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Power players have no power anymore (di Murad Harasheh)
The observer of the latest advancements at the international level regarding climate change actions can conclude that those actions taken at policy levels have counter effects on the oil, gas, and fossil power generators.
Following the global climate summit (COP21) in Paris in 2015, a Task Force on Climate Change and Financial Reporting (TCFD) was born lead by Michael Bloomberg, the establishment of the TCFD came as proposed by the Financial Stability Board (FSB) which was created by the G20 as a prudent response to the 2008 global financial crisis.
The TCFD recommends companies to disclose their risk exposures related to climate hazards and to be part of their routine financial reporting. Furthermore, The TCFD expands its reporting requirement to banks; banks now should disclose the lending to companies with carbon related risks. In this regard, most G20 countries require businesses to disclose material climate-related risks in their financial reports. These requirements have, in fact, two mains goals, first is to ensure the climate and sustainability governance by companies and banks to stay within the 2C degrees warming limit, and second is to ensure more transparent financial environment for financial market investors. The guidelines were directed specially to companies with high climate risks and those are involved in the transition to “Low-Carbon Economy” such as energy, transportation, construction and agricultural-related sectors, with a special attention given to the financial and banking sectors.
In another response to the global actions to mitigate climate risks, the World Bank has decided to end the financial support for oil and gas exploration after 2019 in developing countries, with some exceptional conditions to support oil and gas in very poor countries to ensure energy accessibility and local development, however the support has to have no conflict with 2015 Paris climate accords. The decision was originally taken in 2010 but under the pressure from lobby groups, the bank continued to support $1 billion a year for coal-fired stations.
At the European level, and in addition to the international requirements, power generators are facing a more stringent regulatory environment in which market players with power contracts exceeding a certain limit have to comply with various energy and financial regulations:
- 1- REMIT (Regulation on Energy Markets Integrity & Transparency) of 2011 aims at monitoring the wholesale European energy markets and enhances EU markets’ integrity, requires that physical power contacts has to be reported to competent energy authorities.
- 2- MIFID-II: (Markets in Financial Instruments Directive) of 2014 intends to enhance markets’ transparency and resilience, requires that certain classes of physically settled derivatives to be reported to the competent financial authorities.
- 3- EMIR: (European Market Infrastructure Regulation) of 2012, intends to increase the transparency and reduce risk in the Over-The-Counter (OTC) market, requires that power contracts negotiated on the OTC market (not on standard regular platforms) has to be reported the competent financial authorities.
In this context, figures show that the financial situation of the main power players in Europe is being affected by the more stringent regulatory environment; for example in 2015, 11 companies out of top 20 EU power companies reported a net loss equal to 13 Billion euros compared to 10 Billion euros for other 9 companies, out of the 13 billion losses, E.ON and ENGIE reported about 11.5 billion euro losses.
Seems that tough market conditions are hitting EU power companies due to the drop in the wholesale power price in Europe’s major markets. At the EU level, various factors may contribute to this tough situation, it can be the supply side related to low fuel and emission allowance prices, on the demand side related to low demand caused by the down economics activity, the growth of renewables, and the EU market integration which may bring power prices to its competitive levels. Another important issue related the European Emission Trading Scheme (EU-ETS); since its initiation in 2005, power companies were granted free allocations and they were able to pass-through the price of the allowance to the wholesale price, means that making windfall profits. However, since the beginning of the 3rd trading phase in 2013, power companies are not any more receiving free allocations which contributes to losing part of their market power to pass the cost of free allowance to final customers, this also proves that as we move to further trading phases, power sector’s profits and share prices are in decline.
The story does not stop on huge negative earnings but also to bank borrowing, the shocking data released by big American and European banks revealing the huge size of loans granted to energy companies and many of these are facing the risk of default after the oil and natural gas price drops. To give a glimpse on this, reports reveal that $123 billion is the US banks’ loan portfolio to energy sector; EU banks are also engaged in such huge amounts that exceed $100 billion and in both areas significant portions of these loans are unfunded which makes the default risk to rise to alerting levels. Therefore, European banks are under pressure to raise capital ratios in order to offset troubled loans.
At the end, the last decade shows that ambiguity is surrounding the power sector, and many structural changes have been happening due to stringent regulations, climate issue policies, and the economic downturns. However, policy makers have to be alert by concluding this article by the following questions:
- 1- Is it the right time to penalize the power players for the market power exercised during the last decades?
- 2- Are they really losing power, or they are just gaining power in another shape (in non-conventional generation market)?
- 3- Are we heading to a power crisis in the near future? In which main power players to be acquired by their national governments?
(3 gennaio 2018)
*Murad Harasheh, University of Milan-Bicocca. The views expressed herein are from the author’s perspective and do not necessarily reflect those of the institutions to which he belongs.