I’m on the record with concerns about ENGIE’s (OTCPK:OTCPK:ENGIY) exposure to natural gas. And then came the Russian invasion of Ukraine with immediate consequences looming for ENGIE in the form of abrupt end to Nord Stream 2 pipeline approvals by Germany with US support. With Russian natural gas being such a major part of Europe’s winter heating, this brings out into the open a lot of issues surrounding Russia and gas supply in Europe, which is confronting energy sovereign risk. This event also highlights the role of gas in the current climate emergency. Investors need to think about this as the impact on energy investments is very large. While it is too soon to be definitive about the outcomes, here I consider the situation for major French energy company ENGIE. The ENGIE share price fell from ~$16 to ~$11 when Russia invaded Ukraine, but it has recovered somewhat to trade at ~$13 currently.
It is all about gas
The Russian invasion has sharply brought into focus what has gone almost unnoticed. The point is that all over the world the fossil fuel industry has been very successful in selling “gas as bridge to decarbonisation” even though this is clearly not true. While natural gas has lower CO2 emissions upon its combustion, it is clear that the total emissions from harvesting gas and transporting it are not necessarily less than from coal. Methane emissions are a huge contributor and until recently the fossil fuel industry has been very successful at preventing adequate recording of methane emissions from the natural gas industry.
Extraordinary things are happening as the world warms in response to ever increasing greenhouse gas emissions (largely CO2 and methane). Three very recent examples show just how dramatic (and devastating) these climate events are.
East Coast Australian floods and fires
It is hard to believe that a new flood record could be set more than 2 meters above the previous flood record, but that happened recently in Australia as the East Coast suffered devastating floods in the 2021/2022 summer. And this followed closely upon records fires down the East Coast of Australia (and including South Western Australia) in the summer of 2019/2022.
Great Barrier Reef coral bleachings
Coral bleaching due to excessive water temperature takes about a decade to recover from. The Australian Great Barrier Reef has experienced widespread bleaching events in 1998, 2002, 2016, 2017 and 2020. In 2022 (now) the Great Barrier Reef is experiencing another wide-spread coral bleaching event. This time the event is occurring during a time (La Nina event) that is normally associated with cooler water temperatures. Coral reefs cannot survive such a progression of bleaching events. If you haven’t experienced a coral reef, now is the time to visit because they are not going to survive. Today’s reefs are a shadow of what a coral reef was like 20 years ago.
Extreme weather in the Arctic and Antarctic
Very recently temperatures between 30C and 40C higher than “normal” temperatures have been experienced at both poles. These weather events have resulted from warm moist air (“big atmospheric rivers”) moving both north and south from warmer regions.
Any one of these events is almost unbelievable. That all of these events have occurred in 2022 is beyond extraordinary. It provides the background to an increasingly robust discussion about the dangers of not addressing climate change. The UN Secretary General is becoming increasingly strident about climate action and the role of natural gas (and LNG) in exacerbating the climate emergency. In a recent speech he highlighted Australia’s Government which is seeking have a “gas led recovery from COVID”.
A very recent proposal from the US Securities & Exchange Commission to require US-listed companies to disclose climate-related risks and greenhouse gas emissions is aimed at providing investors with consistent and comparable information to assist investment decisions. The SEC acknowledges that investors representing tens of trillions of dollars of investments are seeking this information to be able to make informed decisions. If the proposal is accepted it will force companies like Exxon Mobil (XOM) to provide complete and clear disclosure. XOM has made it difficult to determine its climate footprint through focus on emissions resulting from its own activities (Scope 1 & 2 emissions) rather than the emissions caused by upstream activities and the products they sell (Scope 3 emissions). Scope 3 emissions dominate XOM’s emissions profile.
There are a number of conflicting issues for ENGIE
The above commentary about natural gas and climate change gives a context for massive change coming that goes well beyond the current crisis in Ukraine and concerning Russia’s oil and gas exports to Europe. ENGIE is in the thick of this crisis and there are a number of elements impacting the company. I outline a few of these issues here.
Nord Stream 2 hiatus
Nord Stream 2 is owned by Russian State gas giant Gazprom (OTCPK:OTCPK:OGZPY), which owns the entire pipeline, but paid just 50% of the costs, with the remaining 50% of costs shared between Shell (SHEL), ENGIE (France), Uniper (OTC:UNPRF)(indirectly 77.96% owned by Finnish energy utility Fortum Oyj through German holding company Fortum Deutschland SE Dusseldorf) and OMV (OTCPK:OTCPK:OMVKY) (Austria). The German Government froze the Nord Stream 2 project in response to Russia’s invasion of Ukraine.
The future for Nord Stream 2 doesn’t get much starker than a quote from US State Department spokesperson saying that the essentially completed $11 billion Nord Stream 2 project is “a piece of steel at the bottom of the ocean”. This project aimed to double gas supplies from Russia to Germany and so this is a really big deal.
