European Utilities Basics Electricity Gas Industry Overview

6 FEBRUARY 2008
EUROPEAN UTILITIES BASICS - ELECTRICITY & GAS INDUSTRY OVERVIEW
European Utilities Research Team +44 20-7325 9069 Chris RogersAC Sarah LaitungAC +44 20-7325 6826 Javier Garrido +34 91- 516 1557 Sofia Savvantidou +44 20-7325 0650 Nathalie Casali +44 20-7325 9023 For specialist sales advice, please contact: +44 20-7325 8623 Ian Mitchell
christopher.g.rogers@jpmorgan.com sarah.l.laitung@jpmorgan.com javier.x.garrido@jpmorgan.com sofia.savvantidou@jpmorgan.com nathalie.x.casali@jpmorgan.com
ian.e.mitchell@jpmorgan.com
For full JPMorgan Global Utilities Team details, please see inside cover
J.P. Morgan Securities Ltd.

See page 117 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. The analysts listed above are employees of either J.P. Morgan Securities Ltd. or another non-US affiliate of JPMSI, and are not registered/qualified as research analysts under NYSE/NASD rules, unless otherwise noted.
Global utilities team

Europe Europe Asia Pacific Asia Pacific
Chris Rogers - Germany, Nordic, UK Energy & CO2

christopher.g.rogers@jpmorgan.com
Edmond Lee, CFA

edmond.ch.lee@jpmorgan.com
Sofia Savvantidou, CFA - France, Greece, UK Water sofia.savvantidou@jpmorgan.com Javier Garrido - Spain, Italy
javier.x.garrido@jpmorgan.com
Ajay Mirchandani Hong Kong, Philippines

Ajay.mirchandani@jpmorgan.com
Boris Kan China

boris.cw.kan@jpmorgan.com
Nathalie Casali
nathalie.x.casali@jpmorgan.com
Shilpa Krishnan India

shilpa.x.krishnan@jpmorgan.com
Sarah Laitung
sarah.l.laitung@jpmorgan.com
Abid Jamal Pakistan

abid.r.jamal@jpmorgan.com
Olek Keenan, CFA - Credit

olek.keenan@jpmorgan.com
Lucius Chong Malaysia

lucius.j.chong@jpmorgan.com
For Specialist Sales advice, please contact Ian Mitchell

ian.e.mitchell@jpmorgan.com USA USA
Sukit Chawalitakul Thailand

chawalitakul.sukit@jpmorgan.com
Ami Tantri Indonesia

ami.t.tantri@jpmorgan.com Russia Russia
Andrew Smith
B A S I C S
andrew.l.smith@jpmorgan.com
Rajeev Lalwani
rajeev.x.lalwani@jpmorgan.com
Sergey Arinin
sergey.v.arinin@jpmorgan.com Latin America Latin America
Stefka Gerova
stefka.g.gerova@jpmorgan.com Australia Australia
U T I L I T I E S
Lilyanna Yang, CFA

lilyanna.yang@jpmorgan.com
Grace Chan
grace.ky.chan@jpmorgan.com
Anderson Frey, CFA

anderson.frey@jpmorgan.com
E U R O P E A N
Raoul Bostrom
raoul.v.bostrom@jpmorgan.com
Ademar Souza Neto

ademar.s.neto@jpmchase.com
Agenda
Page
The energy value chain Electricity generation Natural gas upstream sourcing Trading Transmission and distribution Supply Climate change Renewables
B A S I C S
84 94 99 108
Valuation and drivers Appendix
E U R O P E A N
U T I L I T I E S
The energy value chain

ELECTRICITY Value chain
Generation
Regulated networks Transmission & Distribution
Supply Dual-fuel contracts Supply

3
Fuel sourcing
Trading Sourcing, despatch, management, proprietary
C H A I N
Upstream sourcing / E&P
E N E R G Y
V A L U E
NATURAL GAS Value chain

Source: JPMorgan
T H E

Generation

4
Fuel sourcing
C H A I N
E N E R G Y
V A L U E

Source: JPMorgan
T H E
T H E
E N E R G Y
V A L U E
C H A I N
Economics - the load curve

Shows the order in which different plants are called upon to run based on their variable operating cost Demand / Supply / Price / Cost Peak load Comes on and off very quickly Demand present <30% of the time, timing of peaks predictable, levels less so Generation: oil, OCGTs, storage hydro. Gas: spot market and daily storage
Mid-merit Demand present 30 80% of the time, predictable variability Generation: coal, CCGTs. Gas: contracts with near distance suppliers, seasonal storage and spot Baseload Demand present most of the time (c.80%) Baseload power plants operate continuously, even when it might not be economical to do so Generation: nuclear, lignite, r-o-r hydro, CCGTs Gas: long term contracts with long distance suppliers Renewables Tend to be outside the load curve on a must-take basis run when they can Impact on environment offset partly by need for balancing power Time (Day / Year)
Source: JPMorgan
T H E
E N E R G Y
V A L U E
C H A I N
Economics - the merit order

The short run marginal cost (SRMC) of the last unit required to meet demand sets the marginal price of power at any given point in time
Drives day-to-day price, based only on cost of fuel & CO2 permits Electricity demand has to be met instantaneously by supply - electricity cannot be stored Price tends to be set by mid-merit plant for most hours of the day Baseload plants (hydro, coal, nuclear) have large margins since the marginal unit is typically gasfired, which tend to have higher costs A unit with operating cost below the current price keeps the margin
However, the long term power price is driven by the long run marginal cost (LRMC)
C H A I N
The cost of generating a unit of electricity when all factors of production (i.e. including capital) can be varied If new capacity is required, a profit margin (spread) sufficient to cover all capital costs is needed We therefore need to look at future reserve margins (system adequacy) to determine where spreads need to be
T H E
E N E R G Y
V A L U E
Economics - SRMC
price demand
merit order / load curve 8760 time (hours)
Source: JPMorgan
C H A I N
Which type of power plant will set the power price?

Currently indifferent between building a coal or gas plant in Central Europe as SRMC are the same at prevailing market fuel prices Other considerations, e.g. Germany reliant on Russian gas, whereas Spain uses gas from a variety of sources (pipeline and LNG) so more inclined to build gas fired power plants
E N E R G Y
V A L U E
Indifference between building a new clean (i.e. using CCS technology) or dirty coal plant is a function of the CO2 emission permit price
8
T H E
* Worked example: attractiveness of coal vs. gas
Germany Germany
UK UK Min Hourly demand Max
Power price
Power price
Min
Hourly demand
Max
New lignite
New hard coal
New CCGT
New hard coal
New CCGT
Peaking2 OCGT& Must run

1
Peaking2 Nuclear Interconnector and must run1 Hard coal CCGT
Nuclear
CCGT Lignite 40% 50% 60% Hard coal 70% 80% 90% 100%
0%
C H A I N
10%
20%
30%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
E N E R G Y
V A L U E
Large proportion of low SRMC plant
Large proportion of high SRMC plant
Source: RWE Factbook 2007 1 including renewables and CHP 2 oil, OCGT, hydro, etc.
T H E
Economics - wholesale prices

Price at which electricity generators/ gas producers sell to the market Market arrangements are based on bilateral trading between generators, suppliers, traders and customers
such as BETTA in the UK
Power exchanges have been launched in recent years to provide screen-based anonymous 24 hour trading
EEX in Germany Powernext in France OMEL in Spain and Portugal GME in Italy
C H A I N
APX in The Netherlands UKPX (a subsidiary of APX) in the UK Nordpool in Scandanavia
V A L U E
Generators have contracts with the transmission grid for

Connection Use of the system Balancing services including reactive power
10
T H E
E N E R G Y
Economics - spreads
Spark Dirty = power price - cost of gas Clean = power price - cost of gas - carbon price = power price - cost of coal - carbon price
Dark
= power price - cost of coal
Spark corresponds to gas

C H A I N
Dark corresponds to coal Quark corresponds to nuclear Dirty = brown Clean = green
T H E
E N E R G Y
V A L U E
11
* Worked example Central European spreads

Long term new entrant breakeven price is forecast at 65/MWh This assumes coal at $67/t and carbon at 30/t On current (spot) commodity prices this calculation shows a new entrant would not breakeven at 65/MWh Therefore If commodity costs stay high, power prices will have to rise to encourage new build If not, coal prices will need to fall to $67/t for a new entrant to breakeven at 65/MWh
New hard coal, no CO2 capture, 2008E New hard coal, no CO2 capture, 2008E
C H A I N
Power price - Fuel cost: - Carbon cost: = Clean dark spread (/MWh) - Fixed cost:
+ (capital cost required return) Op & M + capital cost plant life load factor 8760 hours per year
(price of 1t of coal + cost of shipping 1t)
price of CO2 CO2 intensity
65
/$ t/MWh
V A L U E
-(106.9 + 7)/1.45 0.325
-(25/t 0.72t/MWh)
=21.5
(42 + 1144 + (1144 10% )) 50 1000 0.8 8760
12
T H E
E N E R G Y
= - 4.1
* Worked example Central European spreads

