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Interview

Rafael Villaseca – CEO, Gas Natural Fenosa, Spain

Rafael Villaseca, CEO of Gas Natural Fenosa, describes the Spanish energy sector’s resilience to market uncertainties, Gas Natural Fenosa’s move to integrate its gas and electricity businesses, the company’s internationalization strategies, and the competitive edge of Spanish energy outfits abroad.

Gas Natural Fenosa registered a profit of EUR 298 million for Q1 this year despite what you have described as a “profoundly challenging environment.” Where, then, is most of your growth coming from right now?

“The decision to integrate [our gas and electricity businesses] has been one of the defining aspects of our company’s development trajectory.”

The Spanish and European energy sector found itself encountering many difficulties at the start of the year.

First and foremost, the system in Spain experienced significant headwinds in the electricity business, mainly as a result of exceptional weather conditions which were particularly dry (more so when compared to a wet Q1 in 2016) which meant GNF and our peers had to replace hydro production with more expensive thermal production, which in turn translated into higher wholesale electricity prices in Spain, in an environment also affected by higher commodity prices and a peak of gas prices in January. As a result, the lower margins in commercialization couldn’t be offset by higher results in generation, due to the more expensive generation mix experienced during the first quarter. Therefore, utilities in the Spanish energy sector were significantly affected by the environment and exceptional weather conditions, which obviously impacted our earnings too.

The second factor is related to the international evolution of the LNG market. Especially in Spain, the market has decreased its margins due to strong competitive price pressures. This is nothing new in itself, but competition was more severe than usual during the first quarter and we are likely to experience continued pressure on this front going forward. Our hope is that there will eventually be some sort of stabilization, but the fundamental reality is that the market is volatile right now and therefore rather complicated to navigate. Nevertheless, we were able to compensate the weaker margins with higher volumes, resulting in flat results vs. the same quarter of previous year.

Responding to your question in particular, fortunately in the case of Gas Natural Fenosa the bulk of our growth continues to be supported by our regulated activity in gas and electricity networks, both in Spain and Latin America, which experienced steady growth, as well as our contracted activity in GPG (our international power generation arm). Indeed, most of our EBITDA derives from regulated or contracted activities, stable markets which represent c. 75% of our EBITDA. Those parts of the business remain steady and secure and have allowed us to generate significant revenues, partially offsetting the aforementioned issues.

Gas Natural Fenosa is notable for being one of the first movers to integrate the gas and electricity businesses. To what extent has that been a driver of the company’s success?

The decision to integrate has been one of the defining aspects of our company’s development trajectory. The first steps of this transition occurred almost a decade ago when Gas Natural successfully integrated Union Fenosa, which was, at that time, the third energy supplier in the country and boasted a strong positioning in power generation. This merging of talents and competencies crucially allowed the newly formed entity to diversify risks and marked Gas Natural Fenosa’s grand entrance into the world of electricity distribution.

Now we have to face the future once again and adapt to the prevailing trends of the moment. While it is obvious that the world is changing around us, it remains hard to pinpoint just how the utility business will be transformed as we proceed towards a low carbon ecosystem. What has yet to become very clear are the strategies for bridging the present situation and the agreed visions for 2030 and 2050 outlined in the Paris climate accord. The industry has yet to properly understand just how this transition will unfold and which parties will shoulder the bulk of the cost.

We may all agree that climate change makes us pay attention to CO2 emissions, but there remains little common understanding about what we should do with CO2 transmitters, like coal. Equally unclear is what alternatives will have to be applied in countries where nuclear energy will be reduced. This all makes for a pretty confusing environment! Everyone is talking about what we will do in 2050 in terms of energy, but the pathways still need to be defined.

Some of your peers have been pursuing a consolidation strategy and selling off non-core business. The former GDF Suez, now rebranded as “Engie,” is a good example of this with the French firm recently divesting their upstream operations. Gas Natural Fenosa, on the contrary, has made a virtue out of diversification. What makes you so confident that you are betting on the winning horse?