All of the above companies invested in Nord Stream 2 have considerable exposure to Russian fossil fuel, with Austrian integrated oil company OMV perhaps the most exposed as it holds onshore and pipeline interests throughout Russia. Shell is getting out of its Russian investments, as is Uniper which has fully impaired its loss from the loan to Nord Stream 2 and is in the process of divesting its Russian subsidiary Unipro. Unipro operates 5 fossil fuel power plants in Russia with total capacity of 11 GW. Uniper’s midstream gas business has a portfolio of 370 TWh of long term gas supply, with ~200 TWh sourced from Russia. Uniper won’t enter into new long-term supply natural gas contracts with Russia but it is unclear what is happening with existing contracts.
ENGIE’s exposure to failure of the Nord Stream 2 project is ~$1.1 billion. ENGIE has no industrial activity in Russia.
To give a sense of the seriousness of the Russian gas supply issue, note ENGIE CEO Catherine MacGregor’s comments in Q4 2021 Q&A about Nord Stream 2 and more generally access to Russian Gazprom gas: “it is indeed very, very important that we are able to get the import from Russia because such an important contribution of our power supply comes from this Russian gas.” Catherine MacGregor notes that of course problems with Russian supply will have consequences well beyond ENGIE.
It is worth noting that Germany is most exposed to Russian gas supply with ~55% of gas imported coming from Russia. Even more confronting is the fact that Germany imports almost 90% of its natural gas consumption. France has significant exposure with 29% of its natural gas in 2021 being sourced from Gazprom. Russian supplies account for 40% of European gas needs across all operators. The response from Europe so far is to continue importing Russian oil and gas but to urgently seek alternative energy solutions. ENGIE has pledged to comply with any decisions about sanctions.
Threats to gas supply
An early response by ENGIE has been to explore other sources of natural gas and LNG, in particular from Norway.
The talk about exit from Russian natural gas dependence reflects Western commitment to support Ukraine. European dependence on Russian gas is real and substantial but there seems a reality to plans to exit dependence of Russian gas (and oil) as a matter of urgency. Since the French Government has a 23.6% stake in ENGIE, it clearly has a significant role in ENGIE’s response.
I look for evidence of what is being planned to replace the dependence. Of relevance to ENGIE are plans by the French Government to aggressively support substitution of natural gas by electricity (as heat pumps) for domestic heating. Gas heater subsidies have been terminated and heat pump technology is being supported by an increase of subsidies by 1000 Euro until the end of 2022. This has made sense for a long time because heat pumps are dramatically more efficient than natural gas for heating and are low emissions technologies if the electricity is sourced from renewables. So far the impact on gas will be to discourage new gas heaters. It is not clear whether there will be plans to encourage exit from gas use in existing heaters. Heat pumps are rapidly becoming the preferred solution for new buildings and their use in renovations is increasing. Recent studies on heating, domestic hot water and air conditioning in the Greater Paris Metropole indicate that surface geothermal energy could contribute more than 50% of the energy required.
The announcement about increased support for heat pumps comes as France plans to cease importing Russian oil and gas by 2027.
There was already a natural gas crisis before the Russian emergency
A feature of the fossil fuel industry, due to long lead times for development of new discoveries, is that there are cycles of boom and bust as supply/demand mismatches occur. While renewable energy is intermittent, it suffers less from the supply/demand issues caused by investment being dependent on pricing of the products. Once a renewable energy asset is constructed, there are 20+ years of minimal cost power generation. You don’t need new discoveries and all of the costs of developing these resources.
There is some sign that even in “normal” times the extreme volatility of fossil fuel supplies is a big issue. Look no further than the extreme problems being confronted by Asian countries that have adopted LNG as a major fuel source at a time when LNG was cheap, but now experiencing massive price increases which threaten the balance of payments of a number of Asian countries. Of course, the Russian invasion of Ukraine has made this issue even more problematic.
How to replace Russian oil and gas
The opportunity for expansion of renewables
The above issues provide another dimension for my concerns about ENGIE’s natural gas business, which is already threatened by action on climate change. However because ENGIE has a big commitment to the switch to renewable energy, there is also potential upside for the company. I suspect that ENGIE is better positioned for a renewable energy transition than other European power companies such as Uniper or OMV. ENGIE already has a big renewables team in place and aggressive plans to expand its renewable energy footprint.
There are some signs that the Russian emergency might be used in Europe to accelerate the renewable energy transition, since renewable energy projects (solar PV and wind) are quick to implement.
Nuclear power: delaying Belgian nuclear exit?
