EMEIAMAS 1414 Plug in March 2013 - EY - US€¦ · liquefied natural gas (LNG) supply. Two likely...

June 2013

Plug in EY’s latest insights for Power & Utilities

Contents

Navigation bar

Use the navigation bar located in the upper right corner to move through the document.

Left arrow — Move back a page Home — Access the cover page

Contents page Right arrow — Move to the next page

Contents

Trends in regulationThe regulations applied to power and utility companies (P&Us) are growing in complexity. Ernst & Young’s Global Assurance Power & Utilities Leader, Charles-Emmanuel Chosson, says understanding regulatory trends can help P&Us manage the burden and prepare for change.

Based in our Paris office, Charles-Emmanuel Chosson has more than 20 years’ experience working with some of the world’s largest utilities. He supports clients in a number of ways, including advising on the sector’s key risks and reporting issues, and helps them come to grips with their regulatory and compliance requirements. Charles-Emmanuel says current regulatory trends have created a critical time for the sector.

US GAAP and IFRS variancesOne of the biggest regulatory issues of recent times is back on the agenda at the International Accounting Standards Board (IASB). The IASB is considering possible resolutions to the accounting variances between US GAAP and Europe’s IFRS that burden global utilities and have hindered Canada’s transition to IFRS. Charles- Emmanuel, who is part of the Ernst & Young team involved in the talks, says it is critical that the differences are resolved.

“The issue is pretty simple,” says Charles-Emmanuel. “Should regulatory assets and liabilities — that is, those costs or revenues that the regulator permits a utility to defer to its balance sheet — be recognized in the accounts under IFRS rules?”

“If yes, they will be included in the balance sheet of a P&U, which, considering the size of the assets on these balance sheets, may have a significant impact for some companies,” he continues. “If they are not recognized, they will continue to be handled as off-balance-sheet items.”

The IASB is reactivating its rate-regulated activities research project and, in April, launched its “Regulatory Deferral Accounts” exposure draft in an attempt to resolve the variances between US GAAP and IFRS.

“We are involved at a high level in the consideration of this project,” Charles-Emmanuel says. “It’s important for us to be part of what could be the future standard on those regulated assets and liabilities.”

While he does not anticipate a speedy resolution, Charles-Emmanuel says the IASB’s decision will be felt across the sector.

Moves toward convergence Charles-Emmanuel says the lack of development of a single European regulatory model to date is, in some ways, surprising, but he believes some points of convergence are arising due to the regional focus on efficiency, cost reduction and quality of service.

“Europe’s regulators are looking for more areas of comparison and opportunities to benchmark performance, which leads to a form of convergence in the rate-setting mechanisms,” he says. “Nevertheless, we will not see a single European regulatory model any time soon as each regulator continues to keep its own local specificities.”

“This clearly represents a challenge for utilities as operating a regulated business requires having a perfect understanding of specific local regulation, which can, in some cases, be pretty complex,” he continues.

While he says regulation will remain “above all, of a national nature,” Charles-Emmanuel says the trend toward convergence on some matters is still a step in the right direction.

4 | Plug in — June 2013

“It is certainly helping utilities anticipate how the regulatory system may evolve and how it may be applied to the geographies in which they operate,” he said. “Now is the opportunity to start a discussion with regulators and acquire some bargaining power, by using what is done in neighboring countries as a kind of benchmark.”

A broader approachCharles-Emmanuel says today’s regulatory trends are particularly interesting because of the focus on efficiency, an issue he says was less of a priority for regulators a decade ago.

He says that it is part of a trend that sees regulators taking a far broader approach to the development of quality targets and incentives for utilities.

“Regulators are trying to encourage a more balanced approach to cost reduction,” he explains. “They are prepared to offer companies a fair return on their investments, but they want to ensure that financial objectives do not harm the overall quality of the operations.”

This trend is highlighted by the UK regulator’s introduction of its new RIIO (Returns = Incentives + Innovation + Outputs) price control framework, which incentivizes regulated utilities through quality and performance indicators focused on six outputs: safety, environment, customer service, connecting customers, social obligation in particular to vulnerable customers and the reliability of the network.

“RIIO probably represents the clearest example of how regulatory systems are likely to evolve in the future,” Charles-Emmanuel says. “We expect a growing focus on quality and incentives.

“Regulated companies will still be in a position to post good returns on investments but only if they achieve the targets set by the regulators,” he continues. “In other words, the old cost plus regulation will probably definitively disappear, and companies will have to be efficient to improve their results.”

Charles-Emmanuel says utilities will be challenged to monitor an increasing number of variables.

“They will also need to extend their operational targets beyond strictly economic angles,” he says. “This requires a coordinated effort from the various functions of a regulated company, including finance, operations, supply and quality management.”

Anticipating changeWhile keeping an eye on trends can help companies better manage their compliance and performance, Charles-Emmanuel cautions that utilities will “never be in position to know with certainty in advance how their regulatory models will evolve.”

“This is because external factors will always influence the regulators,” he says, “particularly regarding remuneration rates, which are clearly impacted by the financial market and the level of risk premium assigned to regulated activity, which can evolve over time.”

He says the best approach is vigilance.

“Keep comparing what is happening across Europe and not only in your primary geographies,” he says. “What is going on in other countries may represent what you will have to live with in a couple of years. Be proactive and try to anticipate how regulators may make changes.

“Reacting too late is always expensive.”

Charles-Emmanuel Chosson Partner, Global Assurance Power & Utilities Leader [email protected] + 33 14 6437162

Charles-Emmanuel has more than 20 years’ experience in audit and financial consulting and has in-depth knowledge of the power and utilities sector. He supports leading utilities on transactions

including mergers and demergers and has also participated in the listing of several utilities on the New York Stock Exchange and Euronext.


It’s a small island nation, but Malta’s new energy policy may offer big opportunities for utilities to secure a captive market that is forecast to grow. Rudolph Mifsud Saydon, Gilbert Guillaumier and Chris Meilak report.

Capture the market in Malta

The Mediterranean island, an EU member state that is home to about 420,000 people, is under pressure to cut its 100% dependence on fossil fuels, decrease energy costs and increase the usage of renewable energy sources in line with its EU commitments under Energy 2020.

Supplying small islands with stable, clean and affordable energy is always a challenge. Malta has no natural resources of its own and is not currently connected to mainland Europe electricity networks or any gas pipelines.

Shift to natural gasEarlier this year, Malta’s ruling Labour Party unveiled its new energy policy, aimed at cutting power tariffs and boosting the country’s use of renewable energy. At its heart, the policy will shift the country’s power plants, which currently operate on heavy fuel oil (HFO) toward natural gas. The private sector is critical to the success of the move and, in April, the Government issued a call for expressions of interest and capability (EOICs) for a long-term power purchase agreement and gas supply agreement that will be in place by March 2015.

The projects will provide Malta with 200 megawatts (MW) of new capacity and liquefied natural gas (LNG) supply. Two likely short-term infrastructure options to deliver the LNG supply are an onshore storage facility or floating gas storage system. All told, the projects are estimated to cost about €300m (approximately US$388m).

The plan will see Malta’s primary energy provider, Government-owned Enemalta, entering into two agreements with private investors:

1. To purchase electricity — approximately 200MW — from the new, privately owned power station

2. To purchase LNG to supply its existing power station

A high-voltage submarine cable is currently being laid between Malta and Sicily to connect Malta to the Mainland European Grid, which is expected to be operational by mid-2014.

Small but strong economyThe Government is confident of attracting the necessary investment and has declared the project a “safe investment for the private sector.” The EOIC indicates that both the power purchase and gas supply contracts will last for a period of 18 years, with a fixed price for a minimum of 5 years, followed by an indexed price for the remaining period. Both contracts are seen as relatively long-term agreements in the current energy environment.

Interest has certainly been keen to date, with leading international energy companies submitting 19 proposals before the call closed. A contract with the successful bidder is expected to be finalized by September 2013. The EOIC suggests the Government would prefer one dominant energy partner, for both gas and electricity, to build, own, operate and maintain both plants and provide the supply required for the two separate contracts.

While Malta’s market may be small, it is one of the few in Europe with consistent growth and a positive long-term outlook. Malta’s political environment is stable, with both major political parties committed to the overhaul of the country’s energy sector. The average growth of the Maltese economy (relative to historical averages) has been the best in the euro area since the beginning of the financial crisis, and its unemployment rate remains one of the region’s lowest.1

1 The International Monetary Fund’s concluding statement to its Article IV monitoring of the Maltese economy, http://www.imf.org/external/np/ms/2013/051313b.htm, released 15 May 2013.


Be ready for risks Despite the undeniable opportunities, potential investors in Malta’s energy sector should be ready to assume some risks. The country’s growing energy consumption lessens risks surrounding future demand, but fluctuating LNG prices could pose potential risks to private investors around their commitment to supply gas at a fixed price.

Malta’s current lack of a permanent gas supply also adds complexity, although long-term government plans to build a gas pipeline between Malta and Sicily would bring greater stability around supply and offer another opportunity for investors.

And, as with many countries, Malta has its own unique cultural distinctions. Potential investors would do well to partner with local advisors to navigate the business and political environment, avoid unnecessary delays, reduce costs and enhance their chances of success.

