By Jan Frederik Slijkerman, Industry Strategist, TMT
Exposure to high and volatile energy prices is relatively low for telecommunications compared to many other sectors. However, as costs rise, many are looking for alternative, often more environmentally friendly, ways to keep their cost base stable for longer.
The cost of volatile energy markets
Few sectors survived the 2022 energy price surge unscathed. Most telecom operators, however, largely covered the cost of their energy needs, so this wasn't a big deal.
But with energy tariffs remaining above their historical levels for so long, it is worth considering how telecom operators might be affected.
This topic dominated telecom earnings calls over the past year. Historically, wholesale electricity prices hover around €40/MWh. Electricity is often produced from natural gas, with a historical average price of around €20/MWh.
Recent price history for the European natural gas reference price can be found in the chart below. We describe the evolution of energy prices in Europe through the evolution of natural gas prices because each regional electricity market in Europe has its own specific characteristics, while European gas markets are relatively deep.
As you can see, energy was particularly expensive in mid-2022 due to gas supply issues stemming from the war in Ukraine. Gas prices peaked above €250/MWh, while electricity prices traded above €600/MWh for a few days. For companies that had to buy electricity on spot markets, this became a costly affair.
Gas price is now below peak (€/MWh)
Refinitiv, Endex
Energy costs are a relatively small cost component for telecom operators
Based on our industry estimates, energy costs represent a relatively small portion of the overall cost base, which includes depreciation. We estimate that approximately 2% of the total cost was related to energy.
This implies that telecom operators should be able to handle a temporary increase in energy costs, primarily due to general cost-cutting programs and efforts to reduce demand. However, telecom companies generally choose to purchase (cover) their 2023 energy needs at last year's high levels.
The price of natural gas for delivery in July 2023 averaged €106/MWh, just over double the average spot price in 2021.
Therefore, we estimate that energy costs will at least double for companies by 2023. Therefore, energy costs are becoming a larger part of the cost base. However, it's not certain that total costs will increase because management teams are focused on managing expenses.
We also expect the impact of rising energy prices to be largely transitory. As you can see in the chart above, gas prices have fallen rapidly from their 2022 highs.
The futures curve indicates that companies can already purchase energy at prices around €60/MWh for natural gas. This is high compared to the long-term average, but within the same order of magnitude as the 2021 price level.
Green energy supply offered additional help
Many telecommunications companies have offered green bonds and are focusing on reducing greenhouse gas emissions. To do this, companies can source green energy from wind farms, as well as efforts to reduce energy needs through investments in energy-efficient grids, and we examine this in more detail here. For example, Deutsche Telekom (OTCQX:DTEGY) (OTCQX:DTEGF) signed a large, multi-year Power Purchase Agreement (PPA) for green energy from a US wind farm.
The long-term commitment to this venture offered the added benefit of containing exposure to rising energy prices. Given the significant demand for green energy, as well as the desire to avoid energy price volatility, we believe more companies may seek such agreements.
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