Long term new entrant breakeven price is forecast at 65/MWh This assumes gas at $9.6/mmbtu and carbon at 30/t On current (spot) commodity prices this calculation shows a new entrant would not breakeven at 65/MWh Therefore If commodity costs stay high, power prices will have to rise to encourage new build If not, gas prices will need to fall to $9.6/mmbtu for a new entrant to breakeven at 65/MWh
New CCGT, no CO2 capture, 2008E New CCGT, no CO2 capture, 2008E Power price - Fuel cost: - Carbon cost:
(price of 1mmbtu of gas heat rate)
price of CO2 CO2 intensity
C H A I N
65 /$ 1000
(12.9 5900btu/kWh)
1.45 1000
V A L U E
-(25/t 0.37t/MWh)
=3.25
= Clean spark spread (/MWh) - Fixed cost:

+ (capital cost required return) Op & M + capital cost plant life load factor 8760 hours per year
E N E R G Y
(21 + 520
T H E
= - 9.7
+ (520 10% )) 30 1000 0.8 8760

13
Economics - LRMC
European system adequacy Nordel UK UCTE
T H E
E N E R G Y
V A L U E
C H A I N
14
UCTE system adequacy forecast

UCTE - Union for the Co-ordination of Transmission of Electricity Association of transmission system operators in continental Europe* (i.e. excluding the UK and Scandinavia) 50 years of joint activities Synchronous operation of interconnected transmission grids Publishes data on forecasts of the security of supply over the next 15 years Publication: UCTE System Adequacy Forecast 2007-20
Starts with stated build/ close plans for power plants Then looks at potential development in demand, average load evolution Also factors in expected changes in transmission grids and interconnections
C H A I N
Updated annually at www.ucte.org

* Includes: Installed capacity (GW) Germany France Italy Spain Poland Netherlands 122.3 116.4 90.3 76.4 32.4 22.1 Austria Switzerland Romania Czech Republic Belgium Portugal 18.3 17.5 17.2 16.3 16.2 13.9 Greece Bulgaria Serbia Hungary Slovakia Croatia 11.8 11.2 8.9 8.1 6.8 3.9 Bosnia Herzegovina Slovenia Western Ukraine Luxembourg Macedonia Montenegro 3.9 2.9 2.5 1.7 1.2 0.9
15
T H E
E N E R G Y
V A L U E

Generation adequacy Generation adequacy
Remaining capacity (RC) RC (GW)

= national generating capacity (NGC) non-usable capacity - maintenance and overhauls - outages - system services reserve reference load
Compared to the adequacy reference margin (ARM) ARM (GW)

= peak load load at reference time + minimum reserve capacity
Minimum reserve capacity

= 5% of national generating capacity
3 reference points
C H A I N
3rd Wednesday of January at 11:00 3rd Wednesday of January at 19:00 (close to peak) 3rd Wednesday of July at 11:00
V A L U E
Estimates under normal climatic conditions (i.e. temperature and precipitation at long term averages) Reserve margin = RC/NGC
amount of unused available capacity at peak load as a percentage of total capacity
T H E
E N E R G Y
16

Transmission adequacy Transmission adequacy
Imports can support a system provided there is sufficient import and export capacity Overall not an obstacle to power balance management in the UCTE area Sufficient transmission capacity Import and export capacity looks likely to satisfy (RC ARM)
T H E
E N E R G Y
V A L U E
C H A I N
17
UCTE generation adequacy forecast
Without considerable new build/ life extension the system will be out of balance in continental Europe post-2015 5% seen as minimum adequate to limit the risk of system interruptions such as Brown outs (voltage dips) or Black outs (system collapse)
80 70 60 50 remaining capacity (GW) 58.9 52.2 60.7 61.3 53.7 60.7 65.2 57.7
NB. 1GW = 1000MW, or one large coal power station

67.9
41.9 40 30 20 10 0 -10 -20 -30 January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm July 11:00 am January 11:00 am January 7:00 pm 34.6
42.6
Minimum reserve capacity 5%
C H A I N
V A L U E
July 11:00 am
January 11:00 am -9.7
January 7:00 pm
July 11:00 am -3.6
-17.6
E N E R G Y
2007E
2008E
2010E
2015E
2020E
Source: UCTE System Adequacy Forecast 2007-20
T H E
18
UCTE retrospect: reserve margin
There has been large oversupply across Europe in the past The reserve margin is expected to fall below 5% post-2015 Therefore significant reinvestment in generation capacity is needed
14% 12% 10% 8% 6% 4% 2% 0% 2001A -2% 2002A
Jan July
reserve margin
Minimum reserve capacity 5%
V A L U E
C H A I N
E N E R G Y
2003A
2004A
2005A
2006A
2007E
2008E
2010E
2015E
2020E
T H E
Source: UCTE System Adequacy Retrospect 2001-2006 and System Adequacy Forecast 2007-20 All readings 3rd Wednesday at 11:00am
19
Nordel system adequacy forecast

Nordel organisation for the Nordic Transmission System Operators Publication: Nordel Power Balances 2008-11
N.B. looks at MWh/h equivalent to the available capacity in MW
From 2008 to 2011, the Nordic system is able to meet the estimated consumption in average conditions without imports Sufficient to cover simultaneous peak demand without import in 2010-11E Estimated production (MWh/h) that which is available at peak Peak Demand (MWh/h) = maximum one hour load in temperature circumstances with occurrence probability one winter during 10 years Net power export (MWh/h)
C H A I N
= estimated production - peak demand
T H E
E N E R G Y
V A L U E
20
Nordel system adequacy forecast
Temperatures corresponding to the coldest day in 10 years Forecast net importer under peak conditions in 2008-10
Estimated production 79000 Peak demand Net power export
Forecast to become a net exporter in 2010-11

2500 2000 1500
78000 Estimated production/ peak demand (MWh)
77000 Net power export (MWh) 1000 76000 500 0 -500 -1000 73000 -1500 72000 -2000 -2500 2008/09E 2009/10E 2010/11E
75000 74000
E N E R G Y
V A L U E
C H A I N
71000
Source: Nordel Power Balances 2008/09, 2009/10 and 2010/11 Large increase in production in 2010/11 is due to a new nuclear plant in Finland
T H E
21
UK system adequacy forecast

Publication: National Grid Seven Year Statement (SYS) 2007 3 different generation background forecasts: SYS based total capacity (GW) = existing generation projects + those proposed new generation projects for which an appropriate Bilateral Agreement1 is in place Consents based total capacity (GW) = existing generation projects + those proposed new generation projects been granted the necessary consents under Section 36 of the Electricity Act 1989 and Section 14 of the Energy Act 1976 for connection to the network
C H A I N
Existing or under construction total capacity (GW) Consented
V A L U E
E N E R G Y
Existing or under construction
1 An agreement between National Grid and a generator for future connection to the transmission system
T H E
SYS
22

ACS (average cold spell) peak demand base case (GW) - the combination of weather elements that give rise to a level of peak demand within a year that has a 50% chance of being exceeded as a result of weather variations alone, with base case assumptions of economic growth Plant margin - amount by which the installed generation capacity exceeds the peak demand as a proportion of peak demand
N.B. this is a very different calculation to UCTE/ Nordpool and not wholly comparable
As generating units are not available to generate 100% of the time, in the past, large integrated power system utilities (e.g. the Central Electricity Generating Board in England and Wales) sought to achieve a plant margin of 24% Now, the operational plant margin requirement for real time generation is generally 10% depending on prevailing circumstances
C H A I N T H E E N E R G Y V A L U E
23

Plant margin is likely to exceed 24% over the entire forecast period, even under the conservative existing/ under construction background This is a significant contrast to the UCTE
"SYS based" total capacity "Consents based" total capacity "Existing/ under construction based" 100 ACS peak demand (base case)
"SYS based" plant margin "Consents based" plant margin 60 "Existing/ under construction based"
80 Capacity/ demand (GW)
Plant margin (%) = capacity-peak demand/ peak demand
50
40
60
C H A I N
30 24% 20
40
V A L U E
20
10
E N E R G Y
0 2007/08E 2008/09E 2009/10E 2010/11E 2011/12E 2012/13E 2013/14E
0 2007/08E 2008/09E 2009/10E 2010/11E 2011/12E 2012/13E 2013/14E
T H E
Source: National Grid Seven Year Statement 2007
24
Technology - thermal power generation

Thermal generation Electricity produced using a steam generating boiler Steam drives turbine Turbine generates electricity via an alternator (an electromechanical device that converts mechanical energy into alternating current) Coal, oil, gas, nuclear, solar thermal, biomass, geothermal Non-thermal generation Turbine is driven by energy other than steam Hydro, wind, solar photovoltaic Thermal efficiency - efficiency
with which the energy content (measured in gross calorific value) of the input fuel is turned into electrical energy by the generating station
Source: www.tva.gov
25
Electricity generation resources - solid fuel

