S&P Global Ratings believes Fit for 55 will sharply increase growth in demand for electricity, primarily from 2030, which will likely support high power prices in the long run. With the plan, the EU has chosen to pursue decarbonization by dramatically shifting its energy mix away from fossil fuel energies through green electrification. To achieve this, Europe will need to add between 45 and 55 gigawatts (GW) of renewable capacity a year this decade (20-30 GW annually for solar and 25 GW for wind). That compares with 30 GW added in 2020 (20 GW of solar and 10 GW of wind). Under the plan, electrification would increase to 30% of the final energy demand by 2030 and 57% by 2050, from just 25% today.

We believe the greater role given to the carbon price to achieve this electrification of the economy will also support power prices this decade. The reform of the EU Emissions Trading System, which in short encompasses a tightening of supply and the inclusion of more industries, implies a large increase in carbon prices, compared with the average price over the past decade, already partly embedded into today's prices (see "A Heightened Focus On CO2 Emissions Stokes Interest In The Carbon Markets," published on Sept. 21, 2021). That said, forecasting power prices remains extremely tricky, given that by 2030 two-thirds of generation may come from zero- or low-marginal-cost renewables, which could actually depress the average power price.

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Clear Positive Momentum For European Utilities

In what will create a largely positive operating environment for utilities, investments in renewables generation and energy networks will need to pick up significantly to support growth in green power. What's more, investment into the infrastructure for low-carbon mobility--such as charging stations and network abilities--will need a considerable boost. (For details, see "Industry Top Trends Update: Utilities EMEA," July 15, 2021, and "The Energy Transition And The Diverging Credit Path For European Utilities," Feb. 16, 2021.)

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We project annual investments of European utilities to grow an average annual 30% over the next three years, to about €133 billion on aggregate for our rated universe, compared with an already high level in 2019-2020. Unsurprisingly, investments will first go to networks, which we estimate will be 46% of aggregate capex for the top 10 rated integrated utilities, that need upgrades to improve resilience, integrate new renewables, and manage intermittency. We note that investments for some transmission system operators (TSOs) are particularly high, including in the U.K. and Germany, to build corridors connecting renewables (and interconnections from the Nordics) from the north to high-consumption areas in the southern areas of the countries. A large part of the remaining will go into renewables (that we estimate at about 30% of the aggregate for the top 10 rated integrated utilities). This may be somewhat of an underestimate since some companies report net investments: We expect a large degree of capital rotation in this area, meaning that utilities will develop and sell part of their renewables projects to recycle capital and reinvest in new projects. Only a minor share of the investment will go into other unregulated generation and supply, in particular in the large life extension program of EDF's French nuclear fleet as well as its new nuclear plant in the U.K.

We believe European utilities could strongly benefit from Fit for 55's emphasis on green electrification because it will meet high customer demand. Indeed, most energy-intensive industries will seek to secure green energy sources to meet their own decarbonization targets. They will likely seek to secure long-term corporate power purchase agreements from renewables sources or by developing sources of green hydrogen, itself produced from renewables. Either way, European utilities would benefit from long-term, profitable supply contracts, which would provide greater visibility about future cash flow.

The plan, together with the previously release European taxonomy, provides clearer EU policies about how and where to invest in the energy transition and allocates targeted public funding for innovation in the energy transition. We also believe the European utilities sector is already in a phase of high innovation, which we expect will intensify as the world looks for new ways to transform and lower the costs of the energy transition.

Sector's ability to attract capital will support credit quality

Although we expect to see a significant mobilization of capital, we also understand most European utilities want to maintain a disciplined financial policy, which would support credit quality in the sector. We currently do not anticipate deterioration in creditworthiness for the European utilities we rate. Indeed, to support these large investments, we expect to see an increase not only in debt issuance but also in equity raising, including issuance of hybrid capital. What's more, we believe the sector has a particularly strong capacity to attract capital, supported by solid growth prospects and the positive environmental impact of these investments--two major considerations for investors.

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Tighter Energy Supply And Higher Prices, At Least Until 2025

We see a significant tightening in the supply-demand energy balance over the next three years as part of the rollout of Europe's tough decarbonization policies. We note the accelerated anticipated closures of conventional generation plants, notably nuclear and coal, in the next three years. At the same time, the pace of commissioning of new renewables projects and interconnections will not be fast enough to offset the loss of conventional capacity. S&P Global Ratings believes this will lift power prices over 2022-2025 (for details, see "The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update").