We believe that one of the keys enabling Gas Natural Fenosa to maintain a more resilient performance in recent years compared to our European peers, has been indeed our capacity to handle the different sides of the business: gas and power generation, regulated and liberalized markets, as well as a range of geographic points. Gas Natural Fenosa diversified yet integrated business model has proven successful to deliver expansive growth figures, profits and dividends despite the challenges experienced in recent years. This business model has become a source of strength as it reduces our risk exposure and has allowed us to navigate a difficult environment in recent years better than most of our European competitors. The fact that we are able to turn over a good profit despite turbulence in the European gas sector is testament to the worthiness of our business model.

That is not to imply that we are afraid to divest non-performing assets when the time is right. We may well have some business in our portfolio in some locations that we need to reconsider. Right now, our focus is very much upon identifying and implementing new efficiencies across our mature European market operations and this may well entail reconsidering certain parts of our business portfolio. One of our key pillars and part of our Strategic Plan has been the continuous evaluation and optimization of our portfolio of assets, with the aim of delivering long term value creation to our shareholders.

1992 marked the start of Gas Natural’s “great leap abroad.” Nowadays around 50 per cent of your revenues derive from outside of Spain. How would you describe the company’s internationalization strategy?

In Europe, the markets are mature and the regulation stringent, leaving little scope to expand the business. In Latin American, by contrast, the opportunities are bountiful because, in many cases, we are talking about young, dynamic, under-penetrated and as a result high- growth markets. Our last big bet was Chile and we continue to see much potential in that market. Mexico also offers considerable growth prospects. Therefore, we aim to maintain a strong international footprint in growing markets where we can deploy our know-how and expertise, as is the case in Latin America. We believe this will allow us to achieve our long-term ambitions and remain a strong-growth, resilient, and high-performance company.

To date, our foreign expansion has followed the logic of focusing upon those markets where we are confident we can do best, namely Latin American economies where we possess a strong cultural affinity and understanding. Of course, many commentators and analysts have been talking up Asia and the Far East as the next big energy hotspot in terms of mushrooming demand, however, we have been careful to avoid jumping in there blindly without having performed the right levels of due diligence.

What makes those types of markets so complicated?

In the utilities sector, many Asian countries remain “closed” in practice and, even if they don’t openly admit it, many of their governments continue to place strong obstacles in the path of foreign investment channelled towards this particular business segment. Gas Natural Fenosa remains, of course, highly interested in Asia. As a matter of fact, we already possess some important commercial relations over there, and have been physically present over there long enough to have acquired considerable experience and know-how.

Normally our typical entry strategy is to commence with commercial relations and subsequently move on to industrial investments that accompany the network, and then we can start the supply of LNG or power generation. This is the same formula that we strive to apply in Asia. Even though it’s far from easy, we keep trying and hope we will succeed in the future.

Africa also constitutes a potentially attractive market destination for the future; we are especially interested in the electrification and gasification plans in Morocco and South Africa. Other countries are working very hard as well, and when they show more concrete plans, we will be able to seize relevant opportunities.

Your internationalization has followed the usual Spanish strategy of first expanding into Latin America. How do you deal with the political and economic turbulence of the region, especially in Venezuela, but also in Mexico, Brazil and Argentina?

Our company doesn’t have investments in Venezuela at the moment and we would be hesitant to start interacting with that market precisely because of the on-going political uncertainty and the volatile economic environment. We have experienced a few difficulties in some of those countries, but, at the same time, we have been observing with great satisfaction the swift progress made by the new Argentinian administration under President Mauricio Macri. We are optimistic that Latin America is one of those regions where we still have a lot of work to do and where we can really contribute a lot and make a tangible difference. Argentina is an example of one of those markets where we have already made significant investments, in this instance with regard to the distribution of gas in Buenos Aires and where we aspire to do even more with the consolidation of the country’s reform process.

So far we have had the luck, or the sound judgment, to bet on serious countries that allowed us to invest and grow with regularity such as the Colombian, Chilean and Panamanian markets. Brazil is, of course, going through a bit of a purple patch as a result of the political instability, but part and parcel of setting up an emerging market’s portfolio is about being ready and prepared to deal with economic cyclicality. The name of the game is all about reaping the rewards as and when they arise and keeping risks to a minimum when markets you are engaging with are at the bottom of the cycle.