Coal Coal
Typical thermal efficiency (btu/KWh) Hard coal Old technology New technology Lignite Old technology New technology 9,000 7,757 11,000 8,100
Typical thermal efficiency (%) 38% 44% 31% 42%
Where in load Midmerit Midmerit Baseload Baseload
Load factor (%) 66% 66% 80% 80%
Load factor (hr/a) 5,782 5,782 7,008 7,008
Start up time 1-3 days
CO2 (t/MWh) 0.90 0.86 1.25 1.10
1-3 days
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, IEA, Alstom, JP Morgan estimates
Hard coal
Can load follow Dense so can be sourced globally
Lignite
C H A I N
Relatively more sulphur and ash Less energy per tonne so needs to be alongside the mine Lignite has a fixed cost of production so not at the mercy of the global coal market
T H E
E N E R G Y
V A L U E
Source: www.tva.gov
26
Electricity generation resources gaseous fuel

Gas Gas
OCGT (open cycle gas turbine) old style, can start up quickly during peak demand
CCGT (combined cycle gas turbine) - by-product heat is used to generate additional electricity via steam cycle, optimally run base load or mid merit
E N E R G Y
V A L U E
C H A I N
Source: powergeneration.siemens.com
T H E
CHP (combined heat and power) - by-product heat is used to warm local homes or businesses
27
Electricity generation resources gaseous fuel

Gas Gas
Typical thermal efficiency (btu/KWh) OCGT Old technology New technology CCGT Old technology New technology 10,500 9,250 7,000 5,700
Where in load Peak load Peak load Midmerit Midmerit
Load factor (%) <20% <20% 50-60% 50-60%
Start up Load factor time (from cold) (hr/a) <1,752 5-10 mins <1,753 4,380-5,256 4,380-5,256 1-2 hours
CO2 (t/MWh) 0.70 0.60 0.43 0.37
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, IEA, GEpower.com, JP Morgan estimates
The cleanest fossil fuel from a pollution perspective

C H A I N
CCGT can be baseload or midmerit Latest CCGTs are highly efficient but still have relatively high operating costs in the current commodity price environment
T H E
E N E R G Y
V A L U E
28
Electricity generation resources liquid fuel

Oil Oil
Typical thermal efficiency (btu/KWh) Oil 12,000
Typical thermal efficiency (%) 28%
Where in load Peak load
Load factor (%) <20%
Load factor (hr/a) <1752
Start up time 1-2 mins
CO2 (t/MWh) 0.82
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, IEA, JP Morgan estimates
Can start quickly during peak demand Highest operating costs due to:
Low thermal efficiency Low number of hours to amortise fixed costs across
Most polluting
Source: www.tva.gov
29
Electricity generation resources nuclear overview

Nuclear Nuclear
Advantages
Security of supply reduces dependence on finite, and often imported fossil fuels Long term resource Environment protection zero CO2 emissions Uranium reserves are mostly located in stable countries and are abundant Could be almost unlimited due to uraniums multiple energy potential
Depends on prevalence of reprocessing Up to 96% of spent fuel can be recycled
High capital cost but very low operating costs
Disadvantages
C H A I N
Take 1-3 days to start so only shut down when necessary Need to be refuelled every 12-18 months Chequered safety and operation history although image and statistics do not always match
T H E
E N E R G Y
V A L U E
30

Nuclear Nuclear
International Nuclear Event Scale 0 no safety significance 1 anomaly (e.g. minor defects in pipework) 2 incident 3 serious incident (e.g. radioactive doses to workers sufficient to cause acute health effects) 4 accident without significant off-site risk 5 accident with off-site risk (e.g. severe damage to the installation) 6 serious accident 7 major accident (e.g. external release of a large quantity of radioactive material) Areva estimates:
C H A I N
Operational incidents (e.g. uncontrolled boron dilution): 1 in 100 chance per reactor per year Infrequent accidents (e.g. control rod withdrawal at full power): 1 in 100 to 1 in 10,000 Hypothetical accidents (e.g. control rod ejection): 1 in 10,000 to 1 in 1,000,000
T H E
E N E R G Y
V A L U E
Source: www.iaea.org/Publications/Factsheets/English/ines.pdf, Areva Technical Days
31

Nuclear Nuclear
Public acceptance in the US The political climate is favourable towards

Renewal of nuclear operating licenses and Construction of new nuclear plants
There is much more sympathy for nuclear power now than there was a couple of years ago in terms of:
Siting (building new plants adjacent to existing ones) Safety concerns Environmental benefits (a key issue will be the way cap-and-trade and Renewable Portfolio Standards are implemented in the US)
The private sector is willing to build new nuclear, however

investors are hesitant to put up capital due to the time-scale of building a plant,
C H A I N
the latest Energy Bill from Congress makes federal loan guarantees available to build several nuclear plants, but not on an extensive scale Congress has not done anything about long-term storage of nuclear waste since the Yucca Mountain storage site was effectively blocked and the Nuclear Regulatory Commission, which has to approve new plants and extensions of old plants, is currently profoundly under-resourced
T H E
E N E R G Y
V A L U E
32

Nuclear Nuclear
Public acceptance in Europe examples of opinion Pro UK government consulted on the future of nuclear power
Nuclear operators will have to cover the full costs of decommissioning and their share of the management and disposal costs
Anti German nuclear closure program remains controversial

Public increasingly considering the policy unrealistic
France
80% of generating capacity is nuclear Has been generally positive as there have been no accidents and wholesale prices have been remarkably low
C H A I N
Full moratoria in Italy and Spain

Potential for change but unlikely to be soon
Belgium
No new build after closure of the existing two plants scheduled to run til 2015-25, with potential life extension to 2025-2035
Nordic countries - unquestionable shift in favour

Low support for a phase-out in Sweden, despite negative attitudes in the early 1980s 2002 public debate and resulting new build in Finland
Austria - vehemently anti-nuclear
E N E R G Y
V A L U E
Baltics smaller demand base seems to be leading to multinational cooperation
T H E
33
Electricity generation resources nuclear technology

Nuclear Nuclear
Technology
Reliable base-load generation at stable and low cost A complex nuclear fission process an atomic kettle attached to a steam turbine Generation I: reactors mainly being shut down end of this decade (Magnox) Generation II: 1970s 2050s (AGR) Generation III: 1990s at least 2050s (PWR, BWR) Generation III+: improved safety and reliability, 1990s at least 2060s (EPR) Generation IV: will be ready to market between 2020 and 2030 (VHTR, PMBR, Fast breeder reactors) Fusion reactors post 2050 (ITER): experimental plant under construction
T H E
E N E R G Y
V A L U E
C H A I N
Source: Areva Technical Days
34

Nuclear Nuclear
AGR (Advanced gas-cooled reactor)

Generation II (1960s) Mostly used in the UK Graphite is the moderator, CO2 is the coolant The moderator slows down the neutrons released by the uranium fuel preventing run-away reactions Gas picks up the heat generated by the fission reaction Hot gas circulates past the heat exchanger Final steam conditions at the boiler stop valve are identical to that of conventional thermal plants so the same design of turbo-generator is used The control rods can be raised or lowered to adjust the reactor power
C H A I N
V A L U E
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
T H E
E N E R G Y
Charge tubes Control rods Graphite moderator Fuel assemblies Concrete pressure vessel and radiation shielding Gas circulator Water Water circulator Heat exchanger Steam
35
Source: Creative Commons

Nuclear Nuclear
BWR (Boiling water reactor)

Generation III Pressurized boiler Light water (normal water i.e. H2O not 2H2O) is the moderator and the coolant Bundles of uranium-filled fuel rods Heat is produced by a fission chain reaction Water circulating from the bottom to the top of the reactor is brought to 290C Generates steam, which drives the turbine Series of strong, leak-tight physical barriers shield against radiation
Metal cladding of fuel rods Metal enclosure of reactor primary circuit
C H A I N
Reactor core
Containment of reactor
Net power output 1250MW
E N E R G Y
V A L U E
T H E
36

Nuclear Nuclear
PWR (Pressurized water reactor)

Generation III More complex than a BWR 2 circuits Light water is the moderator and the coolant Water under constant pressure so it doesnt boil 155bar higher than a BWR Primary circuit of water at 313C Secondary circuit of steam heated by the primary circuit completely separate and closed Water and steam circulate so constantly cooling down and heating back up Unchanging and uninterrupted
C H A I N
Cooling circuit removes residual heat from the core part of this water evaporates Net power output 1600MW
V A L U E
T H E
E N E R G Y
37

Nuclear Nuclear
EPR (European pressurised reactor)

Generation III+ Takes advantage of the latest operating experience and incorporates the results of French and German R&D programs Higher power, efficiency and life expectancy Generating cost per kWh 10% lower than Arevas latest PWR More advanced passive safety & lower risk of human-error Lower waste production Net power output 1600MW
Beyond
Generation IV potential designs:
Fast breeder reactors fast neutron reactor without moderator, fully closed cycle, minimises production of long-lived waste, gas-, lead- or sodium-cooled Pebble Bed Modular Reactor (PMBR) smaller size, no super-criticality risk but as-yet unproven Advanced water designs, e.g. the very high temperature reactor (VHTR), with water at 1000C, also allows hydrogen production
C H A I N
V A L U E
Typical thermal efficiency (btu/KWh) Nuclear - AGR BWR PWR EPR 8,300 9,200 10,000 9,500
Where in load Baseload Baseload Baseload Baseload
Load factor (%) 60-80% 80-90% 80-90% 80-90%
Load factor (hr/a) 5,256-7,008 7,008-7,884 7,008-7,885 7,008-7,886
Start up time 1-3 1-3 1-3 1-3 days days days days
CO2 (t/MWh) 0.01 0.01 0.01 0.01
E N E R G Y T H E
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, IEA, Areva-np.com, wikipedia, JP Morgan estimates
38
Electricity generation resources renewables

