6 FEBRUARY 2008

EUROPEAN UTILITIES BASICS - ELECTRICITY & GAS INDUSTRY OVERVIEW

European Utilities Research Team +44 20-7325 9069 Chris RogersAC Sarah LaitungAC +44 20-7325 6826 Javier Garrido +34 91- 516 1557 Sofia Savvantidou +44 20-7325 0650 Nathalie Casali +44 20-7325 9023 For specialist sales advice, please contact: +44 20-7325 8623 Ian Mitchell

christopher.g.rogers@jpmorgan.com sarah.l.laitung@jpmorgan.com javier.x.garrido@jpmorgan.com sofia.savvantidou@jpmorgan.com nathalie.x.casali@jpmorgan.com

ian.e.mitchell@jpmorgan.com

For full JPMorgan Global Utilities Team details, please see inside cover

J.P. Morgan Securities Ltd.
See page 117 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. The analysts listed above are employees of either J.P. Morgan Securities Ltd. or another non-US affiliate of JPMSI, and are not registered/qualified as research analysts under NYSE/NASD rules, unless otherwise noted.

Global utilities team
Europe Europe Asia Pacific Asia Pacific

Chris Rogers - Germany, Nordic, UK Energy & CO2
christopher.g.rogers@jpmorgan.com

Edmond Lee, CFA
edmond.ch.lee@jpmorgan.com

Sofia Savvantidou, CFA - France, Greece, UK Water sofia.savvantidou@jpmorgan.com Javier Garrido - Spain, Italy
javier.x.garrido@jpmorgan.com

Ajay Mirchandani – Hong Kong, Philippines
Ajay.mirchandani@jpmorgan.com

Boris Kan – China
boris.cw.kan@jpmorgan.com

Nathalie Casali
nathalie.x.casali@jpmorgan.com

Shilpa Krishnan – India
shilpa.x.krishnan@jpmorgan.com

Sarah Laitung
sarah.l.laitung@jpmorgan.com

Abid Jamal – Pakistan
abid.r.jamal@jpmorgan.com

Olek Keenan, CFA - Credit
olek.keenan@jpmorgan.com

Lucius Chong – Malaysia
lucius.j.chong@jpmorgan.com

For Specialist Sales advice, please contact Ian Mitchell
ian.e.mitchell@jpmorgan.com USA USA

Sukit Chawalitakul – Thailand
chawalitakul.sukit@jpmorgan.com

Ami Tantri – Indonesia
ami.t.tantri@jpmorgan.com Russia Russia

Andrew Smith
B A S I C S

andrew.l.smith@jpmorgan.com

Rajeev Lalwani
rajeev.x.lalwani@jpmorgan.com

Sergey Arinin
sergey.v.arinin@jpmorgan.com Latin America Latin America

Stefka Gerova
stefka.g.gerova@jpmorgan.com Australia Australia

U T I L I T I E S

Lilyanna Yang, CFA
lilyanna.yang@jpmorgan.com

Grace Chan
grace.ky.chan@jpmorgan.com

Anderson Frey, CFA
anderson.frey@jpmorgan.com

E U R O P E A N

Raoul Bostrom
raoul.v.bostrom@jpmorgan.com

Ademar Souza Neto
ademar.s.neto@jpmchase.com

1

Agenda
Page

The energy value chain Electricity generation Natural gas upstream sourcing Trading Transmission and distribution Supply Climate change Renewables
B A S I C S

2

84 94 99 108

Valuation and drivers Appendix

E U R O P E A N

U T I L I T I E S

2

The energy value chain
ELECTRICITY Value chain

Generation

Regulated networks Transmission & Distribution

Supply Dual-fuel contracts Supply
3

Fuel sourcing

Trading Sourcing, despatch, management, proprietary

C H A I N

Upstream sourcing / E&P

E N E R G Y

V A L U E

Regulated networks Transmission & Distribution

NATURAL GAS Value chain
Source: JPMorgan

T H E

The energy value chain
ELECTRICITY Value chain

Generation

Regulated networks Transmission & Distribution

Supply Dual-fuel contracts Supply
4

Fuel sourcing

Trading Sourcing, despatch, management, proprietary

C H A I N

Upstream sourcing / E&P

E N E R G Y

V A L U E

Regulated networks Transmission & Distribution

NATURAL GAS Value chain
Source: JPMorgan

T H E

T H E

E N E R G Y

V A L U E

C H A I N

5

storage hydro. Gas: spot market and daily storage Mid-merit Demand present 30 – 80% of the time. Gas: contracts with near distance suppliers. even when it might not be economical to do so Generation: nuclear.Economics .80%) Baseload power plants operate continuously. timing of peaks predictable. CCGTs.the load curve Shows the order in which different plants are called upon to run based on their variable operating cost Demand / Supply / Price / Cost Peak load Comes on and off very quickly Demand present <30% of the time. predictable variability Generation: coal. levels less so Generation: oil. r-o-r hydro. CCGTs Gas: long term contracts with long distance suppliers Renewables Tend to be outside the load curve on a must-take basis – run when they can Impact on environment offset partly by need for balancing power Time (Day / Year) Source: JPMorgan T H E E N E R G Y V A L U E C H A I N 6 . lignite. OCGTs. seasonal storage and spot Baseload Demand present most of the time (c.

e. based only on cost of fuel & CO2 permits Electricity demand has to be met instantaneously by supply . which tend to have higher costs A unit with operating cost below the current price keeps the margin However.Economics .electricity cannot be stored Price tends to be set by mid-merit plant for most hours of the day Baseload plants (hydro. including capital) can be varied If new capacity is required. coal. a profit margin (spread) sufficient to cover all capital costs is needed We therefore need to look at future reserve margins (system adequacy) to determine where spreads need to be T H E E N E R G Y V A L U E 7 . nuclear) have large margins since the marginal unit is typically gasfired.the merit order The short run marginal cost (SRMC) of the last unit required to meet demand sets the marginal price of power at any given point in time Drives day-to-day price. the long term power price is driven by the long run marginal cost (LRMC) C H A I N The cost of generating a unit of electricity when all factors of production (i.

SRMC price demand merit order / load curve 8760 time (hours) Source: JPMorgan C H A I N Which type of power plant will set the power price? Currently ≈indifferent between building a coal or gas plant in Central Europe as SRMC are the same at prevailing market fuel prices Other considerations. Germany reliant on Russian gas. whereas Spain uses gas from a variety of sources (pipeline and LNG) so more inclined to build gas fired power plants E N E R G Y V A L U E Indifference between building a new clean (i.Economics . using CCS technology) or dirty coal plant is a function of the CO2 emission permit price 8 T H E .g.e. e.

hydro. etc.* Worked example: attractiveness of coal vs. gas Germany Germany UK UK Min Hourly demand Max Power price Power price Min Hourly demand Max New lignite New hard coal New CCGT New hard coal New CCGT Peaking2 OCGT& Must run 1 Peaking2 Nuclear Interconnector and must run1 Hard coal CCGT Nuclear CCGT Lignite 40% 50% 60% Hard coal 70% 80% 90% 100% 0% C H A I N 10% 20% 30% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% E N E R G Y V A L U E Large proportion of low SRMC plant Large proportion of high SRMC plant Source: RWE Factbook 2007 1 including renewables and CHP 2 oil. T H E 9 . OCGT.

Economics . suppliers. traders and customers such as BETTA in the UK Power exchanges have been launched in recent years to provide screen-based anonymous 24 hour trading EEX in Germany Powernext in France OMEL in Spain and Portugal GME in Italy C H A I N APX in The Netherlands UKPX (a subsidiary of APX) in the UK Nordpool in Scandanavia V A L U E Generators have contracts with the transmission grid for Connection Use of the system Balancing services including reactive power 10 T H E E N E R G Y .wholesale prices Price at which electricity generators/ gas producers sell to the market Market arrangements are based on bilateral trading between generators.

spreads Spark Dirty = power price .cost of coal .carbon price = power price .cost of gas Clean = power price .cost of gas .carbon price Dark = power price .Economics .cost of coal “Spark” corresponds to gas C H A I N “Dark” corresponds to coal “Quark” corresponds to nuclear “Dirty” = “brown” “Clean” = “green” T H E E N E R G Y V A L U E 11 .

1 .72t/MWh) =21.325 -(25€/t × 0.8 × 8760 12 T H E E N E R G Y = .* Worked example – Central European spreads Long term new entrant breakeven price is forecast at €65/MWh This assumes coal at $67/t and carbon at €30/t On current (spot) commodity prices this calculation shows a new entrant would not breakeven at €65/MWh Therefore If commodity costs stay high.Carbon cost: = Clean dark spread (€/MWh) .Fixed cost: · + (capital cost × required return) Op & M + § capital cost ¨ plant life ¸ © ¹ load factor × 8760 hours per year (price of 1t of coal + cost of shipping 1t) price of CO2 × CO2 intensity 65 €/$ × t/MWh V A L U E -(106. no CO2 capture.4. no CO2 capture. 2008E New hard coal.9 + 7)/1.45 × 0. coal prices will need to fall to $67/t for a new entrant to breakeven at €65/MWh New hard coal. power prices will have to rise to encourage new build If not.Fuel cost: .5 − (42 + 1144 + (1144 × 10% )) 50 × 1000 0. 2008E C H A I N Power price .

