaimer
This research report is ofa general nature, and is not intended
as specific professional advice. Accordingly, neither Utility Consultants, nor its’ directors and
shareholders, shall be liable for any lossor damage arising from action
or inaction based on thisresearch report.
Also, because the globalelectricity industry is unfolding rapidly, theinformation herein may date rapidly. It is,
however, correct at the time of writing(mid-March 2003)
Contents
Introduction
Summaryof waves to
date Analysisof global trends
& drivers
Shaping theinvestment
climate
Analysis ofpossible
investmentsAnalysis ofcorresponding
investmentclimates
Conclusions
Introduction
Investment in utilitiesover the last 15 years or so
has fallen into 4 broad patternswhich we have referred to as
Waves
This report examinesthe four Waves that have
occurred to date, analyses thedrivers of global investment,and makes some projections
of future investments
Summary ofwaves to date
Four reasonablydistinct waves of global
investment to date
Each wave hasbeen prompted by privatisationsin reasonably distinct regions,along with some other major
utility issues
Four wavesto date are discussed in the
following pages
This chart depictsfour reasonably distinct
waves of investmentover time
Late 1980’s Early 1990’s Late 1990’s Early 2000’s
1st 2nd 3rd 4th
Time
Approx value US$b)
10
Invest
Invest
1st Wave
2nd Wave
Invest
Invest
3rd Wave
Withdraw
Withdraw
Invest
Invest
Invest
Withdraw
Withdraw
Invest
Invest
4th Wave
1st Wave
Prompted by electricityprivatisations in Argentina and
to a lesser extent in Brazil
Investorsincluded AES, Entergy, United
Utilities and EDF. Unsuccessfulbidders included CSW, LG&E
Ontario Hydro and HydroQuebec
Many of theseinvestments are now coming toa sticky end due to economicdifficulties in Latin America
Several of theseutilities were leaders ofconsortia that included
banks
2nd Wave
Prompted by electricityprivatisations in the UK followed
closely by Victoria
Investorsincluded Entergy, GPU, TXU,
Dominion Resources andUtilicorp. ScottishPower also
caught Wave #2 with theiracquisition of
MANWEB
The acquisitions ofNORWEB and SWALEC by waterutilities is noted, but they are not
significant in terms of theoverall global pattern
Most of theseinvestments were by singleutilities – no consortia or
banks were involved
3rd Wave
3rd Wave is less clear cut inthat it also involved withdrawalsuperimposed on investment
Privatisation in Europe, alongwith withdrawal of US utilities
from the UK prompted investment by European utilities such as
E.On, RWE and EdF
Complicating factorof withdrawal of investors
requires detailed examinationof their strategies to fully
understand this Wave
Withdrawalof US utilities from Victoria
provided opportunities for SEAsian utilities such as CKI and
Singapore Power to invest
4th Wave
4th Wave is also less clear cutin that it also involved withdrawal
superimposed on investment
This Wave addsinvestment in the US by
European utilities on top oftheir continued investment in
Europe coincident with USwithdrawal globally
A key feature tobe examined is why the US soquickly shifted from being a
source of investment to adestination
This investment in theUS is proceeding cautiouslyin comparison to the rapid
pace of investment inearlier waves
Wave Source of capital Destination of capital
1st
US and European utilities, several as leaders of consortia involving banks. Coincided with a re-thinking of strategy as domestic deregulation became more likely
Latin America, predominantly Argentina, but also Brazil and Chile to a lesser extent. Prompted by privatisations in these countries
2nd
Comprised almost solely US utilities (in contrast to the First Wave) acting on their own behalf rather than as consortia. Two exceptions were the acquisitions of MANWEB, NORWEB and SWALEC
UK, closely followed by Victoria, as their electricity industries were privatised
3rd
European utilities such as E.On, RWE and EdF investing in Europe, and the emergence of SE Asian investment in Australia as several 2nd Wave investors withdrew
Europe as the early privatisations began, and Australia as a “follow on” wave emerged as US utilities withdrew
4thCash-rich European utilities such as E.On. Presence of SE Asian utilities is not apparent as it was in the 3rd Wave
Europe as privatisation spreads eastwards, and the US as strong utilities are acquired
Four verydistinct strategies behind theinvestments and withdrawals
of each wave
Attempts to explaineach Wave in terms of a
simple investment strategy ofseeking a return greater thanWACC falls short of a robust
explanation
Following pagesoutline four global investmentstrategies and when they have
been adopted
Positional
Finding a niche inan emerging or reshapingmarket, often involves abank or similar to limit
risk exposure
Learning about anemerging or reshaping market
in anticipation of domesticmarkets deregulating
Making a betterreturn on WACC than is
currently available. May alsoinvolve exploiting
regulatory lag
Acquiring adjacentvalue chains to significantlyreshape an industry such as
