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Resources: The power bill arrivesBy Ed Crooks

Published: February 2 2010 23:08 | Last updated: February 2 2010 23:08

Fifteen miles off the south-east coast of England, the worlds largest offshore wind farm isunder construction. Poles are being planted in up to 100ft of water, topped by Siemensturbines that reach as much as 400ft above the sea.

It is difficult and dangerous work: last November a man was killed on a boat working at thesite. But theGreater Gabbardproject, being built by Scottish and Southern Energy of the UKand RWEof Germany, is a prototype for what is expected to be a huge expansion of windpower in the waters around Britain. It will have 140 turbines; the government wants severalthousand in place across UK waters by the end of the decade, at an estimated cost of up to100bn ($160bn, 115bn).

In the words of Frank Mastiaux, head of the renewables business atEon, the German energygroup, wind power and other forms of alternative energy are moving from boutique toindustrial scale. The expansion of wind farms planned by the UK is only a part of the

massive investment required of the European Unions energy industry. This decade, Europeancompanies will have to invest about 1,000bn ($1,400bn, 870bn) to meet government targetsfor developing renewable energy and cutting greenhouse gas emissions, while also replacingageing infrastructure. It is a commitment so big that it will help to shape Europes economy,politics and finances over the coming years.

The EU leads the world in renewable energy and has set more ambitious targets for it than anyother leading economy. It hopes the US will follow. Yet many in the industry are beginning toargue that Europes commitment may be unsustainable.

The pledge to make the continent the global pioneer for renewables and emissions reduction

was sealed by a previous generation of leaders, including Tony Blair of Britain and JacquesChirac of France, at the Brussels summit in March 2007. There was a mood in the EU of

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climate hysteria, as Gnter Verheugen, industry commissioner, put it at the time. Thevulnerability of Europes energy supplies had also been highlighted by the most serious clashin a long-running dispute over gas pricesbetween Russia and Ukraine, in January 2006.

When Gazprom, the state-controlled gascompany, cut off supplies to Ukraine, whichis the transit route for 80 per cent of Russiangas exports to the EU, there were shortagesand price spikes across the EU, from Bulgariato Britain.

The result was two historic commitments:European leaders pledged to cut greenhouse gas emissions by 20 per cent from 1990 levelsand to raise to 20 per cent the share of the EUs energy derived from renewable sources both by 2020.

European energy companies, particularly in France, Germany and Italy, were already facing abig task in replacing the generation of infrastructure installed in the prosperous decades afterthe second world war. The new targets added anextra degree of difficulty. The combinationof the two objectives agreed in Brussels is much harder to achieve than a simple reduction incarbon dioxide emissions would have been.

Replacing obsolete infrastructure is costly enough, but if you do it with emissions reductionsand then put a renewables objective on top, it is incredibly expensive, says Dieter Helm, anenergy expert at New College Oxford.

The cheapest way to cut emissions is to replace coal-fired power stations with gas-firedplants, which produce half the carbon dioxide per megawatt of electricity. Yet with the EUscommitment to renewables, prompted by concerns about the security of gas supplies fromRussia and other potentially unreliable countries, European countries are makingcommitments to invest in costly wind farms. While governments have set the objectives, it isthe private sector that is being expected to deliver the investment.

That will put a big strain on European energy companies, which confronted by a shortage offinance and a slide in demand caused by the recession have cut their capital spendingprogrammes sharply for this year. As things stand, they seem unlikely to be able to step up

again to deliver the investment needed.

The energy industries of the EUs five largest economies Germany, France, Britain, Italyand Spaininvested about 35bn a year for most of the 2000s, then boosted outlays to 60bnin 2008 and 65bn in 2009. But spending will fall back to about 54bn this year, a ccording toanalysts at Citigroup whereas to contribute their share of the 1,000bn, companies in thefive economies must invest 80bn a year for the rest of the decade.

Now the financial freeze is starting to thaw, energy suppliers with their relatively stablerevenues are among the more attractive borrowers in the market. But the demand for capitalwill be vast. Ian Temperton of Climate Change Capital, an environmental investment group,

argues that the UK wind industry, for example, will be a net abso rber of capital for the next

Capital expenditure by segment

Segment PercentageNetworks 32%

Renewables 26%

Water 18%

Nuclear 14%

Fossil generation 10%

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10 to 15 years. He adds: On aggregate it pretty much needs to reinvest every penny it makesfor that period.

