Europe's utilities have made major efforts to clean up. Achieving net zero targets will require much more: Fossil fuel-based energy still dominates the continent's energy mix.

Between 1990 and 2020, the utilities industry was one of the main drivers of an overall reduction in greenhouse gases in Europe. It reduced emissions about 46% over this period. This was achieved primarily through the efficient use of renewables technologies and the phase-out of coal-fired power plants.

Over the same period, Europe reduced emissions by 32%, equivalent to 1.5 billion tons of carbon dioxide. In 2022, the utilities sector, including electricity generation, contributed a total of about 22% to the continent's total greenhouse gas emissions.

There is still much further to go. The utilities industry remains one of the largest carbon emissions contributors in Europe. For companies in the sector, meeting the targets set by governments will take huge investment, technological breakthroughs, and agile management. If they fail to achieve the right balance on the path to net zero, creditworthiness is at risk.

In this report, we examine key hurdles we see for the sector in accelerating the pace of transition, from structural issues to current macro conditions.

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Impediments To A Smooth Transition Are Sectorwide

We see three key themes driving decarbonization for the European utilities sector: policies and regulation, transformation of power generation, and challenges for networks. Each theme offers utilities opportunities for growth and contains risks for creditworthiness.

The utilities sector has a crucial role to play in any achievement of a sustainable future in Europe.   The sector has significantly decarbonized over the past three decades. However, it still remains one of the largest emitters. Therefore, it will have to swiftly cut direct emissions to be able to reach net zero by 2050 if it is to achieve its targets. This means there is also a reliance on offsetting technology to reach net zero.

Only utilities can enable a dramatic transformation of European electricity generation.   They also hold the key to transportation and certain other industries achieving electrification. However, the continent faces an energy trilemma: simultaneously achieving a secure supply of energy, affordability, and climate sustainability. National responses to these issues vary significantly.

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EU regulators and governments have ambitious targets and expect utilities to deliver on them.   For example, the EU has an interim target of cutting greenhouse gas emissions a minimum of 55% by 2030 relative to 1990 levels. This implies more than doubling the average annual reduction compared with the 1990-2020 average. Europe's reductions to date are already a globally unparalleled achievement; hitting the 2030 target will be magnitudes more difficult.

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Speeding up emissions reduction will prove challenging.   In terms of affordability, doubling the pace of reduction requires raising investments immediately, at a time of higher financing rates and cost inflation. In addition, certain technologies, such as carbon capture and storage (CCS) or hydrogen, are unproven at scale. From a security of supply perspective, project execution is a risk, as is equipment and raw material dependency from geopolitically sensitive countries.

Slower and less profitable capex may mean some energy utilities miss their emissions targets, ultimately eroding credit quality.   Political pressure, stranded assets, or displaced energy, and higher carbon costs are likely to weight on credit quality. Ultimately, however, various aims and constraints may reconcile through supportive public-policy responses. Thus, reducing emissions will impact business models and ratings in various ways for the various utilities. Required changes vary wildly – some need to reinvent their power generation mix. Generators have a higher proportion of scope 1 emissions, while for gas grids, scope 3 emissions are a bigger issue. Net-zero target dates and scope therefore vary widely through the sector.

Legislative Environments Have Seen Progress

Europe's energy transition accelerated in the wake of Russia's attack on Ukraine. This was the case at domestic and supranational levels.

For utilities, affordability and permissions have inhibited, or at least slowed, the energy transition.   Solar capacity additions are increasingly cost-competitive and have seen significant uptake for residential capacity and little public pushback on utility-scale development. Wind and nuclear, however, are less obviously cost-competitive. In addition, in a number of countries, public opposition has significantly dampened the pace of deployment and long-term potential for onshore and near-shore offshore wind. Illustrating this point, the amount of solar capacity added in Europe was double that of wind in 2023. This was partly due to the lack of acceleration in Europe's additions of wind power capacity, to 17GW in 2023 from 16GW in 2022.