Fuel cost: .45 × 1000 V A L U E -(25€/t × 0.9.6/mmbtu for a new entrant to breakeven at €65/MWh New CCGT. no CO2 capture. gas prices will need to fall to $9.8 × 8760 13 .9 × 5900btu/kWh) 1. power prices will have to rise to encourage new build If not.Fixed cost: · + (capital cost × required return) Op & M + § capital cost ¨ plant life ¸ © ¹ load factor × 8760 hours per year E N E R G Y − (21 + 520 T H E = . no CO2 capture. 2008E Power price .7 + (520 × 10% )) 30 × 1000 0.25 = Clean spark spread (€/MWh) .37t/MWh) =3. 2008E New CCGT.6/mmbtu and carbon at €30/t On current (spot) commodity prices this calculation shows a new entrant would not breakeven at €65/MWh Therefore If commodity costs stay high.Carbon cost: (price of 1mmbtu of gas × heat rate) price of CO2 × CO2 intensity C H A I N 65 €/$ × 1000 − (12.* Worked example – Central European spreads Long term new entrant breakeven price is forecast at €65/MWh This assumes gas at $9.

Economics .LRMC European system adequacy Nordel UK UCTE T H E E N E R G Y V A L U E C H A I N 14 .

4 90.2 13.Union for the Co-ordination of Transmission of Electricity Association of transmission system operators in continental Europe* (i. excluding the UK and Scandinavia) 50 years of joint activities Synchronous operation of interconnected transmission grids Publishes data on forecasts of the security of supply over the next 15 years Publication: UCTE System Adequacy Forecast 2007-20 Starts with stated build/ close plans for power plants Then looks at potential development in demand.4 32.2 16.9 8.8 3. average load evolution Also factors in expected changes in transmission grids and interconnections C H A I N Updated annually at www.1 Austria Switzerland Romania Czech Republic Belgium Portugal 18.2 0.3 17.org * Includes: Installed capacity (GW) Germany France Italy Spain Poland Netherlands 122.9 Greece Bulgaria Serbia Hungary Slovakia Croatia 11.5 17.UCTE system adequacy forecast UCTE .e.2 8.1 6.9 Bosnia Herzegovina Slovenia Western Ukraine Luxembourg Macedonia Montenegro 3.5 1.4 22.7 1.3 76.ucte.8 11.3 116.3 16.9 15 T H E E N E R G Y V A L U E .9 2.9 2.

outages .system services reserve – reference load Compared to the adequacy reference margin (ARM) ARM (GW) = peak load – load at reference time + minimum reserve capacity Minimum reserve capacity = 5% of national generating capacity 3 reference points C H A I N — 3rd Wednesday of January at 11:00 — 3rd Wednesday of January at 19:00 (close to peak) — 3rd Wednesday of July at 11:00 V A L U E Estimates under ‘normal climatic conditions’ (i. temperature and precipitation at long term averages) Reserve margin = RC/NGC amount of unused available capacity at peak load as a percentage of total capacity T H E E N E R G Y 16 .e.UCTE system adequacy forecast Generation adequacy Generation adequacy Remaining capacity (RC) RC (GW) = national generating capacity (NGC) – non-usable capacity .maintenance and overhauls .

UCTE system adequacy forecast Transmission adequacy Transmission adequacy Imports can support a system provided there is sufficient import and export capacity Overall ‘not an obstacle to power balance management’ in the UCTE area Sufficient transmission capacity Import and export capacity looks likely to satisfy (RC – ARM) T H E E N E R G Y V A L U E C H A I N 17 .

or one large coal power station 67.3 53.9 52.6 42.7 65.2 57.6 Minimum reserve capacity 5% C H A I N V A L U E July 11:00 am January 11:00 am -9.7 NB.7 January 7:00 pm July 11:00 am -3.6 E N E R G Y 2007E 2008E 2010E 2015E 2020E Source: UCTE System Adequacy Forecast 2007-20 T H E 18 .9 41.6 -17.UCTE generation adequacy forecast Without considerable new build/ life extension the system will be out of balance in continental Europe post-2015 5% seen as minimum ‘adequate’ to limit the risk of system interruptions such as Brown outs (voltage dips) or Black outs (system collapse) 80 70 60 50 remaining capacity (GW) 58.9 40 30 20 10 0 -10 -20 -30 January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm 34.7 61.7 60.2 60. 1GW = 1000MW.

UCTE retrospect: reserve margin There has been large oversupply across Europe in the past The reserve margin is expected to fall below 5% post-2015 Therefore significant reinvestment in generation capacity is needed 14% 12% 10% 8% 6% 4% 2% 0% 2001A -2% 2002A Jan July reserve margin Minimum reserve capacity 5% V A L U E C H A I N E N E R G Y 2003A 2004A 2005A 2006A 2007E 2008E 2010E 2015E 2020E T H E Source: UCTE System Adequacy Retrospect 2001-2006 and System Adequacy Forecast 2007-20 All readings 3rd Wednesday at 11:00am 19 .

looks at MWh/h equivalent to the available capacity in MW From 2008 to 2011.Nordel system adequacy forecast Nordel – organisation for the Nordic Transmission System Operators Publication: Nordel Power Balances 2008-11 N. the Nordic system ‘is able to meet the estimated consumption… in average conditions… without imports’ Sufficient to cover ‘simultaneous peak demand without import’ in 2010-11E Estimated production (MWh/h) – that which is available at peak Peak Demand (MWh/h) = maximum one hour load in temperature circumstances with occurrence probability one winter during 10 years Net power export (MWh/h) C H A I N = estimated production .peak demand T H E E N E R G Y V A L U E 20 .B.

Nordel system adequacy forecast Temperatures corresponding to the coldest day in 10 years Forecast net importer under peak conditions in 2008-10 Estimated production 79000 Peak demand Net power export Forecast to become a net exporter in 2010-11 2500 2000 1500 78000 Estimated production/ peak demand (MWh) 77000 Net power export (MWh) 1000 76000 500 0 -500 -1000 73000 -1500 72000 -2000 -2500 2008/09E 2009/10E 2010/11E 75000 74000 E N E R G Y V A L U E C H A I N 71000 Source: Nordel Power Balances 2008/09. 2009/10 and 2010/11 Large increase in production in 2010/11 is due to a new nuclear plant in Finland T H E 21 .

UK system adequacy forecast Publication: National Grid Seven Year Statement (SYS) 2007 3 different generation background forecasts: SYS based total capacity (GW) = existing generation projects + those proposed new generation projects for which an appropriate Bilateral Agreement1 is in place Consents based total capacity (GW) = existing generation projects + those proposed new generation projects been granted the necessary consents under Section 36 of the Electricity Act 1989 and Section 14 of the Energy Act 1976 for connection to the network C H A I N Existing or under construction total capacity (GW) Consented V A L U E E N E R G Y Existing or under construction 1 An agreement between National Grid and a generator for future connection to the transmission system T H E SYS 22 .

this is a very different calculation to UCTE/ Nordpool and not wholly comparable As generating units are not available to generate 100% of the time. the Central Electricity Generating Board in England and Wales) sought to achieve a plant margin of ≈ 24% Now. in the past.B.g.UK system adequacy forecast ACS (average cold spell) peak demand base case (GW) . the operational plant margin requirement for real time generation is generally ≈ 10% depending on prevailing circumstances C H A I N T H E E N E R G Y V A L U E 23 .the combination of weather elements that give rise to a level of peak demand within a year that has a 50% chance of being exceeded as a result of weather variations alone. large integrated power system utilities (e. with base case assumptions of economic growth Plant margin .amount by which the installed generation capacity exceeds the peak demand as a proportion of peak demand N.

even under the conservative existing/ under construction background This is a significant contrast to the UCTE "SYS based" total capacity "Consents based" total capacity "Existing/ under construction based" 100 ACS peak demand (base case) "SYS based" plant margin "Consents based" plant margin 60 "Existing/ under construction based" 80 Capacity/ demand (GW) Plant margin (%) = capacity-peak demand/ peak demand 50 40 60 C H A I N 30 24% 20 40 V A L U E 20 10 E N E R G Y 0 2007/08E 2008/09E 2009/10E 2010/11E 2011/12E 2012/13E 2013/14E 0 2007/08E 2008/09E 2009/10E 2010/11E 2011/12E 2012/13E 2013/14E T H E Source: National Grid Seven Year Statement 2007 24 .UK system adequacy forecast Plant margin is likely to exceed 24% over the entire forecast period.

