The Electro Continent

Intro

Just over a week ago the European Commission unveiled a new plan for the future of Europe with huge ambition. Brussels wants to turn Europe into the world's first Electro Continent.

The Electrification Action Plan wants electricity to supply 46% of the EU's final energy consumption by 2040, double the 23% that’s been gradually creeping up a few percent every few decades.

There are several reasons to pursue this goal, and the implications on my portfolio, the European economy, and the millions of people living in Europe are huge, so I want to delve into what this plan means in reality in today's post.

Electricity Is Growth

Electricity, and Energy more broadly is very closely tied with economic output. In the modern world, electricity is one of the primary input costs for any major economy. Cheap or free electricity enables more automation and flexibility in almost any business or economy, and it compounds.

Modern wind and solar farms are much cheaper than fossil fuels for each unit of electricity generated, and because the output is electricity directly, without burning anything, you don’t lose much energy to heat or light. The same is true for cars that traditionally burned fuel, 70% of the energy of the fuel was lost in heat, friction, etc. Switching to electric vehicles, charged by renewables is therefore significantly more efficient.

The problem is that European power prices are still largely set by gas, so even as wind and solar produce an increasing share of electricity, the unit price remains among the highest in the world. The European Commission estimates that hitting the 46% goal could cut the fossil-fuel import bill by up to €260 billion per year by 2040 on top of reducing electricity costs for consumers and industry.

It’s easy to write off grid upgrades, renewables investment and the push towards electrification as being motivated purely by climate targets or air pollution. In reality, economics is a much more powerful motive, and a large part of the EU’s decision to push harder and faster.

Security and Self Sufficiency

In recent years, this has been one of the biggest road blocks for Europe. Unlike every other continent, Europe has very little cheap Oil and Gas. So while the US benefits from the fracking revolution, and Russia, the Middle East and North Africa are largely self-sufficient, Europe buys most of what it needs on international markets.

The price for those imported fuels has also risen in recent years following the Russian invasion of Ukraine. The more recent conflicts in the Middle East resulted in sharp price shocks, further highlighting the need to find a long-term solution.

If successful, this plan would see a more robust and secure electrical grid, where almost all power is generated within the EU. The increased adoption of electrified vehicles and heating systems would likewise mean the EU is less vulnerable to global oil and gas price swings.

It’s Not About Supply, It’s About Demand

Supply has been steadily trending towards renewables and Nuclear around the world for several years now. This plan will accelerate that trend further, but ultimately it’s not about the supply. It’s about the demand. The goal is for 46% of final energy consumption - meaning moving people away from fuels towards electricity. There are two sectors that do the majority of the heavy lifting; Transport, and Heating.

Transport is already on course to electrify quickly. Most rail has been electrified in western Europe already, and electric vehicle sales are increasing rapidly, with some countries already boasting over 50% of new car registrations last month being battery electric. Cheap EV’s from China are pushing prices lower and forcing innovation despite EU tariffs. This is the low hanging fruit.

Heating is the real heart of the plan. Buildings and industrial heat are still dominated by gas, and the best electric alternative in most cases is heat pumps. The Commission wants to nearly double annual installations by changing electricity price discovery mechanisms to break the link with gas. This will be supported by numerous policies and incentive programmes and more robust installer networks and training.

The Infrastructure Issue

Perhaps the largest obstacle for the EU to achieve this goal isn’t the supply or the demand, but the bit in the middle - the grid infrastructure itself. Electric vehicle charging and heat pumps can easily draw 5-10kW each. If entire neighbourhoods start installing them, not to mention home batteries and rooftop solar, this could stretch existing infrastructure to its limits, especially in older regions that were never designed for this level of capacity. The local stuff is challenging, but it’s at national and international level where the real issue is.

In the UK for example, there are a huge number of wind assets in the North Sea and Scotland, but that power needs to be transported to where it’s needed. For towns and cities close to those areas it’s not a problem, but what if the power is needed in the South, where most of the UK population lives? In the UK’s case, there are several mammoth projects underway to connect different parts of the country to help shift power where it’s needed. Eastern Green Link 1 and 2 are currently under construction with high voltage subsea cables running from Scotland down to England with capacity for around 2GW each and dozens more projects are in the pipeline at various stages.

In the EU the same types of projects are underway alongside even larger projects to connect the grids of different countries to help shift supply to where it’s needed on a continental scale, with thousands of kilometres of transmission cables under construction and many times more planned. The need for interconnectors is accelerating the EU’s Grid Action Plan to synchronize and standardize transmission across the continent.

This is all extremely capital intensive, complex work that takes place on a timeline spanning decades, not just years.

My Portfolio

If you’re familiar with my portfolio you’ll already be aware that there is a big impact on my portfolio for these announcements. My portfolio is heavily exposed to grid infrastructure, electrification, renewable energy and heat pumps.

The high-voltage cable cluster: $PRY.MI, $NEX.PA and $NKT.CO are all European companies that focus specifically on transmission and interconnection. They already have huge order backlogs, but this news could give them the confidence to further invest in capacity to ramp up production and delivery even further. Check out my recent post on these companies here if you missed it.

$ABBN.ZU and $SU.PA and $6501.T are the electrification-equipment and grid-automation layer. Systems to help manage everything, switchgear and intelligence that make a bigger, more complex grid actually work.

On the demand side, $6367.T and $NIBEB.ST offer clean heat-pump exposure. Daikin, although Japanese have sizable European sales, and Nibe is actually based in Europe. They aren’t huge growth engines, but should still provide good growth as adoption increases.

Finally, for electricity generation I have plenty of exposure through $TAN and $IBE.MC.

Overall though, this is precisely the kind of policies I expected to see from the EU, and is precisely why I positioned my portfolio with such high exposure to this theme. Now we just need to monitor and wait.

The Risks

I always aim to be upfront about risks, and there are a few with this announcement

The first is that right now, none of this is legally binding, things could change, get watered down, or simply poorly executed from a legal and policy perspective, not to mention delayed due to the complex bureaucracy of Brussels.

Secondly, most of the actual implementation that needs to take place is at a national level. The EU might do its part perfectly, but national politics could slow things down or kill it entirely in some countries.

Finally there’s the grid bottleneck I mentioned earlier. It’s a double edged sword - offering huge opportunity for investment and growth, but if it fails to materialize quickly enough, it could hold back the electrification end of the project.

Closing Comments

Among the market turmoil right now this is a good reminder that investing is about the long-term returns, not short or medium term noise. This is ultimately good news for my portfolio, even if we must wait to see the benefits. If you have any thoughts or questions, feel free to ask them in the comments.

As usual, thanks for reading, following and copying.