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Utilities will need to address the risk of intermittent supply. Renewables like wind and solar cannot produce energy around the clock, and given thinning spare capacity margins and extreme weather events, we see an increasing risk of blackouts and need for dispatchable power--that is power sources that can be turned on and off on demand. As such, intermittency risk will become another key factor to look at when it comes to growth prospects for renewables. To lessen this risk and meet net-zero ambitions, the market will need solutions that boost system reliability (batteries and storage, transmission upgrades, demand-side response, carbon capture, utilization and storage, and hydrogen in the very long term). At the same time, management of security of supply and network inertia will continue to require conventional, reliable, and flexible generation capacity, which gas can offer over the coming decades. However, net-zero ambitions and Europe's lack of clarity about the role of gas in the transition appears to be curbing appetite for investment into gas assets.

Let's Not Minimize The Many Risks

Europe's ambitious Fit for 55 plan, that is, the energy transition, also presents other large risks for utilities: cost inflation, supply chain disruptions, permitting snags, a scarcity of skilled workers, and increasing social and political risk stemming from record-high energy prices. They all could threaten the pace of renewables growth.

Cost inflation

Renewable energy production costs are showing their first deviation from the expected long-term decline of about 40% on average by 2030. S&P Global Platts Analytics estimates that commissioning costs for solar photovoltaic plants will increase up to 10% this year, and that the cost of offshore and onshore wind projects will rise 4% and 8%, respectively, by the end of 2021 (see "European Offshore Wind Will Continue To Lead Global Growth," Sept 8, 2021). The increases stem from higher prices of raw materials--such as copper, aluminum and steel--that are used for solar and wind plants, which are causing setbacks to both manufacturing and new-build activity. Additionally, bottlenecks in shipping are contributing to the high-cost environment by making it more difficult to procure materials. If the surge endures, it could throw into question the anticipated gradual decline in production costs and slow the pace of growth.

Supply chain snags

As demand continues to grow, we see increasing pressure on European utilities' supply chains, which could result in heightened execution risks as they increase investments in renewables assets. Meanwhile, renewables supply chains are already struggling to keep up with the required pace of development, notably with domestic demand in China. We note that the European green electrification strategy increases the region's dependency on China for a large number of strategic parts and resources. We believe this situation, which we see as unlikely to change over the medium term, could add a degree of execution risks for European utilities. In its May 2021 Report ("The Role of Critical Minerals in Clean Energy Transitions"), the International Energy Agency flags the significant market share of China on some critical products necessary for the energy transition. In particular, China processes about 90% of rare earths (notably used in batteries), 40% of global copper (key for network cables); and about 60% for cobalt and lithium (also for batteries). Beyond dependency upon China's imports, the European supply chain needs to scale up in cadence with growth in investment and demand, which takes time and heavy investments. However, we understand that the largest renewables European players at this stage may have better procurement access than smaller ones.

Permitting remains a key hurdle

So far, the administrative process to build new renewable projects in Europe has been one of the greatest operating challenge for developers, and one that could jeopardize returns for projects due to delays and unforeseen additional costs. This is in part due to local opposition to such projects ("not in my backyard"). Local communities claim harms to the local environment (wildlife, noise, landscape) but also the competition for land such projects may create with agricultural projects. This comes on top of large population density (compared with that in the U.S., for example) and other constraints, such as nonconstructable or military zones. Europe and domestic energy policies aim to tackle the issue by accelerating and simplifying the administrative process for renewables. However, this is yet to be seen; legal procedures in Europe remain protracted, and there are currently many ways for local communities to challenge these projects.

Where will skilled workers come from?

We believe that workforce scarcity could slow down the pace of growth and ambitions for the sector or lead to higher staff costs. Fast acceleration in greener energies—including networks--require building a skilled workforce, which implies hiring, training, and converting workforces to new technologies. This obviously takes time but is a big challenge for the sector. Indeed, it requires indeed a significant ramp-up of engineers and skilled staff ready to work on these new projects in sometimes remote places,

Record-high energy prices elevate social and political risk

Affordability concerns will remain a major risk for the sector as part of this ambitious energy transition. We see policy risks as already on the rise for utilities. Spiking gas, carbon, and power prices are putting social issues, such as energy affordability, in the spotlight. We believe the social implications of rising power prices could result in waning political support and give way to a social and political backlash. The Fit for 55 package explicitly aims at managing these risks by offering a set of fiscal measures and incentives to the most vulnerable population and markets, through its Social Climate Fund. Meanwhile, we see pressure growing and political moves in countries, like Spain, which introduced clawbacks on gas prices for Spanish generators with immediate effect. While the situation is so far unique in Europe, other countries could take sector-negative measures to offset the surge in power prices.

Editor: Rose Marie Burke.

Related Research

• A Heightened Focus On CO2 Emissions Stokes Interest In The Carbon Markets, Sept. 21, 2021
• The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update, Sept. 17, 2021
• European Offshore Wind Will Continue To Lead Global Growth, Sept 8, 2021
• Industry Top Trends Update: Utilities EMEA, July 15, 2021
• The Energy Transition And The Diverging Credit Path For European Utilities, Feb. 16, 2021