Technology . solar photovoltaic Thermal efficiency .thermal power generation Thermal generation – Electricity produced using a steam generating boiler Steam drives turbine Turbine generates electricity via an alternator (an electromechanical device that converts mechanical energy into alternating current) Coal. oil. biomass. gas. nuclear.gov 25 . geothermal Non-thermal generation Turbine is driven by energy other than steam Hydro. solar thermal.tva.efficiency with which the energy content (measured in gross calorific value) of the input fuel is turned into electrical energy by the generating station C H A I N T H E E N E R G Y V A L U E Source: www. wind.

gov 26 .tva.008 Start up time 1-3 days CO2 (t/MWh) 0. IEA.782 5.100 Typical thermal efficiency (%) 38% 44% 31% 42% Where in load Midmerit Midmerit Baseload Baseload Load factor (%) 66% 66% 80% 80% Load factor (hr/a) 5.10 1-3 days Source: Department for Business.757 11.25 1. JP Morgan estimates Hard coal Can load follow Dense so can be sourced globally Lignite C H A I N Relatively more sulphur and ash Less energy per tonne so needs to be alongside the mine Lignite has a fixed cost of production so not at the mercy of the global coal market T H E E N E R G Y V A L U E Source: www. Alstom.782 7. Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007.90 0.86 1.000 7.000 8.Electricity generation resources .008 7.solid fuel Coal Coal Typical thermal efficiency (btu/KWh) Hard coal Old technology New technology Lignite Old technology New technology 9.

optimally run base load or mid merit E N E R G Y V A L U E C H A I N Source: powergeneration. can start up quickly during peak demand CCGT (combined cycle gas turbine) .siemens.Electricity generation resources – gaseous fuel Gas Gas OCGT (open cycle gas turbine) – old style.com T H E CHP (combined heat and power) .by-product heat is used to generate additional electricity via steam cycle.by-product heat is used to warm local homes or businesses 27 .

37 Source: Department for Business.Electricity generation resources – gaseous fuel Gas Gas Typical thermal efficiency (btu/KWh) OCGT Old technology New technology CCGT Old technology New technology 10.752 5-10 mins <1.380-5.256 1-2 hours CO2 (t/MWh) 0.700 Typical thermal efficiency (%) 33% 37% 49% 60% Where in load Peak load Peak load Midmerit Midmerit Load factor (%) <20% <20% 50-60% 50-60% Start up Load factor time (from cold) (hr/a) <1.60 0.000 5. IEA.753 4. Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007. JP Morgan estimates The cleanest fossil fuel from a pollution perspective C H A I N CCGT can be baseload or midmerit Latest CCGTs are highly efficient but still have relatively high operating costs in the current commodity price environment T H E E N E R G Y V A L U E 28 .70 0.380-5.43 0.250 7.256 4.com. GEpower.500 9.

82 Source: Department for Business. Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007.gov 29 . IEA. JP Morgan estimates Can start quickly during peak demand Highest operating costs due to: Low thermal efficiency Low number of hours to amortise fixed costs across Most polluting C H A I N T H E E N E R G Y V A L U E Source: www.000 Typical thermal efficiency (%) 28% Where in load Peak load Load factor (%) <20% Load factor (hr/a) <1752 Start up time 1-2 mins CO2 (t/MWh) 0.tva.Electricity generation resources – liquid fuel Oil Oil Typical thermal efficiency (btu/KWh) Oil 12.

and often imported fossil fuels Long term resource Environment protection – zero CO2 emissions Uranium reserves are mostly located in stable countries and are abundant Could be almost unlimited due to uranium’s multiple energy potential Depends on prevalence of reprocessing Up to 96% of spent fuel can be recycled High capital cost but very low operating costs Disadvantages C H A I N Take 1-3 days to start so only shut down when necessary Need to be refuelled every 12-18 months Chequered safety and operation history although image and statistics do not always match T H E E N E R G Y V A L U E 30 .Electricity generation resources – nuclear overview Nuclear Nuclear Advantages Security of supply – reduces dependence on finite.

uncontrolled boron dilution): 1 in 100 chance per reactor per year Infrequent accidents (e.000. control rod ejection): 1 in 10.org/Publications/Factsheets/English/ines.g.000 T H E E N E R G Y V A L U E Source: www. external release of a large quantity of radioactive material) Areva estimates: C H A I N Operational incidents (e.g.000 to 1 in 1.g. minor defects in pipework) 2 – incident 3 – serious incident (e.g.000 Hypothetical accidents (e.g. radioactive doses to workers sufficient to cause acute health effects) 4 – accident without significant off-site risk 5 – accident with off-site risk (e. control rod withdrawal at full power): 1 in 100 to 1 in 10. severe damage to the installation) 6 – serious accident 7 – major accident (e. Areva Technical Days 31 .pdf.iaea.g.g.Electricity generation resources – nuclear overview Nuclear Nuclear International Nuclear Event Scale 0 – no safety significance 1 – anomaly (e.

but not on an extensive scale… … Congress has not done anything about long-term storage of nuclear waste since the Yucca Mountain storage site was effectively blocked and … … the Nuclear Regulatory Commission. is currently profoundly under-resourced T H E E N E R G Y V A L U E 32 . however… … investors are hesitant to put up capital due to the time-scale of building a plant.… C H A I N … the latest Energy Bill from Congress makes federal loan guarantees available to build several nuclear plants. which has to approve new plants and extensions of old plants.Electricity generation resources – nuclear overview Nuclear Nuclear Public acceptance in the US The political climate is favourable towards Renewal of nuclear operating licenses and Construction of new nuclear plants There is much more sympathy for nuclear power now than there was a couple of years ago in terms of: Siting (building new plants adjacent to existing ones) Safety concerns Environmental benefits (a key issue will be the way cap-and-trade and Renewable Portfolio Standards are implemented in the US) The private sector is willing to build new nuclear.

Electricity generation resources – nuclear overview
Nuclear Nuclear

Public acceptance in Europe – examples of opinion Pro UK government consulted on the future of nuclear power
Nuclear operators will have to cover the full costs of decommissioning and their share of the management and disposal costs

Anti German nuclear closure program remains controversial
Public increasingly considering the policy unrealistic

France
80% of generating capacity is nuclear Has been generally positive as there have been no accidents and wholesale prices have been remarkably low
C H A I N

Full moratoria in Italy and Spain
Potential for change but unlikely to be soon

Belgium
No new build after closure of the existing two plants scheduled to run til 2015-25, with potential life extension to 2025-2035

Nordic countries - unquestionable shift in favour
Low support for a phase-out in Sweden, despite negative attitudes in the early 1980s 2002 public debate and resulting new build in Finland

Austria - vehemently anti-nuclear

E N E R G Y

V A L U E

Baltics – smaller demand base seems to be leading to multinational cooperation

T H E

33

Electricity generation resources – nuclear technology
Nuclear Nuclear

Technology
Reliable base-load generation at stable and low cost A complex nuclear fission process ≈an atomic kettle attached to a steam turbine Generation I: reactors mainly being shut down end of this decade (Magnox) Generation II: 1970s – 2050s (AGR) Generation III: 1990s – at least 2050s (PWR, BWR) Generation III+: improved safety and reliability, 1990s – at least 2060s (EPR) Generation IV: will be ready to market between 2020 and 2030 (VHTR, PMBR, Fast breeder reactors) Fusion reactors post 2050 (ITER): experimental plant under construction

T H E

E N E R G Y

V A L U E

C H A I N

Source: Areva Technical Days

34

Electricity generation resources – nuclear technology
Nuclear Nuclear

AGR (Advanced gas-cooled reactor)
Generation II (1960s) Mostly used in the UK Graphite is the moderator, CO2 is the coolant The moderator slows down the neutrons released by the uranium fuel preventing run-away reactions Gas picks up the heat generated by the fission reaction Hot gas circulates past the heat exchanger Final steam conditions at the boiler stop valve are identical to that of conventional thermal plants … so the same design of turbo-generator is used The control rods can be raised or lowered to adjust the reactor power
C H A I N

V A L U E

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

T H E

E N E R G Y

Charge tubes Control rods Graphite moderator Fuel assemblies Concrete pressure vessel and radiation shielding Gas circulator Water Water circulator Heat exchanger Steam
35

Source: Creative Commons

Electricity generation resources – nuclear technology Nuclear Nuclear BWR (Boiling water reactor) Generation III Pressurized boiler Light water (‘normal’ water i. leak-tight physical barriers shield against radiation — Metal cladding of fuel rods — Metal enclosure of reactor primary circuit C H A I N Reactor core — Containment of reactor Net power output 1250MW E N E R G Y V A L U E Source: Areva Technical Days T H E 36 .e. which drives the turbine Series of strong. H2O not 2H2O) is the moderator and the coolant Bundles of uranium-filled fuel rods Heat is produced by a fission chain reaction Water circulating from the bottom to the top of the reactor is brought to 290°C Generates steam.

Electricity generation resources – nuclear technology Nuclear Nuclear PWR (Pressurized water reactor) Generation III More complex than a BWR 2 circuits Light water is the moderator and the coolant Water under constant pressure so it doesn’t boil – 155bar higher than a BWR Primary circuit of water at 313°C Secondary circuit of steam heated by the primary circuit completely separate and closed Water and steam circulate so constantly cooling down and heating back up Unchanging and uninterrupted C H A I N Cooling circuit removes residual heat from the core – part of this water evaporates Net power output 1600MW V A L U E T H E E N E R G Y Source: Areva Technical Days 37 .