Wind Wind
Wind blows and sets the turbine blades in motion, generating power that can be converted into electricity A steel or concrete tower with a nacelle that turns horizontally in a way such that the rotor (usually equipped with two or three blades) always faces the wind Generation depends on:
cube of wind speed (double wind speed gives eight times more power)
C H A I N
square of rotor diameter (double rotor diameter gives four times more power) density of the air (If the air is 10C colder, density and power production increase by 3%. Moist air is less dense and so will lower power production) mechanical efficiency of generator aerodynamic shape of blades
39
Source: EC Energy Research
T H E
E N E R G Y
V A L U E

Wind Wind
Source: Vestas.com
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Rotor lock Pillow block Main frame Impact noise insulation Hydraulic parking brake Coupling Generator frame Control panel Heat exchanger Generator Gearbox Yaw drive Rotor shaft Rotor hub Pitch drive Nose cone
V A L U E
C H A I N
Typical hub height 80m Typical blade length 40m
T H E
E N E R G Y
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Biomass & biofuel Biomass & biofuel
Biomass Plant-derived organic matter (fix CO2 as they grow, so their use does not add to the levels of atmospheric carbon on a life-cycle basis)
E.g. forest residues, agricultural residues, pulp and paper operation residues, animal waste, landfill gas and energy crops
Co-firing in existing power plants (usually coal) can be used to reduce average CO2 emissions and potentially get green certificates Burnt in conventional steam boilers
C H A I N
Biofuel Many different conversion technologies to produce solid, liquid and gaseous fuels Biomass gasification (release via heat) Anaerobic digestion (release via bacteria)
T H E
E N E R G Y
V A L U E
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Geothermal Geothermal
Conventional geothermal applications rely on the geological coincidence of water-bearing, hot permeable rocks occurring at economically accessible depths At fluid temperatures of 85 - 150C, electricity generation requires the use of binary cycles, in which a working fluid is heated and vaporised in a closed circuit
The vapour drives a turbine, before being cooled and condensed, and the cycle begins again
C H A I N
V A L U E
At fluid temperatures >150C steam can be used to drive turbines

Source: Energy Manager Training
T H E
E N E R G Y
42

Geothermal Geothermal
Enhanced Geothermal Systems utilize heat stored in rocks that are technically accessible but lack the natural permeability Hence they allow geothermal generation to be used in a wider range of locations than before A well is drilled into >180C fractured basement rock and stimulated to enhance the natural permeability of the fracture network and create a heat exchanger into which additional wells are drilled
Water circulated through the wells gathers heat
C H A I N V A L U E
T H E
E N E R G Y
Source: EC Energy Research
43

Solar Solar
Solar photovoltaic PV cells transform the photon energy in solar radiation directly into electrical energy without an intermediate mechanical or thermal process Technology is currently very expensive Concentrated solar/ solar thermal Optical devices focus direct solar radiation onto an area where a receiver is located The radiation is transformed into heat in a medium (oil) and then to steam and electricity as per thermal power Continues to work after dark until collected heat dissipates Technology requires a very large area
Load factor (%) Offshore wind Onshore wind Biomass Geothermal Solar PV Concentrated solar 30-40% 20-30% 40-70% 95% 10-25% 10-35% Load factor (hr/a) 2,628-3,504 1,752-2,628 3,504-6,132 8,322 876-2,190 876-3,066 Start up time <30 sec <30 sec 1 hour 1 day instant instant Build cost (m/MW) 2.1 1.3 0.8-1.2 2.1 6.0-7.0 4.0
E N E R G Y
V A L U E
C H A I N
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, www.geoenergy.org/aboutGE/powerPlantCost.asp, JP Morgan estimates
T H E
44
Electricity generation resources hydroelectric

Hydro Hydro
Run-of-the-river (r-o-r) Natural flow and elevation drop of a river are used to generate electricity free fuel Reservoir Energy extracted depends on the volume and on the head (difference in height between the source and the water's outflow) Pumped storage
Requires energy to pump water into reservoir - when the wholesale price is low (hence not free fuel) Supplies peak demand - when the wholesale price is high
Not pumped
Uses reservoirs that are naturally elevated
Marine
C H A I N
Tidal
Utilizes the daily rise and fall of water Highly predictable Not yet economically viable
V A L U E
Wave
Utilizes the effect of the wind on the sea Not yet economically viable
T H E
E N E R G Y
45
Electricity generation resources hydroelectric

Hydro Hydro
Where in load R-o-R Storage Baseload Peak load
Load factor Load factor (%) (hr/a) 70% 15% 6132 1314
Start up time 1-2 mins 1-2 mins
Source: Department for Business, Enterprise & Regulatory Reform Digest of United Kingdom energy statistics 2007, JP Morgan estimates
E N E R G Y
V A L U E
C H A I N
Source: www.tva.gov
T H E
46
Electricity generation resources in Europe

Germany, Poland and Spain have historically had large domestic coal industries The UK, Norway and the Netherlands have been major producers of oil and gas
UK and Netherlands now in decline New sources: Russia by pipeline, Liquefied Natural Gas by boat for elsewhere in the world
Dash for gas gas power station new build

UK, Spain, Italy Cleaner, cheaper, more efficient than coal
In the Nordic region 60% of generation comes from hydro France (dearth of natural resources) has developed the largest nuclear capacity in Europe
C H A I N
Germany has launched a drive to install Europes largest wind fleet

Other major wind players: Spain, Denmark
T H E
E N E R G Y
V A L U E
47
OECD Europe generation mix (see European Utilities Basics - Country Profiles for more)
Capacity (2005A, GW) Capacity (2005A, GW) Output (2004A, TWh) Output (2004A, TWh)
oil, 31.9, 4% renewables, 41.2, 5% coal, 254.9, 32% hydro, 169.5, 21%
oil, 132.0, 4% renewables, 160.7, 5% coal, 994.4, 28.7%
hydro, 526.5, 15%
gas, 663.0, 19%
gas, 168.4, 21%
nuclear, 137.5, 17%
nuclear, 992.5, 28.6%
C H A I N V A L U E
Source: IEA and EIA
E N E R G Y
Low load factor output on average proportionally lower than capacity e.g. hydro High load factor output on average proportionally higher than capacity e.g. nuclear
T H E
48

Generation

49
Fuel sourcing
C H A I N
E N E R G Y
V A L U E
T H E
T H E
E N E R G Y
V A L U E
C H A I N
50
Gas sourcing
Exploration and production Exploration and production
Natural gas is a regional commodity Its physical properties make it hard to transport, particularly intercontinentally without liquefaction Most natural gas is transported in gaseous form via pipeline Gas markets still regional rather than continental or global European natural gas is priced using an oil-referenced formula The widespread adoption of Liquefied Natural Gas should change the gas market from regional to global Large natural gas consumers (especially power plant operators and retail suppliers) have incentives to hedge their physical commodity exposure as well as the basis (location) risk associated with dealing in different markets
E N E R G Y
V A L U E
C H A I N
T H E
Source: JP Morgan Oil&Gas Basics Presentation
51
Gas sourcing
Exploration and production Exploration and production
Why be involved in upstream gas? No indigenous supply Security Economic hedge If not involved upstream, generators tend to be beholden to very long term contracts (20 years - whereas the coal market is spot-based) with NOCs (National Oil Companies) Major market drivers Weather is both a demand and supply factor
Demand for central heating
C H A I N
Hydro conditions in areas that depend on hydropower drive requirement for CCGT power
T H E
E N E R G Y
V A L U E
Oil price long term contracts tend to be oil-based, take-or-buy decisions impact the natural gas market
52
Gas sourcing
Storage Storage
Natural gas is stored in inventory underground under pressure in 3 types of facilities Depleted reservoirs in oil/ gas fields Aquifers Salt cavern formations Each storage type has its own characteristics which govern its suitability Physical (capacity, deliverability rate, porosity, permeability, retention capability) Economic (site preparation and maintenance costs, deliverability rates, and cycling capability) System integrity maintenance meeting baseload requirements Seasonal storage
C H A I N
Excess supply in the summer traditionally stored to meet winter demand Increasing prevalence of air conditioning in many countries has lowered seasonality but increased demand System balancing meeting peakload requirements Smoothing day-to-day Buffer to meet unexpected demand surges
53
T H E
E N E R G Y
V A L U E
Gas sourcing
Gas providers can Carry out exploration and production themselves Have a stake in a project operated by another party Receive gas from a pipeline under contract e.g. Siberia Spain Receive gas from an LNG train e.g. Australia US
LNG is natural gas that is stored and transported at atmospheric pressure and a temperature of 260F
Liquefaction
Boat transportation
One LNG boat 150 000m3 (liquid volume) of LNG
Regasification
Volume increases 600 times
C H A I N
E N E R G Y
V A L U E
UK daily consumption is 301,000,000m3 (gaseous volume) of natural gas So one tanker is enough for 1/3 of a days demand
T H E
Source: IEA, JPMorgan
54
Gas sourcing
LNG LNG
The global LNG market is small but growing rapidly Declining US gas production means LNG is vital to satisfy demand growth and prevent price appreciation Low European natural gas prices have historically led to a flood of shipments to US terminals The last 2 years have seen a growing trend toward increased US imports in the spring Major market drivers
Upstream additions (Equatorial Guinea, Egypt) Demand patterns (hydro conditions in Spain, Norwegian flows into the UK) Asian demand (economic growth, major Japanese nuclear plant outages)
C H A I N
Trans-Atlantic arbitrage Crude oil arbitrage Operating performance at liquefaction, export and import terminals
V A L U E
LNG projects are among the most expensive energy projects

