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TTF one-year forward price was 16 €/MWh on Jan. 7, 2020 TTF one-year forward price hit 281 €/MWh on Aug. 25, 2022 Goldman Sachs 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. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. EQUITY RESEARCH | September 04, 2022 | 1100 PM EDT Ajay Patel 44 20 7552-1168 ajay.patelgs.com Goldman Sachs International Mathieu Pidoux 44 20 7051-4752 mathieu.pidouxgs.com Goldman Sachs International Following the spike in gas and power prices since mid-June, we believe that the Energy Crisis, and in particular affordability, has reached a tipping point, likely requiring significant policy intervention. In our view, the market continues to underestimate the depth, the breadth and the structural repercussions of the crisis – we believe these will be even deeper than the 1970s oil crisis. At current forward prices, we estimate that energy bills will peak early next year at c.€500/month for a typical European family, implying a c.200 increase vs. 2021 . For Europe as a whole, this implies a c.€2 tn surge in bills, or c.15 of GDP , we estimate. We believe the market is overly negative on regulatory risk and believe that near-term solutions could be a major clearing event. We see scope for the introduction of price caps in power generation, which we estimate could save Europe c.€650 bn pa. Yet, price caps would not fully solve the affordability issue this is why the introduction of a “tariff deficit” might eventually be needed, to spread the spike in bills over 10-20 years and allowing Utilities to securitize these future payments. T owards a new market design and full electrification. We present structural solutions, including a new market design in power generation – to decouple gas prices from the remuneration of fixed-cost generation sources hydro, nuclear, wind, solar – and an acceleration in the electrification of the economy. The deflationary effect of RES sources could lower energy bills by c.75 vs. current levels and make future energy costs more stable. Sector implications. We believe the market is exaggerating regulatory concerns in power generation, the more so given indications reported in QE and Reuters September 1, which suggest that the EU is planning to recommend the introduction of price caps, and the elimination of windfall taxes. This would be a positive development, we believe. The Energy A ordability Crisis Quantication, Solutions, Implications Simon Bergmann 44 20 7552-8588 simon.bergmanngs.com Goldman Sachs International Alberto Gandolfi 39 02 8022-0157 alberto.gandolfigs.com Goldman Sachs Bank Europe SE - Milan branch Mafalda Pombeiro 44 20 7552-9425 mafalda.pombeirogs.com Goldman Sachs International Note The following is a redacted version of the original report published September 4, 2022 [49 pgs]. Executive Summary 4 Quantifying the affordability issue Consumers are being squeezed 11 Windfall taxes debate is misplaced 16 Likely solutions and why the market appears overly-negative 19 Tariff deficit would minimize the impact on consumers 23 RES are part of the solution to the affordability problem 25 Electrification could cut household energy bills by c.75 28 Stock negatives may be meaningful, but temporary 31 The positives are structural 34 Disclosure Appendix 38 4 September 2022 2 Goldman Sachs European Utilities Table of Contents 4 September 2022 3 Goldman Sachs European Utilities Following the spike in gas and power prices since mid-June, we believe that the Energy Crisis, and in particular affordability, has reached a tipping point, likely requiring significant policy intervention. In our view, the market continues to underestimate the depth, the breadth and the structural repercussions of the crisis – we believe these will be even deeper than the 1970s oil crisis. At current forward prices, we estimate that energy bills will peak early next year at c.€500/month for a typical European family , implying a c.200 increase vs. 2021 . For Europe as a whole, this implies a c.€2 tn surge in bills, or c.15 of GDP . We believe the market is overly negative on regulatory risk as currently Utilities do not enjoy any windfall profit owing to hedges, 2022 earnings largely reflect the commodity backdrop of one/two years ago. Thus, most ad hoc measures would limit future increases in power generation profits, as opposed to lowering current earnings. Also, in the context of a €2 tn increase in energy bills, even eliminating the bottom line of the sector c.€30 bn for 2022E would only contribute to solving c.1 of the problem, leaving 99 unresolved. Near-term solutions could be a major clearing event price caps and tariff deficit. We see scope for the introduction of price caps in power generation, which we estimate could save Europe c.