Coronavirus (COVID-19)—Impact on the energy sector

Coronavirus (COVID-19)—Impact on the energy sector

Energy analysis: Although it is too early to tell the full impact of the coronavirus (COVID-19) pandemic on the energy sector, some early issues and trends are emerging. Silke Goldberg, partner, Reza Dadbakhsh, partner (London), Will Breeze, partner (London), Mathias Dantin, counsel (Paris), Matthew Job, partner (London), Lorenzo Parola, partner (Milan), Ignacio Paz, partner (Madrid) and Kingsley Boateng, associate, at Herbert Smith Freehills examine this impact on, and some future challenges for, the upstream oil and gas sector, the European power sector and the EU ETS, and the recent actions of the regulators across Europe. The effects of the pandemic on energy infrastructure, energy sector M&A activity and the timetables for renewable energy subsidy tenders across Europe are also considered, alongside summaries of the legislative support measures for vulnerable customers in some of the worst affected European jurisdictions.

Upstream Oil & Gas

The outbreak of the coronavirus pandemic has heightened the challenges facing oil & gas producers navigating an already challenging business terrain. Saudi Arabia’s dramatic policy reversal to increase its oil production at discounted prices and its resultant price war with Russia has flooded the industry with oversupply.

When considered in tandem with OPEC’s failure to reach a decision on reduced supply caused by demand constraints arising from coronavirus, producers are having to take active steps to simply preserve their position in a market experiencing strong downward price pressure. As recently as 17 March, for example, the Brent Crude futures price had fallen to US$29.77, the first time it had drifted below US$30 since January 2016.

Mitigating price volatility is part of the modus operandi for producers. Many producers therefore have hedging arrangements in place, which are likely to expire by the early part of next year and, importantly, only alleviate price and not volume exposure risks.

Need for increased storage capacity?

Storage rates are rapidly increasing as producers seeking to stock their excess supply compete for limited onshore and offshore storage capacity. The International Monetary Fund (IMF) has predicted that the impact of coronavirus will be ‘significant’, with global growth in 2020 expected to be lower than the 2.9% growth of 2019. The precipitous fall in economic activity across various sectors, the aviation industry in particular, will continue to lessen energy demand and further exacerbate the storage issue. If the situation does not improve, regulators may consider shut-ins to constrict supply and associated storage costs.

Focus on cash flow in light of projected revenue falls

The focus of corporates on maintaining solid levels of cash flow to fund operations and to service debt has sharpened in light of falls in projected revenue due to decreased energy demand. A variety of potential methods of recourse to increase cash reserves are being considered, including:

  • drawing down corporate debt
  • selling non-core assets/businesses
  • rights issues
  • cancelling dividends and/or issuing scrip dividends
  • seeking efficiency savings by reducing capex spend
  • delaying final investment decisions on projects, and
  • considering the availability of the UK Government’s bailout packages

Quarantining and self-isolation in the offshore industry

As governments implement quarantining and self-isolation guidance, producers face operational difficulties in employing such measures on projects, particularly offshore. Force majeure notices are being issued as contractors struggle to move personnel in and out of countries due to travel restrictions, and operations and work schedules are being delayed for lack of available personnel.

For those operating in the North Sea, creative measures are being implemented to mitigate the impact of the virus. Such measures include a ‘corona copter’, an initiative of a group of North Sea operators and a helicopter operator for transporting confirmed and suspected coronavirus sufferers back to shore.

Financial resilience measures by regulators

As the industry continues to adjust to a coronavirus economy, energy regulators such as the Oil & Gas Authority (OGA) are working closely with the Department for Business, Energy and Industrial Strategy (BEIS) and HM Treasury on measures to foster financial resilience while supporting the work of industry and trade associations such as OGUK in supporting producers to achieve operational and logistical resilience.

Drop in Demand and Energy Prices

Upstream and LNG

The reduction in energy demand caused by coronavirus and the lower oil price is causing some commodity deliveries to become uneconomic. Deliveries for products such as LNG are increasingly being cancelled with buyers looking to rely on force majeure provisions to circumvent delivery obligations. In extreme circumstances, some contracts that are now seriously out of money will require renegotiations, causing difficulties to the economics of the underlying energy projects.