Constructing a liquefaction and regasification terminal costs >1b so there is a minimum distance threshold (compared to pipelines)
E N E R G Y
T H E
Regasification may be regulated or merchant

Source: JP Morgan Oil&Gas Basics Presentation
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Generation

56
Fuel sourcing
C H A I N
E N E R G Y
V A L U E
T H E
Trading
Why do utilities trade?
Risk management
Financial Operational
Profit opportunity
Some companies dynamically manage their energy portfolios

e.g. EdFs trading has been very profitable
Strong correlation between oil, gas, electricity and CO2 prices

companies can enter into multi-commodity swaps
C H A I N
Gas price = f(oil, temperature) Power price = f(gas, coal, CO2, temperature, precipitation) CO2 price = f(gas, coal)
E N E R G Y
V A L U E
Therefore coal, oil, gas, power and CO2 can be traded in pairs or swaps
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T H E

Generation
C H A I N
E N E R G Y
V A L U E
Supply

58
T H E
Dual-fuel contracts
Supply
Fuel sourcing
Electricity transmission & distribution
Power station 2.3 3kV
Step up transformer
Transmission towers 115 345kV
Step down substation
Local substation
C H A I N
Distribution pole 2.3 34kV
Homes and small businesses
V A L U E
120 - 240V Commercial and industrial customers

Source: JPMorgan
T H E
E N E R G Y
59

Drivers of network build Growth of demand Improvements in quality
Maintaining voltage, security of supply, preventing blackouts Investment to make the system more robust
Change in supply profile, e.g. renewables: route grid mesh grid Interconnector security
Transmission network build choices Overhead or underground

C H A I N
Underground cable installation is 2x more expensive at 11kV, 20x more expensive at 400kV than an equally rated overhead line2
V A L U E
Route or mesh
Partly a function of geography, load centres and resources
E N E R G Y
International interconnector requirement
T H E
2 Source: energynetworks.org
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Germany has a mesh grid
Cost
Italy has a route grid
V A L U E
C H A I N
E N E R G Y
System security
T H E
Source: JPMorgan
61
Regulation
Regulation
Needed for networks as theyre natural monopolies Also end customer prices where competition is not effective (See Energy supply pp. 72-80)
Main concerns
Costs for customers Security of supply short and long term Government policy on energy mix, climate etc
Network regulation varies significantly:

Cost plus (a specific allowed return based on actual realised costs)
e.g. France, Germany (changing next year), most US states
C H A I N
Incentive (regulator sets allowed revenue may be based on current costs or what the regulator believes costs ought to be)
e.g. UK. There are a whole range of degrees of incentive strengths
V A L U E
May (UK) or may not (Spain) have an explicit regulated asset value in remuneration formulae Unitary (per MWh) or absolute (m) Single or multi-year
T H E
E N E R G Y
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Network regulation key concepts

Regulatory asset/capital value/base x WACC
Allowed Return
+ Opex
C H A I N
+ Capex or Depreciation
E N E R G Y
V A L U E
= Revenue or price cap

Source: JPMorgan
T H E
63

RAV
Regulatory Asset Value normally scaled over time (by depreciation and capex), may include inflation link Weighted average cost of capital (WACC) may be Pre- or post-tax Real or nominal (i.e. with or without inflation)
x WACC
T H E E N E R G Y V A L U E C H A I N
Allowed Return
Allowed return may be unitary (per MWh) or absolute (m) Has to cover interest expense and dividends
64

RAV x WACC Allowed Return Operating expenses Actual in cost plus Allowed in incentive May be volume based or absolute
Opex
T H E
E N E R G Y
V A L U E
C H A I N
65

RAV x WACC Allowed Return
Opex
C H A I N
Capex or Depreciation
V A L U E
Capital expenditure Based on agreed outcomes in incentive Based on defined budget in cost-plus May be volume based or absolute
66
T H E
E N E R G Y

RAV x WACC Allowed Return Opex
C H A I N E N E R G Y V A L U E
Revenue or price cap Provides potential for outperformance Often multi-year Revenue or price cap
Capex or Depreciation
T H E
67

RAV x WACC Allowed Return Opex Capex or Depreciation Revenue or price cap in year 1
C H A I N
Allowed Return
Opex
Capex or Depreciation Often a downward price trajectory to induce efficiency improvements
V A L U E
T H E
E N E R G Y
Revenue or price cap in year 5
68

RAV x WACC Allowed Return Opex Capex Year 1 Revenue or price cap
C H A I N
Outperformance
Capex Achieved WACC Opex efficiencies

outcome below Budget
or Depreciation
longer asset life
T H E
E N E R G Y
V A L U E
Year 2
69

RAV x WACC Allowed Return Opex Capex or Depreciation If can reduce opex and/or capex, can make an achieved return > the allowed return assets worth > RAB Revenue or price cap Have outperformed the regulators assumptions Capex
C H A I N
Outperformance
Achieved WACC
Opex efficiencies
or Depreciation
longer asset life
Normally can retain outperformance in, or across periods (2 5 years) Of course, with tough regulation the opposite can occur
V A L U E
Capex Achieved return (above allowed return) Opex efficiencies

E N E R G Y
or Depreciation
longer asset life
T H E
70
Network regulation details

The regulator defines Regulated Asset Base / Capital Value / Asset Value (RAB, RCV, RAV)
Not necessarily equivalent to the true value or book value of the assets E.g. in UK based on EV after privatisation + capex depreciation In Sweden based on a computer model of optimal network as if built from scratch
Allowed return
Regulator makes assumptions on gearing, cost of debt, cost of equity Pre or post tax? Real or nominal?
C H A I N
Revenue = allowed opex + allowed capex + allowed return

If the regulator is correct in all assumptions (efficiency, cost of operations and capital projects, cost of capital) then the value of the business, by definition, is its RAB Valuations are based on a premium/ discount to RAB methodology Recent M&A transactions have occurred at a premium to RAB i.e. assuming outperformance
71
T H E
E N E R G Y
V A L U E
Ways to outperform on opex

Raise employee productivity
e.g. reduce headcount
Minimise wage inflation Invest in IT infrastructure Reduce network losses (but not always in regulated opex) Improve service time on maintenance Opex Year 1
e.g. In the 2007 Gas Distribution Price Control Review, Ofgems consultants (PB Power) proposed an 11% reduction in total GDN opex for 2008/09 2012/13, including
Work management -10.6%
C H A I N
Opex
Year 2
Emergency -11.0% Repairs -14.2% Maintenance -14.1%
T H E
E N E R G Y
V A L U E
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Ways to outperform on capex

Procurement
Use an established network of suppliers Economies of scale e.g. buy in bulk
R&D
Invest in innovative, more efficient technologies
Capex Year 1
e.g. In the 2007 Gas Distribution Price Control Review, consultants proposed an 18% reduction in total GDN net capex for 2008/09 2012/13, including
Local Transmission System & storage -23.4%
C H A I N
Connections -22.9% Mains reinforcement -12%
Capex
Year 2
T H E
E N E R G Y
V A L U E
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Ways to outperform on WACC

Capital structure Higher gearing than the regulator assumes Lowers pre-tax WACC and provides tax shields Cost of debt Cheaper financing than the regulator assumes
Index-linked debt Covered bonds Derivatives (optimal strategy may depend on market conditions e.g. demand for different currencies) Fixed-floating swaps Forex swaps
x WACC x WACC
Year 1
Year 2
C H A I N
Regulated D/EV Cost of debt Cost of equity WACC 50% 5% 9% 7%
Achieved 70% 5.5% 9% 6.55%
T H E
E N E R G Y
V A L U E
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Generation
Supply
Dual-fuel contracts
Fuel sourcing
C H A I N
E N E R G Y
V A L U E
Supply

75
T H E
Electricity and gas supply

Sale of electricity to the final customer
Commercial Residential
Metering, billing and customer relationship Retail price is sum of generation and transmission so very little value added here Competitive metering in many countries suppliers compete on price and service Dual-fuel (gas and electricity) contracts Consumer services often also provided to generate additional revenue e.g. boiler breakdown cover
T H E
E N E R G Y
V A L U E
C H A I N
76
Retail / Consumer tariff regulation