Big opportunitiesIt may be a small country, but the opportunities available in Malta are not insignificant. With an ambitious program to meet its EU targets, Malta must attract major private investment to fund the conversion of its power plants to LNG, secure its LNG supply and pursue other sustainable energy initiatives, such as solar energy to generate 10% of its energy from renewable sources by 2020 (currently 0.4%). Few countries in the world offer utilities the opportunity to secure a captive market in an economy tipped to grow. Investors should seriously consider Malta’s unique situation and prepare their bid carefully, with local advice and an eye on the risks.

We have a strong presence in Malta and extensive experience in its power and utility sector. Public-private partnership (PPP) projects are increasingly gaining traction in Malta, and professional support may be required from different angles, such as regulatory support, transaction support, business modeling, tax structuring, local insights, negotiations and liaison with

government representatives and bodies, among others. We have advised Malta’s authorities on PPP projects and also provide insights, support and local knowledge to potential investors in the country. For more information on how we can work with you to explore opportunities in Malta, please contact us.

Chris Meilak Valuation and Business Modeling, Malta [email protected] + 356 2134 2134

Chris Meilak is a manager in Ernst & Young’s Valuation and Business Modeling team in Malta and has eight years’ experience advising public and private sector clients within the Transaction

Advisory Services practice. Chris’ experience is within the project finance sector, advising companies in relation to their investment appraisal.

Rudolph Mifsud Saydon Transaction Advisory Services, Malta [email protected] + 356 2134 2134

Rudolph is a senior manager in our Transaction Advisory team and is based in Malta. He has more than 16 years of experience in assurance, business risk services and transaction advisory services

and joined Ernst & Young in 2000. Rudolph assists clients in carrying out due diligence exercises, cost analysis, business plans, bid proposals, investigations, feasibility studies and also regulatory work.

Gilbert Guillaumier Transaction Advisory Services, Malta [email protected] + 356 2134 2134

Gilbert is a senior manager in our Transaction Advisory Services team based in Malta and has been supporting clients in due diligence (buy side and sell side), restructuring and advisory

engagements for more than 10 years. Gilbert has also worked on several transactions in Malta, the UK, Italy, Switzerland and Greece, with a diverse range of clients in the financial services, private equity, technology and manufacturing sectors.


Do the right thing: successful portfolio managementMany power and utility (P&U) companies are in the midst of massive transformation. But with many change programs running in parallel, achieving consistent alignment to business strategy can be challenging. Jonathan Blackmore reports.

A changing market environment and economic volatility are driving wide-scale change among P&U companies. Many organizations are driven by significant cost pressures to transform their businesses while utilities in rapid-growth markets face funding challenges to develop new infrastructure and keep up with demand. Meanwhile, growing and fast-evolving regulatory demands add to the complexity.

For many of these organizations, the success of their transformation programs is crucial to their long-term sustainability and future growth. But with many competing projects and priorities across functions and geographies, it can be difficult for some organizations to “do the right thing” and “do things right.” They may find themselves getting a poor return from their investment in these projects and programs.

Three levels of executionWhen executing these transformation programs, organizations generally operate along three main management levels:

• Portfolio

• Program

• Project

While project management is focused on delivering a tangible outcome, portfolio management is focused on the decision-making process around which programs and projects should be executed based on their alignment with the goals and objectives of the organization. Program management is the intermediate layer that is focused on the delivery of business benefits.

Ernst & Young’s risk-based portfolio management approach helps organizations manage the risk of their transformation in an integrated way. It helps P&U companies focus on the projects that really matter and optimize their portfolio, and it enhances their chance of transformation success.

Typical portfolio challengesIn our experience supporting clients during the portfolio management process, we see many struggle to maintain control because of:

• Too many projects running at the same time that do not deliver because of a lack of focus

• Strategic objectives that are not supported by a project or program

• Investments in a project or program that are not supported by a strategic objective (i.e., are not aligned to the enterprise strategy)

A particular challenge for some P&U companies is their inability to identify all of their current projects, especially if they operate across different geographies. Without a clear inventory, utilities will struggle to resource their projects with the right capabilities while seeing that day-to-day operations are not compromised. Another common danger is a lack of consistent frameworks against which to prioritize the portfolio of projects. Without this kind of guidance, it is difficult for companies to determine which project is more important than others — and what criteria to use when making these decisions.


Five steps to successThe portfolio management process itself is a process that is typically executed a couple of times a year. Although it is tailored to match each utility company, the Ernst & Young approach involves five steps:

1. Translation of the strategy into initiative

2. Identification of programs and projects

3. Optimization of the portfolio

4. Approval of the portfolio

5. Identification of risks and associated remediation strategies

In our experience, P&U organizations may do well at managing the risks of individual projects, but often because of their sheer size and broad geographical footprint, this risk management is not expanded across to the program and portfolio levels. Understanding the risks faced across a portfolio of projects — and the interdependencies of these projects — is critical. It is also important that companies have the ability to consistently drill down from their top to bottom levels so their portfolio remains aligned to strategic business objectives.

Optimize value creationFor utilities juggling competing priorities and pressures, the Ernst & Young risk-based portfolio management approach helps focus efforts on “doing the right thing” and “doing things right.” A well-managed portfolio is directly linked to an organization’s ability to successfully execute its chosen strategy. P&U companies must ask themselves: “Will my portfolio deliver my business outcomes?” If not, the time is now to optimize the overall value creation from their portfolio to achieve future success.

Jonathan is Ernst & Young’s Risk Sub-Service Line Leader for Europe, the Middle East, India and Africa (EMEIA). Prior to taking up this role in January 2012, he was a partner in Ernst & Young Africa, where he led the governance, internal audit, and risk and control advisory practice in Africa. Jonathan has more than 15 years’ experience supporting some of the world’s leading organizations in developing and implementing risk management and control environments.

Jonathan Blackmore EMEIA Risk Sub-Service Line Leader + 44 20 7951 1616 [email protected]

For more informationRead our publication Strategy deployment through portfolio management

How Ernst & Young can helpErnst & Young is working with P&U companies around the world to optimize their portfolios and enhance the success of their transformation programs. Our consistent methodologies, broad sector experience and deep subject matter knowledge help us support clients as they develop solutions to specific business needs and achieve their potential.


mailto:jblackmore%40uk.ey.com?subject=

http://www.ey.com/Publication/vwLUAssets/Strategy-deployment-through-portfolio-management/%24FILE/Insights_on_GRC_Strategy_deployment_through_Portfolio_Management_AU1275.pdf

The impact of the global financial crisis and significant capital investment programs has driven increased divestiture activity by many large utilities, in a bid to strengthen their balance sheets. In Europe during 2012, divestment and privatization programs emerged as the strongest contributors to deal activity, with power and utility (P&U) companies keen to restructure their portfolios in an effort to reduce balance sheet debt levels and free up capital for new investment and deployment in emerging markets and technologies.

Disposing of some assets that are no longer aligned to the business strategy can be an opportunity to refresh the business, pay down debt and focus on investments in a company’s core area. But too often, while companies establish rigorous M&A management, the importance of divestitures as a means of raising, reallocating and preserving capital is sometimes overlooked. P&U companies that are too eager to simply dispose of assets may rush through the sale of a business or asset, leaving value on the table or overlooking other strategic opportunities.

Creating value in a tight marketA value-focused divestiture process begins with proactive portfolio management. Utilities should review their businesses and assets against strategic goals, performance metrics and industry benchmarks. This allows for an accurate current valuation of each component and helps identify divestiture candidates for each asset or group of assets.

Once appropriate divestiture candidates are identified, the challenge for P&U companies is to make sure the deal is completed successfully. In our experience,

many businesses are focusing too much on the transaction sales process and paying less attention to what is required to ensure real value is derived from the deal. Two key processes will improve the chances of a divestiture realizing value:

Tell the equity story: Most P&U companies would benefit from spending more time preparing their equity story — that is, the story that attracts potential new investors into the business. In essence, preparing this story means viewing the sale from the buyer’s perspective. A compelling equity story will include comprehensive and consistent data on business strategies and operational performance, along with a well-considered, robust business plan. These business plans need to be credible and demonstrate in detail how management will derive further value from the business in the short and medium term. An equity story must emphasize a company’s strengths and describe its value and growth potential.

Focus on the carve-out: It is important to ensure adequate attention is paid to properly separating the divested asset from its parent business. Companies will need to assess the services currently being shared by both businesses, such as information technology and human resources, and determine the logistics of the separation and potential financial impact. Developing a detailed stand-alone business model that shows “what’s in and what’s out” of the transaction will enable buyers to value the business, while helping sellers rationalize their own value chain.

Divestment programs were the strongest contributor to deal activity in Europe’s power and utilities sector during 2012. But are companies doing enough to drive real value from these transactions? Report by Ian Whitlock.

Unlocking value through divestitures


Appealing to financial investors Over the last 12 months, increasing numbers of financial buyers have become involved in P&U divestitures, with several infrastructure and pension funds seizing the opportunity to invest in assets with predictable and regulated cash flows and revenues.

Apart from the preparations outlined above, a P&U company can enhance its transactions with financial investors by building a clear picture of the regulatory regime under which the divested business operates. If regulatory obligations, including those relating to pricing and tariffs, are stable, the asset will be more appealing to buyers.