008-7. lead. no super-criticality risk but as-yet unproven — Advanced water designs. also allows hydrogen production C H A I N V A L U E Typical thermal efficiency (btu/KWh) Nuclear .884 7.008-7.886 Start up time 1-3 1-3 1-3 1-3 days days days days CO2 (t/MWh) 0.Electricity generation resources – nuclear technology Nuclear Nuclear EPR (European pressurised reactor) Generation III+ Takes advantage of the latest operating experience and incorporates the results of French and German R&D programs Higher power. IEA.200 10. wikipedia.AGR BWR PWR EPR 8. Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007. e.885 7.or sodium-cooled — Pebble Bed Modular Reactor (PMBR) – smaller size.01 0.256-7.300 9.008 7. efficiency and life expectancy Generating cost per kWh 10% lower than Areva’s latest PWR More advanced passive safety & lower risk of human-error Lower waste production Net power output 1600MW Beyond Generation IV potential designs: — ‘Fast breeder’ reactors – fast neutron reactor without moderator. minimises production of long-lived waste.01 E N E R G Y T H E Source: Department for Business.com.g.000 9. JP Morgan estimates 38 . the very high temperature reactor (VHTR). Areva-np.01 0. with water at 1000°C.008-7. gas-.500 Typical thermal efficiency (%) 41% 37% 34% 36% Where in load Baseload Baseload Baseload Baseload Load factor (%) 60-80% 80-90% 80-90% 80-90% Load factor (hr/a) 5. fully closed cycle.01 0.

density and power production increase by ≈3%. Moist air is less dense and so will lower power production) mechanical efficiency of generator aerodynamic shape of blades 39 Source: EC Energy Research T H E E N E R G Y V A L U E .Electricity generation resources – renewables Wind Wind Wind blows and sets the turbine blades in motion. generating power that can be converted into electricity A steel or concrete tower with a nacelle that turns horizontally in a way such that the rotor (usually equipped with two or three blades) always faces the wind Generation depends on: cube of wind speed (double wind speed gives eight times more power) C H A I N square of rotor diameter (double rotor diameter gives four times more power) density of the air (If the air is 10°C colder.

13. 5. 3. 6. Rotor lock Pillow block Main frame Impact noise insulation Hydraulic parking brake Coupling Generator frame Control panel Heat exchanger Generator Gearbox Yaw drive Rotor shaft Rotor hub Pitch drive Nose cone V A L U E C H A I N Typical hub height 80m Typical blade length 40m T H E E N E R G Y 40 . 9. 12. 11. 15. 16. 10. 4.Electricity generation resources – renewables Wind Wind Source: Vestas. 8. 7. 2. 14.com 1.

g. liquid and gaseous fuels Biomass gasification (release via heat) Anaerobic digestion (release via bacteria) T H E E N E R G Y V A L U E 41 . pulp and paper operation residues. animal waste. forest residues. landfill gas and energy crops Co-firing in existing power plants (usually coal) can be used to reduce average CO2 emissions and potentially get ‘green certificates’ Burnt in conventional steam boilers C H A I N Biofuel Many different conversion technologies to produce solid.Electricity generation resources – renewables Biomass & biofuel Biomass & biofuel Biomass Plant-derived organic matter (fix CO2 as they grow. agricultural residues. so their use does not add to the levels of atmospheric carbon on a life-cycle basis) E.

Electricity generation resources – renewables
Geothermal Geothermal

Conventional geothermal applications rely on the geological coincidence of water-bearing, hot permeable rocks occurring at economically accessible depths At fluid temperatures of 85 - 150°C, electricity generation requires the use of binary cycles, in which a working fluid is heated and vaporised in a closed circuit
The vapour drives a turbine, before being cooled and condensed, and the cycle begins again

C H A I N

V A L U E

At fluid temperatures >150°C steam can be used to drive turbines
Source: Energy Manager Training

T H E

E N E R G Y

42

Electricity generation resources – renewables
Geothermal Geothermal

Enhanced Geothermal Systems utilize heat stored in rocks that are technically accessible but lack the natural permeability Hence they allow geothermal generation to be used in a wider range of locations than before A well is drilled into >180°C fractured basement rock and stimulated to enhance the natural permeability of the fracture network and create a heat exchanger into which additional wells are drilled
Water circulated through the wells gathers heat
C H A I N V A L U E

T H E

E N E R G Y

Source: EC Energy Research

43

Electricity generation resources – renewables
Solar Solar

Solar photovoltaic PV cells transform the photon energy in solar radiation directly into electrical energy without an intermediate mechanical or thermal process Technology is currently very expensive Concentrated solar/ solar thermal Optical devices focus direct solar radiation onto an area where a receiver is located The radiation is transformed into heat in a medium (oil) and then to steam and electricity as per thermal power Continues to work after dark until collected heat dissipates Technology requires a very large area
Load factor (%) Offshore wind Onshore wind Biomass Geothermal Solar PV Concentrated solar 30-40% 20-30% 40-70% 95% 10-25% 10-35% Load factor (hr/a) 2,628-3,504 1,752-2,628 3,504-6,132 8,322 876-2,190 876-3,066 Start up time <30 sec <30 sec 1 hour 1 day instant instant Build cost (€m/MW) 2.1 1.3 0.8-1.2 2.1 6.0-7.0 4.0

E N E R G Y

V A L U E

C H A I N

Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, www.geoenergy.org/aboutGE/powerPlantCost.asp, JP Morgan estimates

T H E

44

when the wholesale price is high Not pumped Uses reservoirs that are naturally elevated Marine C H A I N Tidal Utilizes the daily rise and fall of water Highly predictable Not yet economically viable V A L U E Wave Utilizes the effect of the wind on the sea Not yet economically viable T H E E N E R G Y 45 .when the wholesale price is low (hence not ‘free fuel’) Supplies peak demand .Electricity generation resources – hydroelectric Hydro Hydro Run-of-the-river (r-o-r) Natural flow and elevation drop of a river are used to generate electricity ‘free fuel’ Reservoir Energy extracted depends on the volume and on the head (difference in height between the source and the water's outflow) Pumped storage Requires energy to pump water into reservoir .

Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007.Electricity generation resources – hydroelectric Hydro Hydro Where in load R-o-R Storage Baseload Peak load Load factor Load factor (%) (hr/a) 70% 15% 6132 1314 Start up time 1-2 mins 1-2 mins Source: Department for Business.tva. JP Morgan estimates E N E R G Y V A L U E C H A I N Source: www.gov T H E 46 .

Italy Cleaner. Denmark T H E E N E R G Y V A L U E 47 . cheaper.Electricity generation resources in Europe Germany. more efficient than coal In the Nordic region ≈60% of generation comes from hydro France (dearth of natural resources) has developed the largest nuclear capacity in Europe C H A I N Germany has launched a drive to install Europe’s largest wind fleet Other major wind players: Spain. Poland and Spain have historically had large domestic coal industries The UK. Spain. Norway and the Netherlands have been major producers of oil and gas UK and Netherlands now in decline New sources: Russia by pipeline. Liquefied Natural Gas by boat for elsewhere in the world ‘Dash for gas’ – gas power station new build UK.

5. 17% nuclear.g. 28. GW) Capacity (2005A. 992.0. GW) Output (2004A. 526. TWh) Output (2004A. 41. 31. 4% renewables.7. hydro High load factor → output on average proportionally higher than capacity e. 137. nuclear T H E 48 .4. 168.7% hydro. 19% gas.Country Profiles’ for more) Capacity (2005A.6% C H A I N V A L U E Source: IEA and EIA E N E R G Y Low load factor → output on average proportionally lower than capacity e.2. 169. 994. 132.5.g.4. 28. 4% renewables. TWh) oil.0.5. 21% nuclear.OECD Europe generation mix (see ‘European Utilities Basics . 15% gas. 21% oil.5. 32% hydro.9.9. 254. 5% coal. 663. 160. 5% coal.

proprietary C H A I N Upstream sourcing / E&P E N E R G Y V A L U E Regulated networks Transmission & Distribution NATURAL GAS Value chain T H E . management.The energy value chain ELECTRICITY Value chain Generation Regulated networks Transmission & Distribution Supply Dual-fuel contracts Supply 49 Fuel sourcing Trading Sourcing. despatch.

T H E E N E R G Y V A L U E C H A I N 50 .

Gas sourcing Exploration and production Exploration and production Natural gas is a regional commodity Its physical properties make it hard to transport. particularly intercontinentally without liquefaction Most natural gas is transported in gaseous form via pipeline Gas markets still regional rather than continental or global European natural gas is priced using an oil-referenced formula The widespread adoption of Liquefied Natural Gas should change the gas market from regional to global Large natural gas consumers (especially power plant operators and retail suppliers) have incentives to hedge their physical commodity exposure as well as the basis (location) risk associated with dealing in different markets E N E R G Y V A L U E C H A I N T H E Source: JP Morgan ‘Oil&Gas Basics Presentation’ 51 .

