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The European gas market is currently undergoing major structural changes. These changes have the potential to deeply reshape the gas infrastructure industry over the coming years. They lead all players (Gas Infrastructure Operators, regulators, investors) to take a fresh look at the sector in a context of increased risk. To cast a light on these changes, we analyzed their drivers and their impacts, and interviewed top-level executives of 12 major European operators. This paper is a summary of our findings; it can help Gas Infrastructure Operators (GIOs), regulators, and investors to challenge their views on the changes at work and their appreciation of the risk in the industry.
The European gas market is undergoing major structural changes. Changes in the geography of production and consumption are restructuring gas flows in Europe. As domestic production (especially in the North Sea) sharply declines, new sources of gas will emerge. But the respective shares of the many pipeline and LNG suppliers and the routes that will be used are still to be determined. Similarly, the trend for gas consumption in the EU is uncertain. The role of gas in the transition towards a low-carbon economy will depend on many factors, among which the prices of gas, CO2 and coal, political orientations, the development of renewable energy production and electricity storage technologies. At the same time, shippers are increasingly moving towards short-term, tightly-adjusted bookings, making gas flows more versatile and infrastructure booking more uncertain. This change is driven by market rules and network codes defined at the European level, which incentivize short term bookings. In a context of general overcapacity with utilization rates well below bookings, shippers seize the opportunity of the expiration and non-renewal of Long Term Contracts.
Furthermore, some of the key sectorial trends may seem contradictory, for instance:
- The EU aims at transitioning towards a low-carbon economy by 2050 and pushes for the development of new gas infrastructure (LNG terminals, storage, pipelines), but the uncertainty associated with financing new infrastructure over its life time is high
- The market value of gas infrastructure capacity is low, but it is credited with an important role in the security of energy supply of the EU
- Market valuations of GIOs are very high, although the financial risk of these companies is on the rise because capacity utilization rates decrease and gas flows become more versatile
- The EU Gas Target Model (GTM) drives gas market areas towards consolidation, but the implementation of this process currently underway is challenged by many stakeholders, including national regulators that want to keep their prerogative.
These deep changes and contradictory trends create uncertainty for GIOs. In this context, is their current business model sustainable? In other words, are GIOs and their shareholders facing a risk of stranded assets? If so, what would be the mechanisms at work?
Our analysis and interviews of top-level EU gas infrastructure operator executives led to the following findings:
- Revenue cap regulation cannot entirely mitigate the risk of stranded assets, i.e ensure a fixed level of revenue. Indeed, if the utilization of an asset goes down to zero, there is reason to believe that regulators will not let end consumers bear the whole cost of it. Although most interviewees do not believe that regulators would remove stranded assets from the RAB before full depreciation, increased pressure on tariffs could lower the revenue of operators.
- In the case of Transmission System Operators (TSOs), the impact of adverse scenarios on the equity value could range between 0% and -20% by 2035.
- The risk level can be very different from one asset to another, because it depends on the type of regulation, current long-term capacity bookings, outlook for domestic demand, share of transit in bookings, and the long-term evolution of gas flows. For instance, transit pipelines are considered more exposed than storage because the latter is seen as critical for Security of Supply.
- The form of risk is also different for revenue-cap than for non–revenue cap regulated assets. For the latter, it takes the form of lower revenue proportional to lower bookings, whereas for the former it is a risk of increased pressure from the regulator on tariffs. Interviewees unanimously anticipate increasingly fierce negotiation with their national regulators. According to some of them, up to 10 to 20% of their revenue is at risk through increased pressure on WACC and OPEX incentives. Thus, they emphasize the importance of negotiation to realign the RAB depreciation rate with the anticipated utilization level of assets.
- There is a range of possible mitigating actions GIOs can take to significantly reduce risk, but their relevance has to be assessed on a case-by-case basis due to the specificities of each GIO:
- Negotiations with regulatory authorities are paramount to ensure regulatory stability and secure appropriate allowed revenue. CAPEX and OPEX allowances and incentives, WACC level and RAB depreciation rate are key for security of supply, quality of supply and return on investment for assets amortized over decades.
- Energy policy makers can provide the stable political and regulatory framework over 50 years necessary for new investments in gas infrastructure. This requires the industry to advocate the role of gas more fiercely. Indeed gas has an essential part to play in the next 20 years, in combination with intermittent renewable electricity and as a key contributor to European energy supply’s security. Several objectives can be pursued for a more stable framework, including a stable CO2 pricing mechanism and a revised Gas Target Model (GTM). A full-fledged roll-out of the GTM is not considered likely by most Interviewees beyond the implementation of national initiatives such as HoKoWä (harmonization of entry tariffs for all German TSOs) because of the great diversity of national situations across Europe. Some view it as beneficial from an investor’s perspective because it would socialize the risk of stranded assets at a European level.
- The development of green mobility and green gas (biomethane and hydrogen generated by electrolysis using green electricity) is an opportunity for GIOs. Since it is likely to play a major part in their future, they will need to adjust to it: prospective studies highlight the possibility of gas networks de-carbonated over 50%. The question is: how can they support it? Interviewees generally favor direct involvement in green gas developments, which requires creating innovative models with regulators. Although they see green mobility as a major driver to sustain gas demand in Europe, they differ on their legitimacy to be direct players in this field.
- External growth can create value by improving OPEX efficiency and reducing risk. However, value creation for operators and investors highly depends on companies. It is also limited by incentive OPEX regulation and the systemic sectorial risk in EU gas infrastructure. For GIOs seeking to invest in other GIOs, identifying the level of value creation is key because financial investors are driving M&A transaction levels prices way above net RAB value. In this context, more and more GIOs are considering merging with other types of infrastructure: LNG, transmission and storage; gas and power.
Threats to the sustainability of the business model of GIOs are on everyone’s mind. However, our Interviewees strongly assert their confidence in the long lasting role of gas in the European energy mix. This may reflect the fact that scenarios of drastic demand reduction in the long run are not considered likely. Indeed, the creation of an effective CO2 pricing mechanism, or a lowering of costly renewable generation targets could radically change the outlook.
This confidence in the future of gas in Europe is also reflected in the appetite of private equity players for such assets. Moreover, price paid in recent transactions (although widely judged as excessive with respect to pure industrial criteria) is a sign that investors believe in the possibility to increase their value.
Possible actions to mitigate risk and increase value do not have the same impact and accessibility. Although none should be neglected, the ability to prioritize and implement these actions will be key for GIOs at a crucial time for the gas infrastructure industry: initiative should be taken today in order to influence long term trends.
Crédit photo : Luca Galuzzi