Financial investors interested in P&U divestitures are typically pension funds and infrastructure funds that value long-term, low-risk returns. The equity story told to these buyers should therefore include

relevant information regarding long-term capital expenditure requirements and opportunities for the potential investor to improve the operational efficiency of the business.

Prepare early for successSuccessful P&U companies view divestitures as a crucial element of their overall capital agenda. But the key to obtaining optimum value through these deals is adequate preparation. When crafting a divestiture planning framework, companies must begin early to articulate clear strategic plans and consider a multitude of factors at play during any transaction. Careful preparation that focuses on building a strong equity story and clear carve-out models will help companies extract greater value, increase speed to close and minimize disruptions to the core business.

Ian Whitlock UK & Ireland — Head of Power & Utilities Transaction Advisory Services, London, UK + 44 20 7951 0892 [email protected]

Ian is a Partner in Ernst & Young LLP’s Transaction Advisory Services practice with more than 23 years of experience providing transaction support services to clients in the power and utility sector.

For more informationRead more about essential considerations for a successful divestiture in Divesting for value.

How Ernst & Young can helpErnst & Young has supported many of the world’s largest utilities through divestiture programs aimed at optimizing portfolios, unlocking value and creating opportunities. Our teams work with companies through the entire process, from the initial considerations around a disposal, to divestiture preparations, including building an equity story and developing carve-out models, to successful completion of the transaction.


http://www.ey.com/Publication/vwLUAssets/Divesting_for_value/%24FILE/Divesting_for_value.pdf

As regulations tighten and as stakeholders demand that companies do more to mitigate their environmental impact, leaders of the world’s P&U companies are asking themselves challenging questions about their operations, strategy and reporting mechanisms. What will utilities need to do to adapt to the low carbon economy?

Carbon-constrained worldWhile P&U companies will face numerous challenges as they strive for growth in a low-carbon economy, three main issues will focus their attention:

1. Changing the mindset. Carbon regulations hit P&U companies at their very core. The impacts of climate change, most notably the restrictions regarding emissions, will see the sector shift from a generation-led environment to one driven by demand. This has implications across the business. Generation will shift from traditionally large, centralized power plants toward smaller, decentralized renewable generation sources. Grid infrastructure will need to be developed and managed accordingly, driving new capital programs but also to ensure grid stability. This will, in turn, drive demand management solutions, the use of smart meters and an increasingly empowered consumer who will be expected, and possibly incentivised through dynamic pricing, to take an active role in generating power (e.g., solar photovoltaic) and changing their consumption patterns. P&U companies will need to be innovative and develop closer relationships with customers.

2. Organizational innovation. Thriving in a low-carbon economy will require true creativity and a willingness to move away from the sector’s traditional business models. P&U companies must

engage in innovative thinking around how to overcome the challenges of increased regulation and develop the types of services, products and investments that are appropriate for a carbon-constrained world.

3. Capital structure and risk management. As the world transitions to a low-carbon economy, P&U companies are likely to be challenged by the cost of shutting down large, unviable assets while at the same time investing in renewable sources of power generation. They will need to look for new ways to finance infrastructure upgrades through joint ventures with financial institutions. These arrangements will require P&U companies to take a different approach to how they structure and manage these projects over time.

Early movers embrace changeAs P&U companies face these fundamental changes, those that take a proactive approach to overcoming them can reap a strong competitive advantage. Not only will they directly benefit through the cost savings of carbon-efficient practices, but they also have the opportunity to create a strong brand differentiation. Companies that are seen to adopt low-carbon practices may build a better relationship with customers and other stakeholders and create sustainable value going forward.

The example of Consolidated Edison Company (Con Edison) shows how early preparations for a carbon-constrained world can be a smart strategic move. Con Edison — one of the largest investor-owned energy companies in the United States — owns seven power plants but has decided to make the transition to renewable power generation. The company has used energy efficiency initiatives

A carbon-constrained future will demand power and utility (P&U) companies completely rethink the way they do business. But it’s not all bad news — opportunities abound for those prepared to innovate. Arnaud Bouillé reports.

Doing business in a low-carbon world


to help customers reduce electricity consumption and, in 2008, Consolidated Edison Development, a subsidiary of Con Edison, sold all its fossil-powered generating assets.

While Con Edison has obligatory carbon reduction targets under the Regional Greenhouse Gas Initiative (RGGI), the company is going further, setting its own goal of a 40% reduction of its direct emissions by 2020 (compared to 2005 levels). Management is incentivized through key performance indicators and monetary rewards to achieve these targets. The company also actively lobbies the Federal Government for a federal carbon scheme that covers all sectors, whether under a cap-and-trade system or a carbon tax.

Denmark’s DONG Energy is another company shifting its generation mix. Traditionally an oil and gas company, DONG Energy decided to move to a generation mix sourced mostly from renewable energy, particularly wind power. Now the world’s largest offshore wind developer and operator, DONG Energy partners with large institutional and private investors to fund its projects. The company’s innovative approach is bringing down the cost of wind power; it recently announced that it could cut the costs of offshore wind farms to well below UK Government targets by 2020.1

Lack of regulatory clarityWhile the actions of Con Edison and DONG Energy show how P&U companies can turn carbon constraints into a business opportunity, they also highlight the risks inherent in any fundamental shift in generation mix. Renewable energy may offer great potential but the long-term success of any large investment in these sources is still largely dependent on the policies and decisions of governments and regulators.

Regulatory certainty is an increasingly important factor in the decision-making of P&U leaders. It is therefore critical that authorities create trust and stability in the market as well as incentives for long-term investments. Unless the sector can operate within a secure regulatory framework that encourages confidence in investors, companies will have difficulty in attracting investment, the cost of capital may increase and the pace of progress will slow.

P&U companies also must manage the large administrative burden that comes with carbon regulations. While this is certainly a challenge, a proactive approach to compliance can also bring opportunities. Organizations that invest time and effort in streamlining their compliance process, lobbying the appropriate authorities and developing a corporate carbon management strategy are likely to see a significant payback for their investment.

Winners and losersA low carbon economy will require a fundamental shift in the way P&U companies operate. Adapting to these changes will not be easy for an industry seen historically as traditional and conservative. P&U companies that do not change their mindset will find it difficult to overcome the organizational and risk profile challenges presented by regulations.

But those companies that take a proactive approach to these risks will find they also offer numerous opportunities that go beyond cost saving. Changing consumer behavior and regulations may stimulate new product development and open up new markets. Adaptation to the physical impact of global warming will require the development of new services, products and investments. There also will be opportunities to offer differentiated low-carbon products to the market. Companies that act on these longer-term opportunities will differentiate themselves from competitors, create sustainable value and secure a strategic advantage.

Arnaud Bouillé Director, Lead Advisory — Environmental Finance + 44 1392 284 392 [email protected]

Arnaud currently leads Ernst & Young’s Corporate Finance proposition to the renewable energy sector across EMEIA. He has 12 years of experience in the provision of M&A, project finance

and commercial advisory services to the renewable energy industry. Arnaud’s clients include governmental organizations, utilities, project developers, financial institutions technology providers and other corporate institutions across all major renewable energy technologies.

For more informationRead the article How do companies do business in a carbon-constrained world?: investment decisions and bottom line

How Ernst & Young can helpErnst & Young is supporting P&U clients navigate climate change and carbon regulations. Our deep knowledge of the sector and global network of professionals helps utilities develop and implement their strategies to mitigate risk and make the most of the opportunities presented by a low-carbon world.

1 Gosden, Emily, “Offshore wind farm developer DONG Energy claims it can beat government cost target,” The Telegraph, 1 March 2013.


mailto:abouille%40uk.ey.com

http://www.ey.com/Publication/vwLUAssets/How-do-companies-do-business-in-a-carbon-constrained-world/%24FILE/Economics-of-Carbon.pdf

Super powerIf key barriers are overcome, superannuation funds could hold the solution to upgrading Australia’s infrastructure, including assets in the power and utilities (P&U) sector. But, in a complex market, deep sector understanding and local knowledge will be needed to produce a return on investment. Matt Rennie reports.

As superannuation funds have grown, Australia’s infrastructure gap has widened. In the P&U sector, significant new investment is needed to upgrade aging assets and construct the new assets required as the sector adapts to a low-carbon future and new models of doing business.

Ernst & Young was engaged by Australia’s Financial Services Council to review the overall profile of superannuation investment in infrastructure, including P&U infrastructure. Results show that, while superannuation funds may be attracted to P&U assets, these investors will need to develop deep understanding of both the sector and Australia’s complex political and regulatory frameworks, or engage with advisers who do, if they are to win these assets and achieve a return on investment.

Barriers to investmentSuperannuation funds have one clear function: to invest member funds to meet members’ future retirement needs by optimizing the level of return. The allocation of funds to investment assets is a complex process but one driven by a desire for low-risk, long-term, sustainable returns. While infrastructure, including P&U assets, can be an important part of a superannuation fund’s portfolio, we found several key barriers to investment:

• Lack of a clear pipeline and government commitment

• Lack of suitably structured projects

• Inconsistent, complex and expensive bidding processes

• Regulatory and industry pressures

The lack of a clear pipeline of projects and government commitment is particularly relevant to the P&U sector in Australia, where government has been reluctant to release major assets to the market. But, as public pressure against rising power prices increases, we expect to see moves toward privatization in an attempt to lower costs and consumer energy bills. We expect generation assets to become available to private investors within one to three years, while network assets will come to market within two to four years.

