Return of Enron to the Energy Sector?

The lure of forever-cheap money. But now rates are going up.

By Leonard S. Hyman and William I. Tilles:

Ignacio Galán warns of Enron-like failures in the energy industry. Ignacio who?

Ignacio Galán is the CEO of Iberdrola, the far flung Spanish-based utility holding company with operations in Spain, the UK, Brazil, Mexico, and the US (where it owns Northeast electric and gas distributor Avangrid). In an interview with the Financial Times, Mr. Galan was publicly expressing his concerns regarding the state of the renewables business. In particular, he addressed recent low bids to supply power offered by highly leveraged newcomers to the industry. He likened these new entrants in the renewables business to legendary corporate fraudster Enron in terms of excessive leverage coupled with limited operational skills.

“Because money is so cheap, many people who have no talent in the sector have been coming with an extremely high level of leverage,” he said. “With the change of the rates, there will be a clean-up of the sector.”

The Financial Times ads:

Mr Galán was not accusing any new entrants in the renewable sector — some of whom are private equity or infrastructure funds — of the kind of false accounting that led to US energy trader Enron’s collapse in 2001. He was instead highlighting how cheap money was pushing some into a business they did not understand.

Is this merely sour grapes from a high cost, losing bidder? Last year in Spain, for example, Iberdrola’s renewables unit did not win any of the 3,000 additional MWs open for bid. Perhaps. But the point of Mr. Galan’s criticism is that a protracted period of extremely low interest rates has affected the bidding process for electricity driving down costs and profitability for all participants. Conversely, he anticipates that rising interest rates will inevitably put pressure on highly leveraged bidders in power markets.

Producing electricity, regardless of technology employed, is a capital intensive business. Cost of capital makes up 70-80% of the levelized cost of a wind or solar project. Most prospective providers of renewable energy purchase equipment from the same list of reputable suppliers like Siemens or GE. As a result, the cost of physical assets ought not to differ significantly from supplier to supplier.

So how can wholesale renewable electricity suppliers differentiate themselves in such a vigorously competitive market? There are three areas:

  • Understanding their own cost structures (with an eye towards rigorous cost controls).
  • Assumptions about energy output.
  • Their underlying cost of capital.

Roughly speaking, a one percentage point increase in cost of capital requires a 15% price hike to cover increased interest and equity expense.

Is a one percentage point rise in interest rates and capital costs so unlikely these days? And what happens to profitability when new builders of renewable generating assets submit bids on the basis of current capital costs yet complete their project with a different, higher cost of capital?

According to international sources, new bids to supply onshore wind and solar electricity are in the 4-5¢ per kwh range. In the US, the Energy Information Administration, which produces the most elaborate technology estimates, projects onshore wind and utility solar levelized costs of 4.4¢ and 5.8.¢ respectively for plants going into service in 2022, after tax credits.

Just to clarify, that means that the actual expected electricity costs from the new renewable assets is about are 5.6¢ and 7.4¢ respectively, before Uncle Sam returns money to plant builders in the form of tax credits. So, are we back to the bad joke – I lose money on every box I sell, but I make it up on volume?

Mr. Galán’s point, we believe, is that a lot of the new financially-motivated highly-leverage low bidders in US and European wholesale renewables power markets will end up in financial distress. His implied point is that they have miscalculated their true costs and when push comes to shove, their bankers can’t or won’t bail them out.

“Bankers always give an umbrella when it is not raining, but when it rains they ask for it back,” he said.

The bottom line? Renewables now face significant near term financial headwinds, so to speak. Production costs, while continuing to fall, are no longer falling as fast as before. And the cost of capital will rise with interest rates, and as we previously showed, that matters.

Many of the amateurish over-leveraged new entrants will exit the business. And so will their bankers. The boom – caused by cheap money and declining costs of wind turbines and solar panels – will eventually meet the bust when that cheap money disappears.

But even after backing out the benefits of tax credits and measures to protect the electric grid from the intermittent nature of renewables, this business remains highly competitive with conventional power generating resources. And over time is likely to become even more so. By Leonard S. Hyman and William I. Tilles.

