transformative energy infrastructure

Transformative times for European energy infrastructure

Tom Levering, Global Industry Analyst
Tim Casaletto, Global Industry Analyst
2023-10-31
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only. For professional, institutional, or accredited investors only. This is a marketing communication. Please refer to the prospectus of the Enduring Assets Fund and to the KIID before making any financial investment decisions. Capital at risk.

Europe’s current energy supply crisis has precipitated a boom in demand for energy infrastructure that we think has the potential to provide a significant tailwind for the European utility sector. What’s behind our positive view on the sector and where are the investment opportunities?

What’s behind the crisis?

Today’s energy crisis has two components: an availability crisis and an affordability crisis.

Availability crisis: Prior to Russia’s invasion of Ukraine in February, Russia supplied around 40% of Europe’s natural gas requirements. Today, that number is close to zero. Against a backdrop of a drought-induced drop in hydroelectric power output and maintenance issues with France’s nuclear power plants, Europe is now facing a severe shortage of both natural gas and electricity. Finding alternative energy sources has become critical, encompassing options such as importing more liquefied natural gas (LNG), increasing domestic gas production, extending the life of nuclear plants, enhancing the use of coal plants and building more renewable energy plants. While some of these potential solutions like extending nuclear and burning coal are more immediate, the longer-term solutions such as expanding renewables and LNG infrastructure can take several years. 

In our view, Europe’s stores of natural gas are sufficiently high to cover this winter, provided we do not experience exceptionally cold weather conditions. However, supplies are likely to be considerably depleted by the winter of 2023/2024 (Figure 1).

Figure 1
Die europäische Energieinfrastruktur im Umbruch Abb. 1

Affordability crisis: The price of European natural gas has skyrocketed during the last year because of the supply shortage and relatively inelastic demand, causing massive increases in gas and electricity bills across Europe. As a result, energy consumers across Europe face significant increases in their utility bills, even with the cushioning provided by the various national support packages and the European Union’s (EU’s) proposals to put caps on power prices and apply windfall taxes to the oil and gas sector.

The renewable energy solution for Europe?

We think significant investment in domestic energy infrastructure is critical if Europe is to resolve the energy crisis. We anticipate the building of new wind and solar farms and more electric networks to connect renewables to the grid, the construction of more LNG import terminals and natural gas networks to accommodate the increased LNG and the development of more electricity and gas interconnections across the region. This transition towards greater self-sufficiency is also supported by ambitious decarbonisation goals, most notably, the REPowerEU Plan, which targets a 150% increase in Europe’s renewable energy capacity between now and 2030.

How does the situation in Europe compare with the rest of the world?

Europe’s energy crisis has highlighted the US’s relative advantage in terms of energy supply. While Europe relies heavily on imported energy, the US is largely self-sufficient, so the increase in US natural gas prices has been much less dramatic than in Europe and Asia (Figure 2). As of 30 September, European natural gas prices were a staggering seven times higher than the price of US natural gas. 

Figure 2
Die europäische Energieinfrastruktur im Umbruch Abb. 2

Data is rolling front month futures for TTF, Henry HUB and JKM priced in euros/megawatt hours (MWh), as of 30 September 2022. | Sources: Bloomberg and Wellington estimates.

However, just as in Europe, the need to decarbonise the US energy production is now driving significant investment into renewable energy and the electricity network across the country, with the US Inflation Reduction Act serving as a meaningful catalyst.

While spot LNG prices in Asia have followed the upward rise in European LNG prices, Asia is in a far better position than Europe as the region's long-term oil-linked contracts currently imply prices far below those experienced in Europe. In addition, the muted pace of the Chinese economy has helped offset any supply shortages.

Capturing the investment opportunities

In our view, this transition to a more reliable and renewable energy framework creates a number of potentially compelling investment opportunities within the global utilities sector. 

Stock selection and geographical diversification are, however, more essential than ever in this environment to create a balanced portfolio: for instance, by combining exposure to select opportunities in Europe with more stable US utility allocations. We also think it is important to focus on businesses that have significant growth potential in the areas of renewable energy and electricity networks and that have a low likelihood of negative regulatory intervention. In contrast, we believe investors should avoid companies with valuations that may be vulnerable to negative future regulatory intervention. 

We think that Europe’s energy crisis has highlighted the urgent need for significantly improved and enhanced domestic energy infrastructure. Implementing these changes won’t happen overnight, which, we believe creates a likely long runway for growth to the benefit of patient investors.

This material and its contents may not be reproduced or distributed, in whole or in part, without the express written consent of Wellington Management. This document is intended for marketing purposes only. It is not an offer to anyone, or a solicitation by anyone, to subscribe for units or shares of any Wellington Management Fund (“Fund”). Nothing in this document should be interpreted as advice, nor is it a recommendation to buy or sell securities. Investment in the Fund may not be suitable for all investors. Any views expressed in this document are those of the author at the time of writing and are subject to change without notice. Fund shares/ units are made available only in jurisdictions where such offer or solicitation is lawful. he Fund only accepts professional clients or investment through financial intermediaries. Please refer to the Fund offering documents for further risk factors, pre-investment disclosures, the latest annual report (and semi-annual report), and for UCITS Funds, the latest Key Investor Information Document (KIID) before investing. For each country where UCITS Funds are registered for sale, the prospectus and summary of investor rights in English, and the KIID in English and an official language, are available at www.wellington.com/KIIDs
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In the UK, issued Wellington Management International Limited (WMIL), a firm authorised and regulated by the Financial Conduct Authority (Reference number: 208573). In Europe (ex. UK and Switzerland), issued by Wellington Management Europe GmbH which is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin). Shares of the Fund may not be distributed or marketed in any way to German retail or semi-professional investors if the Fund is not admitted for distribution to these investor categories by BaFin. 

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