Energy infrastructure assets are long-term investments that can be significantly impacted by political and regulatory pressures. As rising electricity prices drive consumer unrest, the Australian Government is ramping up its pursuit of structural reform. And while regulators are keen for greater discretion to reduce energy costs to consumers, this creates uncertainty for investors seeking predictable returns.

Adding further complexity is Australia’s multi-tiered system of government, which sees the federal government set the regulatory framework for state government-owned assets to operate within. Political uncertainty over Australia’s carbon tax scheme — at least until after September’s federal election — also makes decisions regarding investment in the sector more difficult and highlights the need for potential investors to partner with local advisers.


Perfect matchIf these barriers can be overcome, superannuation investors may be almost the perfect match for P&U assets. These funds, unlike some other investors, are free of many equity constraints and are prepared to continue to inject capital for many years. Their willingness to enter into a long-term commitment makes them a good partner, especially for electricity and gas assets, which need regular capital upgrades.

But this is a relationship of mutual attraction. Network assets, in particular, offer the predictable and regulated returns that appeal to these investors. And while generation assets are subject to more competitive pressure and government intervention (including carbon taxes), they too are desirable because of their ability to offer predictable, sustainable returns.

P&U assets have the potential to offer real opportunity for superannuation funds; however, for the most part, these funds currently lack the sector knowledge that will be critical to realizing the potential

of these investments. These assets will only deliver optimal returns if they are run as efficiently as possible to maximize profits while also being reliable, safe and in compliance with all regulatory frameworks. As it may be unrealistic for superannuation investors — active in many sectors — to develop such sector-specific expertise, a smarter approach may be to partner with experienced advisers.

Time to prepareWhile several barriers to superannuation investment in Australian infrastructure, including in the P&U sector, remain, chances are good that these can be overcome in the short — to medium-term as the sector transforms.

The market for infrastructure assets is global. We expect the predictable returns of these assets to make them attractive to a wide range of investors from many sectors and countries, and competition to acquire them will be fierce. Potential investors must prepare now to give their bid the best chance of success. All funds will need access to specific knowledge

and experience of the sector, particularly in network assets, to maximize the operational performance of these assets. International funds should also arrange consortiums with local partners to enhance strengths and minimize weaknesses; engage with international tax and finance advisers; and seek local support to help navigate Australia’s often complex regulatory and legal frameworks.

Read the article Financing Australia’s infrastructure needs

Financing Australia’s infrastructure needs

Superannuation investment in infrastructure

How Ernst & Young can helpErnst & Young’s deep practical sector knowledge and global network can help investors, including superannuation funds, understand the complexity of Australia’s infrastructure market and make informed investment decisions.

Matt Rennie leads Ernst & Young’s Power and Utilities segment across the service lines of assurance, transactions, tax and advisory in the Oceania region. He is an economist and an adviser on regulatory, commercial and pricing matters to debt and equity participants and governments in the energy, water and gas infrastructure sectors.

Matt Rennie Oceania Power and Utilities Leader + 61 7 3011 3239 [email protected]


http://www.ey.com/Publication/vwLUAssets/Financing_Australia_infrastructure_needs/%24FILE/Superannuation_Investment_In_Infrastructure.pdf

mailto:[email protected]

Turning risk into resultsWhat are today’s top risks and opportunities for power and utility companies? And how can they best mitigate and capitalize on these to drive growth and ensure long-term sustainability? Keith Harrison reports.

Ernst & Young’s Business Pulse for power & utilities is our snapshot of the power and utilities (P&U) industry today and a forecast ahead to 2015. Drawn from interviews with the world’s leading utilities, it offers insight into the biggest challenges facing a sector undergoing massive transformation.

A shift in thinking is evident in this year’s report. It is clear that utilities recognize that their traditional business model is under threat and that new approaches are needed to achieve future success.

Regulatory pressures top risksThe fast-paced change of regulatory and compliance criteria ensure this is the top risk for utilities now and into the future. In established markets, these regulations are driven by market reforms and a move toward competition in all aspects of utility operations. In emerging markets, regulation is increasing as the sector grows to keep up with energy demands. The challenge for utilities is to better manage their regulatory obligations by keeping abreast of frequent changes and effectively communicating with stakeholders about how these will affect prices.

Ongoing economic volatility may be accepted as “the new normal,” but it remains a challenge for utilities. Commodity and emissions market uncertainties add risk to utility investment planning, as do fluctuations in energy and climate policy. In developed markets, aging infrastructure and the low-carbon agenda will require vast amounts of capital expenditure, while in developing markets, the growing demand for energy is the principal driver behind the need to invest heavily in capital assets. Companies will need to carefully consider how they will access new sources of capital — beyond the banks — to finance their future investment needs.

Emerging markets lead opportunitiesUtilities continue to see emerging economies as their top opportunity. The International Energy Agency forecasts non-OECD economies, particularly China and India, to grow the most rapidly in coming years. China’s demand is forecast to rise 60% by 2035, while India’s is set to more than double. Opportunities in emerging markets are not just of interest to utilities from developed markets, as demonstrated by Chinese power company investment in South America.

Top 10 risks 2013 ranking

2015forecast

Compliance and regulations 1 3

Commodity price volatility and access to competitively priced long-term fuel supplies

2 2

Political intervention in P&U markets 3 1

Uncertainty in climate policy and carbon pricing 4 4

Significant shifts in the cost and accessibility of capital 5 5

Capital project execution 6 6

Economic shocks and resulting short-term energy demand shocks 7 7

War for talent 8 8

Aging generation and network infrastructure 9 10

Managing planning and public acceptance 10 9


Top 10 opportunities 2013 ranking

2015forecast

Rising emerging markets’ energy demand 1 1

Acquisitions or alliances to gain new capabilities 2 2

Growth in energy and ancillary services markets 3 3

Enhancing relationships with external regulatory and compliance bodies 4 4

Improving public perceptions 5 9

Increased focus on investor relations programs and communications 6 5

Integration of distributed energy resources 7 8

Increased investment in generation capacity and delivery infrastructure in emerging markets

8 7

Rising energy innovation in emerging markets 9 6

Improving onshore and offshore wind supply chain efficiency 10 10

As utilities move to capitalize on the potential of emerging markets, they face the challenge of mitigating the inherent risks of overseas expansion. Foreign markets can be complex to navigate, and a local presence is key to understanding the regulatory, political and cultural frameworks.

Using an acquisition or alliance to develop new capabilities, move into emerging markets and spread the cost — and risk — of large-scale capital projects is seen as a growing opportunity for utilities. But decisions regarding these transactions are complex, and utilities will need to engage with the right expertise as they plan and implement any merger or acquisition.

Many of the risks facing power and utility companies are largely beyond their control and can only be mitigated by contingency planning and damage minimization. Other challenges, such as the relationships with customers, offer opportunities to make real change and reap a competitive advantage. We expect the smart revolution to play a major role in realizing this opportunity. Access to near-real-time data from smart meters opens the door for utilities to build better relationships with customers and to move toward selling new services and solutions.

Utilities may see regulatory pressures as their biggest risk, but interestingly, many also recognize that improving relationships with regulators may offer one of their greatest opportunities. Building stronger, more trusting relationships with regulators can minimize the risk of non-compliance

and enhance a power and utility company’s ability to influence the rules.

New challengesApart from the top 10 risks identified by utilities, several other emerging challenges warrant attention. Two of these are likely to have a significant impact on utilities:

Disruption of the traditional utilities value chain: although the dominance of the vertical utility chain is being eroded by evolving regulatory regimes and new entrants, the time frame for change is unclear. Large utilities still control the majority of customers, but regulators may force change to encourage competition. And, as consumers gain more control through technical innovations, they may also vote with their wallets.

Ineffective energy storage solutions: the high cost of existing storage solutions makes their large-scale rollout unlikely,

while some question whether a major expansion of energy storage is even required — demand response programs or reserve capacity could resolve many of the relevant issues. And, as the structure, operation and regulation of electricity markets will ultimately shape incentives to build storage, this creates a significant political or regulatory risk for potential developers or funders of these projects.

Be ready to respondBoth the top risks and opportunities reflect the evolving nature of energy production, delivery and supply, as well as the arrival of new and innovative market participants. They drive home the need to assess your company’s business model and strategy to ensure its readiness for the sector’s transformation. In an increasingly competitive, globalized world, utilities that are aware of the risks and opportunities they face — and have strategies in place to respond — stand the best chance of success.

Keith Harrison Lead Analyst, Global Power & Utilities Center + 44 77 6099 1110 [email protected]

Keith joined Ernst & Young in April 2012, following four years as a research director and analyst with IT research and advisory firm Gartner, where he focused on technologies associated with energy and utility company operations. Before Gartner, Keith worked in the power and utilities sector in the UK and North America for 15 years.