A utility in Texas takes the first steps. Incumbents are not amused. Read…  Wholesale Power Generators to Get Hurt by Grid Batteries

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  13 comments for “Return of Enron to the Energy Sector?

  1. Korkin says:

    Thus, the idea of old Hubbert in the current conditions will be reformulated as follows:
    “Peak of oil and renewable energy will come after the exhaustion of easily recoverable money.”

  2. So it’s a cyclical problem, the build out in renewables brought prices down, meets the rising cost of new capital to build more renewable sources. In no way does this harm the efficacy of current sources, except to make them more profitable. If there is an energy policy it would state its purpose to be that of bringing down energy costs. To that end I expect governments (who get it) will nationalize and subsidize energy costs lower, even if they have to run their business at a loss (gasp!). Up until now the benefits from global monetary expansion have been tossed into the kids sandbox, where speculators chase the markets. It’s time to put that money into action.

    • stan barber says:

      govenments will not nationalise or subsidise the energy costs. governments are not in the business of helping their taxpayers.
      governments are in the business of ever increasing feecing of their taxpayers, very much beyond the excruciating pain threshold.
      at least those taxpayers that can still just about afford to pay, while everybody else increasingly turns to an easier life or piggybacking on the whatever is still available on social security.

    • BTilles says:

      Hi Ambrose Bierce,

      Re “So it’s a cyclical problem.”

      That’s not completely unfair. Mr Galan’s point is that a new bunch of financially reckless players have greatly increased the cyclicality of wholesale electricity markets. The problem isn’t that the “cowboys” so to speak go bust. Far worse is that they languish as desperate sellers merely attempting to remain afloat and limit market prices for all wholesale participants.

  3. mean chicken says:

    Well, if I can just throw a few solar panels on my roof, watch my meter spin backward while charging my fossil-free EV and be done with it, they’re in big trouble.

    Not to mention there’s no need for big box stores anymore, so shopping malls, local tax revenue and the employment they generate are toast as well.

    • BTilles says:

      Hi mean chicjen,

      Re “I can just throw a few solar panels on my roof…”

      Yes to everything you say. But it was what you didn’t say is of unterest re economics. It all depends. Where do you live, how much do you use and when? The typical payback periods for these systems is measured in years. But once you have one, you may never have another electric bill or gasoline bill, assuming you also own an electric vehicle.
      Also, you’ll have electricity to sell back to the electric company, or perhaps swap with neighbors. The implication is correct that the utility is right to be concerned regarding their long term prospects.

      • Paulo says:

        Utilities should be concerned for there are many savings possible for consumers (reducing their profits). Gone are the days, or soon will be as people have to watch their money, that folks simply set their thermostats and grumble a bit when the utility bill shows up. I live north of 50 on the BC wet coast so solar isn’t feasible….in the slightest. I have crunched the numbers numerous times. I also have too many treees around so ditto for a windmill, (even though I built one for fun). The river I live on is tidal and doesn’t have a steady enough flow for even a rudimentary paddle system. But super insulation and a woodstove works wonders in the winter and cross ventilation and good windows take care of the summer heat.

        Central heating, unless it’s a heat pump, is a concept well past its prime. Forget about it.

        Our residential rate is now 8.58 cents per Kwh (tier one), and rises to 12.5 cents for additional useage. Our last 2 month bill during this cold winter was $113.00. Let’s call it $56 per month, including admin fees. As I write this I am sitting in my shorts watching the snow fall outside my window. In my attic I have R50, r20 in the walls and floor, and new double pane windows. We burn 4 cords of wood per year to heat a 1200 sq ft house. For back-up we installed in-wall electric fan heaters and a thermostat for every room. Almost everyone can do their insulating themselves, most can swap out windows, and a good many can do their electrical by pulling their own permit and doing some basic research.

        Increasing insulation and swapping out bulbs to LEDs are very low hanging fruit. Once in awhile upgrade grants are available. Or as my Brit father-in-law says, “Put on a sweater”.