€650 bn pa. Yet, price caps would not fully solve the affordability issue the increase in energy bills would still be of €1 .3 tn, or c.10 of GDP , we estimate. This is why the introduction of a “tariff deficit” might eventually be needed, to spread the spike in bills over 10-20 years and allowing Utilities to securitize these future payments. Towards a new market design and full electrification. We present structural solutions, including a new market design in power generation – to decouple gas prices from the remuneration of fixed-cost generation sources hydro, nuclear, wind, solar – and an acceleration in the electrification of the economy. The deflationary effect of RES sources could lower energy bills by c.75 vs. current levels, while the fixed-cost nature of RES would make future energy costs more stable. Sector implications. We believe the market is exaggerating regulatory concerns in power generation, the more so given indications reported in QE and Reuters September 1, which suggest that the EU is planning to recommend the introduction of price caps, and the elimination of windfall taxes. This would be a positive development, we believe. At the same time, investors appear to be ignoring the structural positives, such as the urgent need to accelerate electrification investments. Executive Summary Following the spike in European gas and power prices since mid-June, we believe that the Energy Crisis, and in particular affordability, has reached a tipping point, likely requiring significant policy intervention. In our view, the market continues to underestimate the depth, the breadth and the structural repercussions of the crisis – we believe the repercussions will be even deeper than the 1970s oil crisis. At current forward prices, we estimate that energy bills will peak early next year at c.€500/month for a typical European family, implying c.200 increase vs. 2021 . For Europe as a whole, this implies a c.€2 tn surge in energy bills, or c.15 of GD P. We believe the market is exaggerating regulatory concerns in power generation, the more so given indications reported in QE and Reuters September 1, which suggest that the EU is planning to recommend the introduction of price caps, and the elimination of windfall taxes. This would be a very positive development, we believe. At the same time, investors appear to be ignoring the structural positives, such as the urgent need to accelerate electrification investments. Consumers soon to spend c.€500/month on power and gas For most families and industrial customers, energy bills are renegotiated every twelve months; on our estimates, energy bills for most consumers will peak this winter. We estimate a c.€500/month cost for power and gas currently, implying a c.200 increase vs. 2021 when average bills were c.€160/month. Energy bills could approach €600/month in a zero flows from Russia scenario we believe. 4 September 2022 4 Goldman Sachs European UtilitiesFor Europe as a whole, assuming the same magnitude of increase, this would be equivalent to a near c.€2 tn increase in gas and power spending equivalent to c.15 of GDP. The following Exhibit shows a sensitivity analysis in the surge in energy bills for Europe, depending on the development of gas and power prices. Exhibit 1 Based on current forward curves, household energy bills in Italy could reach nearly €500/month Italian power and gas household bills evolution €/month 57 60 103 146 193 97 98 215 333 402 154 157 318 479 596 2020 2021 2022E 2023E Zero flows Power Gas c.200 c.250 Source Eurostat, Goldman Sachs Global Investment Research Exhibit 2 For Europe as a whole, the increase in energy costs between 2021 and 2023 could approach €2 tn Europe’s increase in energy costs calculation TWh, €/MWh and € bn Power Gas Energy Consumption TWh 3,300 5,500 - Consumption adj for CCGTs TWh 3,300 4,125 - Energy price in 2021 €/MWh 75 27 - Current energy price €/MWh 450 200 - Energy bills increase 2021-now € bn 1,238 714 1,951 Source Goldman Sachs Global Investment Research 4 September 2022 5 Goldman Sachs European UtilitiesExhibit 3 Europe’s energy bills could surge by c.€1-4 trillion vs 2021, depending on the evolution of gas/power prices Surge in Europe’s gas/power bills vs 2021 power at €75/MWh, gas at €27/MWh EU Energy bills increase vs 2021 € bn Power Gas Energy Gas €100/MWh, Power €250/MWh 578 301 879 Gas €150/MWh, Power €350/MWh 908 507 1,415 Gas €200/MWh, Power €450/MWh 1,238 714 1,951 Gas €250/MWh, Power €550/MWh 1,568 920 2,487 Gas €300/MWh, Power €650/MWh 1,898 1,126 3,024 Gas €350/MWh, Power €750/MWh 2,228 1,332 3,560 Gas €400/MWh, Power€ 850/MWh 2,558 1,539 4,096 Source Goldman Sachs Global Investment Research Windfall taxes focus appears misplaced As described above, the increase in energy bills for Europe implied by current forward curves is c.