Read Business Pulse for power and utilities


http://www.ey.com/GL/en/Industries/Power---Utilities/Shift-in-thinking-requires-new-approaches

http://ey.com/powerandutilities/business-pulse

http://ey.com/powerandutilities/business-pulse


After a transformative 2012 for power and utility companies (P&Us) around the world, the first quarter of this year delivered a more robust platform for M&A in the sector. While deal value has decreased (reaching US$25.3b in Q1 2013, down from US$27.6b in Q4 2012), encouraging signs are in place, including progress on large European privatizations and divestment initiatives.

Key findings, Q1 2013• Q1 2013 global P&U M&A registers

US$25.3b, down US$2.3b (8%) on the prior quarter.

• Divestments in Europe remain the center of activity, while power generation deals drive an increase in US activity.

• Capital is on the move with cross-border M&A rising 49% (US$3.2b) quarter-on-quarter, driven by a need to secure energy supplies, expand market share and add stable cash flows.

• Renewable M&A contributes 50% to global deal volume (23% to value), with Asia Pacific the new clean energy hub.

Europe driving global activity Europe remained the focal point for global M&A, contributing more than 51% (US$13b) to global deal value in Q1, with activity mostly driven by continued divestments by large utilities, including GDF Suez, E.ON, RWE, Dong Energy, Iberdrola and Veolia. Many of these companies turned their interest to higher growth markets. In Brazil, E.ON raised its stake in MPX Energia while, Enerjisa, a joint venture between Turkish Sabanci and E.ON, placed the highest bids in privatization tenders for Turkey’s Toroslar and Ayedas power grids (US$1.7b and US$1.3b, respectively).

Power prices to rise in the US In the US, hybrid utilities — those with regulated and non-regulated portfolios — continued to divest competitive power generation assets, with FirstEnergy, Dominion and Ameren Energy announcing sales of competitive assets in the quarter.While the sale of these generation assets by hybrids is nothing new, Dynegy’s acquisition of Ameren’s competitive business for US$599m was warmly welcomed by investors. The deal is in line with Ameren’s strategy to exit the merchant generation business. For Dynegy, the deal marks its resurgence from a bankruptcy restructure in 2012 and is expected to create value by building upon the company’s existing scale in key markets. The Ameren acquisition also gives Dynegy an established retail business with significant scale.

The deal encourages the growing sense that power prices may be on the rise, at least from the very low levels seen today. With upcoming coal retirements in companies such as PJM and declining reserve margins in the Electric Reliability Council of Texas (ERCOT), there is a hint of optimism. Prices don’t need to rise much. For example, it has been reported that a rise of just US$1 per million metric British thermal units in gas prices will deliver Dynegy about US$330m in EBITDA.1

Cross-border and renewables up Q1 2013 witnessed a surge in cross-border deal activity driven primarily by Canada, Germany and Japan. For Canadian investors, expansion of the clean energy portfolio and acquisition of natural gas assets — particularly in the US — remained the key focus, while German utilities continued to grow their business outside their domestic markets. In Japan, investors focused on European renewable assets. Of the five outbound Japanese

Get ready for a robust 2013 in utilities mergers and acquisitions (M&A). Our latest Power transactions and trends report reveals how deals are shaping the global utilities sector in 2013. Joseph Rodriquez reports.

Capital on the move

1 “Dynegy’s Power Play on Natural Gas,” The Wall Street Journal, 1 April 2013, http://online.wsj.com/article/SB10001424127887324883604578396491252357064.html


transactions in the quarter, four involved solar and wind assets, with Mitsubishi Corp. participating in three of them. In fact, renewables were generally on the rise this quarter, contributing 50% to global deal volume (23% to value). While most of these deals took place in Europe, the Asia Pacific region is seeing more renewable energy transactions and, in Q1, achieved a two-year high of US$3.8b. Large Chinese hydro deals contributed the bulk (US$3.1b).

Aggressive stance from financial buyers Following a two-year high in 2012, financial buyers continued their aggressive stance into Q1 2013. US-based private equity (PE) and infrastructure funds, such as Energy Capital Partners, emerged as the most active bidders, participating in six deals worth a combined US$1.9b. Transmission and distribution, merchant assets and

renewable energy assets in Europe and North America emerged as the key target segments for buyers. We anticipate that their investment in the sector will grow significantly in 2013, with a particular focus on network deals in Europe.

Anticipate the buyer Expect an exciting year in P&U transactions with M&A activity on track to outpace 2012. Utilities are continuing to reshape their asset portfolios — to deleverage from commodity volatility or increase footprint in high-growth markets — and creating significant opportunities for buyers and sellers. As companies, particularly in Europe, continue their divestment programs, they will need to be aware of what the new breed of buyer wants. Carve-out financials, clear and concise financial and operation information and a well-articulated value proposition are essential ingredients to a successful program.

Joseph Rodriquez Global Power & Utilities Sector Resident Transaction Advisory Services New York, US + 1212 773 7105

Joseph is the Global Power & Utilities Sector Resident for Transaction Advisory Services and has managed numerous transactions for private equity, corporate investors and sovereign

wealth funds. His experience includes financial analysis and due diligence (buy-side and sell-side); deal negotiation; analysis of financial forecasts; working capital requirements; analysis of free cash flow; and synergy assessments. Joseph has experience on a number of power and utility and infrastructure transactions, including power generation, gas and electricity transmission and distribution, and renewables.

Spotlight on China Recent news that Chinese economic growth dipped slightly in the first quarter of 2013 disappointed those hoping for an increase in the recovery that began midway through 2012. However, despite market volatility and a global economic outlook that is far from certain, Chinese companies continued to rise in prominence in the global M&A market. Positive foreign investment policies, diversification of funds and geographic expansion are driving outbound M&A, with the P&U sector a core focus for Chinese investors. Most interest is in Europe’s privatization and divestment programs, although we also expect Chinese buyers to explore deals in Australia and the US in the future. All the ingredients are in place for 2013 to be an exciting transaction year.

For more information

Read more about Power transactions and trends Q1 2013

Robust outlook for 2013 deals

activity. Despite deal value decreasing US$2.3b (8%) from US$27.6b in Q4 2012 to US$25.3b in Q1 2013, encouraging signs emerged, including progress on large European privatizations and divestments.Q1 2013 registered seven billion-dollar-plus transactions. Europe remained the driver of global M&A, accounting for 51%, or US$13b, of the deal value. This was underpinned by the Turkish privatization program, which included the sale of four power distribution grids for US$3.5b. The biggest deal of the quarter emerged from the

divestment efforts of E.ON SE and GDF Suez, which agreed to sell their combined 49% stake in Slovak gas group Slovensky Plynarensky Priemysel AS for US$3.5b to Czech investment fund Energeticky a Prumyslovy Holding.

hoping for an increase in its recovery. However, despite market volatility and an uncertain global economic outlook, Chinese utilities continued to gain prominence in the global M&A market. 2013 could be a record year for outbound power and utilities (P&U) deals as thirst

Capital is on the move and 2013 is shaping up as an exciting year. Portfolio management continues as the strongest theme in the global P&U market. As utilities continue to reshape their asset portfolios, we anticipate a robust M&A climate in 2013 that is likely to outpace last year. Joseph Fontana Global Transactions Power & Utilities Leader

Q1 2013

Power transactionsand trends

Global power and utilities mergers and acquisitions review

• Despite seven billion-dollar-plus transactions, Q1 2013 global P&U M&A registers US$25.3b, down US$2.3b (8%) from the prior quarter. Europe remains the center of activity, driven by large divestments.

• Capital is on the move as European players divest transmission and distribution (T&D) assets and reinvest in emerging markets. Further, cross-border M&A rises 49% (US$3.2b) from the prior quarter.

• The US power generation market is again active, headlined by a number of asset

in key markets provide some optimism for power generators.•

emerges as the new clean-energy hub, contributing 66% to the total renewables deal value.

Q1 2013 review and 2013 outlook

This Ernst & Young study examines transactions and market trends in the global power and utilities sector in Q1 2013 and considers the outlook for the remainder of the year.

Contents

Q1 2013: Activity and outlook ...........2

Global snapshot .................................4

Spotlight ............................................6Chinese outbound M&A poised to take off in 2013

Transaction volume and value ............7

Global contacts ..................................8

Data source and industry scope

Power transactions and trends quarterly is based on Ernst & Young’s analysis of Mergermarket data from Q1 2011–Q1 2013. We use standard industrial

and utilities” as companies in generation, transmission and distribution, renewable and other sub-sectors. Deal activity and

on the date we accessed Mergermarket’s database.

If you would like to know about the methodology of this report, please contact Joseph Rodriquez.

Chinese outbound deal value and volume by target geography, 2008–2012

72.3%

10.6%

10.0%

7.1%

Total: US$37.9b Europe Asia Pac

North America Latin America


http://www.ey.com/GL/en/Industries/Power---Utilities/Power-transactions-and-trends-Q1-2013

The financial crisis of 2007 to 2009 changed the game for power and utility companies (P&Us), with many battling to secure the capital they needed to fund new investment in volatile economic conditions. But some high-performing utilities have managed to defy the doom and gloom and actually grow beyond their traditional markets to secure new customers, enter new markets and develop new products and services.