merging electricity & gas
Investigative
Traditional
Transformational
Wave Positional Investigative Traditional Transformational
1st √ √
2nd √ √ √
3rd √ √ √
4th √ √
Next few pagesexamine the prevailing drivers
of each Wave, along with amodel that outlines key
investment issues
Model starts fromthe premise that privatisationcreates the initial investmentopportunity but other factors
determine the success &tenure of investment
These other factorsare both internal and external
to the investing utility
Privatisationcreates initial
investmentopportunity
External drivers•Political stability & risk•Economic drivers•Regulatory risk•Social cohesion
Internal drivers•Strategic posture•Risk profile•ROI hurdle•Balance sheet size & strength
These issues determine ability to make initial
investment and then to retain investment
1st Wave
Privatisationin Argentina (and a few other
countries) created theopportunities
Impending deregulation inUS & Europe (although it was
still a few years away, thesharper utilities did correctly
recognise it coming)
Lack of globalInvestment experience,particularly in correctly
identifying politicalrisks
Accumulatedcash reserves
2nd Wave
Privatisation inUK and in Victoria
created opportunities
Rapid maturingof thinking, particularly with
Investment risk
Coincident privatisationof gas distribution & supply in
Victoria provided the opportunityto develop transformational
strategies
Recognition that thesemarkets could be similar to
those likely to emerge inthe US
3rd Wave
Privatisations in Europecreated investment
opportunities
Withdrawalof early-mover US utilities
such as Entergy
Cash-rich positionof several SE Asian utilities,
combined with their recognitionof eventual deregulation in
their domestic markets
Emergence of politicalrisk in Western countries (UK
wind-fall tax) and regulatory riskin the UK water sector
4th Wave
Privatisation inEastern Europe creates
investment opportunities
Regulatory constraintsforce large utilities like E.On
to divest non-core assets,strengthening their cash
positions
Over-exposure to tradingrisk and under capitalisation of
many US utilities led to their exit,prompted significantly but not
totally by Enron’s collapse
Further regulatory risksemerge such as the electricity& gas price controls in Victoria
and the Epic Energy tariffdispute in Western
Australia
Also importantto consider the valueof acquisitions within
each wave
Most 1st and 2nd,
Wave acquisitions werevalued between about US$600mand US$1b (at the time of writing
the US$ and the € are aboutequal and are usedinterchangeably)
As the 3rd and 4th Wavesemerged, acquisition valuesclimbed noticeably into the
order of US$3b to US$5b
E.On’s recentacquisition of Ruhr Gas for
€10b altered the dynamics ofglobal acquisitions, suggesting
that only the largest utilitieswill continue to play
The possibleprivatisations of EdF and
GdF for prices in the order of€100b may further alter this
dynamic another orderof magnitude
A key factor inthis appears to be the depth
of acquisition that has occurredcoinciding with the huge warchests amassed by utilities
like E.On, Vivendi andSuez
One hypothesisis that future Waves couldcomprise one or two very
large acquisitions – we willtest this hypothesis in
later sections
However thetiming, source and destinationof the Ruhr Gas and proposed
Iberdrola acquisitionssuggests a continuation
of the 4th Wave
We will examinepossibilities for the 5th andsubsequent Waves in later
sections
Analysis of globaltrends & drivers
This sectionidentifies the drivers, issues
and risks that the globalelectricity industry faces
These issuesbroadly fall into 7 groups or
clusters, although some issuescould fall into more than 1cluster and may conflictwith other issues in the
same cluster
Clusters aredepicted as clouds to emphasise
fuzzy, shifting boundaries
Industry & market events
&features
Industry & market events
&features
Primary energy supply, natural
resources & environment
Primary energy supply, natural
resources & environment
Regional economy
Regional economy
Societal advancement &
cohesion
Societal advancement &
cohesion
Public opinion & policy
Public opinion & policyNational &
regional regulatory & competition
National & regional
regulatory & competition
National & regional political position
National & regional political position
Primary energy supply, natural
resources & environment
Primary energy supply, natural
resources & environment
Shift towardsgas-fired generation asnew reserves emerge
Shift towardsgas-fired generation to
drive down costsShift towards
gas-fired generation toreduce emissions
Shift towardsgas-fired generation asnuclear generation is
closed to meet EUentry criteria
Renewed interestin coal as clean-coaltechnologies emerge
or as gas reservesdwindle
Ambivalence towardclimate change initiatives
by major nations
Continued issueof disposal of spent
nuclear fuel
Expected shift togas-fired generation maybeconstrained by dwindling
reserves or accessto corridors
National & regional political position
National & regional political position
Certainty ofaccess to gas
