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Even before the coronavirus shut down most of Europe, there was huge political will behind stopping climate change. Every EU member state had signed the Paris Agreement: an ambitious plan to halt global warming above 2% of pre-industrial levels. Furthermore, every member state had also agreed to support the European Green Deal: an ambitious plan to achieve climate neutrality in Europe by 2050.

This last initiative – the European Green Deal – is now being described as a compass that can turn the coronavirus crisis into an opportunity to stop climate change. It is seen as a chance by some to rebuild Europe’s economy differently so it can transition more easily towards a low-carbon model. And, at the heart of this vision lies the utilities sector.

The new EU Green Deal   Some recent signs show that the commitment to a greener economy did not fade away with the health crisis, and could actually become even stronger. The European Union has placed the fight against climate change at the heart of its plans to rebuild the coronavirus-ravaged economies across the region. In the wide ranging plans, allocations of: €91bn a year for home energy efficiency and green heating €25bn of renewable energy €20bn for clean cars over a two year period €60bn has been pledged for zero-emissions trains 2m charging points over the next five years. 1m tonnes of clean hydrogen produced. The EU’s plans have the potential to reach further than just its members states, a proposed border tax on carbon-intensive industrial imports from other nations could potentially raise up to €14bn. It is hoped that the investment will create one million jobs (a green army) and attempt to transition workers from emission heavy industries into the developing green economy.

Different technologies will be used by utility companies to tackle climate change

One of the biggest challenges Europe faces is that the energy mix and grid infrastructure differ considerably across the continent. Differences in geography, population size and infrastructure development will have a strong influence on the route each EU state takes towards decarbonisation. Every European nation will, however, experience a dramatic change in how energy is generated. Each one will also be left with a very different energy mix to what they have today. Behind this change are a few powerful structural trends that will increase energy demand in the future. These include the electrification of Europe’s road network and the increasing number of data centres needed to support the digital economy.

According to the European Environment Agency, electric vehicles will increase their share of energy demand to 9.5% by 2050.² Globally, the widescale proliferation of data centres could account for as much as 13% additional global energy demand by 2030.³

This extra demand on Europe’s energy grid will place the utilities sector, at the forefront of the energy transition.

Electric vehicle energy demand as a fraction of total electricity demand per country in 2050
Increase in demand (%)

Source: European Environment Agency (EEA)

Utility stocks will benefit from the low-carbon energy transition

The utilities sector has long been considered part of the climate change problem. Energy companies within this sector currently produce 29% of all EU greenhouse gas emissions.⁴

However, they are also part of the solution. Europe’s utility companies are leading the way especially when it comes to renewable energy. In fact, Europe has some of the most developed renewable energy infrastructure in the world and is considered a global leader in this field. This is not surprising. Europe has the right geography for generating renewable energy and it is able to accommodate most types of renewable energy technology. For instance, in the south of Europe, there is no shortage of sunshine, which makes it ideal for solar power. Meanwhile in the north of Europe, the conditions are ideal for wind power.

The future development of renewable capacity:   The International Energy Agency forecasts that renewable energy capacity will rise by 50% by 2024, as demand keeps rising, and a growing set of regulations and policies aim to curb climate change. Estimates show that in order to be carbon-neutral in 2050, 86% of European electricity will have to come from renewable sources by then, versus 21% in 2018.

Europe’s renewable energy is now more attractive than coal

Thermal coal is no longer the most economic means to generate electricity. In fact, more than half a trillion dollars could be saved by cancelling new coal power projects globally.⁵

Onshore wind and solar power are leading the way to replace coal. They have both experienced plummeting levelised costs of energy (LCOE) – a measure that is used to compare different methods of electricity generation – thanks to technological advances that have unleashed significant Capex and OpEx savings.

Global benchmarks - PV, wind and batteries

Source: Bloomberg NEF. Note: The global benchmark is a country weighted-average using the latest annual capacity additions. The storage LCOE is reflective of utility scale Li-ion battery storage system with four hour duration running at a daily cycle and includes charging costs assumed to be 60% of wholesale average power price.

 

Interestingly, the market is yet to price in this trend and utility stocks are, therefore, yet to be rerated. However, this is unlikely to last for long. Utilities have already caught the attention of investors who are focused on ESG.

These investors have realised that the energy transition will dramatically alter the way Europe’s utility companies operate. This could be at the start of a new growth era for utility stocks, the likes of which have not been experienced in generations.

Europe’s utility industry has a bright renewable energy future

Solar power and onshore wind farms have already proved their worth in Europe. The next frontier is likely to be floating offshore wind farms.