Gas sourcing Exploration and production Exploration and production Why be involved in upstream gas? No indigenous supply Security Economic hedge If not involved upstream.whereas the coal market is spot-based) with NOCs (National Oil Companies) Major market drivers Weather is both a demand and supply factor Demand for central heating C H A I N Hydro conditions in areas that depend on hydropower drive requirement for CCGT power T H E E N E R G Y V A L U E Oil price – long term contracts tend to be oil-based. take-or-buy decisions impact the natural gas market 52 . generators tend to be beholden to very long term contracts (≈20 years .

deliverability rates.Gas sourcing Storage Storage Natural gas is stored in inventory underground under pressure in 3 types of facilities Depleted reservoirs in oil/ gas fields Aquifers Salt cavern formations Each storage type has its own characteristics which govern its suitability Physical (capacity. porosity. deliverability rate. and cycling capability) System integrity maintenance – meeting baseload requirements Seasonal storage C H A I N Excess supply in the summer traditionally stored to meet winter demand Increasing prevalence of air conditioning in many countries has lowered seasonality but increased demand System balancing – meeting peakload requirements Smoothing day-to-day Buffer to meet unexpected demand surges 53 T H E E N E R G Y V A L U E . permeability. retention capability) Economic (site preparation and maintenance costs.

Gas sourcing Gas providers can… Carry out exploration and production themselves Have a stake in a project operated by another party Receive gas from a pipeline under contract e. Australia → US LNG is natural gas that is stored and transported at atmospheric pressure and a temperature of –260°F Liquefaction Boat transportation One LNG boat ≈150 000m3 (liquid volume) of LNG Regasification Volume increases ≈600 times C H A I N E N E R G Y V A L U E UK daily consumption is 301. Siberia → Spain Receive gas from an LNG train e. JPMorgan 54 .000m3 (gaseous volume) of natural gas So one tanker is enough for ≈ 1/3 of a day’s demand T H E Source: IEA.g.000.g.

major Japanese nuclear plant outages) C H A I N Trans-Atlantic arbitrage Crude oil arbitrage Operating performance at liquefaction. Norwegian flows into the UK) Asian demand (economic growth. Egypt) Demand patterns (hydro conditions in Spain.Gas sourcing LNG LNG The global LNG market is small but growing rapidly Declining US gas production means LNG is vital to satisfy demand growth and prevent price appreciation Low European natural gas prices have historically led to a flood of shipments to US terminals The last 2 years have seen a growing trend toward increased US imports in the spring Major market drivers Upstream additions (Equatorial Guinea. export and import terminals V A L U E LNG projects are among the most expensive energy projects Constructing a liquefaction and regasification terminal costs >€1b so there is a minimum distance threshold (compared to pipelines) E N E R G Y T H E Regasification may be regulated or merchant Source: JP Morgan ‘Oil&Gas Basics Presentation’ 55 .

The energy value chain ELECTRICITY Value chain Generation Regulated networks Transmission & Distribution Supply Dual-fuel contracts Supply 56 Fuel sourcing Trading Sourcing. management. despatch. proprietary C H A I N Upstream sourcing / E&P E N E R G Y V A L U E Regulated networks Transmission & Distribution NATURAL GAS Value chain T H E .

Trading Why do utilities trade? Risk management Financial Operational Profit opportunity Some companies dynamically manage their energy portfolios e. coal. precipitation) CO2 price = f(gas. EdF’s trading has been very profitable Strong correlation between oil. gas. temperature) Power price = f(gas. power and CO2 can be traded in ‘pairs’ or ‘swaps’ 57 T H E .g. CO2. temperature. electricity and CO2 prices companies can enter into multi-commodity swaps C H A I N Gas price = f(oil. gas. oil. coal) E N E R G Y V A L U E Therefore coal.

despatch. proprietary C H A I N Upstream sourcing / E&P E N E R G Y V A L U E Regulated networks Transmission & Distribution Supply NATURAL GAS Value chain 58 T H E Dual-fuel contracts Regulated networks Transmission & Distribution Supply Fuel sourcing . management.The energy value chain ELECTRICITY Value chain Generation Trading Sourcing.

3 – 3kV Step up transformer Transmission towers 115 – 345kV Step down substation Local substation C H A I N Distribution pole 2.240V Commercial and industrial customers Source: JPMorgan T H E E N E R G Y 59 .3 – 34kV Homes and small businesses V A L U E 120 .Electricity transmission & distribution Power station 2.

org 60 . 20x more expensive at 400kV than an equally rated overhead line2 V A L U E Route or mesh Partly a function of geography. preventing blackouts Investment to make the system more robust Change in supply profile.g. load centres and resources E N E R G Y International interconnector requirement T H E 2 Source: energynetworks.Electricity transmission & distribution Drivers of network build Growth of demand Improvements in quality Maintaining voltage. renewables: route grid → mesh grid Interconnector security Transmission network build choices Overhead or underground C H A I N Underground cable installation is 2x more expensive at 11kV. e. security of supply.

Electricity transmission & distribution Germany has a mesh grid Cost Italy has a route grid V A L U E C H A I N E N E R G Y System security T H E Source: JPMorgan 61 .

climate etc Network regulation varies significantly: Cost plus (a specific allowed return based on actual realised costs) e. There are a whole range of degrees of incentive strengths V A L U E May (UK) or may not (Spain) have an explicit regulated asset value in remuneration formulae Unitary (per MWh) or absolute (€m) Single or multi-year T H E E N E R G Y 62 .g. UK.g. Germany (changing next year). most US states C H A I N Incentive (regulator sets allowed revenue – may be based on current costs or what the regulator believes costs ‘ought’ to be) e. France. 72-80) Main concerns Costs for customers Security of supply – short and long term Government policy on energy mix.Regulation Regulation Needed for networks as they’re natural monopolies Also end customer prices where competition is not effective (See ‘Energy supply’ pp.

Network regulation – key concepts Regulatory asset/capital value/base x WACC Allowed Return + Opex C H A I N + Capex or Depreciation E N E R G Y V A L U E = Revenue or price cap Source: JPMorgan T H E 63 .

Network regulation – key concepts RAV Regulatory Asset Value normally scaled over time (by depreciation and capex). may include inflation link Weighted average cost of capital (WACC) may be Pre. with or without inflation) x WACC T H E E N E R G Y V A L U E C H A I N Allowed Return Allowed return may be unitary (per MWh) or absolute (€m) Has to cover interest expense and dividends 64 .or post-tax Real or nominal (i.e.

Network regulation – key concepts RAV x WACC Allowed Return Operating expenses Actual in cost plus Allowed in incentive May be volume based or absolute Opex T H E E N E R G Y V A L U E C H A I N 65 .

Network regulation – key concepts RAV x WACC Allowed Return Opex C H A I N Capex or Depreciation V A L U E Capital expenditure Based on agreed outcomes in incentive Based on defined budget in cost-plus May be volume based or absolute 66 T H E E N E R G Y .

Network regulation – key concepts RAV x WACC Allowed Return Opex C H A I N E N E R G Y V A L U E Revenue or price cap Provides potential for outperformance Often multi-year Revenue or price cap Capex or Depreciation T H E 67 .

Network regulation – key concepts RAV x WACC Allowed Return Opex Capex or Depreciation Revenue or price cap in year 1 C H A I N Allowed Return Opex Capex or Depreciation Often a downward price trajectory to induce efficiency improvements V A L U E T H E E N E R G Y Revenue or price cap in year 5 68 .

Network regulation – key concepts RAV x WACC Allowed Return Opex Capex Year 1 Revenue or price cap C H A I N Outperformance Capex Achieved WACC Opex efficiencies outcome below Budget or Depreciation longer asset life T H E E N E R G Y V A L U E Year 2 69 .

or across periods (2 – 5 years) Of course. can make an achieved return > the allowed return → assets worth > RAB Revenue or price cap Have outperformed the regulator’s assumptions ☺ Capex C H A I N Outperformance Achieved WACC Opex efficiencies outcome below Budget or Depreciation longer asset life Normally can retain outperformance in. with tough regulation the opposite can occur V A L U E Capex Achieved return (above allowed return) Opex efficiencies outcome below Budget E N E R G Y or Depreciation longer asset life T H E 70 .Network regulation – key concepts RAV x WACC Allowed Return Opex Capex or Depreciation If can reduce opex and/or capex.

in UK based on EV after privatisation + capex – depreciation In Sweden based on a computer model of optimal network as if built ‘from scratch’ Allowed return Regulator makes assumptions on gearing. RCV. RAV) Not necessarily equivalent to the true value or book value of the assets E. assuming outperformance 71 T H E E N E R G Y V A L U E .Network regulation – details The regulator defines Regulated Asset Base / Capital Value / Asset Value (RAB.g. cost of capital) then the value of the business. by definition. cost of equity Pre or post tax? Real or nominal? C H A I N Revenue = allowed opex + allowed capex + allowed return If the regulator is correct in all assumptions (efficiency. cost of debt.e. cost of operations and capital projects. is its RAB Valuations are based on a premium/ discount to RAB methodology Recent M&A transactions have occurred at a premium to RAB i.

1% T H E E N E R G Y V A L U E 72 .2% Maintenance -14.Ways to outperform on opex Raise employee productivity e. In the 2007 Gas Distribution Price Control Review.g. including Work management -10.g.0% Repairs -14. reduce headcount Minimise wage inflation Invest in IT infrastructure Reduce network losses (but not always in regulated opex) Improve service time on maintenance Opex Year 1 e.6% C H A I N Opex Year 2 Emergency -11. Ofgem’s consultants (PB Power) proposed an 11% reduction in total GDN opex for 2008/09 – 2012/13.