Electricity

The power sector also faces a significant drop in demand as a result of the lockdown in many jurisdictions which, in turn, results in low electricity prices.

The current, non-climate driven drop in total demand is nearly exclusively driven by the overall reduction of industrial and commercial demand due to measures related to the coronavirus pandemic; the mild winter and general climatic conditions with heavy rainfall and wind availability is also a factor.

This drop in total demand will not be balanced by the increase in household demand as a result of increased home working. The continued generation of electricity at relatively high levels will need to continue to ensure security of supply. We may see the introduction of lost load value payments in some jurisdictions, depending on how long the current situation lasts.

The role of clean energy and impact on climate change focus

Generation plants with little or no need for permanent on-site operation and maintenance, such as solar, wind, nuclear and small gas generation plants (peakers), appear well placed to cope with the social distancing measures and disruption caused by the current situation; the increased domestic demand may also be favourable to distributed generation.

Some commentators suggest that coronavirus will displace climate change as the sector’s number one concern, however this is likely to be a temporary situation – the underlying challenges of decarbonisation have not gone away and if anything, the current situation has highlighted the need for reliable power sources and stable grids.

EU ETS

The mid- or long-term impact of coronavirus on the EU ETS is as yet unclear. Following the steep fall to around €14 on 23 March 2020, the price per EU ETS allowance seems to have recovered some ground to nearer €17 by 25 March 2020. As economic activity significantly slows down across most sectors due to coronavirus, there will be fewer emissions for the 2020 compliance period (and possibly beyond), and allowance prices will likely struggle to gain their previous price level in excess of €26 in the near future. Some commentators have already called for an EU ETS floor price, however, given the complexity of agreeing any change to the EU ETS, this does not seem to be a realistic option for the time being.

Supply security

Security of supply is naturally of foremost concern for electricity system operators, regulators and legislators. In many jurisdictions, in particular those strongly affected by coronavirus or under an already longer lockdown, additional measures have been taken to ensure the continued security of supply.

France

On 15 March 2020, France’s electricity transmission system operator (RTE) announced a plan to organise its activity ‘to ensure the continuity of its public service mission’. As part of this plan, which comprises several phases that may be deployed as the situation evolves, RTE has decided that only those activities ‘essential to the proper operation of the power system and the supply of electricity’ will be carried out in person.

Earlier, on 1 March 2020, the French grid operator Enedis set up a national crisis unit, announcing the same measures, and citing ‘continuity of power supply to sensitive sites such as hospitals’ as one of the missions covered by ‘adapted work organisation’.

A business continuity plan for electricity exchanges has also been put in place to preserve the normal functioning of the market mechanisms necessary for the proper functioning of the electricity system.

Gas system operators have also stated that they will ensure the continuity of gas transmission activities.

Italy

In Italy, where manufacturing and commercial activities (other than the essential services) have been suspended since 22 March 2020, a series of energy sector activities deemed system-critical continue to be permitted, such as:

  • coal production
  • oil and gas production
  • production of coke and other refined oil products, and
  • supply of power, gas and steam (which includes power generation)

In addition, any activities functionally necessary to secure the continuity of the above (eg operation and maintenance) may continue, subject to notification to local authorities.

Spain

In Spain, Article 17 RD 463/2020 authorises the ‘delegated competent authorities’ to adopt the measures necessary to guarantee the supply of electricity. Existing Spanish legislation (Electricity Sector Law 24/2013, of 26 December (Ley 24/2013, de 26 de diciembre, del Sector Eléctrico) already empowered the Spanish Government, at any time, to adopt the ‘measures necessary to guarantee the supply of electricity’ for a ‘specific period of time’ in case of:

  • risk to the supply of electricity
  • supply shortages of any or some primary energy sources
  • situations that could seriously jeopardise the physical integrity or safety of people, objects or facilities or the integrity of the electricity transmission or distribution networks, and
  • situations triggering a substantial reduction in the availability of production, transmission or distribution facilities or the supply quality indices of any one of them

As such, the new measures merely delegate this responsibility further.

