Giants Strive for Integration of Gas and Electricity Business

If the main motivation of the first wave of mergers and acquisitions was to increase competitiveness and reduce costs – the goal of the new wave is to increase capacity, acquire reserves, technologies, competencies….

Written by: Alfredo Višković

In the world of energy in the 21st century, a secure future awaits only the giants. The European spirit tells us that we need to ‘mix blood’ of energy entities because only the emergence of energy entities in Europe, including Croatia, will enable us to conduct a common European energy policy.

With the intensive process of liberalization of energy sectors that has swept the world in the last decade, an equally intense and seemingly paradoxical process of industrial concentration has emerged. As has happened in many other sectors opened to the market, so it has been in energy. After the first phase of fragmentation of energy companies, a phase of re-consolidation followed, redirecting the entire energy structure towards forms of unified supply. The first major wave of mergers and acquisitions occurred in the second half of the 1990s in the international oil industry. The ten most powerful companies (Mobil Royal Dutch Shell, British Petroleum, Total, Chenon-Texaco) were formed by merging 45 companies. In two decades, the number of estimated American companies decreased from 400 to 138, while their combined volume tripled. The leading company in the world formed by the merger of Exxon and Mobil increased production and profit by 2.5 times.

After the first wave of mergers and acquisitions, peaking in 2000, a second wave followed from the mid-decade encompassing the entire spectrum of energy systems, with transaction amounts exceeding 350 billion euros in 2006 and 2007. New records are expected in 2008. European electricity companies and gas business firms show particular interest. The result is the same: the creation of new giants, greater market concentration; their increasing importance in the supply of such forms of energy. Excessive growth is the main driver of competition in global energy markets. The growth strategy imposes itself as the most effective response to the processes of liberalization and privatization that, thanks to the development of financial markets, have increased the potential for entry into new sectors and new countries.

Such strategies are pursued by financial investors to increase the value of their shares. In conditions of increasing market uncertainty and risk, such strategies favor the large volume of investment needed to maintain production. The search for and exploitation of new oil and natural gas fields, as is the case with Sakhalin in Eastern Siberia or Kashagan in Kazakhstan, require investments of billions of euros just to start production and up to eight times more to ensure its exploitation until reserves are depleted. To effectively manage risk, companies must turn to a greater number of projects and countries, increasing financial investment resources. Therefore, it can be concluded: for operators in the world of energy to be competitive, it is essential to be global. Encouraging the merger of Exxon and Mobil, the then president of Exxon stated:

– Such a merger will strengthen our position as a true global competitor in an increasingly weaker global economy and in an increasingly competitive industry. If the main motivation of the first wave of mergers and acquisitions was to increase competitiveness, reduce costs – the goal of the new wave is to increase capacity, acquire reserves, technologies, competencies….

The conclusion is that in the world of energy in the 21st century, the future is secured only for giants. This applies to all, but especially to European energy markets, which have rapidly expanded to 460 million consumers with a gross domestic product greater than that of the USA. In the end, true competitors will be countable on the fingers of one hand. Those who have strengthened, at home and abroad, will be among the first, while others will be their easy prey. Those who were deluded that liberalization in the market arena would require and create a large number of players, believing that only in this way true competition is created, have reason to change their minds and regret.

International experience, especially Anglo-Saxon, shows that concentrations are a paradoxical result of liberalizations. What political reasons artificially dismantle, economic reasons subsequently reassemble. After the initial dismantling imposed in almost all European countries through legislation, companies began to re-vertical reintegrate and horizontally consolidate to be competitive in a market that is transitioning from national to continental and expanding beyond the borders of the Union. The reasons are, therefore, economic viability or strengthening market power.

After the liberalization of the electricity market, the United Kingdom counted 26 companies, and today there are six, of which four are under external supervision. Strong initial competition was followed by market regulation with a small number of operators offering the product – energy, with a subsequent increase in prices and profits. Once protections, external and internal, are dismantled, those who remain within their borders will not be able to survive. This could apply to all local energy companies, which are strong in their territory – which is still controlled under monopoly conditions – but do not exist in the dimension of the European market according to which large associations are formed. The comparison in productive, financial, and market frameworks is too uneven and directed in favor of large ‘players’ for our ‘small companies’ to hope for a future.

The search for intensive and diverse economies, for minimizing risk, along with the desire to compensate for lost spaces in internal markets, forces companies to grow towards external international lines. On the other hand, competition among the few large ones in relation to numerous small and weak does not necessarily harm consumers. Moreover, quite the opposite. In the electricity sector of Europe, which has fewer companies, prices are lower, as for example in France, while where companies are more numerous, for example in Italy, prices are by no means more favorable. The European electricity sector has achieved relatively the best market opening, and thus the strongest industrial consolidation. The German giant E.ON, formed by merging numerous companies, produced about 240 billion kWh in 2006 and sold 400 billion kWh, while in 2000 it sold only 1 billion kWh, and acquired Ruhrgas, the leading gas producer, thanks to strong support from the central government. In the new wave of mergers and acquisitions in the electricity and gas sector in Europe, two new factors emerge in major operations. First: their cross-border character driven by the need to penetrate as many markets as possible, especially in relation to the complete liberalization of electricity supply initiated in July 2007, recognizing the freedom of choice of suppliers for domestic customers.

Second: the inter-sectoral character finalized by the integration of the electricity and gas business as in the case of German E.ON/Ruhrgas, French Suez/Gas de France, Dutch Nuon/Essent, and partially Italian ENEL/Endesa. The reason is clear. In the electricity market, they only compete when they also compete in gas supply, a source on which electricity production increasingly depends. Opposing mutual mergers of sectors, which are considered a cause of narrowing competition, penalizes efficiency, while reducing companies’ willingness to invest. The new wave of mergers and acquisitions has recorded two more new elements worth noting due to the implications that could develop in the Western energy industry. First is the emergence of new interests in the financial market, hedge funds such as the Sovereign Wealth Fund, which possess endless liquidity and are interested in maximizing the value of their assets. There is no company, neither small nor large, that does not feel protected from possible hostile takeovers in such a situation, and that is what causes outrage. The second novelty is the emergence of state companies from producer countries such as Russia, China, and India, which have led consolidation operations primarily within their states, but with increasingly frequent incursions abroad.

Concerned about the scarcity of energy reserves but rich in enormous financial resources, Chinese, Indian, Middle Eastern, and Russian companies are increasingly turning their interest towards Western companies, especially those that believe that in energy it is not crucial who carries the flag. And, in the end, do we really believe that cheap energy produced in Eastern countries can be bought and brought to Croatia? There will be no such possibility! The ‘European spirit’ tells us that we need to ‘mix blood’ of energy entities, because only the emergence of energy entities in Europe, including Croatia, can lead us to a common European energy policy, as is happening in other strategic branches of industry, for example in airspace, defense, etc. Such will also have to be the solution for Europe’s energy security, along with stabilizing relations with energy-producing countries.