In a fully competitive market there are advantages of: Cost control (low prices) Investment incentives Consumer choice Quality of service improvement
However markets are not always competitive and governments like to intervene therefore often tariffs are managed or regulated
77
EU tariff regulation
EU Electricity Directives History of regulated tariffs - recent trend towards liberalisation of generation and supply UK pioneered privatisation, deregulation and liberalisation of utilities has not had controls on retail prices since 2002 EU pushing for free competition throughout the region
From July 2007 at the latest, all consumers will be free to shop around for gas and electricity supplies
In theory tariff regulation should not exist, in reality it does Third EU competition directive for electricity and gas will seek to stamp out tariff regulation although not immediately
T H E
E N E R G Y
V A L U E
C H A I N
78
EU tariff liberalisation
EC Benchmarking Report (2006) conclusions Nordic countries
Liberalisation fully embraced
Germany
Broad acceptance all gas and electricity customers are free to choose supplier Pressure for unbundling of RWE and E.ONs distribution activities Domination by a few large players prevents effective competition
Italy
Many calling for more control of prices Tariffs are adjusted on a quarterly basis to reflect commodity prices
France
Centrally controlled tariffs
C H A I N
Liberalisation in theory but not really in practice EdF and GdF only partially privatised
V A L U E
Spain
Tariff deficit system The Directives have not been transposed The regulatory framework does not allow for effective competition
T H E
E N E R G Y
79
Tariff deficit
The shortfall of regulated revenues from the tariffs versus revenue that would be realised by prevailing market prices
Occurs when the regulated price is < the market price Represents both a system failure and possible upside depending on what the market prices in We forecast shortfall in Spain: 2008E tariff deficit of 3bn
Due to internalised cost of CO2 by companies lowering sector revenues Spanish legislation requires that utilities are reimbursed
In France GDF have forecast a gas tariff deficit of 1bn

80
Unbundling
Many countries have pursued a regulatory policy of unbundling Separation of transmission and distribution from generation and supply Intended to increase competition by improving the fairness of network access Many countries and corporates have resisted unbundling citing
Diversification of risk Scale/ scope economies Legal/ management unbundling should be sufficient Regulatory/ compliance oversight may be used
T H E
E N E R G Y
V A L U E
C H A I N
81
The end customer bill retail power

Unliberalised France (2007E) Total: 120/MWh Taxes VAT Environmental Public service Taxes = 37/MWh VAT (29) Local taxes CTA for pensions CSPE for public services Network access = 49/MWh 7.25% pre-tax No inflation link Cost plus Review mid 2007 Liberalised Germany (2008E) Total: 217/MWh Taxes and levies = 82/MWh
VAT (32.5) Concession fee (17.9) Electricity tax (20.5) CHP act (2.9) Renewables act (8.2)
(8)
Network access Regulated fee Balancing costs Transmission Distribution

C H A I N
Network access = 62/MWh 6.5% post-tax Inflation link for old assets Moving to incentive Reviews due April 06 & new system July 06
T H E
E N E R G Y
Generation Pool / spot price Cost-plus based Gas sourcing L.T. contracts Oil / coal link
Generation = 34/MWh Cost plus based Features 80% nuclear Remainder bought in Germany
Generation = 67/MWh Based on EEX Mostly a coal system Need for coal / gas to replace nuclear CO2 approx 8/MWh for gas and 18/MWh for coal Sales/marketing = 6.5/MWh
82
V A L U E
Source: JPMorgan estimates
Typical retail consumer uses 3.5MWh/a
The end customer bill - European comparison

Comparison of power prices Pan-Europe, 3.5MWh domestic Comparison of power prices Pan-Europe, 3.5MWh domestic customer, /MWh, 2007A customer, /MWh, 2007A /MWh Italy Ireland Germany Portugal Netherlands Norway Slovakia UK Belgium Denmark Sweden Austria Hungary Spain Poland
C H A I N
Affordability - Retail power Affordability - Retail power price % GDP/capita, 2006A price % GDP/capita, 2006A Romania Slovakia Poland Italy Denmark Portugal Hungary Netherlands Bulgaria Germany Sweden Czech Republic Belgium Lithuania Spain Austria Ireland Slovenia Latvia UK France Estonia Finland Norway Greece
Source: Eurostat
Price ex tax 165.8 146.5 143.3 142.0 140.0 136.1 129.2 125.4 122.9 117.0 108.8 105.0 101.9 100.4 94.5 92.1 89.8 88.7 87.7 85.5 66.1 65.8 63.5 58.3 54.7
Tax 56.0 20.5 46.3 7.0 89.0 45.5 22.7 5.6 33.2 138.4 58.6 45.9 16.2 20.8 25.5 28.6 15.8 17.5 27.3 15.2 5.7 10.9 11.5 10.6 10.7
Price with tax 221.8 167.0 189.6 149.0 229.0 181.6 151.9 131.0 156.1 255.4 167.4 150.9 118.1 121.2 120.0 120.7 105.6 106.2 115.0 100.7 71.8 76.7 75.0 68.9 65.4
Power cost % GDP 3.6% 3.2% 3.1% 3.1% 2.9% 2.9% 2.6% 2.4% 2.4% 2.4% 1.9% 1.8% 1.8% 1.8% 1.7% 1.7% 1.6% 1.6% 1.6% 1.6% 1.5% 1.5% 1.4% 1.4% 1.0%
Increasing power costs as a proportion of GDP political pressure on utilities
France Czech Republic Slovenia Finland Romania Greece Lithuania Estonia Latvia Bulgaria
Source: Eurostat
T H E
E N E R G Y
V A L U E
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Agenda
Page
The energy value chain Climate change Renewables Valuation and drivers Appendix
B A S I C S
2 84 94 99 108
E U R O P E A N
U T I L I T I E S
84
Climate change regulation

1992 UNFCCC (UN Framework Convention on Climate Change) established 1997 - Kyoto Protocol signed
41 industrialised countries (Annex 1 countries) agreed to reduce their greenhouse gas emissions (GHGs: CO2, NOx, methane, CFCs) by a specific percentage by 2008-2012 from 1990 levels 5% cut in total globally 8% cut for EU-15 and most other European countries These targets define each countrys volume of allowed emissions (AAUs) Burden sharing principle Use of flexible mechanisms (market mechanisms, cap-and-trade schemes) Clean Development Mechanism (CDM) system for pollution reduction schemes in developing economies
Permits : Certified Emission Reductions (CERs)
Joint Implementation (JI) system for pollution reduction schemes in developed economies
C H A N G E
Permits : Emission Reduction Units (ERUs)
Emissions Trading Scheme (ETS) EU emission permits trading scheme

Permits: EU Emission Allowances (EUAs)
C L I M A T E
CERs can be transferred into EUAs etc. but the total number of AAUs is fixed
85

s CE R s EUA
EUAs
If Germanys actual emissions are higher than its assigned allocation it can purchase CERs from Brazil and transfer them into EUAs Total AE = total AAU AE actual emissions AAU assigned allocation unit
CERs
AAU
AE
AE
AAU
Brazil
C H A N G E
Germany
C L I M A T E
86

EU target 8% by 2010 from 1990 levels 20% by 2020 or 30% by 2020 if a broad-based global agreement on GHGs can be reached Emissions Trading Scheme was set up Member states are given National Allocation Plans (NAPs) for CO2 permits Covers power, paper, steel, iron, mining, oil and cement Import allowance for CDM/JI subject to certain limits CO2 emission permits can be traded within each phase with banking also possible between phases 2 and 3
Phase 1: 2005-07 Phase 2: 2008-12
C H A N G E
Phase 3: 2013-20 Includes new sectors such as airlines, aluminium, petrochemicals, etc.
Note other trading schemes will probably emerge globally, but may not necessarily be fungible with the EU ETS
C L I M A T E
87
EUA price forecast

Estimation: Long-term demand for permits A function of EUA shortage vs demand Allocation plans Compliance buyers including governments Non-compliance buyers CER/ERU balance Abatement opportunities various methods of abatement have different costs CDM/JI permits trade at a discount to EUAs due to project failure risk UK coal-to-gas switching German lignite-to-coal switching
C H A N G E
Existing and new plants
Industrial abatement (N.B little willingness for this from industrials so far)
C L I M A T E
88
EUA price forecast
The price of CO2 is determined by the Demand for abatement Supply of abatement Forecast 25/t for phase 2
50 45 40 35
Price (/t)
2008 abatement stack

German l-t-g
Industrial, <35/t Industrial, <30/t Industrial, <27.5/t Industrial, <25/t Industrial, <20/t
30 25 20 15 10 5 UK c-t-g summer
UK c-t-g winter
Demand for abatement
C H A N G E
0 0 50 100 150 200

V olume (mt/a)
Source: JPMorgan estimates
250
300
350
400
C L I M A T E
89
Carbon capture and sequestration

Clean coal Capture via post-combustion, pre-combustion or oxyfuel combustion Storage in deep geological formations, deep oceans or mineral carbonates (although UN unlikely to approve ocean & carbonation Technology for large scale capture of CO2 already commercially available, problem is pipeline and regulation Capturing and compressing CO2 requires energy lowers overall thermal efficiency There are firm plans for around 8.3GW of CCS-type capacity 51mt/year of abatement Abatement cost estimate 28-30/t a function of:
Margin loss (CCS plant new build cost coal ex-CCS plant new build cost + energy loss) x CO2 avoided Estimate: 16-17/MWh output or 24/t of CO2 Transport cost
C H A N G E
Estimate: 2-2.5/t Storage cost Estimate: 3-3.5/t
C L I M A T E
90
Climate change regulation outcomes