Shareholders are aware that the requirements are daunting. In the three years since theBrussels summit, the stock market ratings of European energy companies have wilted as thescale of the investment challenge has become apparent. Investors are becoming increasinglyconcerned over the levels of capital spending required of utility companies, says Peter

Atherton of Citigroup. On current proposals, utility companies could account for 25 per centof all private sector capital expenditure in Europe. These concerns are depressing share prices,casting even more doubt on whether the enormous investment programmes can be funded.

Enterprising bankers have been looking at a range of unconventional sources of finance,including wealth funds and companies with an interest in renewable energy, such asGoogle.Last November China Investment Corp, the sovereign wealth fund, acted to spend $2.2bnbuying 15 per cent of the shares and 35 per cent of the wind power business of AES, the USpower company. Masdar, an Abu Dhabi clean energy company, stepped in to back theLondon Array, another large offshore wind farm, when Royal Dutch Shell pulled out. It isnow being courted by energy companies all over the world that are seeking funding.

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Ultimately, however, the only way that the industry will stand any chance at all of attractingthe capital it needs is if governments make commitments to guarantee investors returns. NickLuff, finance director of Centrica, the owner of British Gas, argues: If you put the rightframework around them, these assets are very suitable for pension funds and other long-terminvestors.

Every European country has a subsidy system such as feed-in tariffs, which offer set pricesfor electricity generated from renewables, paid for by a premium added on to customers bills.If investment is to grow, those subsidies will have to increase too. That means higher profitsfor companies and higher prices for consumers.

Hitting European consumers with higher energy bills, at a time when their resources arealready about to be squeezed by the increased taxes needed to bolster governments finances,could be a significant additional drag on economic growth. It is also likely to become anincreasingly contentious political issue.

Energy bills have already proved aflashpoint in a number of Europeancountries. Pierre Gadonneix lost his job aschief executive of EDF of France last yearafter arguing, to the fury of PresidentNicolas Sarkozy, that prices would have torise to fund investment. The severity of thattreatment may be unusual but energycompanies in Britain and Germany arefamiliar with newspaper headlines blastingthem for high bills and excessive profits.

Already, the cost of supporting renewableenergy has prompted cuts in some Europeansubsidies. Spain curbed its solar powersubsidy in 2008 and the industry therecollapsed last year. Germany plans subsidycuts for solar power to take effect in April.People want green energy, but are theyreally prepared to pay for it? asks Eons MrMastiaux. Thats a big question.

Part of his answer is that the investmentmust be made as cost-effective as possible,to keep the burden to consumers undercontrol. Yet much of it will be in equipmentthat pushes back technological frontiers and,as a consequence, is more susceptible todelays and rising costs.

The offshore wind farms of the future, forexample, will be built further from land, in

deeper water and on a larger scale thananything yet seen. The Areva EPR reactor at

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Olkiluoto in Finland, the first of the new generation of nuclear plants that will be built inEurope, is running well behind schedule and over budgeta monument to the risks inherentin ambitious construction projects.

Another answer is energy efficiency. If consumers and businesses use their energy more

carefully, with power-saving appliances, better insulation and so on, they can cut their bills byusing less energy, even as the unit cost is rising. Yet if consumers use less energy, returns toinvestors will be at risk. No one has yet implemented a successful business model that allowscompanies to have higher profits while selling less energy.

Mr Luff of Centrica argues that consumers will simply have to get used to the idea that energywill take up a growing share of their spending. He says there is a need for an educationprocess in terms of the understanding of the public and business about what energy bills will

be. The question, however, is what happens if the public is fully educated and not happyabout what it has learnt.

After the disappointment of the Copenhagen climate talks, European governments have beeninsistent that their commitment to cutting emissions and developing renewable energy was asstrong as ever. Britains Gordon Brown wrote an open letter on Monday pledging hisgovernments unstinting commitment both at home and internationally as we embark on thisvital year in the global battle to tackle climate change.

Yet if momentum continues to drain away from the climate talks with energy legislationstalled in the US, for exampleEuropean consumers are likely to question ever more vocallywhy they should carry the burden alone. Politicians would then have to find ways of

promising that the 1,000bn power bill can be cut.

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