transmission corridors,particularly in Eastern
Europe
Increasingwillingness of
governments to intervenewhen prices spike
Risk ofnationalisation hasbecome very real in
certain countries
Increased potentialfor political fall-out to
disrupt delicatelybalanced energy
markets
Continued likelihoodof electricity being a
political football
Public opinion & policy
Public opinion & policy
Increasingpublic opposition tonuclear generation
Continuedunlikelihood of coherent
long-term energypolicies in most
countries
Emerging trend ofincreasing policy lurchesin response to short-term
shifts in publicopinion
Increasingpublic opposition to
privatisation
Increasingpublic opposition to
regionalisation &globalisation
National & regional
regulatory & competition
National & regional
regulatory & competition
Slowing butdefinite move toward
ring-fencing linesand energy
Slowing ofring-fencing of supply
from generation
Price control riskis well established – no longer a remote
possibility
Increasingregulatory constraints as
multiple jurisdictionsbecome involved
Continuedtension between utilities
and regulators overmarket definition
Increasedsurveillance of financial
processes
Industry & market events
&features
Industry & market events
&features
Reality of high costof nuclear generation
as closures occur
Global shifttoward more conservative
risk profiles andcapital structure
Increasingdemand as economies
shift in developingnations
Many largeutilities now face market
dominance limits
Increasingdemand as market
economies gaintraction
Abruptchange in financial
fortunes of historicallystrong US utilities
Decliningability to recoverstranded costs
Societal advancement &
cohesion
Societal advancement &
cohesion
Status as anagricultural, industrial,service or knowledge
economy
Generallevel of order& discipline
Whether order &discipline is enforced bystrong individual values
or by centralisedauthority
Access todue process
Degreeof transparency and
corruption
Regional economy
Regional economy
Vulnerability ofmany economies to
single issues orindustries
Recentdevaluation of
LatAm currencies
Certainty oftaxation including“wind fall” taxes
Reconstructionrequiring investment in
regions of high risk
Environmentalpressure constrainingeconomic growth in
developing countries
Shaping theinvestment climate
We now examinehow these issues, risks &drivers shape investmentopportunities & climates
Critical to distinguishbetween the issues that create
investment opportunities and theissues that create favorable
investment climates
Following table isderived from a matrix thatscores each investment
destination out of a total of 320points based on 32 key
issues
Key issues, drivers & risks
1st Wave 2nd Wave 3rd Wave 4th Wave
Latin America
Victoria UKWestern Europe
Victoria & SA
US UK
National & regional political positions (score 60)
28 49 51 46 46 52 40
Public opinion & policy (score 40) 19 27 31 20 25 33 26
Regulatory & competition (score 50)
39 37 39 31 32 30 28
Industry & market features (score 40)
29 33 31 25 29 28 25
Societal advancement & cohesion (score 50)
17 43 43 30 42 42 40
Regional economy (score 50) 38 42 42 38 39 41 32
Primary energy, natural resources & environment (score 30)
25 22 20 18 20 26 17
Total score (score 320) 195 253 257 208 233 252 208
Key drivers of thisdecline in the UK were the
increased risk of tough pricecontrol, increased market risk,electricity becoming a political
football and the windfalltax
Observations fromthe previous table are that
investment attractiveness inboth the UK and Victoriahas declined over time
Key drivers of thisdecline in Victoria were the
increased risk of tough pricecontrol and increased
market risk
Latin America’sscore drops 31 points
when re-assessed to the presentbased on currency instability
and tough price controls
Analysis ofpossible investment
opportunities
The followingmaterial is speculative in nature
in that the emerging opportunitiesand investment climate drivers
are not yet clear
Following mapoutlines 10 regions that
will be examined
Six blue regions(A thru’ F) have eithernot yet privatised theirelectricity or are at the
early stages
Four red regions(G thru’ J) have already
privatised, but could be subjectto further exit/entry
processes
Possibledestinations
for investment
A
B C
D
E
F
G
I
H
J
Six blueregions (A thru’ F)
Africa
Russia
Canada
China
SE Asia
Central Asia
Four red regions(G thru’ J)
US
Latin America
Australia& New Zealand
Europe
Region Opportunities / remarks Expected value
Africa
•Continual progress toward privatisation in smaller countries such as Zambia and Tanzania – how successful they will be in the midst of political unrest and low social cohesion remains to be seen•Most significant opportunity is the proposed sale of 30% of Eskom’s generation capacity, of which 20% will be to the public
•Based on replacement cost of generation assets, the 30% stake could be worth between US$4b and US$6b
Russia (UES)
•Disaggregation of UES and sale of the Federal Grid Company (transmission grid) – date not clear, but likely to be within the next year or so
•Market cap in mid-March 2003 is US$5.77b.