Phase 1 ETS was effectively bankrupt since there has been a surplus of permits Currently phase 2 permits are trading at around 20-25/t We forecast 25/t for phase 2 Emissions of 2,300mt/a, a 10% cut in NAPs vs. phase 1, 160mt total extra demand from airlines, a shortfall of 210mt/a on average and CDM/JI permit deliveries of 780mt total Phase 3 deeper and broader Emergence of subnational and national schemes Extension to other GHGs, other industries Utility sector the most impacted Positive for revenues Negative for costs depending on free allocations/ auctioning
C H A N G E
Free allocations have been positive for profits overall, but unlikely post 2012 Although windfall for low / zero CO2 emitting plants will remain
C L I M A T E
91
Climate change regulation outcomes

Impact on utilities profits: Marginal cost pricing
Higher variable costs per MWh and higher long-term power prices Revenue will include 100% of the price of a permit Windfall profits are incurred if permits are allocated to thermal plants for free and non-thermal plants are price takers
Degree of forward contracting

e.g. E.ON and RWE have already sold forward a large part of 2008 and 2009 output so the impact of volatility of phase 2 CO2 on them will be minimal
Change in load stack

A higher CO2 price will move gas-fired power plants further into the baseload compared to coal-fired Coal-fired plants will suffer from lower volumes and hence lower profits and fixed costs per MWh
Carbon intensity relative to average will drive valuation

Exposure to coal vs. nuclear etc. Exposure to generation vs. networks and supply
C L I M A T E
C H A N G E
For more information, see our series All you ever wanted to know about carbon trading at www.jpmorgan.com/climatechange
92
EU thermal regulation: LCPD (2001)

Large Combustion Plant Directive Applies to combustion plants with a thermal output of >50 MW Aims to reduce acidification, ground level ozone and reduce aerosol particulates throughout Europe by controlling emissions of sulphur dioxide (SO2), nitrogen oxides (NOx) and dust Using emission limit values (ELVs) The UKs National Grid has warned the extra costs of coping with the implementation of LCPD could substantially increase transmission constraint costs
Set to have an impact on system costs of around 15m 12GW of capacity has opted out of the LCPD Running hours of these plants will be limited on a chimney stack basis (either the whole plant is running or not) to 20,000 hours across the 8 year period to 2015 NG says it expects operators will look to maximize earnings from the remaining 20,000 hours by optimizing running and operating multiple units as a single block at the same time Coal plant will be the most affected For opted out coal units, the 20,000 hour limit is likely to act as a constraint on output and the costs of reserve will rise
NG has put forward 2 possible scenarios for plant operations:

C H A N G E
Summer-cold regime generators decide to run the units over the winter and make them unavailable over the summer, either on maintenance or moth-balled Year-round running regime generators will focus their running hours on the peak power price periods across the year, irrespective of season
C L I M A T E
93
Agenda
Page
The energy value chain Climate change Renewables Valuation and drivers Appendix
B A S I C S
2 84 94 99 108
E U R O P E A N
U T I L I T I E S
94
Mapping the renewable energy space

Drivers : Climate change; Energy Security; Economics Policy regimes: Standards; Pricing/support; R&D
Renewable / Alternative Energy
Equipment Operators Electricity
Utilities
New entrants Autos Big oil New entrants Hybrids / Plug-ins Wind
R E N E W A B L E S
Traditional Transportation Nuclear Mini hydro New Tech
Clean Thermal CCS Biomass
Biofuels
Solar Thermal
Marine
Onshore Concepts Technologies
Offshore
PV
Corporates
95
Renewables
Climate change concerns Solar, wind, r-o-r hydro and geothermal technologies do not emit any GHGs Pumped storage hydro uses a small amount of electricity
Renewables
Biomass combustion emits CO2, but unlike fossil fuel combustion, this has not been out of the carbon cycle for a long time
Energy security concerns By definition, renewable energy is not finite It allows a country to reduce its reliance on foreign imports of electricity/coal/oil/gas Hence governments have been very keen to encourage investment in renewable energy capacity
R E N E W A B L E S
96
Renewables capacity support mechanisms

Feed-in tariffs fixed pricing framework with a cap-and-floor of floating prices to provide a return well over WACC
e.g. Spain RD486 and RD661
Green certificate schemes

Energy suppliers required to submit certificates to show they have sourced a certain % of supplies from renewables Certificates bought from a pseudo market buy-out fund
e.g. Renewable Obligation Certificates in UK
Tax credits levy charged on all suppliers unless they qualify for an exemption
e.g. Production Tax Credit in US, CCLECs in UK
Capital subsidies can by-pass state aid rules

R E N E W A B L E S
e.g. Greece: 35-55% of capital cost
97
EU renewables targets
EC proposals on member state targets for renewable energy as a proportion of all energy consumption EC proposals on member state targets for renewable energy as a proportion of all energy consumption
2005 RES Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden UK EU 27 23.3% 2.2% 9.4% 2.9% 6.1% 17.0% 18.0% 28.5% 10.3% 5.8% 6.9% 4.3% 3.1% 5.2% 34.9% 15.0% 0.9% 0.0% 2.4% 7.2% 20.5% 17.8% 6.7% 16.0% 8.7% 39.8% 1.3% 6.4%
Source: European Commission, JPMorgan estimates
2020 Target-RES 34% 13% 16% 13% 13% 30% 25% 38% 23% 18% 18% 13% 16% 17% 42% 23% 11% 10% 14% 15% 31% 24% 14% 25% 20% 49% 15% 20%
Basis points/year 71.3 72 44 67.3 46 86.7 46.7 63.3 84.7 81.3 74 58 86 78.7 47.3 53.3 67.3 66.7 77.3 52 70 41.3 48.7 60 75.3 61.3 91.3 90.8
% CAGR 2.6% 12.6% 3.6% 10.5% 5.2% 3.9% 2.2% 1.9% 5.5% 7.8% 6.6% 7.7% 11.6% 8.2% 1.2% 2.9% 18.2% 12.5% 5.0% 2.8% 2.0% 5.0% 3.0% 5.7% 1.4% 17.7% 7.9%
The targets proposed on 23rd January were harsh but widely expected and the horizon is far out A proposal for tradeable Guarantee Of Origin (GOO) certificates would allow suppliers to meet their obligations with output from another country
Positive for suppliers and generators with pipeline in low tariff/high deliverability countries Negative for generators in green certificate/ low deliverability countries e.g. Italy and the UK
R E N E W A B L E S
98
Agenda
Page
The energy value chain Climate change Renewables Valuation and drivers Business drivers Valuation drivers Typical catalysts
B A S I C S
2 84 94 99
Appendix
108
E U R O P E A N
U T I L I T I E S
99
Business drivers
What makes a successful utility? Generation Transmission and distribution Supply Big vs. small
V A L U A T I O N
A N D
D R I V E R S
100
What makes a successful utility?

Generation Generation
Success mainly derives from operations rather than business model

New build on time/budget Minimise outages Efficient fund sourcing Efficient operating costs Off take contracting, e.g. fixed cost contracts, PPAs ideally
Returns/ sustainability a function of type

Carbon clean vs. dirty Fuel price volatility/ availability Correct funding
D R I V E R S
Diversity in a given region is important

Exposure to fuel vs. price setter
A N D
Development potential
Plant improvements - operational, environmental Life extensions Expansion via new plant including new regions
101
V A L U A T I O N

Networks Networks
Regulatory relationship
Delivery Constructive dialogue Reliability Health and safety
Opex
IT management of inventory Sourcing at a low cost Optimal staffing
Capex
Purchasing at a low cost Pipeline delivery within budget and on time
D R I V E R S
Partly exogenous
Politics and type of regulation
V A L U A T I O N
A N D
102

Supply Supply
Competitive upstream sourcing A function of the competitive environment

Peer group behaviour Degree of consolidation Politics
Pricing for margin vs. pricing for market share Superior customer service to peers Dual fuel contracts Well hedged exposure to wholesale power prices
D R I V E R S V A L U A T I O N A N D
103

Advantages of scale Advantages of scale
Load (lower fixed costs per MWh) Economies of scale in procurement Economies of scale in financing Reputation and brand name
Large customer base
R&D possibilities, patents Integrated utilities tend to be larger

Upstream/downstream hedging Management cost savings Expertise
D R I V E R S
Operational diversification Geographical diversification
V A L U A T I O N
A N D
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Valuation methods
Absolute Discounted cash flows (DCF)/ dividend discount model (DDM) utilities generate long term cash flows with high visibility Premium/ discount to RAB Sum of the parts (SOP) useful in diversified utilities
Multiples DCF/ DDM RAB-based
Relative Traditional relative multiples limited usefulness due to diversity

P/E more useful under IFRS Dividend yield generally income stocks with growth
D R I V E R S
EV/EBITDA traditional measure, free cash flow (FCF) yield important given capex cycle
Utilities-specific multiples according to asset

Supply: EV/#customers Generation: EV/MW, Nuclear Relative Multiples Networks: EV/RAB
V A L U A T I O N
A N D
105
Utilities stock price catalysts

