No volte-face for power prices

Overcapacity and the commodity slump have been depressing wholesale electricity prices for more than a year. Investors need to adapt to the new normal.

If there’s one thing investors don’t like, it’s being left in the dark. Distressed deals notwithstanding, increased volatility in commodity markets has thrown a chill on capital deployment in the space. Much uncertainty remains as to where coal, gas and oil prices are currently headed.

While that makes most consumers of the stuff happy, the commodity slump is casting a shadow on an adjacent sector: the wholesale power market. Electricity prices, indeed, have followed those of hydrocarbons over the last 18 months. A study by Moody’s published today estimates that European baseload power prices have fallen by up to 30 percent since the start of 2015, broadly on par with the decline of coal and gas.

Few insiders think they will rapidly recover; in the longer run most simply don’t know. “Who has visibility today on where power prices will be longer out into the future than five or six years”, a banker recently asked us to consider.

The trouble is that the price of ‘pure’ commodities, such as oil and gas, are not the only ones impacting the electricity market. How much carbon should cost is also crucial to calculating what one will pay for power, and it’s a parameter largely determined by political decisions. Most importantly, the EU’s renewables push in the wake of COP21 will likely continue to pressure power prices, potentially offsetting any gain on the commodity side.

Tellingly, many utilities are already considering low prices a new normal. This is reflected in their latest business plans, most of which are not assuming that wholesale prices will go back up – at least not to the levels they were at three or four year ago, says Paul Marty, a vice president at Moody’s. Long-term strategies are being reshaped as a result: a core group of utilities are moving away from commodity-exposed businesses, favouring safer plays like subsidised renewables or energy services.

For infrastructure investors, there are several likely consequences. Opportunities will emerge as utilities seek to offload assets, in line with the trend observed in recent years. Some won’t be suited to low-risk, yield-focused investors, since part of the assets power groups aim to divest are among those most exposed to merchant risk. But some will – particularly when utilities are looking to recycle capital held in operational assets into new projects, triggering secondary sales. Keep an eye on offshore wind for a case in point.

But depressed prices will give investors a headache as well. “Electricity prices are the big elephant in the room,” a fund manager told us this month. On the most exposed assets, he adds, volatility is making it very hard to anticipate returns. The corollary: fund managers can’t skimp on developing capabilities to analyse power price risk anymore – just like they can no longer forecast traffic simply through educated guesswork.

Power price volatility is the main reason why, despite more stable regulation and plummeting input costs, return expectations on renewable assets haven’t really weakened. Investors who switch on fast to the new normal stand to reap good rewards.

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