As previously alluded to, I am tracking investment opportunities in the energy sector for the current year 2019 and have been talking about waste-to-energy. I want to present one of the most interesting investments out there: TRANSMISSION GRIDS. So without further ado, let us go into it.
The beginnings of the German power grid can be traced back to the Weimar Republic
The Federal Republic of Germany inherited a unique legal structure previous to the existence of the Federal Republic of Germany, which had legal ramifications for how the electricity grid was run.
At that time, the goal was to provide electricity to the masses of the population as efficiently as possible. It was the case that one benefited from economies of scale, meaning that a single operator holding the operating licenses would be more likely to deliver the electricity to the end user, and at the lowest cost possible.
The privatization wave since the 1990s meant that the German electricity grid was systematically privatized to make the German power transmission grid business more efficient and also to stimulate competition in the electricity industry. This process was driven primarily by the newly created Federal Network Agency, whose only purpose was to help regulate the network infrastructure of the Federal Republic of Germany after it was transferred from the public sector to the private sector. This also included the electricity and gas sectors.
Especially in the electricity sector, the grid operators still believed in the 1990s that privatization would be to the benefit of the existing monopolists in Germany’s electricity market. As it turned out, however, this cartel-like structure of the four large network operators in Germany was broken up and sub-areas of the grid infrastructure in the area of electricity assigned to separate legal entities all independent of each other, in the so-called Electricity-Unboundling. I
In addition, the Federal Network Agency regulated the operation of the power grids by checking the network availability for consumers and efficiency of the power transmission and by means of which the agency was able to make precise statements when and where companies should invest to maintain the network infrastructure.
Likewise, there were guidelines for long-term grid investments and, based on the operating license for the grids, it was possible to determine when it would be necessary to re-invest to upgrade the grid infrastructure. The operating licenses of the electricity transmission grids are awarded every 20 years, with the result that many licenses expire at the same time. The need for investment thus increases dramatically in a short period of time, as a result of which the neglected investments in infrastructure are only just beginning to resurface.
Profitable business opportunities for transmission system operators are decreasing rapidly
Of course, the profitability of network operators has always been a core issue, and comprehensive regulatory action has resulted in the profit margin moving within a certain range where it is no longe profitable to maintain the network and make investments to technically upgrade the grid infrastructure.
Certain network provider malpractices also had an impact on the efficiency of the electricity operation, which reduced profitability over an agreed period, all under guidance of the Federal Network Agency. Now it is so that the network operators have tried to delay the investment period as far into the future as possible, toward the end of the operating license in order to achieve the highest possible profit margins, due to the depreciation of their assets.
As a result, there appeared a backlog of investments, which means that the future operators were made liable for the technical maintenance and upgrade of electricity grids. Only in recent years has the Federal Network Agency recognized this problem and set new targets for the transmission system operators to guarantee fulfilling their end of the bargain, and they had to keep operating costs high to maintain their transmission networks.
The high investment costs in the transmission network operation overwhelm the operators, and reduce their profits
The ever increasing investment costs indicate that the transmission network operation business will no longer be a good investment opportunity in German-speaking Europe, the same applies to countries located in Northern Europe and Central Europe. The high investment costs ensure network stability but lead to nationalization of transmission network operations, at the expense of operating profits generated in the electricity business.
Due to higher electricity and gas prices, operating profits of the transmission system operators has been more closely examined in recent years, which also reduces their earnings potential. The transmission networks are losing out, and therefore it would make investments in transmission network operations even more unattractive for private investors in a high-interest environment, also because of their tight profit margins, despite stable earnings.
Occasionally, weak economic growth is to blame for the low interest rate environment. But transmission network operations still attract various fund companies in the insurance business, businesses that currently see electricity networks as alternatives to government bonds. The German electricity transmission networks provide a good return on investment, under these circumstances they find themselves in.
Entry of global insurance companies into the electricity transmission network business
Above all, the insurance funds are still looking for ways to escape the economic chaos in the world economy with stable profit opportunities in electricity networks that are the A-rated. Transmission networks in Northern Europe definitely count as A-rated. Power grids are particularly interesting to them because the global economy and the European economy are in a low interest rate environment.
But it is obvious that the investors have to deal with the subject matter and most of them understand very little of what is going on in the energy industry. In order to get a precise overview of the investment opportunities one needs to understand the business.
Among other things, Australian insurance companies are trying to invest in the German transmission network business. But it doesn’t stop there.
We also see a growing interest of the Chinese owners who become active and want to invest in German power transmission networks. The East German transmission system operator 50Hertz came extremely close to being sold to China. However, a state intervention ensured that 50Hertz, a critical part of the national energy infrastructure remains in German hands.
Electromobility will of course create new investment opportunities in the electricity grids which is why I think that there are still good opportunities for investors in the electricity business because electromobility will play a more important role in the future, not only in the German transport business. This is so because new technical developments of battery technology are becoming available in Europe. However, electromobility offers the opportunity to invest in transformers suitable for power conversion processes.
Larger stock corporations such as ABB will certainly offer investors a good opportunity to enter the electricity business in 2019, as transformers must be replaced in German-speaking Europe in the coming years. A huge amount of technical facilities in the energy industry are still from the 70’s, and have to be renewed very soon.
Of course, this also applies to other European countries, such as Great Britain. Another good investment opportunity are decentralized electricity grids. The digitalization and operation of electric cars requires the expansion of grid capacities at the low voltage level, for which the local grids have not been designed at all. Voltage fluctuations also put more strain on the transformers, and usually transformers are one of the most expensive components of the network infrastructure.
Renewable energies will also open up new investment opportunities
Electricity production in Germany has a strong regional focus, and renewable energy production is spread throughout the country. There are additional opportunities to benefit from the energy transition in German-speaking Europe. So it is the case that wind energy, especially offshore wind energy, is produced in northern Germany and then is send to southern Germany where most industrial production facilities are, located, especially for the automotive industry and the chemical industry.
In order to transport the electricity from northern Germany to southern Germany, it will be necessary to build new power lines, i.e. those that transmit electricity via high-voltage direct current in order to minimize the losses of power transmission. This is not the only problem that currently exists in the power transmission grid business.
Telecommunications transformation, smart metering and 5G are creating new opportunities
Above all, most investors still underestimate the fact that as digitalisation takes hold in industralized economies, so does the demand for electricity. This inevitably leads to the power grids also having to be adapted. Certainly there are efficiency increases in the power requirement. But various studies have shown that the new innovative solutions cannot necessarily reduce the consumption of a particular energy resource, but potentially increase it. It has yet to be proven in practice whether the Advanced Metering Systems are also capable of reducing the power consumption of end users in the long term. Scientific studies have shown that power consumption savings of smart metering applications is highly dependent on household size, and it can not be said that smart metering has an impact on electricity consumption.
Furthermore, bitcoin mining has also been shown to correlate with a sharp increase in electricity demand, with the result that many bitcoins are now mined in central China, where rich coal deposits are relatively cheap to come by, to produce electricity. Of course, these options do not exist in north-western Europe and Central Europe, where electricity is transported over long distances to the end user. Should it come to this, meaning a global collapse of the financial system, blockchain technology and a state-licensed crypto-currency is a realistic alternative to the conventional currencies. So that would lead to a significant increase in energy demand which would also be covered by renewable energy sources. This would result in an major expansion of electricity transmission networks.