Europe's energy infrastructure is ageing and development in the sector is too slow. The European Union (EU) and European Commission (EC) have set high investment targets to be met in 2020 and 2030. To meet these targets, the energy sector will require significant investment in the form of EU funds as well as funds from member states and private investors. A sufficient pipeline of viable energy projects to be invested in will also be required. The EU and EC have implemented a number of initiatives and funds in recent years with the aim of aiding these requirements.
There has, however, been minimal progress in bringing them together into a clear framework to help project developers and investors use them for greatest benefit. In an attempt to unlock investment, a labyrinth of initiatives has, over time, created confusion and uncertainty.
WHERE ARE WE NOW?
Currently, the European internal market does not work properly – the energy system is underperforming. The fragmentation and market design does not allow for sufficient investments and competition. Energy islands continue to exist in the EU; countries and regions are not properly connected and cannot reap the benefits of the internal energy market.
The EU has recently agreed on even more stringent goals, aiming to lower CO2 emissions by 40 per cent compared with 1990 and achieve a 27 per cent increase in renewable share. This changing generation requires adaptation of the transmission networks and grids.
European electricity and gas transmission systems, particularly connections across borders, are insufficient to bring about the internal energy market. The energy sector across Europe has evolved rapidly over recent years and the changes in the power generation mix require a different approach to the structure of Europe's grids that transport power and gas.
Energy islands and disconnected regions need to be brought out of isolation and Europe's energy markets need to be better integrated. To date, there has been limited support for cross-border transmission at an EU level. Energy infrastructure has been a matter for each member state and each country has had a domestic focus on development and structure. Now, energy infrastructure has been elevated to a European level.
FILLING THE FUNDING GAP
The EU estimates that, in the next six to 10 years, around €200 billion will be needed for the construction of trans-European gas pipelines and electricity transmission grids. More specifically: €140 billion for high-voltage electricity transmission systems, storage and smart grid applications; €70 billion for gas pipelines, storage, LNG terminals and reverse flow infrastructure (to allow gas to flow in both directions); and €2.5 billion for CO2 transport infrastructure. Compared with the period 2000 to 2010, this would mean a 30 per cent increase in investments in the gas sector, and a 100 per cent increase in the electricity sector.
Others estimate that more than €1 trillion will need to be invested into the EU's energy sector in the next five years alone. In the same vein, many institutions agree that there is a global energy infrastructure investment requirement of at least $50 trillion until 2035.
Traditionally, only banks have been able to provide consistent funding to (underfunded) government pipelines of infrastructure projects. However, the need for long-term energy infrastructure has outgrown the capital available from banks and their ability to provide debt has declined.
Against this backdrop, it is clear that investment is needed. With the abundance of funds ready and willing to be put to work by, primarily, global pension and insurance funds as well as dedicated infrastructure funds, we are no longer in the midst of a funding gap. However, there remains a perceived gap between the required investment and the available funding for the commercially less viable projects.
AN ENERGY UNION
On 25 February 2015, the European Commission adopted a framework strategy for a resilient energy union with a forward-looking climate change policy, the purpose of which is to outline the EC's vision of an Energy Union.
To streamline regulatory regimes across the EU and mobilise funds to upgrade and extend transmission systems, in particular interconnectors, a vision is put forward of an integrated, continent-wide energy system where energy flows freely and competitively across borders based on best use of resources.
Interconnectors allow increased diversity of supply in that, when fully built out and optimised, they will, for example, provide renewable energy generated in the North Sea and Norway to energy-intensive industry in Germany or gas from North Africa to France via Spain. In addition, they will contribute to avoiding excessive investment in peak generation and can help break the isolation of the energy islands (a good example of which is the recently announced plans to build a gas pipeline to supply internationally-sourced natural gas from Poland to the Baltic States).
INVESTMENT AND PIPELINE
While there is a clear need for investment in energy infrastructure and interconnectors, there is a lack of it. The global financial crisis hit Europe hard and many EU countries are still struggling with high unemployment, limited growth (if any) and ailing investment despite huge needs. As a consequence of the economic and financial crisis, the level of investment has dropped off considerably.
According to the EC and the European Investment Bank (EIB), the main reason for weak investment levels is low investor confidence, rooted in low expectations of demand, fragmentation of financial markets and lack of risk capital to catalyse investment. For these reasons, together with a lack of confidence in the common currency and high levels of indebtedness in parts of Europe, access to credit remains difficult, in particular for long-term financing of projects and for small- and medium-sized companies (SMEs) in hard-hit member states.
This lack of investment has been exacerbated by austerity measures in most if not all member states. It is neither possible nor advisable for the EU and its institutions to provide all of the funding required to bring back growth and investment to Europe.
This has led the European Commission to push hard for a gigantic €315 billion investment plan for Europe – the Juncker Plan, which many commentators initially viewed with grave scepticism, but which is now rapidly taking shape.
The EC has further acknowledged that corporates and projects in the EU are too dependent on bank debt, which makes the real economy less resilient in case of a banking crisis. Compared with the US, the EU average of capital markets (debt and equity) against bank debt is 30 to 70 whereas in the US, the ratio is the opposite. The EC aims to deliver a framework under which reliance on bank debt will be less dominant – the Capital Markets Union.
There remains however a perceived lack of viable projects in the pipeline. During the global financial crisis, commentators and policy makers were focused on the funding gap – hence credit enhancement as a tool to promote investment. While the gap still exists, it has arguably moved from a shortage of debt, to a shortage of projects that benefit from ready government backing.
For investors to move into a certain country or investment space, there needs to be a sufficiently substantial pipeline of investable, bankable and feasible projects. One or two projects, or a vague promise of a pipeline, is not sufficient. One of the most important tasks for the EC is to ensure there is a visible, transparent and accessible pipeline of investable, bankable and feasible projects.
NEED TO CONNECT THE DOTS
So far, there have been a number of initiatives to promote and incentivise investment in energy infrastructure: Projects of Common Interest (PCIs) (including the Connecting Europe Facility (CEF); EU Cohesion Policy Funds; the EIB's Project Bond Initiative; the European Energy Programme for Recovery; European Fund for Strategic Investment (the Juncker Plan); and financing under the European Structural and Investment Fund (ESIF), pooling resources to finance economically viable investments that counter market distortion and fragmentation.
The Energy Union is intended to bring cohesion to the existing financing schemes to maximise impact. However, neither the Capital Markets Union nor the Energy Union can be approached in isolation. The success of the Energy Union is dependent on the financing made available, both publicly and privately. Ultimately, only properly integrated European capital markets will bring the required funding across EU for the Energy Union. Thus, only by connecting the dots and avoiding silos can these next steps in the development of the EU be the success the European Commission is seeking.