Utilities go back to the 19th century

The shift from electricity transmission to distribution will cause a seismic transformation in Europe’s power market, Dominic Nash, senior utilities analyst at Macquarie Group argues, and have financial consequences for the region’s listed utilities.

A quiet revolution is taking place among Europe’s power utilities.

The high voltage transmission lines that since the onset of last century have transported electricity to consumers hundreds of miles away are carrying a decreasing load.

With the expansion of wind farms, solar panels and the proliferation of smaller thermal plants, power is increasingly produced and distributed close to the end users, without the need for transmission.

More power will be generated, controlled and distributed locally, as was the case before the introduction of transformers in the 1880s facilitated long distance transmission. Electricity utilities are going back to the 19th century.

We estimate the percentage of installed power capacity that does not use the high-voltage transmission grid will surpass, on average, 20 per cent in Europe by 2020 and up to 37 per cent in Germany.

National Grid, which operates Britain’s power lines, now expects to connect less than half the new power generation it previously estimated over an eight-year plan.

This rise in distributed generation is a disruptive and irreversible trend.

Utilities will move away from a model of large centrally dispatched stations to more localised power generation and control networks, leading to reduced use of the transmission network, and, at the same time, increasing network instability.

Falling wholesale prices

Power prices in Europe are already under pressure as this transformation progresses and could stagnate or fall further as renewables and other distributed-type supply continue to expand.

We do not expect any European markets to experience a capacity shortfall, placing further pressure on prices.

The economics of power plants is guided by the value of electricity spreads, a function of the supply and demand balance in the market. An oversupplied market will push these spreads close to zero. A spread below zero means plants will simply not run.

Industry winners and losers

There will be winners and losers in this disruption.

Those companies with large exposure to the growth in power distribution will outperform. Companies that can demonstrate flexible generation capacity are also better placed in this environment.

There will also be a significant increase in the importance of ancillary services to safeguard the stability and security in the power grid. Nash says these could comprise up to 80 per cent of a plant’s gross profit as wholesale prices continue to decline.

A number of new technologies such as solar rooftops, low-voltage distributed generation and energy storage may gain a more prominent role in the next decade.

Inevitably, however, many generators will close. The European Network of Transmission System Operators for Electricity estimates about 30 gigawatts of supply will be turned off in Europe in the next five years. The majority of this will involve the closure of coal and ignite plants, which typically have high fixed costs.

Others may repower into a distributed generation network or target new investments, such as open cycle gas turbines.

In the UK there will also be a large number of coal fire power station closures across the country.

The disruption caused by this renaissance in electricity distribution will be transformative, adding to the conundrum of falling power prices. The scope of this shift in European utilities is clear, and governments, regulators and investors alike should recognise the effects it may have on future investment and services.