Four drivers of successIn our latest report on these high performers, we examined how these companies have been more successful in identifying and responding to opportunities to maximize their potential market. We found that their ability to outperform their peers comes from executing against the four drivers of competitive success:

1. Operational agility: moving beyond a commodity service

2. Cost competitiveness: focusing on all cost and revenue drivers

3. Stakeholder confidence: telling the right story in the right way

4. Customer reach: extending from tax payer to valued customer

Fresh faces bring agilityWhen focusing on improvements to their operational agility, high-performing P&Us are making changes that strike at the very heart of their business model. An industry once dominated by engineers and other technicians is now beginning to understand that thriving in the current environment requires a broader set of skills. High performers are investing heavily in people, specifically to bring in innovators, marketers and those with extensive financial services experience. They are also building an “ecosystem” of business partners to ensure they have

the well-rounded knowledge and skills necessary to achieve their ambition. While not neglecting the fundamental technical skills required to “keep the lights on,” utilities are shifting their mindset to go beyond providing a basic service to thinking more creatively and responding more quickly to changes.

Competing on cost more challengingGrowth in tough economic conditions requires focus on all cost and revenue drivers, and a flexible approach to pricing, costs, cash and capital across the organization and its entire supply chain.

Achieving differentiation based on cost competitiveness is more challenging for P&U companies than for companies in many other sectors. Most of the costs that make up the end-user price of energy — the cost of buying or generating the energy, the cost of transporting and distributing energy, and taxes — are beyond the control of most companies, making it difficult to create real price differentiation. This challenge regarding cost competitiveness makes it even more important that utilities seek to execute against the other three drivers of success.

Boosting stakeholder confidenceMost utilities know they must tell — and sell — a story to stakeholders, but some are doing it better than others. According to our research, high performers are communicating more effectively to internal and external audiences, using engagement to boost stakeholder confidence. This confidence within and about the organization is more important than ever as the industry endures its “perfect storm” of multiple, large-scale changes that will require significant investment and consumer support. The ongoing

Times are tough, but high-performing utilities are still managing to grow beyond their traditional products and services and seize new opportunities in new markets. What’s their secret to thriving when others are just surviving? Alain Bollack reports.

Driving growth in adversity


transformation of the P&U sector (through, for example, infrastructure upgrades and smart meters) cannot take place if external and internal stakeholders are not on board.

High performers are boosting shareholder confidence through:

• Going beyond the minimal requirements of compliance and giving more information on risk, investment and operational performance

• Engaging with their workforce to motivate and foster feelings of ownership

• Being open and transparent about potential problems — but only if and when the plan to overcome the problem is clear

• Backing up their words with actions — intentions are no longer enough to satisfy savvy stakeholders

Customer is kingBut while all four drivers are important for successful, sustainable growth in difficult times, customer reach may be the most relevant and challenging for P&Us, particularly retail and sales businesses.

A March 2013 Ernst & Young survey revealed that just 20% of customers trust their utility provider.1 This is an issue for utilities, wherever they are in the world, and represents a key challenge to growth, even in regulated markets where utilities are evaluated and rewarded based on their performance against customer service standards.

This customer dissatisfaction comes at a time when P&Us face mounting infrastructure investment needs, competition from new market entrants, increased regulatory pressure and rising energy prices.

They are also dealing with the emergence of today’s “know it all, want it all” customers who demand far more from their utilities. These empowered customers expect better and more services, transparent and competitive pricing and the power to control their own interactions with their provider and engage with them on their terms.

The notion that “customer is king” has been slow to reach the P&U sector but we are finally seeing some utilities adopt this mindset to their advantage. High-performing companies are

out-performing their competitors by recognizing that the relationship with the customer is key to addressing current challenges and positioning themselves for future success. These high performers are:

• Investing significantly in customer relationship management solutions

• Implementing customer service improvement programs to “get the basics right” — such as, answering queries promptly, resolving complaints quickly and simplifying transactions and adding a level of transparency

• Adopting smart meters early to provide customers with more transparency around consumption and improve customer satisfaction levels

• Educating their installation crews and technicians to ensure they adopt customer-friendly practices, such as cleaning up after in-home visits

• Rewarding customers when they stay loyal to the company, rather than when they first join

• Working with customers to co-develop new products and services tailored to their needs

By taking these actions, high performers can broaden their customer reach, not only to maintain and attract utility customers, but also to offer new services in areas including energy management technologies, security, the ability to monitor smart appliances remotely and telehealth.

Utilities are not only the best-placed, both technically and in terms of capacity, to capitalize on these opportunities — they must do so if they are to move beyond energy supply and serve the additional needs of their customers. Until they do this, they risk losing customers to the in-sector and new market entrants that step in to fill the gap.

Act now, don’t “go slow”No one should underestimate the ongoing volatility of the current market and, even if and when conditions stabilize, P&Us cannot expect to go “back to normal.” The sector is witnessing massive change that will change forever the way companies operate and determine which utilities will succeed. High-performing utilities recognize this and are acting now to seize the opportunities presented by these changes and play an active role in reshaping their sector. By resisting the urge to go slow, high performers instead drive their own growth through making future-focused operational changes; clearly communicating to stakeholders; competing where possible on cost; and putting the customer at the center of everything they do. High performers know that further changes and challenges are to be expected and that, by addressing these four key issues, they will be best positioned to respond and succeed.

Alain Bollack Director, Global Power & Utilities Center [email protected] + 44 20 7951 7147

Alain is a director in our Global Power & Utilities Center and is responsible for driving the global growth of our advisory business in the areas of smart metering and Smart Grid. Alain has almost 25

years of experience supporting clients as they transform their business.

What is a high-performing utility?

High-performing utilities (HPs) take charge of their own destiny and are first to respond when this industry changes. The way that HPs have been pursuing the current customer transformation has created opportunities for them to grow beyond their traditional markets.

Read our paper Growing Beyond: how high performers are competing for growth in difficult times


1 Richard Postance, “Trust: the energy industry at a crossroads …,” The Raconteur, 1 May 2013.


http://www.ey.com/Publication/vwLUAssets/Growing_beyond_-_How_high_performers_are_accelerating_ahead/%24FILE/Growing_beyond-How_high_performers_are_accelerating_ahead.pdf

Turning the tideStill rebuilding after the 2011 earthquake and tsunami, Japan’s water sector is struggling to cope with increasing urbanization and a stalling economy. Is it time to turn to the private sector? Kenichiro Fukuda reports.

Japan’s water sector faces considerable challenges, including declining tariffs, the growth of new cities and massive rebuild efforts in the wake of 2011’s natural disasters. Investment is urgently needed to renew the country’s aging water assets and ensure future security of supply. Opportunities for international utilities could promise great rewards — but significant barriers must be overcome first.

Tariffs on the declineIncreasing urbanization and the spread of new cities are putting more pressure on the security of Japan’s water supply. Lower demand due to the economic downturn and declining population — set to shrink by 30% by 2060 — has reduced tariff revenue for water utilities.

Unfortunately, while tariffs are on the slide, the need for new investment in Japan’s water sector is at an all-time high. Many of the country’s water systems were constructed during Japan’s economic boom of the 1960s and are in need of urgent renewal. The earthquake and tsunami of 2011 also caused extensive damage to much of Japan’s infrastructure, including water pipes, sewers and plants. While repairing these assets — and strengthening them to withstand future earthquakes — is a Government spending priority, wider post-earthquake reconstruction efforts have decreased the amount of available funding. The crucial question now is how to ensure that these aging assets are ready to meet the challenges of Japan now and into the future.

Radical reforms neededWhile the newly elected Liberal Democratic Government has pledged to increase public works spending in the next budget by 20%, the long-term sustainability of Japan’s water supply remains uncertain. Radical reforms are needed. Authorities may consider putting in place one single administrative body to oversee both water and wastewater services in a municipality or merging the water services in adjacent municipalities. Merging the multiple bodies currently responsible for the sector would enable economies of scale, optimize assets and ensure greater flexibility to respond to emergencies, including natural disasters.

It also seems inevitable that the private sector will begin to play a bigger role in the renewal of Japan’s infrastructure, including its water industry. Increased private sector participation would bring new insights, introduce competition and attract the investment necessary to upgrade assets.


Japan’s politicians have traditionally been opposed to privatization, but current conditions may force sector transformation. Public/private partnerships in other infrastructure projects, including Osaka’s huge subway system and the Kansai International Airport, could pave the way for private participation in the water sector. In 2011 the Private Finance Initiatives Act was amended to open up the sector to private investors, but these changes are yet to be harmonized with current water and wastewater regulation frameworks. If these regulatory changes advance, the opportunities for international utilities to play a part in Japan’s water sector could be significant.

Potential investors should watch this space — and seek careful advice before diving into Japan’s water sector.

Kenichiro is a manager in the infrastructure advisory group in Ernst & Young ShinNihon LLC (EYSN). He has deep knowledge of the water and sanitation sector in the group based in Tokyo. Kenichiro has a focus on PPP/PFI, structuring and financing infrastructure projects and has extensive experience in development and management of many water and wastewater engagements.