The EU's legislative acceleration toward net zero continues.   It was initiated through the Fit for 55 package of measures in 2021. This was followed by 2022's REPowerEU plan to reduce dependence on Russian fossil fuels and the European Commission's March 2023 proposals for a Net-Zero Industry Act (NZIA) and Critical Raw Material Act (CRMA). On Feb. 6, 2024, the EU Council and the European Parliament approved a preliminary version of the NZIA. They had approved a preliminary version of the CRMA on Nov. 13, 2023. The final version still needs to be agreed by the EU's council and parliament before becoming effective. In addition, legislation will require massive budget support over the coming decade.

Each EU member state has committed to cutting its greenhouse gas emissions by 55% relative to 1990 levels by 2030.   This is the first milestone on a demanding net-zero path for European utilities (see Related Research below). Several countries have legally tightened maximum emissions limits and formalized deadlines. For example, in 2022, Germany amended its Climate Protection Act to increase the required emission reduction from 55% to 65% by 2030. It also moved its net-zero target year to 2045 from 2050 (see "Germany's Green Energy Ambitions Spark A Transformative Decade For Utilities," published Sept. 14, 2023). In addition, the EU has clarified that the 2030 goal for renewables' contribution to the overall energy mix is 42.5%, aspiring for 45%. This means the challenge can be sized. To visualize, the EU needs to add about 510GW of wind and 600GW of solar capacity in aggregate by 2030, about double the recent pace, according to European Commission data.

The EU also aims to reshore substantial parts of its wind, solar, and battery equipment chains.   In many cases, it is unclear whether it can sufficiently incentivize investments into manufacturing and address challenges. For example, bridging the cost gaps versus non-European competition from nations such as China and meeting the capital-return expectations of renewable developers could prove difficult. This is the case for offshore wind and solar alike. For solar, European supply chains have to contend with 45GW of panel imports annually from China. Despite record domestic renewable additions, China is trying to address considerable overcapacity across technologies. This heavily weighs on prices. In relation to this, ingot-maker Norwegian Crystal's AS declared bankruptcy in August 2023, NorSun AS temporarily halted production in September 2023 , and Germany's Meyer Burger Technology AG decided in March 2024 to close one of its last European factories. It cited the U.S. Inflation Reduction Act as providing more support for investments in manufacturing capacity outside of Europe. These developments risk the EU Solar Strategy's goal of creating a manufacturing base with annual production of 30GW by 2030.

Efforts are also underway to address cost challenges on green hydrogen.   At the same time, the future of European natural gas depends on greener options, including notably hydrogen. There is a gap between the cost of producing hydrogen from renewable power sources and the price consumers are currently willing to pay for hydrogen, whether from renewables or from natural gas. In a bid to overcome this, the EU conducted its pilot hydrogen auction, with €800 million funding, in November 2023. Yet, the cost challenge remains: Non-renewable gray hydrogen, which is derived from natural gas, remained cheaper than green hydrogen to produce, even during the 2021-2023 energy crisis. This is likely to remain the case going forward, as title transfer facility (TTF) prices are very moderate, in the high-single digit gas prices area in dollars per 1,000 cubic feet, versus the high double-digits in the second half of 2022 (see "S&P Global Ratings Has Lowered Its North American And European Gas Price Assumptions For 2024 And 2025," published Feb. 20, 2024).

Elevated power prices can help generators.   We also see added legal and cash flow complexities, and exposure to secondary-market asset-value risk. Benefits could occur through increasing remuneration of future capex versus legacy assets. This could potentially happen as it has in Germany from 2024 as gas grid operators receive accelerated remuneration for assets that may become obsolete by 2045. In our view, even if storage solutions grew sharply from currently negligible levels, intermittent generation growth will increasingly pressure power price levels and volatility in the second half of this decade (see "Europe's Utilities Face A Power Price Cliff From 2026," published June 22, 2023). Flexible production could therefore become more beneficial. For some government-related entities, the level and nature of government support may assist their transition.

