Vasile Iuga: Technology and regulatory framework might reconcile sustainability with competitiveness

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This is the transcript of the message delivered by Vasile Iuga, partner PwC România, during the 2016 Energy Strategy Summit, held on May 31 at Snagov Palace. For a sum-up of the main ideas, check our previous material: 27 essential ideas after Energy Strategy Summit 2016.

Good afternoon, thank you for the invitation.

Sustainability and competitiveness are the topics for this session. They seem deeply antagonistic. On the one hand, sustainability refers to caring about the environmental impact, as well as sustainability for the business investors, and it seems to generate very high costs in terms of competitiveness – both for industrial consumers, and for end-consumer. Competitiveness has a stake especially for the industrial consumers, and energy poverty, if I may, affordability is important for the individual consumer. And the question is: can these two concepts be reconciled? And if so, how? Because if you reconcile and balance them you can generate a win-win type situation. My opinion is that they can be balanced and reconciled through several mechanisms.

The first mechanism is the technology, the other mechanism is linked to the market and the regulatory framework. Technology is rapidly and deeply changing the energy paradigm; the current situation is primarily the result of technological developments. On the one hand, on the delivery, supply, and production side, technological developments have brought to market new resources, previously inaccessible, i.e., hydraulic fracturing or marginal fields of deep offshore, but also significantly influenced electricity generation. Thus, on the supply side there is a lot of energy. On the demand side, all technological developments influenced its dramatic downward. New technologies, energy efficiency, decreasing energy intensity in a number of economies, have all led to a decoupling of the energy demand from the economic growth. In Romania, for example, between 2010 and 2014, GDP cumulatively increased by 18%, while consumption, energy demand fell by 10%. IEA forecast for the period 2013 – 2040 a global GDP growth by 150%, which means that in 2040 the global GDP will be 2.5 times higher than in the present, while the energy consumption will be only 30% higher. So we have this decoupling of economic growth from energy consumption. Let’s remember that in Romania, 8-10 years ago, ministers and the president said: “If I want to see how the economy goes, I look on energy consumption.” Wrong, this is no longer the case! The two were disconnected. Technology increases the offer and decreases the demand, and this has led to an abundance of energy. This fundamentally changes the market, because from a market of suppliers, we operate now in a buyers’ market. And this change occurred very fast and very violent.

At the same time, technology constantly decreases the cost of energy. Let us remember what was the price per installed megawatt in photovoltaics, six years ago. It probably decreased by 3.5 times till now. So, as technology only lead to lower prices, it is clear it will preserve its disruptive impact to energy.

Let’s move further! If this is the case, what is the impact on the business model? The energy business has been considered for a long time a strategic business of geopolitical and geostrategic relevance, especially due to the oil and gas component. Business relationships in the field of oil were often compared with friendship between a girl and a boy; they go out together, feel good, but separate without much remorse. That reflected the fact that the oil market was a global marketplace, efficient, liquid, and large. In contrast to the gas market, which was likened especially to marriage, I wouldn’t necessarily say a Catholic marriage, but a commitment on a somewhat longer term – with reference to the geopolitics of pipelines. They required large investments and very long periods of time for return of investment, and, as in a marriage, at separation, there is always the sharing problem, and, for sure, one of them will end up being not satisfied.

The policy in this sector has changed violently and rapidly. How? Investments still need to be made on long term. But all forecasts in recent years from all forecast organisms proved to be wrong. And the energy business remains a business with large high-risk investment, and long-term return. So, under these uncertainty and volatility conditions, one cannot tell what the price will be and what the demand will be. What happens to investments, because it investments that matters? That led to a change in investor behavior under today’s conditions of limited and minimum price per cubic meter of gas: some of the fields that were profitable for operating at 100 dollars a barrel or 300 dollars per thousand cubic meters are now unprofitable.

Moreover, a lot has changed into the business model for major utility companies. Utility companies were considered the most stable, the safest and the most profitable investment. It was as if you had deposited money in the bank, at a much higher interest rate than any bank would give you today, at a much lower risk of bankruptcy of the bank, and with a much lower risk that your money may disappear from your account, to turn you from a client into a shareholder through the process of bail-in – that we’ve seen, for example, in Cyprus, and which is covered as well by the Romanian legislation. So, investments in the utility business were stable and secure and very profitable.

Few years later, the business model for large utility companies is completely messed up. And many of these companies have registered significant losses due to price volatility, but also because of the regulatory framework. Because the regulatory framework can play an essential role for the destiny of some utilities and market participants. If you give priority to renewable producers, for entering the system, it is obviously that providers of stable electricity generation may suffer. Under these circumstances, in addition to changing the business model of companies in the sector by considering the risks of volatility, changing the regulatory framework is mandatory. Otherwise, the technology and the market move faster than policies, and the risk is that in attempting to balance or adjust the market to provoke perverse effects that were not originally considered.

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