CEE: New Optimism

Despite last year’s cautious optimism about the prospects of the energy industry, the crisis has indeed shaken the trade, both in terms of financial performance and executives’ mindsets.

This is the conclusion of a survey conducted by GJP International, a search and management audit company specializing in the European energy industry. The study conducted interviews with 73 board-level executives and senior managers from the energy world who discussed the effect of the crisis at length with the interviewers.

The targeted companies earned revenues that ranged from €1 million to €80 billion per year, with the average falling between €1 billion and €10 billion. Forty-nine per cent of the companies were located in Western Europe, the rest in Central Eastern (CEE) and South Eastern Europe (SEE).

Eastern European executives seemed more optimistic than their Western counterparts. Fifty per cent of Western European managers expected their businesses’ results to continue their downhill slide through the remainder of 2009, compared with only 27 per cent of CEE executives and 23 per cent in SEE. The largest differences were found in expectations for 2010, as 95 per cent of Western business leaders envision their companies falling into a black hole until 2011, when the crisis is expected to ease. Executives are comparatively optimistic in CEE: only 58 per cent predict continued gloomy statistics through 2010. In SEE, 15 per cent predicted worse results, and a whopping 62 per cent expect a financial upswing. The general SEE consensus is that the results will bottom out by mid-2010.

Some SEE executives are looking at cash flows from privatization processes as a potential springboard for recovery. Others remain optimistic because of their belief that the media has exaggerated the crisis. And yet another justification of Eastern European optimism in face of the crisis is that less developed industrialization and incomplete privatization processes have left considerable leverage in governments’ hands, ameliorating the effects experienced by more free-market oriented economies. In general, the crisis seems to be "spreading in waves," as one respondent claimed, and there appears to be a certain delay of effects in Eastern Europe.

Europe’s energy intensive industry sector (e.g. pulp and paper, steel, etc.) has been strongly affected since the outset of the crisis in 2008. In addition to falling demand, wholesale attitude is also changing, especially with regards to renegotiations of contracts and pricing structures. Retail demand remains relatively stable, but is expected to decline in all European regions and across the value chain this year. Nonetheless, countries that are less industrialized – predominantly those in South Eastern Europe – seem to be less impacted according to the findings of the study.

Low profitability followed by consolidation in the mid-term?

Declines in profitability have given rise to consolidation speculation. Interviewees were polarized in regards to questions about consolidating possibilities in both East and Western Europe, with roughly 50 per cent arguing either way. Those expecting consolidation plans anticipate them to materialize in 2010, as executives consider attractive investments too expensive for the coming year. Currently, major investments are generally on pause – Western Europeans are re-evaluating their strategies and the Eastern Europeans are awaiting further developments, with a close watch on the actions of Western European companies. Certain respondents foresee a shift in the focus of future merger and acquisition trends from East to West; However, respondents hinted that takeover opportunities in Western Europe are becoming more attractive, reversing the trend that began in the mid-1990s.

When asked about key reasons for revising investment strategies, all CEOs gave precedence to risk attitude and access to loans. Eastern Europeans pointed out that politics also play a significant role, while rating agencies carry more weight with Western European companies.

What about liberalization?

Participants were also asked to give their opinion on the effects of the crisis on liberalization proceedings. The reactions were again polarized: In Western Europe, some companies are discussing the basic parameters of liberalization and have questioned their validity. Eastern Europeans are mostly in a waiting position, expecting further developments in the international investment and local political trends, both mentioned as major influences on liberalization. In Western Europe, more regulation is expected in the gas industry than in electricity, as the gas business has been shaken up both by the financial crisis and the recent gas crisis, when a dispute between Ukraine and Russia disrupted gas supplies to much of Europe.

The transformation of investment strategies

Western European companies have saved money predominantly by contracting investment activities, greater concentration on domestic markets and pulling out of projects still in planning stages. The projects implemented shortly before the outset of the crisis are still active, and all projects concerning the security of supply and direct access to gas and oil fields have retained their priority status. Investments in renewable energy are still important but are heavily affected by cost issues and EU directives. A number of Western European companies have been re-examining the logic and calculations behind SEE investments, and several have postponed investments in South Eastern Europe for fear of losing positive credit ratings. On the other hand, some companies with strong liquidity see the crisis as an opportunity to acquire assets at lower prices, overtake competitors and reposition themselves for when the crisis dies down.

Strategy changes are also reflected in internal restructuring. In stark contrast to previous years, only 42 per cent of the companies will increase their workforce in 2009. Some companies have implemented massive budget cuts in human resource departments and hiring freezes, while most of the companies have cut training budgets and fringe benefits.

One sector – risk management – is typically excluded from hiring freezes and budget cuts, as risk awareness has reached new heights among leading executives. The vast majority of interviewees, both in Western (75 per cent) and Eastern Europe (86 per cent), expect major changes in the attitudes toward risk, particularly regarding the issue of how to minimize risk. Risk management task forces have been developed in a number of companies, and some are investing in modeling software that will centralize risk functions and direct a spotlight on subsidiaries. When asked to give a desired characteristic of top managers, the most frequently mentioned was "risk-awareness," emphasizing the importance of risk responsiveness in today’s business world. The survey highlighted the need for critical interpretation of data in order to understand risk in all its complexity and the interrelation of risk-related aspects in an organization, including total portfolio risk.

Searching for the ‘big picture’

The majority of energy companies were unaffected by the crisis until the final two quarters of 2008. For an extended period, many believed the energy industry would be affected less than many other industries; However, since the advent of the crisis, the energy world has been re-evaluating its investments, re-examining portfolios and reflecting on its options. In Eastern Europe, many hope for an upward trend in mid-2010, while in Western Europe positive news are not expected earlier than 2011. No one, however, has a crystal ball.

One thing seems certain: Many changes await the industry, and many new challenges are in store for energy-related companies at every step along the value chain. The industry is not insulated from financial crises, and when the global economy will improve remains uncertain. But the industry seems to have transformed its mindset, refocusing strengths and reevaluating the search for the next generation of cool-headed global leaders with a firm understanding of risk management.