United Kingdom

The Electricity System Operator (ESO) for Great Britain has issued a statement to the effect that they have well-developed procedures in place to manage the effects of a pandemic, and have analysed anticipated effects on electricity supply and demand of mass self-isolation of the UK’s workforce. No legislative measures have been introduced in the UK.

Energy Infrastructure

Coronavirus has invariably had an impact on the development and construction schedules of energy projects; and some building sites have had to be suspended for multiple reasons, including:

  • equipment rental companies no longer offering their services due to a lack of manpower
  • foreign subcontractors returning to their countries, or
  • interruption to the supply of equipment being imported from abroad, particularly China

Construction activity on energy projects may grind to a halt as governments look to stop all non-essential activities. This is already the case in Italy and expected to spread to the other countries in due course. In the UK so far, we have seen Hinckley Point C construction continue while HS2 operations are imminently expected to be paused. Contracts being hindered by governmental measures flowing from a response to the virus may shift the focus from force majeure/relief event analysis to a consideration of change in law provisions. In addition, some parties are assessing the potentially increased risk of joint venture (JV) partner defaults which, in turn, might push projects into default or other JV partners into financial difficulty.

However, where parties seek to rely on force majeure clauses, their application will depend on the relevant governing law as well as the precise drafting of the relevant clauses. The mere advent of coronavirus in itself is unlikely to be a sufficient force majeure trigger in the majority of cases, issues such as the specific impact of any governmental measures or sickness of a company’s work force will almost certainly be a factor in the relevant analysis.

Impact on M&A in the energy sector

It is likely that cash-rich buyers may seize any M&A opportunities the market may present within the next six months.

Deals taking place within this depressed market will likely raise concerns for sellers on achieving the right level of consideration on disposals and for buyers on access to financing from lenders, who themselves are facing challenges on pricing transactions.

In response, this is likely to result in an upturn in the use of consideration deferral mechanisms with buyers relying on a mixture of cash reserves and, in the oil & gas sector, reserve-based lending (depending on borrowing base redetermination dates).

Adjusted timetables for Renewables Subsidy tenders across Europe

In a number of jurisdictions, due to the pandemic, regulators have adjusted the timetable for bids for subsidies under the relevant support schemes.

Germany

In Germany, where the receipt of subsidies pursuant to the Renewable Energy Act (Erneuerbare Energien Gesetz (EEG)) is subject to strict deadlines for the construction and commissioning of new renewable energy plant, the Federal Network Agency (FNA) has announced that it will be taking a pragmatic approach to its enforcement practice, in particular by extending construction and commissioning deadlines and avoiding penalties so as to reduce the impact on plant operators’ subsidy awards on top of any delays to their projects.

Pursuant to the EEG, subsidies are awarded in public tenders. To date, the FNA has not altered any of the key tender dates (which are set by statute) and all auctions will run as usual. However, in practice, it is likely that there may be a delay as the tender process is personnel-intensive which may pose challenges in the context of social/physical distancing measures.

Although the tenders will go ahead, the FNA has decided not publish the resulting tender awards on its website for the time being to avoid triggering the start time for the relevant project implementation periods and will instead announce the awards in due course once the current situation has stabilised. For onshore wind energy plants and biomass plant, the FNA has indicated that it will grant an extension to the implementation deadlines upon request by the relevant project sponsors.

Italy

In Italy, by Law-Decree of 17 March 2020, No 18, all terms applicable to permitting proceedings have been suspended from 23 February 2020 and 15 April 2020.

France

In France, the Directorate General for Energy and Climate (DGEC), the central service of the Ministry for the Ecological and Inclusive Transition sent a letter to the Markets and Transformation Directorate of EDF stating that, given the exceptional circumstances arising from the coronavirus pandemic, extension periods will be granted to producers penalised by delays and the impossibility of ensuring deliveries of key equipment, particularly photovoltaic modules.

On 23 March 2020, DGEC amended the schedule for the next calls for tenders in France for various renewable energy sectors by (i) splitting the tender rounds into two ‘batches’; and (ii) extending the tender deadlines by two months.