€2 tn; as a reference, European Utilities generate c.€30 bn of net income per year, globally and across divisions including regulated activities. In this context, even eliminating the Utilities’ bottom line would mitigate only c.1 of the increase in bills we anticipate, while harming private investment in energy security and compromising the REPowerEU plan. 4 September 2022 6 Goldman Sachs European UtilitiesNear-term solutions price caps and tariff deficit We see scope for the introduction of price caps in power generation, which we estimate could save Europe c.€650 bn in power bills pa. These could follow the example set in Spain, where there are two co-existing caps 1 a cap on gas prices that CCGTs are permitted to translate to the electricity price c.€70/MWhg, which compares with current TTF levels of c.€200/MWhg; and 2 a cap on the level of remuneration fixed-cost technologies hydro, nuclear, wind, solar are allowed to receive c.€75/MWh. Exhibit 4 Potential windfall profits are created in rising gas price environments Impact from rising gas prices on power supply curve €/MWh Exhibit 5 A temporary price cap on gas led to a decoupling of the Spanish forward curve from those of the rest of Europe Forward 1-year power price evolution, by region €/MWh 0 50 100 150 200 250 300 350 400 450 Solar Wind Hydro Nuclear Gas TTF 30 Gas TTF 200 Potential windfall profit Power price at €425/MWh Power price at €90/MWh 0 100 200 300 400 500 600 700 03-Jan 02-Feb 04-Mar 03-Apr 03-May 02-Jun 02-Jul 01-Aug Rest of Europe Italy and Germany Spain c.€250 c.€450 Source Goldman Sachs Global Investment Research Source Bloomberg, Goldman Sachs Global Investment Research 4 September 2022 7 Goldman Sachs European UtilitiesHowever, price caps would not fully solve the affordability issue the increase in gas and power bills would still be €1 .3 tn, or c.10 of GDP , we estimate. This is why the introduction of a “tariff deficit” might eventually be needed, to spread the recent spike in bills over 10-20 years, and allowing the Utilities to securitize promptly these future payments. Although this scheme would limit demand destruction, we believe it would smooth the increase in tariffs, limit the near-term decline in industrial production, and largely defuse regulatory risk. Towards a new market design and full electrification We present structural solutions, including a new market design in power generation – to decouple gas prices from the remuneration of fixed-cost generation sources hydro, nuclear, wind, solar – and an acceleration in the electrification of the economy. The deflationary effect and the fixed-cost nature of RES sources could lower energy bills by c.75 vs. current levels, while the fixed-cost nature of RES would make future energy costs more stable. Exhibit 6 Tariff deficit would spread the same cost for gas bills, over a much longer period, as seen in this example for Italy Italy monthly gas bills per household evolution, average per month €/month 0 50 100 150 200 250 300 350 400 450 500 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 Current scheme Tariff Deficit Source Goldman Sachs Global Investment Research, Eurostat 4 September 2022 8 Goldman Sachs European UtilitiesExhibit 7 Merchant, fixed-cost activities benefit from rising gas/power prices, without any impact on the cost base Impact from rising gas prices on power supply curve €/MWh 0 100 200 300 400 500 600 700 Solar Wind Hydro Nuclear Gas TTF 30 Gas TTF 300 Potential windfall profit Power price at €620/MWh Power price at €90/MWh Source Goldman Sachs Global Investment Research Industry implications near-term negatives vs. structural positives We believe the market is exaggerating regulatory concerns in power generation, the more so given indications reported in QE and Reuters September 1, which suggest that the EU is planning to recommend the introduction of price caps, and the elimination of windfall taxes. This would be a very positive development, we believe. Additionally, we see most of the negatives from the perspective of the utilities regulatory risk, demand destruction as temporary, while the positives a green energy capex super-cycle and higher-for-longer energy prices appear more structural. Stock conclusions we favour RES and look for regulatory inflection points In our view, price caps might in fact prove a near-term relief, especially if coupled with a recommendation for the elimination of all other windfall taxes, as reported in the Reuters article mentioned above. Structurally, higher-for-longer energy prices and broadly speaking the strong need to accelerate investments drive our strong preference for companies with a RES developer focus. Certain power generators may benefit too from the above-mentioned clearing event, whils
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