Source of opportunities
Countries in CEE must work on increasing their energy supplies if their emerging markets are to grow. At the moment the emphasis is still on expanding domestic production, for example with the help of coal and nuclear energy. Eventually these countries will also invest more in other sources such as renewable energy. And they will have to invest in their gas pipeline infrastructure. Expanding interconnections between countries is a precondition for competitive and affordable prices.
By Rodolphe Olard, Global Head of Natural Resources Advisory at ING, and Alexander Alting von Geusau, Global Head of Utilities at ING
The one thing that is crucial for future energy supplies is having a mix. Countries would be wise to not put all their eggs in one basket of energy sources, such as natural gas, coal or nuclear energy. Instead they should make use of multiple sources, including sustainable sources. Having a mix is also important when it comes to the infrastructure. Countries that want to benefit from favourable prices in the future must see to it that they import from more than one country. Working together is necessary to achieve this mix. This is a hurdle that should not be hard to overcome for countries in the CEE region. After all, Bulgaria, Romania, Hungary, Poland, Slovakia and Czech Republic are used to wheeling and dealing with their neighbouring countries as a result of their geographical location.
Nevertheless, CEE countries have not really made much headway when it comes to working together in the field of energy. For the time being the countries seem to be mainly focusing on national concerns when it comes to energy security. After the fall of the Berlin Wall the countries naturally focused on their own independence. Countries in the CEE region did not want to become too dependent on Russian gas. Their drive for independence is visible in the investments they have made and are still are making in the energy sector.
ING’s Global Head of Utilities Alexander Alting von Geusau explained that CEE countries have invested a great deal in thermal power plants such as coal and lignite. “Poland is a good example. The country wants to be as self-sufficient as possible and not have to depend too much on Russia or Western Europe for their energy supplies. Around 90% of the power production in Poland is derived from coal. They have huge coal reserves that can provide cheap fuel to their power plants. The balance of the power production mainly comes from biomass and wind energy.” The security of power supplies is also a priority in other CEE countries although differences do exist in the choice of energy sources. Countries south of Poland like Czech Republic and Slovakia secure their energy supplies mainly through a mix of coal, hydro, nuclear energy and a limited amount of gas. Governments in CEE countries are encouraging investment in new nuclear power plants to secure future energy independence.
The fact that this need for independence is as prevalent as ever is also visible in recent M&A activity. Alting von Geusau: “Local and regional players dominate the market and keep consolidating further while large Western European energy giants are leaving. Vattenfall, for instance, sold its assets to the Polish players Tauron and PGNiG, and we are seeing the emergence of new energy players such as EPH Group (Energetický a pr myslový holding) in the Czech Republic. That company was created through a large number of acquisitions over a period of eight years, and ING played an important role in the transformation of EPH into a major player in the CEE region.
Renewable energy is also an option worth considering for countries that want to be self-sufficient. After all, renewable energy sources are not only less polluting and risky than coal, lignite and nuclear energy; they also ensure that a country is less dependent on imports of raw materials and electricity. A number of CEE countries have laid a good foundation for this with the help of hydropower. Although they want to continue to expand in this area, the subsidies required for constructing renewable energy projects will add a significant amount to energy prices. This is difficult to justify at a time of economic slowdown. In the medium term this growth in these Eastern European countries will mainly have to come from biomass and wind energy. The target for wind energy is a massive 17.5 gigawatt. Various countries already have experience in this area, including Poland and Romania (ING has supported wind energy projects in both countries).
Economic powerhouse Germany can serve as an example when it comes to investing in renewable energy. The country is proof that targets can be met if the government supports private investment with predictable subsidies. The cost to the consumer and industry, however, is very high as evidenced by every increasing power prices driven by the generous subsidy system. Therefore is has been very difficult for CEE countries to follow Germany’s lead in the current economic climate. It started off well. CEE countries had ambitious growth targets of 20 percent for renewable energy. These targets have now been relaxed and lowered in nearly every country (with the exception of Romania). And it still remains to be seen if these less ambitious targets will be met.
According to Alting von Geusau subsidy schemes in CEE countries, as in many Western European countries, have often proved to be unreliable. “Governments unexpectedly changed the subsidies in a number of countries, sometimes even retroactively for existing projects. This has made investors wary and with the uncertainty of future subsidies in most countries it is very challenging to finance renewable projects in CEE.” This is aggravated by the euro crisis and the low prices of coal and CO2 as well as the fact that not all the grids are ready for supplies from sustainable sources (that are less stable and dependent on the sun and the wind). The example set by Germany shows that this is a serious issue that needs to be resolved because the grids in this West European country are already struggling to cope with energy excesses during extremely sunny or windy weather.
That brings us to another aspect of energy supplies that the CEE countries will have to invest in in the not too distant future: the infrastructure - not only for electricity transmission, but also gas transport. The interconnection is this region is still quite limited for both gas and electricity supplies. When it comes to the gas infrastructure Russia in particular has been working hard on a web of pipelines including Nord Stream and South Stream. Russia and Gazprom are making significant investments to increase the number of routes supplying the European gas markets. The South Stream project in particular is aiming at improving security of supply to Eastern and Southern Europe. It is a long term investment that is supported by a number of countries in the CEE as well as by some of the largest European oil and gas and energy companies. ING is assisting in this endeavour through the provision of financial advisory services for the offshore section of the pipeline system across the Black Sea as well as for the onshore section in Hungary. A number of other pipeline projects are seeking to provide supply routes from Azerbaijan via onshore Turkey. It is fair to say that debt markets tend to respond well to such projects, as demonstrated by the success of Nord Stream financing.
A great deal can also still be achieved when it comes to the electricity infrastructure in the CEE region. Dozens of billions of euros are needed to adapt grids to modern-day requirements. Hefty financial injections are required not only for maintenance and improvement but also to increase the interconnectivity between countries. The electricity grid in Europe can be divided into seven power islands (two of which are in the CEE region) within which energy is predominantly exchanged. According to Alting von Geusau many more connections are possible and necessary to achieve a level playing field with fairer price setting. “The development of this interconnection in the CEE region is progressing slowly. That is because of this previously mentioned focus on energy security. Local ‘monopolists’ are of course also not applauding cheaper imports.” Alting von Geusau believes that interconnectivity should be a priority in European politics and investments could be promoted through a reliable European subsidy scheme. “The European Investment Bank could create incentives for this. That would encourage large investors to commit. Right now the electricity transmission market is still quite domestically orientated. This could be different. A grid operator like TenneT in the Netherlands and Elia in Belgium have proven that cross-border European transmission companies can be created and efficiencies can be achieved if countries work together.”
Alting von Geusau believes that interconnection can be further improved with the support of the European Commission and banks such as the EIB. ING can play a useful role in financing infrastructure projects and improvements across Europe. “We know a lot about how the global energy market works. We view the situation through pan-European glasses. We work together with large energy companies. And we have a wealth of experience in local markets where ING is present. This, combined with our knowledge about the region, makes us an ideal partner for financing energy projects in Central & Eastern Europe.”