Legislative efforts bring risks and opportunities for the energy sector.   Overall, legislation is looking to reshape the EU energy landscape and concurrently achieve affordability, reliability, and climate sustainability. In our view, individual power and gas utilities can benefit from this. While ambitions are set at the EU level, details are generally defined at national levels, creating a patchwork of energy regulations across Europe that may be tricky to navigate. Reshaping business profiles without weakening financial profiles under the weight of heavy investment will not be easy.

Power Generators Are On The Front Line

European utilities' individual transition strategies, including their choice of business mix and the accompanying financial leverage, will significantly impact their creditworthiness well into this decade, in our view. Protecting credit quality means balancing stepped-up investments in the transition with consideration of credit metrics. And few utilities have much buffer in their credit metrics to start with.

The transitions of utilities will have macro implications.   We are cautious about Europe's ability to fully meet in a timely manner 2030 objectives on renewable generation, especially for wind. It could take several more years for the region to fully reach its 42.5% target, in our view. This is just as investment and refinancing costs have increased considerably. For example, the German government's 10-year rate is currently between 2% and 3%, compared with negative rates through January 2022. In addition, staffing and supply chain issues could drag project execution out over multiple years and complicate costing and hedging. This has led strong and committed generators to recently delay investment decisions into renewable energy systems. Certain generators that are simultaneously running several large projects are seeking to part finance their investments by selling stakes in them to third parties. While typically a financial relief and shared burden, it also adds group complexity.

For generators, the mix needs to both switch from fossil fuels and expand considerably.   Fossil fuels today contribute about a third to power supply in Europe. Meanwhile, total capacity also needs to expand considerably to support growth of about 3% in annual demand for the rest of the decade. This demand growth is from electrification megatrends for heating; transportation; and substantial parts of industrial processes, including those that are energy-intensive, such as steel or cement.

Demand growth in Scandinavia, Germany, and Benelux is likely to exceed 3%.   We expect unprecedented demand growth to continue until 2050, in some cases doubling consumption by then. About 80% of generation growth will need to come from renewables, since the contribution from nuclear will not meaningfully rise, net of retirements. This is despite renewed interest in nuclear from many countries and its inclusion in the EU Taxonomy.

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For networks, resilience of transmission systems is a growing challenge.   Europe must concurrently manage the expansion of the capacity and resilience of power transmission systems. It needs to ensure grid stability despite the intermittent and widely distributed power generation of assets such as solar and wind. This is even if, beyond hydroelectric power and in some cases nuclear, peaking gas capacity remains in place to support grid stability in certain countries.

• Strengthening power grids is key in a number of countries. In Germany, Sweden, and the U.K., for example, considerably more power transmission capacity will be needed to get energy from northern areas, where most renewable generation takes place, to southern regions that consume more energy. In Italy, southern areas need to get power to the north.
• In terms of gas, certain sections of the existing grids can be repurposed for hydrogen. Meanwhile, adding hydrogen-dedicated sections to grids will face considerable planning, permitting, execution, and financing challenges. This adds to the uncertainty surrounding the pace of renewables and hydrogen buildups, which may require regulatory frameworks to provide the necessary incentives, including in countries where the weighted-average cost of capital for such projects has been kept low to date.
• It is unclear how European economies and regulations can sufficiently foster storage capacity growth, beyond occasional, project-specific renewable hybridization.

To enable generators to realize net-zero strategies, investments in transmission systems need to, at least, go hand-in-hand with renewable power generation growth and demand changes. Network operators will be unwilling to invest though, without frameworks that are stable enough to ensure returns.

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• EMEA Utilities 2024 Outlook: Benelux, France, Italy, Iberia, Jan. 8, 2024
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• Vattenfall's SEK5.5bn Impairment Relating To Norfolk Boreas Offshore Will Not Immediately Affect Its Business Profile, July 20, 2023
• Germany's Green Energy Ambitions Spark A Transformative Decade For Utilities, Sept. 14, 2023
• Utilities Handbook 2023: Western Europe Regulated Gas, Sept. 20, 2023
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• EU's Proposed Energy Market Redesign Mitigates Merchant Risks And Accelerates Renewables, April 3, 2023
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