The development of high-voltage direct current lines can bring offshore wind energy thousands of kilometres inland with very little transmission loss. This energy will be delivered where it is most needed – Europe’s largest cities.

There are other factors too that could serve to further enrich Europe’s renewable energy mix. For instance, mass battery storage could lower the LCOEs of renewable energy even further. Power-to-gas technology could also use the excess energy from wind and solar power to produce hydrogen from water, which could then be stored and used when needed.

Utilities outperforming other equity sectors in Europe

Total returns in % including dividend, as of 18/05/2020 (source Bloomberg). Past performance is not a reliable indicator of future results.

 

Utilities are already well known for their attractive cash flow generation and dividend yields that they offer. It is not surprising that this sector has outperformed the rest of the market.

Allianz Climate Transition - Utility stocks will benefit from the low-carbon energy transition

Investing in the utilities sector requires a selective approach. This is important if you want to take advantage of the sector’s potential. The companies that have rewarded investors the most so far are those that have an ambitious and credible climate-conscious strategy. For instance, Italy’s Enel and Spain’s Iberdrola have both outshone the rest of Europe’s utilities sector.

Both companies are leading Europe’s energy transition in their own ways. Enel has launched Enel X – an operation dedicated to developing future solutions for the energy transition. Meanwhile, Iberdrola is a big believer in offshore wind power and has already built an impressive international portfolio of developments.

Ørsted   Viewed as a leader in offshore wind.The Offshore market is currently only 2% of European production, although offshore wind has the potential to be the largest source of regional power production between 2030 and 2040. Orsted’s current offshore capacity is 3.6GW out of the total global market of 20GW Last year, approx. 85% of Orsted’s business (EBITDA) was offshore. Most of Orsted’s business is in Europe with a particular focus on the UK and Denmark. By 2026 it is estimated 20% of the capacity will come from the US which becoming increasingly importance. The company’s stock has a total return of +73.8% since 01/01/2019 (in local currency – DKK) This is not a recommendation or advice (solicitation) to buy or sell any particular security. A stock mentioned as example above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date

Enel   Is now recognized by investors as a credible leader in renewables, notably claiming the objective of a zero coal-based power generation by 2030. In spite of the ongoing Covid-crisis, Enel recently confirmed its commitment to increase its focus on sustainability, which boosted its sales revenue in 2019 (+6.1% vs 2018). On a press release from April 30th, the company notably announced that the weight of sustainability objectives would increase from 25% to 30% in the short term variable management remuneration, and from 10% to 25% in the long term component. This is not a recommendation or advice (solicitation) to buy or sell any particular security. A stock mentioned as example above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date

 

Clearly, there is a risk premium to be earned in selecting utility stocks that are divesting from coal energy generation. Investors need to consider the timeline utility companies are following as they decarbonise the energy they provide.

The increasing use of financing instruments, such as green bonds, are an important consideration. Their ability to negotiate power purchase agreements could also have a positive impact on profitability.

For investors, it is a matter of actively researching and analysing utility companies that sit in this sector. There will be winners and losers from the energy transition. Picking those that are likely to win is therefore crucial.

Allianz Climate Transition aims to support and profit from European companies that are best equipped to tackle climate change. As an Sustainable Development Goals fund, the fund’s objective is both to generate financial performance and positive climate performance. The strategy invests in “Green Utilities” and therefore gives investors the opportunity to benefit from the potential upside outlined in this document. For further information about the fund please visit our dedicated fund details page.

 

 

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¹Frost, R. (6 April 2020). Coronavirus crisis fast-forwards green energy 10 years into the future. Euronews. Retrieved April 29, 2020, from <https://www.euronews.com/living/2020/04/06/coronavirus-crisis-fast-forwards-renewable-green-energy-10-years-into-the-future>
²Electric vehicles and the energy sector - impacts on Europe’s future emissions. (19 September 2016)., p. 3. European Environment Agency
³Andrae, A., & Edler, T. (2015). On global electricity usage of communication technology: trends to 2030. Challenges, 6, 117–157.
⁴How are emissions of greenhouse gases by the EU evolving?. (2020). Shedding light on energy in the EU. Retrieved May 11, 2020, from <https://ec.europa.eu/eurostat/cache/infographs/energy/bloc-4a.html>
⁵Gray, M., & Sundaresan., S. (March 2020). How to waste over half a trillion dollars: the economic implications of deflationary renewable energy from coal power investments, pp. 5, 9-10, 18-19. Carbon Tracker Initiative

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A security mentioned as example above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date. 
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