Kenichiro Fukuda Manager Ernst & Young ShinNihon LLC + 81 3 3503 1557 [email protected]

How we can helpErnst & Young has extensive experience in Japan’s water and wastewater sectors, advising on the development and management of many of the country’s key water projects. We are working with leading utility companies throughout the world, developing practical approaches to the challenges of changing market conditions.



http://www.ey.com/Publication/vwLUAssetsPI/Citizen_Today_-_October_2012/$FILE/Citizen_Today_October_2012.PDF

Transforming tax through centralizationAs pressure increases on global power and utility (P&U) companies to cut costs, a centralized approach to tax, compliance and reporting may improve efficiencies, enhance controls and allow for a sharper focus on the core business. Ute Benzel reports.

Around the world, companies are in the midst of a finance transformation initiative. Economic pressures and the challenge of meeting complex compliance regulations in all of the jurisdictions in which they operate have more and more organizations moving toward centralizing some tax processes through co-sourcing or outsourcing partnerships.

However, due to the close links between the tax, compliance and reporting cycle, decisions regarding the centralization of processes should be made with the entire cycle in mind. Ernst & Young’s Global Compliance and Reporting Process enables companies to standardize the delivery of compliance services around the world and realize three key benefits:

• Quality assurance

• Fulfillment of compliance regulations

• Creation of additional value

These benefits may be particularly relevant to the P&U sector, which faces a growing need to keep energy prices low while financing massive capital upgrades.

Where are the benefits?For P&U companies, those areas that may benefit most from a centralized approach to tax are:

• Value-added tax (VAT): Companies operating within the European Union may consider centralizing the VAT processes of numerous countries, cutting costs through reducing staff in individual countries while also improving efficiency and creating a central repository of tax information.

• Tax accounting: The accurate and timely calculation of current and deferred taxes included within the group financials has become more important in the face of increasingly tight submission deadlines. Centralizing the preparation of group financial statements will typically produce cost reductions while increasing the transparency of this information across the entire group.

They may also centralize routine finance processes such as accounts payable and accounts receivable.

Achieving the optimal

balance

GCRrequirements

Back-office focused

High quality,high cost

Business focused, high risk

Processes/systems

Operatingmodel

Value

Control Efficiency

Compliance and reporting

elementsStatutory

accounting and reporting

Tax accounting and provisions

Income tax compliance

Indirect tax compliance

Governance and control

Business outcomesMarket reach

Operational agility

Cost competitiveness

Stakeholder confidence

Tax value


Beyond cost savings, centralization can give P&U companies a strategic advantage by freeing up resources and delivering an overview of the group’s overall tax position that can enhance future planning.

Overcoming challengesCentralized tax functions have the potential to reap significant cost and efficiency benefits for P&U companies, but the process can be complex and must be managed carefully. Before embarking on any centralization of processes, organizations will first need a thorough understanding of exactly what these processes are, how they are performed and what information is required to complete them accurately and on time.

Once centralization begins, a key challenge is to standardize the local processes of many different countries into one centralized process. Companies will need to:

• Design standardized process maps

• Define controls based on scenario planning that considers exactly what could go wrong

• Test these controls

Another issue is the selection of an appropriate low-cost jurisdiction in which to establish the centralized function. The decision about whether to move staff to this new location or hire local people should be approached strategically and with caution if the envisioned cost reductions are to be achieved.

Co-sourcing or outsourcing?When many companies centralize their tax functions, they will often engage a third-party provider to manage the complexity of the process and mitigate the risks. Determining whether to outsource or co-source with this third-party provider will depend upon a utility’s individual circumstances, countries of operation and corporate culture.

Outsourcing tax functions would see all aspects of these processes performed by a third party with no local department remaining. Co-sourcing may be a better option if a local tax function remains but at a reduced level. These remaining staff would work in collaboration with the third-party provider to perform all the necessary processes.

Ernst & Young professionals work with many P&U clients in both outsourcing and co-sourcing arrangements. Our global network and deep sector experience allow us to help design and implement tailored centralization arrangements that bring real value to our clients. The transparent, standardized and easily accessible data we provide gives P&U leaders confidence that their tax processes are efficient, compliant and aligned to their organization’s strategy.

Seamless collaborationA successful implementation of global tax processes can bring significant cost reductions and increased efficiency for P&U companies at a time when the pressure to improve performance is greater than ever. The Global Compliance and Reporting Process can serve as a valuable road map for organizations as they centralize these processes. Whether an outsourcing or co-sourcing approach is taken, the goal for any company centralizing these functions is a seamless collaboration between their team and their third-party provider. The right third-party provider will be a true partner, giving companies confidence that their centralized tax functions will create sustainable value and competitive advantage.

Ute Benzel is Partner and Head of the Business Tax Practice for Germany, Switzerland and Austria. Ute has a strong knowledge of company finance and tax processes including “record to report” and global compliance and reporting. She is also very experienced in tax accounting, cross-border tax planning and SOX 404.

Ute Benzel Partner, Head of Business Tax Practice (Germany, Switzerland, Austria) + 49 221 2779 25648 [email protected]

For more informationRead the full report on Seizing the opportunity in Global Compliance and Reporting


http://www.ey.com/Publication/vwLUAssets/Seizing_the_opportunity/%2524FILE/Seizing_the_opportunity_Global_compliance_reporting_survey_2011.pdf

http://www.ey.com/Publication/vwLUAssets/Seizing_the_opportunity/%24FILE/Seizing_the_opportunity_Global_compliance_reporting_survey_2011.pdf

When striving for new ways to create value within a tight economic environment, few power and utility (P&U) companies appropriately consider their control processes. Often thought of as a boring must-have, controls are viewed primarily as costly and a hindrance to a company’s ability to be flexible and dynamic. Smart P&U companies think differently. By streamlining their control process, they are reducing duplication, driving down costs and adding value to the business.

Catching up with change While many large companies have inefficient control processes in place, P&U companies may be at particular risk due to their long history and the industry’s heavy regulation. Common trends include:

• Spending more on controls without quantifying the gains

• Inheriting controls through acquisitions

• Accumulating layers of redundant and ineffective controls as regulations increase

• Adding extra controls that are disconnected from business operations

• Underutilizing enterprise resource planning systems and relying too much on manual controls

• Failing to put in place the transparent controls needed to ensure stakeholders are confident that risks are properly mitigated

As organizations rapidly evolve through increased regulation, privatization and acquisitions, it can be difficult for the control environment to catch up, leading to a misalignment between the control processes and the company’s overall strategy.

The advantages of Smart Control Many P&U companies fear that streamlining controls would reduce quality and increase exposure to risk. Others may recognize the need to improve their controls, but they take a suboptimal approach that may not realize the full potential benefit. Many deploy monitoring tools on top of existing controls, rather than get to the root of the problem, while others attempt to retrofit, rather than integrate, controls. A common pitfall is not considering the changes needed in organizational design, technical proficiencies and behavior to reduce risk.

Ernst & Young’s Smart Control approach helps companies realize reductions in the cost of controls, enable growth and keep the business safe. Our approach can help companies:

• Reduce spend on controls by considering the key drivers for controlling spending, calculating the costs, and comparing financial outlay to risks and acceptable levels of risk exposure

• Improve accountability for risk by assigning major risk assessment and mitigation activities to key people throughout the organization and empowering employees to manage risk through ongoing communication, training and reporting

• Develop a faster process that eliminates duplicate or unnecessary activities and makes the most of automation

• Align with strategy so that risk management and controls are supporting the business objectives

Many power and utility companies view their control processes as cumbersome and of limited value. A smarter approach can improve efficiencies, keep the business safe and offer a real competitive advantage. Tony Martin reports.

Rethinking controls


Smart Control supports utilities to build an integrated, streamlined and dynamic control environment that provides the agility necessary to anticipate or respond to changes. By balancing value, cost and risk in their processes and controls, Smart Control helps companies create a competitive advantage.

Tools for transforming controlsErnst & Young has developed a technology platform called the Risk and Controls Analysis Platform (RiCAPTM), which helps evaluate an organization’s control environment and identify opportunities for Smart Control. This platform evaluates key inputs, such as enterprise objectives, risks, controls, cost drivers and acceptable risk levels. The results provide insight on areas that are over- and under-controlled and helps prioritize areas of improvement and guide future state design.

Another useful Ernst & Young tool to help companies transform their controls is our Power and Utilities Maturity Model and Architecture (PUMMA). PUMMA is a pool of constantly updated data on the best practices of the world’s leading utilities. PUMMA is especially useful to unwind control processes that have been built up over the years and recalibrate these to fit the company’s future vision.

Tony Martin Leader, Risk Advisory Melbourne, Australia + 61 3 9288 8000 [email protected]

Tony is Ernst & Young’s Leader of Risk, Melbourne and a member of Oceania’s Advisory Utilities Industry Group.Tony has over 20 years’ experience in performing assurance and risk management engagements on large, complex and global P&U organizations. He leads teams to develop pragmatic and valued risk approaches that help his clients see measurable improvements. Tony’s insights into trends in internal audit and enterprise risk management are particularly relevant to the P&U sector.

Turning the lights back onA major Australian electricity provider was experiencing increasing levels of customer dissatisfaction and rising operational costs surrounding its process of resolving network faults. The utility engaged Ernst & Young to help it streamline the control process, with the aim of getting the lights back on faster and more efficiently.