In the 2007 Gas Distribution Price Control Review. including Local Transmission System & storage -23.4% C H A I N Connections -22. consultants proposed an 18% reduction in total GDN net capex for 2008/09 – 2012/13.g. more efficient technologies Capex Year 1 e.g.Ways to outperform on capex Procurement Use an established network of suppliers Economies of scale e.9% Mains reinforcement -12% Capex Year 2 T H E E N E R G Y V A L U E 73 . ‘buy in bulk’ R&D Invest in innovative.

Ways to outperform on WACC Capital structure Higher gearing than the regulator assumes Lowers pre-tax WACC and provides tax shields Cost of debt Cheaper financing than the regulator assumes Index-linked debt Covered bonds Derivatives (optimal strategy may depend on market conditions e.55% T H E E N E R G Y V A L U E 74 .g. demand for different currencies) — Fixed-floating swaps — Forex swaps x WACC x WACC Year 1 Year 2 C H A I N Regulated D/EV Cost of debt Cost of equity WACC 50% 5% 9% 7% Achieved 70% 5.5% 9% 6.

The energy value chain ELECTRICITY Value chain Generation Regulated networks Transmission & Distribution Supply Dual-fuel contracts Fuel sourcing Trading Sourcing. proprietary C H A I N Upstream sourcing / E&P E N E R G Y V A L U E Regulated networks Transmission & Distribution Supply NATURAL GAS Value chain 75 T H E . despatch. management.

boiler breakdown cover T H E E N E R G Y V A L U E C H A I N 76 .Electricity and gas supply Sale of electricity to the final customer Commercial Residential Metering. billing and customer relationship Retail price is ≈ sum of generation and transmission so very little value added here Competitive metering in many countries – suppliers compete on price and service Dual-fuel (gas and electricity) contracts Consumer services often also provided to generate additional revenue e.g.

Retail / Consumer tariff regulation In a fully competitive market there are advantages of: Cost control (low prices) Investment incentives Consumer choice Quality of service improvement However markets are not always competitive… … and governments like to intervene… … therefore often tariffs are ‘managed’ or regulated C H A I N T H E E N E R G Y V A L U E 77 .

recent trend towards liberalisation of generation and supply UK pioneered privatisation. deregulation and liberalisation of utilities – has not had controls on retail prices since 2002 EU pushing for free competition throughout the region ‘From July 2007 at the latest. all consumers will be free to shop around for gas and electricity supplies’ In theory tariff regulation should not exist.EU tariff regulation EU Electricity Directives History of regulated tariffs . in reality it does Third EU competition directive for electricity and gas will seek to stamp out tariff regulation – although not immediately T H E E N E R G Y V A L U E C H A I N 78 .

EU tariff liberalisation EC Benchmarking Report (2006) conclusions Nordic countries Liberalisation fully embraced Germany Broad acceptance – all gas and electricity customers are free to choose supplier Pressure for unbundling of RWE and E.ON’s distribution activities Domination by a few large players prevents effective competition Italy Many calling for more control of prices Tariffs are adjusted on a quarterly basis to reflect commodity prices France Centrally controlled tariffs C H A I N Liberalisation in theory but not really in practice EdF and GdF only partially privatised V A L U E Spain Tariff deficit system The Directives have not been transposed The regulatory framework does not allow for effective competition T H E E N E R G Y 79 .

Tariff deficit The shortfall of regulated revenues from the tariffs versus revenue that would be realised by prevailing market prices Occurs when the regulated price is < the market price Represents both a system failure and possible upside depending on what the market prices in We forecast shortfall in Spain: 2008E tariff deficit of €3bn Due to internalised cost of CO2 by companies lowering sector revenues Spanish legislation requires that utilities are reimbursed In France GDF have forecast a gas tariff deficit of ≈€1bn C H A I N T H E E N E R G Y V A L U E 80 .

Unbundling Many countries have pursued a regulatory policy of unbundling Separation of transmission and distribution from generation and supply Intended to increase competition by improving the fairness of network access Many countries and corporates have resisted unbundling citing Diversification of risk Scale/ scope economies Legal/ management unbundling ‘should’ be sufficient Regulatory/ compliance oversight may be used T H E E N E R G Y V A L U E C H A I N 81 .

The end customer bill – retail power Unliberalised – France (2007E) Total: €120/MWh Taxes •VAT •Environmental •Public service Taxes = €37/MWh •VAT (29) •Local taxes •CTA for pensions •CSPE for public services Network access = €49/MWh •7.9) •Electricity tax (20.5/MWh 82 V A L U E Source: JPMorgan estimates Typical retail consumer uses 3.25% pre-tax •No inflation link •Cost plus •Review mid 2007 Liberalised – Germany (2008E) Total: €217/MWh Taxes and levies = €82/MWh •VAT (32. contracts •Oil / coal link Generation = €34/MWh Cost plus based Features 80% nuclear Remainder bought in Germany Generation = €67/MWh Based on EEX Mostly a coal system Need for coal / gas to replace nuclear CO2 approx €8/MWh for gas and €18/MWh for coal Sales/marketing = €6.2) (8) Network access •Regulated fee •Balancing costs •Transmission ¼ •Distribution ¾ C H A I N Network access = €62/MWh •6.5) •CHP act (2.T.5% post-tax •Inflation link for old assets •Moving to incentive •Reviews due April 06 & new system July ‘06 T H E E N E R G Y Generation •Pool / spot price •Cost-plus based Gas sourcing •L.5) •Concession fee (17.9) •Renewables act (8.5MWh/a .

4% 2. 2006A Romania Slovakia Poland Italy Denmark Portugal Hungary Netherlands Bulgaria Germany Sweden Czech Republic Belgium Lithuania Spain Austria Ireland Slovenia Latvia UK France Estonia Finland Norway Greece Source: Eurostat Price ex tax 165.6 33.9% 2.5% 1.7 5.6% 1.0 136.4 122.European comparison Comparison of power prices – Pan-Europe.1 65.6 10.9 118. €/MWh.4 150.0 189.6 45.9 65.1 255.4% 1.6 106.9 117.5 92.8 17.0 140.2 115.7 105.3 142.7 85.2% 3.Retail power price % GDP/capita.5 143.8 88.0 100.6 149. 2007A customer.6 15.5 10.5% 1.8% 1.7 Price with tax 221.9% 1.Retail power Affordability .9 100.6% 3.6% 1.1 129.5 22.5 46.0 101.1 89.7 87.1 121. 2007A €/MWh Italy Ireland Germany Portugal Netherlands Norway Slovakia UK Belgium Denmark Sweden Austria Hungary Spain Poland C H A I N Affordability .0 20. €/MWh.2 20.5 58.6% 1.4 58.0 156.7 Tax 56.8 25.2 5.0 120.7 71.1% 2.6% 2.0 89.5 27.8% 1.0 45.3 54.1% 3.3 7.0 229.4% 1.8 105.8% 1.4 Power cost % GDP 3.8 167.7% 1.9 11.0 68.0% Increasing power costs as a proportion of GDP → political pressure on utilities France Czech Republic Slovenia Finland Romania Greece Lithuania Estonia Latvia Bulgaria Source: Eurostat T H E E N E R G Y V A L U E 83 . 3. 2006A price % GDP/capita.4 94.7% 1.The end customer bill .5 66.4% 2.0 108.4% 1.8 63. 3.5MWh domestic customer.8 76.2 138.2 125.5 28.9 131.2 120.3 15.9 16.7 10.6 151.8 146.7 75.6% 1.4 167.5MWh domestic Comparison of power prices – Pan-Europe.9% 2.0 181.

Agenda Page The energy value chain Climate change Renewables Valuation and drivers Appendix B A S I C S 2 84 94 99 108 E U R O P E A N U T I L I T I E S 84 .

CFCs) by a specific percentage by 2008-2012 from 1990 levels 5% cut in total globally 8% cut for EU-15 and most other European countries These targets define each country’s volume of ‘allowed’ emissions (AAUs) Burden sharing principle Use of flexible mechanisms (market mechanisms. methane.Kyoto Protocol signed 41 industrialised countries (‘Annex 1 countries’) agreed to reduce their greenhouse gas emissions (GHGs: CO2. cap-and-trade schemes) Clean Development Mechanism (CDM) – system for pollution reduction schemes in developing economies Permits : Certified Emission Reductions (CERs) Joint Implementation (JI) – system for pollution reduction schemes in developed economies C H A N G E Permits : Emission Reduction Units (ERUs) Emissions Trading Scheme (ETS) – EU emission permits trading scheme Permits: EU Emission Allowances (EUAs) C L I M A T E CERs can be transferred into EUAs etc. but the total number of AAUs is fixed 85 .Climate change regulation 1992 – UNFCCC (UN Framework Convention on Climate Change) established 1997 . NOx.