In ENGIE’s Q4 2021 earnings call Q&A, CEO Catherine MacGregor made two points about the planned nuclear winddown in 2025. Firstly she gave a clear statement about ENGIE’s position : “From the ENGIE standpoint though, very consistent to what we’ve said all along, which is we do not see any scenarios where we will have time to extend 2 tranches beyond 2025 should we be asked. So I understand your point on ASCN, but you have to realize that there is a lot of other factors to be considered. You have, of course, the security of — and the safety of operations, which the authority that you are mentioning is important. But there are a lot of other aspects, including the fuel, including other countries permitting, including potentially a new CRM. There is a number of things.
Not to mention, of course, a major investment in the assets that we continue to believe that we do not have time to do that before 2025. So I understand your point. But really from our point of view, absolutely no change. And we are planning, as I’ve mentioned in my slide, for an orderly phaseout of Nuclear by 2025.” This was ENGIE’s position on Feb 15th.
Secondly Catherine MacGregor indicated that ENGIE had won two new gas contracts in Belgium to provide partial replacement of the decreased power production resulting from exit from nuclear power. Of course, the question arises as to whether the plan was to source the gas from Nord Stream 2.
The Q4 earnings call preceded the Russian invasion of Ukraine and indeed in the Q&A there was talk of improving conditions with possible decreased tension in Ukraine which might lead to normalisation of Russian gas supply. Of course, the past month has gone in a dramatically different direction with some countries (US, UK) exiting Russian oil purchases, while Europe has undertaken to exit dependence on Russian oil and gas as a matter of urgency.
This has led to calls in Belgium and Germany to reverse planned nuclear shutdowns and extend the lifetime of reactors that are close to the end of their operational lives. As indicated above ENGIE manages the Belgian reactors. A very recent report suggests that the Belgian Government will soon seek approval to prolong the operational life of some of the Belgian reactors. Clearly part of this discussion is to discuss with ENGIE what can be done and what it will cost. At this stage ENGIE has not been approached to have these discussions, and the times are highly unusual, but the clear statement by Catherine MacGregor in the Feb 15 Q4 2021 earnings call was that it was too late to extend the 2025 closure date. I suspect that if a decision is made to seek extension, it is going to be very expensive noting that sometimes time runs out to have band-aid solutions. Germany seems to be sticking to its resolve to exit nuclear.
Reflecting a view that fossil fuels (or their equivalent from biomass) cannot be replaced by renewables, ENGIE is doubling down on biomass production. My major objection to this is that emissions are emissions; the atmosphere doesn’t give a free pass to CO2 and methane produced by so-called renewable production.
For those resistant to arguments about how renewable biomass is, a new report from IEEFA looks at land use for generating fuel for transport. The 70 fold difference in productivity in favour of land covered with solar panels versus growing corn to make ethanol, makes a convincing case that ethanol production uses too much land and makes no sense. The report “India’s ethanol road map off course” shows that accelerating electrification of transport (based on solar PV electricity production) is the way to achieve emission reductions goals using a fraction of land used to produce ethanol, therefore freeing up land for food production, which makes for a double win. Note also that ethanol consumption involves blending 20% ethanol with gasoline in the Indian program, so fossil fuel is still the core of the fuel. The IEEFA report claims that a US study of ethanol blending results in fuel that is up to 24% more emissions intensive than just using gasoline.
While the IEEFA report focuses on ethanol, I suspect other biomass projects have similar issues.
The complexity of world energy supply and its role in addressing climate change continues to be overshadowed by other events. And so it is with the Russian invasion and decision by major customers of Russian oil and gas to exit as soon as possible reliance on Russian oil and gas. Climate has barely been mentioned in this story, yet the outcome might be positive for action on exit from fossil fuels. For some time I’ve thought that possibly the biggest issue concerning climate change has been acceptance that gas is a transition fuel, and so expansion of gas is a huge problem for addressing climate change. The “transition fuel” argument has been a very successful program by the oil and gas industry. I’ve thought for some time that Russia was likely to be very resistant to climate action as its economy is so dependent on exploiting oil and gas. It is interesting that President Putin may have inadvertently set in motion a solution to the problem of Russian negative contribution to climate change by invading the Ukraine, which has led to wide actions to stop acquiring Russian oil and gas. Of course, the fossil fuel industry cannot see the solution to exit from Russian oil and gas other than as a substitution exercise. Those focused on the climate emergency see this as an opportunity to accelerate the switch to renewable energy which also leads to energy independence. The next months are not only critical for the future of Ukraine, they will also have a major impact on addressing climate issues. ENGIE is well placed to play a significant role in these dramatic developments, but exactly how this will play out remains unclear at this time.
I am not a financial advisor but I follow closely the energy transitions that are underway as the world begins to address an accelerating climate emergency due to fossil fuel exploitation. I hope my commentary helps give perspective to considerations by you and your financial advisor as you consider you energy portfolio investments.