        • DV says:

          I wonder how much this all cost you, but this does not matter as the slack is being picked up by 3D printers, composite manufacturing, data centers, crypto miners and many other things that make today’s life comfortable. The world is not progressing, unless the per capita energy consumption is rising. That has always been a rule. Of course, you can go back to burning wood or pellets for heating, do a lot of things to become more energy efficient (such banning high-power vacuum cleaner or even microwaves like in Europe), but you cannot change the rule of life – the population is increasing along with per capita energy consumption. It may be stagnant or even falling due to deindustrialization in some developed nations, but will be rising fast in less developed ones, which now consume next to nothing. They need more efficient energy, so they switch from “biofuels” (meaning from bruning wood) to other more effcient, but still not so costly sources such as coal. Contrary to what you hear, it is the share of “biofuels”, not coal or gas that has been shrinking fast globally!

          Bottom-line – you will not see better living standards even in the developed countries unless per capita energy consumption keeps growing. It may actually cost you less for now, but this will back-fire when reliability starts to suffer. But in countries like Germany end customers actually pay one of the highest rate financing renewables development, despite the fact that the market rates are so low that they cannot sustain power producers. They created huge overcapacity and someone has to pay for it. It is not like a gas-fired plant can stay idle for nothing, the owner will still need to be compensated for keeping it operational and also for its cost of capital plus some margin, even if it operates just a few days a year! You can hardly call this system efficient. It really gets ugly when hydro-power operators cannot cover their operating costs because operators of coal and renewable capacity dump their excess output on the power market. That is how things are today.

    • walter map says:

      “I can just throw a few solar panels on my roof”

      Until the fossil fuel companies rent enough politicians to make it a criminal offense to have them.

      They’re already making it prohibitively expensive to even complain about getting flammable gases out the tap at your kitchen sink or about the pile of coal ash blocking your driveway.

  4. Scott says:

    This article pairs very nicely with the one from earlier this week about the decline of coal. The access for cheap financing has certainly played a major role in it; both directly (cheaper financing for renewables) and indirectly (cheaper financing to frack gas).

    Renewable projects also benefit from tax-equity investing, which is being reduced as a result of the tax cuts. These investments increase transaction costs, but are generally beneficial to smaller developers. My understanding from reading articles is that the lower tax cuts made tax equity investment less appealing to the traditional investors (insurance companies and banks) and that they need time to analyze the actual impact. If the slowdown is something more permanent, then the cost to finance these projects could increase significantly.

    My theory is that one of the reasons the solar industry was so public about their opposition to the PV tariffs is that they know these other factors will hurt development, but don’t want to admit that other government policies benefiting them are disappearing.

    • walter map says:

      All very true. And yet, economics, environmental awareness, and implementation momentum favor the adoption of renewable energy. OTOH, politics, and industrial and social inertia, favor the continuance of fossil fuels. Overall, for the present, installation of renewables will continue a slow acceleration while fossil fuels, e.g., coal-fired plants, will continue to be gradually retired. Still, if all you’re looking for is short-term or medium-term investment opportunity, you could cleverly establish favorable strategies either way.

      But what you’ll find, in the end, is that renewables will not largely displace fossil fuels, and never will, and could not have prevented the coming ecological catastrophe in any case. The slow realization is that it is simply too late. Reality is increasingly asserting itself, regardless of ones hopes, or rationalizations, or wishful thinking, or self-deceptions. Which is to say, that either way, for everybody, or nearly everybody, it will not matter.

      On a related noted, established plot devices indicate that GOT will surely pay homage to LOTR, achieving denouement very similarly, with a great evil defeated at the cost of magic going out of the world.

      In industrial history and in literature, we art critics know how to anticipate narrative trends. That’s why we’re often so very sad.

      And that’s all I say.

      • Tom T says:

        Mr. Map,

        Your message is unduly masked by too prideful presentation 12th century courtiers have been hung for less. I got your point but it is these heartless technicians we need to impact it seems to me

  5. plaentxi says:

    Iberdrola is another beneficiary of easy money.
    ECB owns 10% of Iberdola’s bonds thanks to QE program that is distorting energy market.

    Ignacio Galan should not be giving easy money lessons.

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