Our team began by assessing how information received via the company’s control center was passed onto network maintenance crews. By identifying how more effective communication processes could help the company get a better overview of fault situations, it was given the tools to prioritize issues and improve the scheduling and efficiency of maintenance crews. Accountability for resolving faults was also transferred from the call centers to the maintenance crews that actually held the skills to fix the problem. These changes led to faster resolution of faults, improved levels of customer satisfaction and reduced costs, as staff overtime was greatly reduced.

Boost cost optimizationAs P&U companies focus on cutting costs, many have overlooked the role that control processes can play in cost optimization programs. Our Smart Control approach has helped companies realize 20% to 40% reductions in the cost of controls by creating an integrated, streamlined and dynamic control environment. P&Us that reconsider the value of controls can think beyond keeping the business safe, boost cost-saving programs and derive a competitive advantage in an increasingly tight market.

Read our previous Plug in article on PUMMA


Read more about Smart Control



http://www.ey.com/GL/en/Industries/Power---Utilities/Plug-in---Fit-for-the-future

http://www.ey.com/Publication/vwLUAssets/Smart_Control_-_Transforming_controls_to_reduce_cost%2C_enable_growth_and_keep_the_business_safe/%24FILE/SmartControl.pdf

Beyond the numbersEuropean power and utility companies (P&Us) are posting end-of-year results — but do we really understand what they mean? With different companies using different indicators, it can be challenging to truly compare performance. Louis-Mathieu Perrin talks us through financial communication.

Ernst & Young looked at how 16 of Europe’s top P&Us1 are communicating their financial results to the market. Beyond the numbers, which are scrutinized by financial analysts, we found a great degree of variation among the indicators and language used, making it difficult to directly compare the financial performance of companies. But, despite the complexity, we also found a number of common trends in qualitative and quantitative communication, which also highlight key concerns for the sector.

Key differencesAggregates and indicators: The companies we looked at used 52 different aggregates or indicators, mostly non-GAAP, which can be split into 12 categories (see Table 1). Some aggregates, such as EBIDTA and EBIT, are commonly used, but most are customized, creating difficulty when comparing performance between companies.

Debt: P&Us are talking about their debt levels in different ways, making it hard to benchmark results. For example, EDF and E.ON build pictures of their debt in very different ways.

Income: When talking about income, P&Us are using various forms of non-GAAP aggregates, such as net income excluding non-recurring items, group net ordinary income, underlying net income, adjusted profit before tax or recurring net profit. And while some companies present a detailed bridge of the difference between the “accounting” net income and the “adjusted” net income — such as EDF in its 2012 annual results presentation — others stick to a short explanation indicating that extraordinary or one-off items have been excluded from the computation, or that only recurring elements have been

maintained. The type of disclosure is, in many cases, partial at best.

Past performance: Communication about past performance is also diverse, with 27 different financial indicators used. As actual performance does not always fit within the predefined target aggregates, we sometimes see the redefinition of “adjusted” metrics in order to compare initial target and achieved performance.

Operational targets: Most P&Us also communicate on operational targets such as nuclear or conventional thermal output, forward hedging or extra-financial targets, which are, by nature, not really comparable between companies. GDF Suez, for example, has set specific targets towards 2015 covering growth in installed renewable capacity, health and safety, biodiversity, diversity and training.

What everybody’s talking aboutBut while these differences make comparisons challenging, identifying areas of convergence offers insights into what issues are currently on the radar for Europe’s P&Us:

Balance sheet structure is a critical issue: Thirteen of the 16 companies we considered highlight the maturity of their debt, while 12 showcase the liquidity that helps them run their business. All 16 companies communicated either through an absolute debt number or via a ratio on their level of debt, and 10 set specific targets for the future.

Cost reduction is a key pillar of communication: Ten companies — about two-thirds — communicated their progress on current cost reduction plans or on new cost reduction targets. For example, in

1 Centrica, CEZ, EDF, EDP, E.ON, Enel, Fortum, Gas Natural Fenosa, GDF Suez, Iberdrola, RWE, Suez Environnement, Vattenfall, Veolia Environnement and Verbund for year-end 2012, and SSE for the six months ending 30 September 2012. We considered the core presentations and their appendices, but not the full-year accounts, nor the annual reports.


its latest strategic update, Enel sets out a target of reducing operational expenses by €4b (about US$5.2b) by 2017, while Fortum announced it will improve cash flow by €1b (about US$1.3b) as part of its 2013–14 efficiency program.

Strong commitment to capital discipline: The specific capex levels or divestments achieved disclosed by all 16 P&Us examined in their financial communication underlines the ongoing precise monitoring of investment budgets. Twelve companies also shared in their guidance-specific capex or divestments targets, in a number of cases reducing capex levels and increasing divestments.

Dividends are vital to the value proposition: Almost all P&Us put the level of dividend or pay-out ratio as one of the central elements of their 2012 achievements. Seven companies committed to a firm level of dividend in 2013, while seven others committed to a range of pay-out ratios, showing that confidence in 2013 earnings performance is probably depending on a number of external factors, not all of which are under the control of the company.

Regulation remains a concern: This is particularly an issue in Southern Europe — Iberdrola dedicated eight pages to the impact of recent regulatory measures. We are also seeing companies caution that achieving their financial targets is dependent on “no significant regulatory and macroeconomic changes.”4

Common concerns highlight challengesWhile the use of diverse and often customized financial indicators makes it difficult to conduct strict comparisons of the financial performance of Europe’s P&Us, an awareness of these different types of communication can help to

understand results, as well as to identify where companies’ priorities lie. And while differences abound, we also found many points of convergence, showing that European P&Us share several common concerns that highlight the challenges they continue to face in a period of significant transformation for the sector.

Category Number of aggregate/ indicator2

List of aggregates/indicator used3

Revenue 1 Revenue/sales

Earnings before interest, taxes, depreciation and amortization (EBITDA)

4 EBITDA, recurring EBITDA, comparable EBITDA, EBITDA margin

Operating income 6 Earnings before interest and taxes (EBIT), adjusted/comparable operating profit, reported operating profit, current operating income, adjusted operating income, operating result

Other operational 3 Gross margin, operational expenditure (opex)/gross profit, net operating expenses

Cash flow 6 Cash flow, adjusted operating cash flow, operating cash flow/fund from operations/cash flow from operations, net cash from operating activities, free cash flow, free cash flow/revenue

Net income 12 Net income, net profit, net income/result group share, reported net profit, profit after tax, net income excluding non-recurring items, group net ordinary income, underlying net income, adjusted profit before tax, recurring net profit, net recurring income group share, adjusted earnings

Earnings per share (EPS) 2 Underlying EPS, adjusted earnings per share

Financial results 2 Financial items net, net financial expenses/results

Debt 6 Net debt/interest bearing net debt/net financial debt, adjusted/economic/comparable net debt, net debt or adjusted net debt or comparable net debt or economic net debt/EBITDA, adjusted net financial debt/(operating cash flow before working capital + operating financial assets repayments), funds from operations (FFO) or retained cash flow (RCF)/adjusted net debt or net debt, gearing or leverage or net debt/equity

Dividend 2 Dividend, pay-out ratio

Capital expenditure (capex) 5 Capex, capex and acquisitions, consolidated investments, net investments, divestments

Other 4 Return on capital employed, return on shareholder’s equity, adjusted effective tax rate, rating

Louis-Mathieu Perrin is a senior manager with more than 10 years’ experience in the power and utilities sector. Louis-Mathieu supports clients across a range of areas including audit, IFRS transitions, due diligence, asset valuations and reviews of internal systems. He works with many of Europe’s leading utilities and France’s energy regulator, Commission de Regulation de l’Energie.

Louis-Mathieu Perrin Assurance sector resident, Global Power & Utilities Center + 33 6 74 57 72 89 [email protected]

2,3 More information on specific indicators and aggregates in the full report link 4 GDF Suez Consolidated Financial Statements 2012, GDF Suez, 2013

Table 1:

For more informationRead a more in-depth version of this article, including more information on specific indicators and aggregates


http://www.ey.com/Publication/vwLUAssets/Financial_communication_in_power_and_utilities/%24FILE/Financial_communication_in_power_and_utilities.pdf

About Ernst & YoungErnst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com.

About Ernst & Young’s Global Power & Utilities CenterIn a world of uncertainty, changing regulatory frameworks and environmental challenges, utility companies need to maintain a secure and reliable supply, while anticipating change and reacting to it quickly. Ernst & Young’s Global Power & Utilities Center brings together a worldwide team of professionals to help you achieve your potential — a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant sector issues. Ultimately it enables us to help you meet your goals and compete more effectively. It’s how Ernst & Young makes a difference.

© 2013 EYGM Limited. All Rights Reserved.

EYG no. DX0191

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

The views of third parties set out in this publication are not necessarily the views of the global Ernst & Young organization or its member firms. Moreover, they should be seen in the context of the time they were made.

ED None

EMEIA Marketing Agency1000177

Ernst & Young

Assurance | Tax | Transactions | Advisory

EMEIAMAS 1414 Plug in March 2013 - EY - US€¦ · liquefied natural gas (LNG) supply. Two likely...

Documents

Transcript of EMEIAMAS 1414 Plug in March 2013 - EY - US€¦ · liquefied natural gas (LNG) supply. Two likely...