Climate change regulation s CE R s EUA EUAs If Germany’s actual emissions are higher than its assigned allocation it can purchase CERs from Brazil and transfer them into EUAs Total AE = total AAU AE – actual emissions AAU – assigned allocation unit CERs AAU AE AE AAU Brazil C H A N G E Germany C L I M A T E 86 .

paper. iron. etc. petrochemicals. mining. steel.Climate change regulation EU target 8% by 2010 from 1990 levels 20% by 2020 or 30% by 2020 if a broad-based global agreement on GHGs can be reached Emissions Trading Scheme was set up Member states are given National Allocation Plans (NAPs) for CO2 permits Covers power. oil and cement Import allowance for CDM/JI subject to certain limits CO2 emission permits can be traded within each phase with banking also possible between phases 2 and 3 Phase 1: 2005-07 Phase 2: 2008-12 C H A N G E Phase 3: 2013-20 — Includes new sectors such as airlines. Note other trading schemes will probably emerge globally. aluminium. but may not necessarily be fungible with the EU ETS C L I M A T E 87 .

EUA price forecast Estimation: Long-term demand for permits A function of EUA shortage vs demand Allocation plans Compliance buyers including governments Non-compliance buyers CER/ERU balance Abatement opportunities – various methods of abatement have different costs CDM/JI permits – trade at a discount to EUAs due to project failure risk UK coal-to-gas switching German lignite-to-coal switching C H A N G E Existing and new plants Industrial abatement (N.B little willingness for this from industrials so far) C L I M A T E 88 .

<€35/t Industrial. <€30/t Industrial.EUA price forecast The price of CO2 is determined by the Demand for abatement Supply of abatement Forecast €25/t for phase 2 50 45 40 35 Price (€/t) 2008 abatement stack German l-t-g Industrial.5/t Industrial. <€27. <€25/t Industrial. <€20/t 30 25 20 15 10 5 UK c-t-g summer UK c-t-g winter Demand for abatement C H A N G E 0 0 50 100 150 200 V olume (mt/a) Source: JPMorgan estimates 250 300 350 400 C L I M A T E 89 .

Carbon capture and sequestration ‘Clean coal’ Capture via post-combustion.3GW of CCS-type capacity – 51mt/year of abatement Abatement cost estimate €28-30/t a function of: Margin loss (CCS plant new build cost – coal ex-CCS plant new build cost + energy loss) x CO2 avoided Estimate: €16-17/MWh output or €24/t of CO2 Transport cost C H A N G E Estimate: €2-2.5/t Storage cost Estimate: €3-3. deep oceans or mineral carbonates (although UN unlikely to approve ocean & carbonation Technology for large scale capture of CO2 already commercially available.5/t C L I M A T E 90 . problem is pipeline and regulation Capturing and compressing CO2 requires energy lowers overall thermal efficiency There are firm plans for around 8. pre-combustion or oxyfuel combustion Storage in deep geological formations.

300mt/a. phase 1.Climate change regulation outcomes Phase 1 ETS was effectively bankrupt since there has been a surplus of permits Currently phase 2 permits are trading at around €20-25/t We forecast €25/t for phase 2 Emissions of 2. a 10% cut in NAPs vs. a shortfall of 210mt/a on average and CDM/JI permit deliveries of 780mt total Phase 3 deeper and broader Emergence of subnational and national schemes Extension to other GHGs. but unlikely post 2012 Although windfall for low / zero CO2 emitting plants will remain C L I M A T E 91 . 160mt total extra demand from airlines. other industries Utility sector the most impacted Positive for revenues Negative for costs – depending on free allocations/ auctioning C H A N G E Free allocations have been positive for profits overall.

ON and RWE have already sold forward a large part of 2008 and 2009 output so the impact of volatility of phase 2 CO2 on them will be minimal Change in load stack A higher CO2 price will move gas-fired power plants further into the baseload compared to coal-fired Coal-fired plants will suffer from lower volumes and hence lower profits and fixed costs per MWh Carbon intensity relative to average will drive valuation Exposure to coal vs. Exposure to generation vs. nuclear etc.jpmorgan.g.com/climatechange 92 .Climate change regulation outcomes Impact on utilities’ profits: Marginal cost pricing Higher variable costs per MWh and higher long-term power prices Revenue will include 100% of the price of a permit Windfall profits are incurred if permits are allocated to thermal plants for free… … and non-thermal plants are price takers Degree of forward contracting e. networks and supply C L I M A T E C H A N G E For more information. E. see our series ‘All you ever wanted to know about carbon trading’ at www.

the 20.000 hours by optimizing running and operating multiple units as a single block at the same time Coal plant will be the most affected For opted out coal units. ground level ozone and reduce aerosol particulates throughout Europe by controlling emissions of sulphur dioxide (SO2).EU thermal regulation: LCPD (2001) Large Combustion Plant Directive Applies to combustion plants with a thermal output of >50 MW Aims to reduce acidification.000 hours across the 8 year period to 2015 NG says it expects operators will look to maximize earnings from the remaining 20. nitrogen oxides (NOx) and dust Using emission limit values (ELVs) The UK’s National Grid has warned the extra costs of coping with the implementation of LCPD could substantially increase transmission constraint costs Set to have an impact on system costs of around £15m ≈12GW of capacity has opted out of the LCPD Running hours of these plants will be limited on a chimney stack basis (either the whole plant is running or not) to 20. irrespective of season C L I M A T E 93 .000 hour limit is likely to act as a constraint on output and the costs of reserve will rise NG has put forward 2 possible scenarios for plant operations: C H A N G E Summer-cold regime – generators decide to run the units over the winter and make them unavailable over the summer. either on maintenance or moth-balled Year-round running regime – generators will focus their running hours on the peak power price periods across the year.

Agenda Page The energy value chain Climate change Renewables Valuation and drivers Appendix B A S I C S 2 84 94 99 108 E U R O P E A N U T I L I T I E S 94 .

Mapping the renewable energy space Drivers : Climate change. R&D Renewable / Alternative Energy Equipment Operators Electricity Utilities New entrants Autos Big oil New entrants Hybrids / Plug-ins Wind R E N E W A B L E S Traditional Transportation Nuclear Mini hydro New Tech Clean Thermal CCS Biomass Biofuels Solar Thermal Marine Onshore Concepts Technologies Offshore PV Corporates 95 . Economics Policy regimes: Standards. Energy Security. Pricing/support.

r-o-r hydro and geothermal technologies do not emit any GHGs Pumped storage hydro uses a small amount of electricity Renewables Biomass combustion emits CO2. renewable energy is not finite It allows a country to reduce its reliance on foreign imports of electricity/coal/oil/gas Hence governments have been very keen to encourage investment in renewable energy capacity… R E N E W A B L E S 96 .Renewables Climate change concerns Solar. wind. but unlike fossil fuel combustion. this has not been ‘out’ of the carbon cycle for a long time Energy security concerns By definition.

Greece: 35-55% of capital cost 97 . Renewable Obligation Certificates in UK Tax credits – levy charged on all suppliers unless they qualify for an exemption e. Spain RD486 and RD661 Green certificate schemes — Energy suppliers required to submit certificates to show they have sourced a certain % of supplies from renewables — Certificates bought from a pseudo market ‘buy-out fund’ e. Production Tax Credit in US.g.g.g.Renewables capacity support mechanisms Feed-in tariffs – fixed pricing framework with a cap-and-floor of floating prices to provide a return well over WACC e.g. CCLECs in UK Capital subsidies – can by-pass state aid rules R E N E W A B L E S e.

9% 6.0% 5.3 61.1% 17.3% 3.3 67.4% 2.0% 18.2% 1.2% 34.0% 3.3 91.3 52 70 41.0% 0.3 66.7 47. Italy and the UK R E N E W A B L E S 98 .3 46 86. JPMorgan estimates 2020 Target-RES 34% 13% 16% 13% 13% 30% 25% 38% 23% 18% 18% 13% 16% 17% 42% 23% 11% 10% 14% 15% 31% 24% 14% 25% 20% 49% 15% 20% Basis points/year 71.7 60 75.7% 16.5% 17.3% 6.7% 11.8 % CAGR 2.3 84.3 48.6% 8.3% 5.0% 8.7% 39.9% 0.4% 17.2% 2.2% 3.0% 2.5% 5.3 90.g.9% The targets proposed on 23rd January were harsh but widely expected and the horizon is far out A proposal for tradeable ‘Guarantee Of Origin’ (GOO) certificates would allow suppliers to meet their obligations with output from another country Positive for suppliers and generators with pipeline in low tariff/high deliverability countries Negative for generators in green certificate/ low deliverability countries e.5% 5.4% 7.7% 7.3 72 44 67.2% 9.3 74 58 86 78.2% 12.9% 15.6% 12.6% 3.9% 18.9% 5.3 53.4% Source: European Commission.6% 7.5% 10.9% 4.8% 6.8% 6.7 77.0% 2.7 46.8% 6.0% 5.6% 10.8% 1.7% 1.7 81.1% 5.0% 28.7 63.5% 7.8% 2.9% 2.3% 2.2% 1.2% 20.EU renewables targets EC proposals on member state targets for renewable energy as a proportion of all energy consumption EC proposals on member state targets for renewable energy as a proportion of all energy consumption 2005 RES Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden UK EU 27 23.