Regulation Tariffs: e.g. unexpected (or earlier than expected) changes, politics Networks: RAB and allowed return, e.g. expectations of a forthcoming review Carbon: pricing and allocations Raw materials prices Coal, oil, gas, uranium, equipment Wholesale power prices Demand growth
D R I V E R S
Weather Temperature affects demand Precipitation drives hydroelectric generation
V A L U A T I O N
A N D
106
Utilities stock price catalysts

Management strategy Opex and capex plans Short/ medium term targets Trading statements M&A prospects Re-gearing potential, buy-backs, dividends Interest rates and taxes Development of competitive market
D R I V E R S V A L U A T I O N A N D
107
Agenda
Page
The energy value chain Climate change Renewables Valuation and drivers Appendix Acronyms Glossary Abbreviations Conversions Metrics Key websites Bloomberg & Reuters codes
B A S I C S
2 84 94 99 108
E U R O P E A N
U T I L I T I E S
108
Acronyms
AAU ACS AGR ARPU ARM BETTA BWR CCGT CCLEC CCS CDM CER CHP E&P ELV
A P P E N D I X
Assigned Allocation Unit average cold spell advanced gas cooled reactor average revenue per user adequacy reserve margin British electricity trading and transmission arrangements boiling water reactor combined cycle gas turbine climate change levy exemption certificate carbon capture and sequestration Clean Development Mechanism Certified Emission Reduction combined heat and power exploration and production emission limit value
EPR ERU ETS EUA GFR JI LCPD LDZ LFR LNG LRMC MSR NAP NETA
European pressurised reactor Emission Reduction Unit Emissions Trading Scheme EU Emission Allowance gas fast breeder reactor Joint Implementation large combustion plant directive local distribution zone lead fast breeder reactor liquified natural gas long run marginal cost molten salt reactor national allocation plan new electricity trading arrangements
109
Acronyms
NISM NOC OCGT OFGEM OFWAT PPA PSCs PSO PTC PV PWR RAB RAV notification of inadequate system margin national oil company open cycle gas turbine British electricity and gas regulator England and Wales water regulator power purchase agreement public service contracts public service obligation production tax credit photovoltaic pressurised water reactor regulated asset base regulated asset value RC RCV RD ROC RPS SCWR SFR SRMC SYS TPA UCTE UNFCCC VHTR remaining capacity regulated capital value royal decree (Spain) renewable obligation certificate renewable portfolio standard super-critical water reactor sodium fast breeder reactor short run marginal cost seven year statement third party access Union for the Co-ordination of Transmission of Electricity UN Framework Convention on Climate Control very high temperature reactor
A P P E N D I X
110
Glossary
Adequacy reference margin = margin against the peak load +minimum reserve capacity British thermal unit a unit of heat equal to 252 calories, enough heat to raise the temperature of one pound of water 1F Load curve order in which different plants are called upon to run based on their variable operating cost Minimum reserve capacity = 5% of national generating capacity Margin against the peak load = peak load load at reference point Plant margin - amount by which the installed generation capacity exceeds the forecast peak demand Remaining capacity = reliably available capacity reference load Reliably available capacity = total generating capacity non-usable capacity maintenance and overhauls outages system services reserve Reserve margin amount of unused available capacity of an electric power system at peak load, expressed as a percentage of total capacity Tariff deficit the shortfall of regulated revenues from tariffs versus the revenues that would be realised by prevailing market prices Thermal efficiency - efficiency with which the energy content (measured in gross calorific value) of the input fuel is turned into electrical energy by the generating station
A P P E N D I X
Thermal generation electricity production using a steam-driven turbine Windfall profits additional profits due to free CO2 allocations
111
Abbreviations
b or bbl cf bcm t Mcf Mt boe kboe kb toe Mtoe Btoe or Gtoe Btu KW MW GW TW MWh /y or /a /d
A P P E N D I X
barrel cubic feet billion cubic metres metric tonne million cubic feet million tonnes barrel of oil equivalent thousand boe thousand barrels tonne of oil equivalent million tonnes of oil equivalent billion tonnes of oil equivalent British thermal unit kilowatt megawatt gigawatt terrawatt megawatt hours per year per day
112
Conversions
tonnes of LNG
To: From: boe GJ kWh mmBtu tce toe m3 of gas tonnes of LNG Gcal
A P P E N D I X
boe Multiply by 1 0.1634 0.0006 0.1724 4.79 6.84 0.0062 8.58 0.685
GJ
kWh
mmBtu
tce
toe
m3
of gas
Gcal
6.12 1 0.0036 1.0551 29.29 41.87 0.0381 52.52 4.187
1700 277.78 1 293.07 8136.11 11631 10.58 14590 1163
5.80 0.95 0.0034 1 27.76 39.68 0.0361 49.78 3.97
0.2089 0.0341 0.0001 0.0360 1 1.4295 0.0013 1.7933 0.1429
0.1462 0.0239 0.0001 0.0252 0.6995 1 0.0009 1.25 0.1
160.68 26.25 0.09 27.70 768.99 1099.27 1 1379.00 0.107
0.1165 0.0190 0.0001 0.0201 0.5576 0.7971 0.0007 1 0.0769
1.4599 0.2388 0.0009 0.2519 7 10 9.35 13.00 1
113
Electricity margin metrics

Reserve margin (%) = capacity reserve / demand Capacity margin (%) = capacity reserve / available capacity
Output = Capacity x Time [kWh] = [kW] x [h]
Load factor =
Electricity generated Installed capacity
Load factor 1 Power plants sometimes have technical problems and have to shut down
A P P E N D I X
The wholesale price may be too low for it to be economical to run the plant
114
Key websites
Dti.gov.uk/energy/statistics/index.html Iea.org Eia.doe.gov System adequacy
Ucte.org Nordel.org Nationalgrid.com/uk/Electricity/SYS/
Technology
Alstom.com Powergeneration.siemens.com Gepower.com Areva.com/servlet/finance/investorrelations/arevatechnicaldays-en.html Vestas.com
EU
http://ec.europa.eu/research/energy/index_en.htm http://ec.europa.eu/energy/electricity/benchmarking/index_en.htm http://epp.eurostat.ec.europa.eu http://ec.europa.eu/environment/climat/climate_action.htm
A P P E N D I X
115
Bloomberg tickers
SX6P (Dow Jones Stoxx European Utilities index) ERIXP (renewable energy index) EMIT (electricity emission allowance) EPWR (European electricity prices) PWNX (French electricity prices) ELEU (UK electricity prices) ELGE (German electricity prices) ELNF (Nordpool electricity prices)
A P P E N D I X
116
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A P P E N D I X
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6 FEBRUARY 2008

EUROPEAN UTILITIES BASICS - ELECTRICITY & GAS INDUSTRY OVERVIEW

christopher.g.rogers@jpmorgan.com sarah.l.laitung@jpmorgan.com javier.x.garrido@jpmorgan.com sofia.savvantidou@jpmorgan.com nathalie.x.casali@jpmorgan.com

J.P. Morgan Securities Ltd.

Global utilities team

Chris Rogers - Germany, Nordic, UK Energy & CO2

Edmond Lee, CFA

Ajay Mirchandani Hong Kong, Philippines

Boris Kan China

Shilpa Krishnan India

Abid Jamal Pakistan

Olek Keenan, CFA - Credit

Lucius Chong Malaysia

For Specialist Sales advice, please contact Ian Mitchell

Sukit Chawalitakul Thailand

Ami Tantri Indonesia

Lilyanna Yang, CFA

Anderson Frey, CFA

Ademar Souza Neto

Valuation and drivers Appendix

The energy value chain

Regulated networks Transmission & Distribution

Supply Dual-fuel contracts Supply

Trading Sourcing, despatch, management, proprietary

Upstream sourcing / E&P

Regulated networks Transmission & Distribution

NATURAL GAS Value chain

The energy value chain

Regulated networks Transmission & Distribution

Supply Dual-fuel contracts Supply

Trading Sourcing, despatch, management, proprietary

Upstream sourcing / E&P

Regulated networks Transmission & Distribution

NATURAL GAS Value chain

Economics - the load curve

Economics - the merit order

merit order / load curve 8760 time (hours)

Which type of power plant will set the power price?

* Worked example: attractiveness of coal vs. gas

UK UK Min Hourly demand Max

New hard coal

New hard coal

Peaking2 OCGT& Must run

Peaking2 Nuclear Interconnector and must run1 Hard coal CCGT

Large proportion of low SRMC plant

Large proportion of high SRMC plant

Economics - wholesale prices

APX in The Netherlands UKPX (a subsidiary of APX) in the UK Nordpool in Scandanavia

Generators have contracts with the transmission grid for

= power price - cost of coal

Spark corresponds to gas

* Worked example Central European spreads

-(106.9 + 7)/1.45 0.325

* Worked example Central European spreads

= Clean spark spread (/MWh) - Fixed cost:

+ (520 10% )) 30 1000 0.8 8760

UCTE system adequacy forecast

Updated annually at www.ucte.org

UCTE system adequacy forecast

Remaining capacity (RC) RC (GW)

Compared to the adequacy reference margin (ARM) ARM (GW)

Minimum reserve capacity