How Draghi’s plan for electrification could jumpstart Europe’s economy

Electrification, a key piece of the puzzle to reduce carbon emissions, could also boost the European economy.

Europe should increase overall investment by about €800 billion ($867 billion) a year, according to a report on European competitiveness from Mario Draghi, former head of the European Central Bank. More than half of that sum would be for clean energy (€300 billion) and electric mobility (€150 billion). Draghi was asked by the EU to examine how to boost private investment and close the productivity gap with the US.

"We see the plan as bullish for utilities," Alberto Gandolfi, head of the European utilities for Goldman Sachs Research, writes about Draghi's competitiveness analysis.

Electricity costs for large manufacturers in Europe are more than double what similar power customers in the US pay, a problem that has worsened in recent years.

A key element in Draghi's proposal is the creation of a liquid market for power purchase agreements (PPAs) which would allow companies to contract directly with renewable energy producers. "If implemented, we believe that it would lower the cost of capital for renewable companies, whilst supporting faster top-line growth in power grids and renewables," Gandolfi writes.

Why was Draghi asked to assess Europe's economic competitiveness?

Europe's ability to compete with the US economy has worsened in recent decades, with the labor productivity gap widening to about 25% today from 5% in 1995, according to data from Eurostat and the US Bureau of Labor Statistics. The cost of electricity is one of the reasons for the disparity in productivity between the US and Europe, according to Goldman Sachs Research.

Likewise, energy is one of the Draghi report's key areas of focus, and it found that European power costs create major competitive disadvantages. A typical large car manufacturing facility in Europe may pay an extra €500 million a year compared with a US competitor, while a chemical plant could face annual excess costs of €1 billion.

"Electrification, thanks to low-cost renewable energy, could narrow the gap and lead to largely fixed power bills," Gandolfi writes.

Goldman Sachs Research case studies of a chemical facility in Germany and a large car plant in Belgium come up with numbers similar to the scenarios in the Draghi report.

The creation of a corporate PPA market as Draghi's plan envisions would make it possible to sell electricity to industrial customers at fixed prices that are lower than the prices they pay right now. "PPA contracts from wind and solar should lower the cost and the volatility of electricity bills for industrial customers," Gandolfi writes.

Draghi's report suggests Europe's power market could benefit from reform. The current market design essentially uses hourly auctions to set prices based on the most expensive plant that gets dispatched into the grid. This so-called marginal power supply is often gas-fueled: Gas-powered plants supply just 20% of the region's output but set prices 65% of the time.

That system can be effective in providing incentives to efficiently dispatch power, but it's not necessarily the most cost effective, according to Goldman Sachs Research. When comparing power supply costs, including investment, operation and fuel expense, also known as the levelized cost of energy, onshore renewables are meaningfully less expensive than gas-fired plants.

While there are risks, Europe is poised for an electrification supercycle

Draghi also calls for investment in the modernization of power grids to support the transition to renewables and boost system resilience and reliability. After several decades of underinvestment, European transmission and distribution assets are rapidly aging. Goldman Sachs Research forecasts that capital spending on grid infrastructure toward the end of this decade will be about double what it was just a few years ago.

At the same time, there could be some negative business impacts from the changes Draghi proposes. Suggested changes in the power market could affect the profitability of certain vertically integrated business models, which are helped today by adding wind and solar that lowers procurement costs and boosts retail margins.

Altogether, electrification is at the core of Draghi's plan. His analysis envisions approximately €3 trillion - €4 trillion in spending on electrification and energy transition over 10 years, or about a quarter of eurozone GDP. Goldman Sachs Research expects this to drive a capital expenditure supercycle in electrification infrastructure.

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