Agenda Page The energy value chain Climate change Renewables Valuation and drivers Business drivers Valuation drivers Typical catalysts B A S I C S 2 84 94 99 Appendix 108 E U R O P E A N U T I L I T I E S 99 .

Business drivers What makes a successful utility? Generation Transmission and distribution Supply Big vs. small V A L U A T I O N A N D D R I V E R S 100 .

price setter A N D Development potential Plant improvements .What makes a successful utility? Generation Generation ‘Success’ mainly derives from operations rather than business model New build on time/budget Minimise outages Efficient fund sourcing Efficient operating costs Off take contracting. environmental Life extensions Expansion via new plant including new regions 101 V A L U A T I O N .operational. PPAs ideally Returns/ sustainability a function of type Carbon ‘clean’ vs.g. ‘dirty’ Fuel price volatility/ availability ‘Correct’ funding D R I V E R S Diversity in a given region is important Exposure to fuel vs. fixed cost contracts. e.

What makes a successful utility? Networks Networks Regulatory relationship Delivery Constructive dialogue Reliability Health and safety Opex IT – management of inventory Sourcing at a low cost Optimal staffing Capex Purchasing at a low cost Pipeline delivery within budget and on time D R I V E R S Partly exogenous Politics and type of regulation V A L U A T I O N A N D 102 .

What makes a successful utility? Supply Supply Competitive upstream sourcing A function of the competitive environment Peer group behaviour Degree of consolidation Politics Pricing for margin vs. pricing for market share Superior customer service to peers Dual fuel contracts Well hedged exposure to wholesale power prices D R I V E R S V A L U A T I O N A N D 103 .

patents Integrated utilities tend to be larger Upstream/downstream hedging Management cost savings Expertise D R I V E R S Operational diversification Geographical diversification V A L U A T I O N A N D 104 .What makes a successful utility? Advantages of scale Advantages of scale Load (lower fixed costs per MWh) Economies of scale in procurement Economies of scale in financing Reputation and brand name Large customer base R&D possibilities.

Nuclear Relative Multiples Networks: EV/RAB V A L U A T I O N A N D 105 . free cash flow (FCF) yield important given capex cycle Utilities-specific multiples – according to asset Supply: EV/#customers Generation: EV/MW.Valuation methods Absolute Discounted cash flows (DCF)/ dividend discount model (DDM) – utilities generate long term cash flows with high visibility Premium/ discount to RAB Sum of the parts (SOP) – useful in diversified utilities Multiples DCF/ DDM RAB-based Relative Traditional relative multiples – limited usefulness due to diversity P/E – more useful under IFRS Dividend yield – generally income stocks with growth D R I V E R S EV/EBITDA – traditional measure.

unexpected (or earlier than expected) changes. e.g. politics Networks: RAB and allowed return.g. equipment Wholesale power prices Demand growth D R I V E R S Weather Temperature affects demand Precipitation drives hydroelectric generation V A L U A T I O N A N D 106 . gas. oil.Utilities stock price catalysts Regulation Tariffs: e. expectations of a forthcoming review Carbon: pricing and allocations Raw materials prices Coal. uranium.

Utilities stock price catalysts Management strategy Opex and capex plans Short/ medium term targets Trading statements M&A prospects Re-gearing potential. buy-backs. dividends Interest rates and taxes Development of competitive market D R I V E R S V A L U A T I O N A N D 107 .

Agenda Page The energy value chain Climate change Renewables Valuation and drivers Appendix Acronyms Glossary Abbreviations Conversions Metrics Key websites Bloomberg & Reuters codes B A S I C S 2 84 94 99 108 E U R O P E A N U T I L I T I E S 108 .

Acronyms AAU ACS AGR ARPU ARM BETTA BWR CCGT CCLEC CCS CDM CER CHP E&P ELV A P P E N D I X Assigned Allocation Unit average cold spell advanced gas cooled reactor average revenue per user adequacy reserve margin British electricity trading and transmission arrangements boiling water reactor combined cycle gas turbine climate change levy exemption certificate carbon capture and sequestration Clean Development Mechanism Certified Emission Reduction combined heat and power exploration and production emission limit value EPR ERU ETS EUA GFR JI LCPD LDZ LFR LNG LRMC MSR NAP NETA European pressurised reactor Emission Reduction Unit Emissions Trading Scheme EU Emission Allowance gas fast breeder reactor Joint Implementation large combustion plant directive local distribution zone lead fast breeder reactor liquified natural gas long run marginal cost molten salt reactor national allocation plan new electricity trading arrangements 109 .

Acronyms NISM NOC OCGT OFGEM OFWAT PPA PSCs PSO PTC PV PWR RAB RAV notification of inadequate system margin national oil company open cycle gas turbine British electricity and gas regulator England and Wales water regulator power purchase agreement public service contracts public service obligation production tax credit photovoltaic pressurised water reactor regulated asset base regulated asset value RC RCV RD ROC RPS SCWR SFR SRMC SYS TPA UCTE UNFCCC VHTR remaining capacity regulated capital value royal decree (Spain) renewable obligation certificate renewable portfolio standard super-critical water reactor sodium fast breeder reactor short run marginal cost seven year statement third party access Union for the Co-ordination of Transmission of Electricity UN Framework Convention on Climate Control very high temperature reactor A P P E N D I X 110 .

enough heat to raise the temperature of one pound of water 1°F Load curve – order in which different plants are called upon to run based on their variable operating cost Minimum reserve capacity = 5% of national generating capacity Margin against the peak load = peak load – load at reference point Plant margin .efficiency with which the energy content (measured in gross calorific value) of the input fuel is turned into electrical energy by the generating station A P P E N D I X Thermal generation – electricity production using a steam-driven turbine Windfall profits – additional profits due to free CO2 allocations 111 .Glossary Adequacy reference margin = margin against the peak load +minimum reserve capacity British thermal unit – a unit of heat equal to ≈ 252 calories. expressed as a percentage of total capacity Tariff deficit – the shortfall of regulated revenues from tariffs versus the revenues that would be realised by prevailing market prices Thermal efficiency .amount by which the installed generation capacity exceeds the forecast peak demand Remaining capacity = reliably available capacity – reference load Reliably available capacity = total generating capacity – non-usable capacity – maintenance and overhauls – outages – system services reserve Reserve margin – amount of unused available capacity of an electric power system at peak load.

Abbreviations b or bbl cf bcm t Mcf Mt boe kboe kb toe Mtoe Btoe or Gtoe Btu KW MW GW TW MWh /y or /a /d A P P E N D I X barrel cubic feet billion cubic metres metric tonne million cubic feet million tonnes barrel of oil equivalent thousand boe thousand barrels tonne of oil equivalent million tonnes of oil equivalent billion tonnes of oil equivalent British thermal unit kilowatt megawatt gigawatt terrawatt megawatt hours per year per day 112 .

00 0.0360 1 1.0001 0.35 13.Conversions tonnes of LNG To: From: boe GJ kWh mmBtu tce toe m3 of gas tonnes of LNG Gcal A P P E N D I X boe Multiply by 1 0.95 0.52 4.70 768.1724 4.6995 1 0.1165 0.0201 0.107 0.0341 0.0009 1.0551 29.58 14590 1163 5.0239 0.29 41.0769 1.2388 0.4599 0.0252 0.68 0.0062 8.12 1 0.0381 52.78 3.7971 0.5576 0.97 0.87 0.2089 0.79 6.0001 0.685 GJ kWh mmBtu tce toe m3 of gas Gcal 6.76 39.0013 1.58 0.00 1 113 .07 8136.84 0.80 0.0034 1 27.0009 0.68 26.25 0.09 27.99 1099.2519 7 10 9.0006 0.0361 49.27 1 1379.25 0.0001 0.1429 0.4295 0.1462 0.1634 0.0190 0.1 160.0007 1 0.7933 0.11 11631 10.187 1700 277.0036 1.78 1 293.

Electricity margin metrics Reserve margin (%) = capacity reserve / demand Capacity margin (%) = capacity reserve / available capacity Output = Capacity x Time [kWh] = [kW] x [h] Load factor = Electricity generated Installed capacity Load factor ≠ 1 Power plants sometimes have technical problems and have to shut down A P P E N D I X The wholesale price may be too low for it to be economical to run the plant 114 .

gov.org Eia.org Nationalgrid.eu/environment/climat/climate_action.htm A P P E N D I X 115 .htm http://epp.siemens.com/servlet/finance/investorrelations/arevatechnicaldays-en.ec.com/uk/Electricity/SYS/ Technology Alstom.html Iea.Key websites Dti.eurostat.com Powergeneration.eu http://ec.gov System adequacy Ucte.com Gepower.europa.doe.eu/energy/electricity/benchmarking/index_en.europa.htm http://ec.europa.html Vestas.eu/research/energy/index_en.com Areva.org Nordel.uk/energy/statistics/index.com EU http://ec.europa.

Bloomberg tickers SX6P (Dow Jones Stoxx European Utilities index) ERIXP (renewable energy index) EMIT (electricity emission allowance) EPWR (European electricity prices) PWNX (French electricity prices) ELEU (UK electricity prices) ELGE (German electricity prices) ELNF (Nordpool electricity prices) A P P E N D I X 116 .

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