Canada
•Hydro-Quebec very unlikely to be sold•Hydro One (Ontario) very unlikely to be sold•Break up and privatisation of BC Hydro was mooted in late 2002, but would seem unlikely•Other provinces also generally seem against any form of deregulation or privatisation mainly due to very low prices.•Recent political intervention in Ontario is likely to discourage private sector interest, although strong pressure from US utilities wanting access to Canadian electricity could over-ride this
Region Opportunities / remarks Expected value
China
•State Power Corp breakup details finalised in late 2002•Likely that generation assets will be allocated amongst 5 pre-existing companies and that T&D assets are likely to be split into a Southern and a Northern company•State Electricity Regulatory Commission formed as part of the breakup•Some companies already seeking foreign investment, but only of the order of 1% of total industry value
•Total value of State Power Corp estimated at US$144b
SE Asia
•Reform and privatisation well underway in Singapore•Privatisation just starting in South Korea and Philippines (Philippine government is already expecting bids for Transco to be heavily discounted)•Move toward diminishing government funding in Indonesia, allowing PLN to raise private debt•PNG privatisation halted
•Philippines Transco indicatively valued at US$2b, but may be heavily discounted
Region Opportunities / remarks Expected value
Central Asia
•Reform and privatisation underway in India•Break up of Sri Lanka’s CEB should be complete by end of 2004
US•Listed capital provides obvious acquisition paths to most utilities, but recent interest of European utilities such as E.On and RWE has cooled.
Latin America
•Opportunities are arising from various exits, but circumstances surrounding these exits make for very unattractive investments, particularly currency devaluations in Argentina.
Australia & New
Zealand
•Present political climate in both Australia and New Zealand is unlikely to attract global investment.•Recent regulatory determinations and trends may make it difficult to retain existing capital
Europe
•Current Gas Natural bid for Iberdrola•Anticipated privatisation of EdF and GdF•EnBW’s proposed IPO possibly in 2004•On-going deals arising from merger concessions of big deals such as Ruhrgas and Iberdrola, and from privatisation programs
•€14b•US$100b
Analysis ofcorresponding investment
climates
Following table scoreseach investment destination
out of a total of 320 points basedon 32 key issues as defined
previously
Destinationspreviously analysed haveshown a marked drop inattractiveness (analysed
in subsequent pages)
Key issues, drivers & risks
Africa Russia Canada ChinaSE
AsiaCentral
AsiaUS
LatAm
Aus & NZ
Europe
National & regional political positions (score 60)
18 39 23 31 25 22 48 15 27 27
Public opinion & policy (score 40)
18 26 17 30 21 20 30 15 10 11
Regulatory & competition (score 50)
32 32 23 30 25 25 21 21 21 24
Industry & market features (score 40)
27 26 20 29 23 27 18 24 26 18
Societal advancement & cohesion (score 50)
8 21 43 16 14 13 42 18 41 28
Regional economy (score 50)
24 36 37 36 32 33 37 21 28 30
Primary energy, natural resources & environment (score 30)
18 25 17 24 24 26 23 21 15 22
Total score (score 320)
145 205 180 196 164 166 219 135 168 160
Destination1st Wave
score
2nd Wave
score
3rd Wave
score
4th Wave
scoreProjected
scoreKey reasons for
score movement
LatAm 195 135
•Increased likelihood of political intervention•Decreased currency stability
US 252 219•Increased market risk•Slight increase in regulatory intervention
Victoria 253 233168 (incl.
