Life is all about the choices we make. Late in 2006, we made the choice to expand the energy presence of Renova Group beyond Russia to Europe and established Avelar Energy, headquartered in Zurich. Our initial choice of industrial focus was Italy, with its second largest continental consumption of gas and very hydrocarbon-based energy structure.
The original logic was to focus both on conventional energy, centered around gas and power, and renewable energy, initially centered on wind. Both concepts evolved over time. In conventional energy, we have made a decision to avoid a common path of low-WACC utilities, and were very discriminative about entering into expensive infrastructure assets. Instead, we sourced gas and power from existing capacities, focused on delivering structured products to our medium-size customers, less of a target for larger competitors. We were building only what made economic sense and what would be strategically important, which in our case was some gas-fired power generation and gas storage assets.
In renewable energy, we quickly realised that our ambition to build scale in wind was seriously hindered by two very important market realities. First, the wind market became quite mature by 2006 – 2007, bringing in large utilities and, as a consequence, bidding up prices of not only finished parks but also projects in early stage of development. Second, the authorisation process for medium- to large-scale wind installations (50Mw+) in the Italian market took substantially longer than a startup (which we were at that time) could afford. On the other hand, the solar (PV) market was in its infancy, enjoying a highly simplified authorisation process, a fixed tariff, and was overlooked by our competitors. All of it sounded very attractive, assuming we could create an effective business model.
2009 was a very difficult year for the business community around the world, the energy industry not excluded. The price of oil dropped, bringing down, through contract formulas, prices for natural gas in Europe. The price of electricity followed the gas trend. Banks froze project finance, a critical component of any energy development. We happened to use difficult times to become bigger and fundamentally stronger, growing business beyond USD 1 billion in revenues. More importantly, we established a very strong platform for further growth in 2010. Our results were based on several relatively simple decisions made in late 2008, in the course of commercial campaign for the next year, and early 2009.
We watched, with increasing skepticism, raising energy prices of the summer of 2008, and ultimately decided that the world of USD 140 oil, and everything that came with it, was not sustainable. We continued selling energy contracts to customers for 2009 delivery. By December 2008 the world was different, and we suddenly found ourselves with a highly profitable set of 2009 supply contracts amid a vastly different pricing environment.
As the market was getting more and more nervous, we put in place stricter risk management and credit risk guidelines. In the first half of 2009, we often had to make a difficult choice of turning down sizeable top-line opportunities if we felt they were accompanied by greater-than-the-policy credit risks.
In assessing the solar value chain, we were not persuaded to invest into upstream – neither by skyrocketing polysilicon prices, nor by long panel delivery lead times of the first half of 2008. We were seeing from the ground that the abundant new panel manufacturing capacity had more and more difficulty transforming itself into solar installations. Banks somehow did not catch equity market enthusiasm for solar and were slow and careful to lend; network operators took their time connecting projects to the grid; communities were slow to approve large and intrusive photovoltaic fields. Change of tariff regime in Spain left the solar industry essentially in limbo, and we realized that the game of the next five years will be played in the downstream segment of the market, and the most attractive market for the next three years would be Italy, where we already had home field advantage. Pursuing the downstream strategy, we made a strategic investment into Kerself S.p.a., the Italian market leader in photovoltaic business.
These fundamental choices determined our results in 2009. We have managed, crossing our fingers, to reach our sales target in electricity and gas without being hit by significant customer defaults. Unlike pure upstream players in solar, we were not dealing with rapidly depreciating solar panel inventories and spare capacity. Consistent with the earlier decision, we developed and profitably sold 80Mw of wind assets. And we went forward with developing our key projects.
In conventional business, we continue to build a business model which would be profitable irrespective of the direction of the underlying energy (electricity and gas) prices. This model implies operating control over several assets, allowing us to exploit the volatility. Our most important project in this area, a 1.4 Bcm depleted-field gas storage facility in southern Italy, has received critical environmental approvals in 2009 and will go into construction in 2010. Once it becomes operational in early 2012, we would be able to trade gas around summer-winter differentials, and lock spark spreads for our electricity contracts. Another very important project for us in conventional power is a 400Mw combined-cycle gas power plant, which we are building in partnership with Alpiq of Switzerland and which is scheduled to go into operations in December 2010.
In the solar business, we are very busy building the pipeline for solar parks across Southern Europe, most importantly in the Italian market. This is a very time-consuming process, requiring very local-level effort with communities, grid operator and regulators. In some respect, we like the distributed nature of the effort since it deters competition and makes our position ultimately quite defensible. Fortunately for us, these are the same locations where we are already present with our conventional-power projects. Our goal is to achieve 200-250MWp of installed capacity in Europe in the next two years and then take this credibility and expertise to the new markets.
With growth of the business come new choices and new challenges. Some of the questions we are facing today require quick answers, and would be fundamental for our further development.
The future of independent conventional power players in the not-yet-so-liberalised land of incumbents is difficult, and options are relatively limited. We are facing some critical tests for the governments in terms of their commitment to true liberalisation of the energy market in Europe. This commitment should manifest itself in some decisions about further privatisation of energy infrastructure and support of private investment into energy projects. One of the most important areas of required government support is permitting third-party access (TPA) exemptions. It is impossible to expect that private investors would be able to continue financing energy projects – LNG terminals, gas storage facilities, commercial power lines – without the prospect of being able to use it commercially (in the absence of TPA exemption an asset falls under regulated regime, which would fail cost-of-capital tests of most private investors).
Government support aside, our success would depend on whether we can find defensible niches for growth and gather strength in the next two to three years without facing a direct competition of balance sheets. It means offering highly customised energy solutions to a targeted customer segment, being very creative in financing our balance sheet commitments, growing scale by entering adjacent segments, fortifying ourselves with selected infrastructure investments and ultimately adapting very, very quickly.
Despite all the excitement, solar business is still far from securing its place as a legitimate part of the energy menu of tomorrow. It is expensive, offers relatively low intensity and is confined to a specific set of geographies. The beauty of solar lays in its abundance (the world does not need anything else if we crack the technology and business model) and predictability. However, strategic viability of the solar business is as of yet far from certain and depends on a dynamic interplay between two seemingly unrelated processes. On one hand, the political discussions that took place in Copenhagen at the end of 2009 will determine the scope of government support for the renewable energy industry in general and solar in particular. (We, of course, remain highly optimistic.) On the other hand, technological progress, taking place around the world, may deem such support less and less relevant in a short period of time. (And we are carefully watching new technologies and applications coming to the market.) At a more tactical level, in the next two years success in the solar business will depend on a correct judgment on the level of post-2010 tariffs in Europe and strategic choice of the new big market.
As in 2008, we smell a distinct aroma of discontinuity, bringing with it an opportunity for change. While we are now much bigger than in early 2008, we still retain the most important source of competitive advantage – the ability to sense such opportunities and act on them quickly.
Igor Akhmerov is CEO of Avelar Energy