For onshore wind and ground-based solar tender rounds, there are now two separate tender ‘batches’; the date for submitting bids will end (i) in July 2020 (as initially planned) for a first batch representing 1/3 of capacity subject to the tender and (ii) in November 2020 for a second batch representing 2/3 of the relevant capacity.

The new schedule is as follow:

SectorsDate of submission of bids 
 Old dateNew date
Solar PV Sol3 July 20201/3 : 3 July 2020
2/3 : 3 November 2020
Solar PV Fessenheim31 July 202030 September 2020
Wind1 July 20201/3 : 1 July 2020
2/3 : 1 November 2020
Solar PV Building6 July 20206 September 2020
Solar PV Innovative3 April 20203 June 2020
Solar PV ZNI12 June 202012 August 2020
Self-consumption18 May 202018 July 2020
Small hydro31 March 202030 May 2020

United Kingdom

In the UK, the Crown Estate has extended the timetable for the current Round 4 of its offshore tender round for new offshore wind projects. The first stage of the invitation to tender will now open at the end of March 2020 (w/c 30 March) with the submission window being extended from seven to ten weeks. For more information, see: Offshore Wind programme delayed due to coronavirus (COVID-19), LNB News 24/03/2020 79.

Ofgem will also review its overall processes, including how their consultations can be run over the next year, mindful of the limits on consultees and the different priorities that they will be working towards. It has already postponed RIIO-2 hearings until further notice and will publish revised plans in due course. For more information, see: Ofgem to review its 2020 workplan in light of coronavirus (COVID-19), LNB News 24/03/2020 86.

However, in contrast to other European regulators, Ofgem has not published further guidance or concrete amendments to their usual processes.

Support for vulnerable customers

Great Britain

For the GB downstream gas and electricity markets, Ofgem has published a statement to the effect that all regulatory obligations remain in place while, at the same time, indicating that the regulator would be pragmatic in their approach to compliance with a focus on the protection of consumers from immediate harm, particularly vulnerable customers or where customers are at risk of going off supply.

France

Due to the current situation, the Ministry for the Ecological and Inclusive Transition, Elisabeth Borne, has requested the energy suppliers, in a letter dated 17 March 2020, to apply a two-month extension to the effects of the ‘winter truce’ (trêve hivernale) according to which the most vulnerable consumers cannot have their gas, heat or electricity supply cut off.

The French government is also authorised to issue formal ordinances in this respect as well as for the benefit of microenterprises (companies that employ fewer than ten persons and have an annual turnover or balance sheet total not exceeding €2m) whose activity is affected by the spread of the epidemic in order to allow the postponement of the payment of rents, water, gas and electricity bills without any economic repercussions or penalties.

Italy

In Italy, electricity and gas bills are suspended until 30 April 2020 in the 11 Municipalities originally affected by the coronavirus outbreak. The Italian regulatory authority for Energy, Networks and Environment (ARERA) has stopped any supply interruption/suspension due to users’ insolvency. In particular, these proceedings are suspended from 10 March 2020 to 3 April 2020. The relevant provision is applicable to low-voltage connected clients and clients with a consumption not exceeding 200,000 Smc/y.

Spain

In Spain, measures for the protection of vulnerable customers were already enshrined in existing legislation and new measures have been introduced to prohibit electricity supply being cut off between 18 March and 17 April 2020. However, this does not mean that the relevant electricity supplier will not suspend supply or seek to enforce outstanding payments after this date.

Conclusion and outlook

It is not possible as yet to estimate the mid- or long-term impact of coronavirus and the measures to combat the pandemic on the energy sector. As the situation evolves, it is likely that the energy markets will respond further to the existing measures; the catalogue of restrictive measures is also likely to evolve further in some jurisdictions.

It is therefore possible that, in time, the enforcement of certain competition law rules could be relaxed to facilitate cooperation (eg sharing data between producers on best practice measures) to mitigate the impact of the pandemic.

While the energy sector has proven resilient in the past, and there is no suggestion that the sector as a whole is in distress, it is possible that governments may have to consider a safety net for energy companies to ensure the security of supply.

Interviewed by Rosie Elizabeth Taylor

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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