NZ)
•Increased likelihood of political intervention•Increased public opposition to globalisation etc•Significant tightening in regulatory trends•Decline in underlying economic attractiveness
UK 257 208160 (incl. Europe)
•Increased likelihood of political intervention•Increased public opposition to globalisation etc•Significant tightening in regulatory trends
Projectingpossible future
waves
The followingmaterial is speculative in nature
in that the emerging opportunitiesand investment climate drivers
are not yet totally clear
This section rollstogether the analysis to dateinto a high level that should
reveal possible futureinvestment patterns
Followingcharts suggest that mostopportunities are likely to
occur In the immediatefuture
Unpredictableinvestments such as Gas
Natural’s unsolicited offer forIberdrola can complicate
this analysis becauseof their size
DestinationLikely size of investment opportunities emerging
Likely timingAttractiveness of
investment climate
Africa
•Eskom likely to sell30% of generation, 20% will be to the public – possible value US$4b – US$6b
•Possibly over next 2 years
•Poor
Russia
•Sale of UES likely to start with sale of Federal Grid Co. – possible value of FGC about US$360m (total value may be US$6b)
•Possibly within the next year
•Good
Canada•Opportunities unlikely, lease of all from Ontario and Quebec
•Average
China
•Some foreign investment to about 1% of industry’s value – not clear if full privatisation will proceed (possible value US$144b)•Bond market is likely to open up as State Power Grid spends aboutUS$5.3b over the next few years
•Good
DestinationLikely size of investment opportunities emerging
Likely timingAttractiveness of
investment climate
SE Asia
•Philippines and South Korea – likely to be heavily discounted because of perceived risks
•Any time now •Average
Central Asia•India and Sri Lanka - opportunities appear minor compared to others
Already in progress
•Average
US •No obvious opportunities •Good
LatAm•Investor exit creating opportunities, but these are unattractive
•Poor
Aus & NZ •No obvious opportunities •Average
Europe
•Several major deals appear close such as Gas Natural’s bid Iberdrola and the possible privatisation of EdF and GdF•Regulatory concessions from big deals are likely to prompt smaller deals
•Any time now •Average
Following tablesuggests that the most
obvious investment is likely tobe in Europe, but broadlycontinuing the 4th Wave,
confirming ourhypothesis
It is acknowledgedthat the Ruhrgas and Iberdrola
acquisitions are large enough toconstitute their own Wave, but
happen to coincide withthe 4th Wave
The proposedEdF and GdF privatisations
will almost certainly constitutetheir own Waves
Timing Description & value of transactionDoes it fit the 4th Wave ??
Now – 6 month
•E.On’s acquisition of Ruhrgas (€10b) Yes
•Gas Natural’s proposed acquisition of Iberdrola (€14b) Yes
•Privatisations in Philippines & South Korea (no precise details available)
No
6 – 12 month •Privatisation of UES (possibly US$6b) Yes
12 – 24 months
•Privatisation of 30% of Eskom’s generation capacity, 20% available to the public (US$4b – US$6b)
No
•China’s State Power Grid is likely to be spending about US$5.3b, and will be issuing bonds
No
24 months - •No obvious deals
Unclear•Possible privatisation of EdF and GdF (about €100b) – precise timeframe not available.
Yes
Following chartextends the chart presented
under “Summary of Waves todate” based on our analysis
Conclusions arenot particularly exciting, but
that’s what the analysishas revealed
Note thatinvestment in the State PowerGrid (China) Is likely to be debt
via a bond issue rather thanequity
This chart depictsthe expected Waves
Now – Sep 03 Sep 03 – Mar 04 Mar 04 – Mar 05 Unclear
Ruhrgas
Time
Approx value US$b)
10
Iberdrola
UES Eskom
China SPG
(Bonds)
EdF & GdF
(Not to scale)
Continuation of 4th Wave Distinct future Waves Wave all of its’ own
Conclusions
Our analysisleads to the following
conclusions…
Opportunitiesprompted by privatisations maybecome fewer as political and
energy policies re-shape, manyin response to perceived
“market failures”
Investmentclimates are becoming less
attractive as price control, marketrisks and political risks
emerge
Unwillingness toprivatise and the unattractive
investment climate may prompta rise in debt funding
and tothe following
conclusions …
Mergerconcessions associated with
the really big deals are likely toprompt a flurry of smaller deals
in the €500m range
Many of these biggerdeals are likely to be fundedfrom sale proceeds (requiredas merger concessions) or
by share swaps
Future Wavesmay be characterised more by
coincident timing rather than byany common geographical
component
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