by Tony Daltorio, Investment U Research
Tuesday, March 30, 2010
Over the last several decades, the Western world has made reducing greenhouse gas emissions one of its top priorities.
Developing renewable energy sources is all well and good… but Europe especially might want to step back and consider its practicality.
The continent leads the world in renewable energy efforts. And it wants to keep that distinction, as evidenced by recent pledges to:
- Slash greenhouse gas emissions by 20% compared to 1990 levels… by 2020.
- Rely on renewable energy for 20% of their energy needs… by 2020
When they made those extremely optimistic goals, they did have a few other things on their mind other than saving the planet. Understandably, they want to pull away from their dependence on Russian natural gas supplies. But regardless of the reason, making good on their promises won’t be easy.
To meet those goals, European utility companies have to invest about €1 trillion ($1.4 trillion). Worse yet, they have to take care of that at a time when they also have to replace the aging infrastructure.
It’s hardly a promising situation…
A Lack of Green for Renewable Energy
Those utility companies could choose the cheap route of replacing coal-fired power plants with the gas variety. That would halve the amount of carbon dioxide emitted per megawatt of electricity.
At least they could if they were allowed to. European leaders have passed legislation instead, which made the decision for them. So since the government wants wind farms, the utilities have to oblige.
That works wonderfully for Denmark’s Vestas Wind Energy ADR (PINK: VWDRY) and its competitors. And it makes the governments behind that decision happy as well.
But the utility companies themselves don’t fare nearly as well. And they have to actually pay for those decisions… the European equivalent of an “unfunded mandate.”
That puts a big strain on utilities, which also have to deal with tight, financial market conditions and decreased demand. Unable to fund the status quo, they have already cut their capital spending sharply this year.
For example, the utility industries of Germany, France, Britain, Italy and Spain – Europe’s largest economies – invested some €35 billion a year for most of the 2000s. They then boosted their outlays to €60 billion in 2008 and €65 billion in 2009.
This year, however, they can only afford about €54 billion. Yet they need to spend a collective €1 trillion by 2020. That requires them to shell out €80 billion per country per year for the rest of the decade.
Possible Solutions For European Utility Companies
European utility companies’ shares have vastly underperformed the market for the past few years.
Italy’s ENEL ADR (PINK: ENLAY), Spain’s Iberdrola ADR (OTC: IBDRY), France’s EDF ADR (PINK: ECIFY), Germany’s RWE ADR (OTC: RWEOY) and E.on ADR (OTC: EONGY)… their performance keeps dwindling as investors learn more and more about the challenge they face.
Citigroup’s Peter Atherton explains it this way: “On current proposals, utility companies could account for 25% of all capital expenditure in Europe. These concerns are depressing share prices, casting even more doubt on whether the enormous investment programs can be funded.”
Ultimately, governments have to step in if they expect European utilities to attract the capital they need. They have to either tempt investors back into the market. Or they have to cut their ambitious renewable energy targets to something more reasonable.
If done properly, limited government backing could work as well.
The Reality… And What To Do About It
Nick Luff, the finance director of British utility, Centrica, believes that: “If you put the right framework around them, these assets [wind farms, etc.] are very suitable for pension funds and other long-term investors.”
However, recent history suggests that the government won’t be sending support anytime soon. Already, supporting renewable energy has prompted cuts in some European attempts.
Spain curbed its solar power subsidy in 2008, causing the industry to collapse the next year. And Germany plans similar cuts effective in April.
Of course, utility companies could just raise rates to procure the necessary funding. But high utility prices have already created enough of an uproar that they probably won’t bother trying that route.
Frank Mastiaux, the head of the renewable energy business at German utility Eon, summed up the dilemma succinctly: “People want green energy, but are they really prepared to pay for it? That’s a big question.”
Until Europe makes up its mind one way or the other, investors should steer clear of those stocks. Because right now, the European path to lowering emissions quite simply is not working.
Aggressive investors may even want to consider shorting ETFs like WisdomTree International Utilities Fund (NYSE: DBU) that focus on those firms.