What is your blueprint for ensuring you are prepared and able to seize those opportunities that arise in emerging markets?

First, we already maintain contacts in these markets as we have commercial relations there, especially in LNG sales. We have therefore been able to amass a knowledge base over time with regard to the local business dynamics of those markets. The usual sequencing is that the midstream and downstream gas sectors have been managed and dominated by a public or handful of semi-public companies and the government of the day initiates a liberalisation reform that allows in the private sector and permits foreign investors like us to enter the market. We already have a good awareness of the market through our commercial activities and will be able to combine that with our experiences from other newly liberalised markets around the world. These qualities allow us to seize the initiative and get in quick as an early mover. We are also currently working on developing new business initiatives in the gas markets through projects with FSRU infrastructure as well as Small Scale solutions, with direct access to the end customer.

Our idea is to replicate this tried and tested sequencing in Asia as well, just as we have successfully done in Latin America. To date, we have established offices in New Delhi and in Singapore for example. Besides commercial contracts, we are trying to follow through on new emerging opportunities as and when they occur.

Returning to the European marketplace, Gas Natural Fenosa is renowned for having created one of the first LNG networks in the region. How do you intend to build upon this legacy and leverage your competency in LNG to plug some of the outstanding energy gaps?

In LNG, Gas Natural Fenosa possesses one of the most significant fleets in the Atlantic and this is certainly a market segment where we believe we have a great deal to contribute. A notable difference between the oil and LNG markets is that the LNG market is not as globalized and faces additional barriers. That withstanding, we identify great potential for LNG as a solution to some of Europe’s major energy security problems. Gas interconnection infrastructure between France and Spain remains minimal which means LNG takes on greater importance than would otherwise be the case. Currently, LNG is the obvious way to circumvent these kinds of bottlenecks where the fixed infrastructure network is clearly lacking.

Gas Natural Fenosa possesses the necessary midstream instruments to get to the downstream. Our interest is access to final clients, not to sell in organized markets. We aim to create long-term commercial operations with clients, making the supplies stable in terms of volume and price. Our European clients are pleased with this, which is helping us get to markets such as France and the Netherlands among others.

Furthermore, while the North of Europe is well connected with fixed pipelines from Russia and Norway, the South needs LNG so as not to be cut up into separate energy islands. This is why we took the strategic decision to develop our LNG capabilities and expand the coverage of our LNG fleet to include the Atlantic coast as well as the Pacific Ocean. At the same time, we have also been very engaged in the development of fixed pipelines in Southern Europe, notably the pipeline connections between Spain an Algeria. In the foreseeable future, however, we see LNG as essential to bolster and enhance Europe-wide energy security.

Spain is very keen to transition from an energy island encompassing the entire Iberian Peninsula to acting as an energy hub for Europe; what role could Gas Natural Fenosa play in this?

We clearly support the government initiatives to make better interconnections with Europe. We already have very good connections with Algeria, thanks to the two pipelines in which we participate. Due to the lack of interconnections with France in terms of gas and power generation, Spain sadly still feels very much like an island. This is a real problem because it prevents the creation of a single market and is pushing the country to develop singular regulation regarding power generation and supply. Therefore, we are supporting the government as much as we can, in their policy of developing integration with the European network. This is indeed an incredible commercial opportunity of course!

“Due to the lack of interconnections with France in terms of gas and power generation, Spain sadly still feels very much like an island.”

How do you see the current level of gasification within Spain?

One of our objectives is to increase the penetration levels of the current gasification in Spain. It is clear that, for climatic reasons, Spain will never attain the same gasification levels as Germany or the UK, but we should be able to achieve parity with neighbouring countries such as Italy and the South of France. We are working very hard to put in place all requisite infrastructures in terms of pipelines and refineries to be able to feasibly achieve this objective. This under-penetration is the main driver underpinning our steady growth in our gas networks regulated activity in Spain.

What innovation efforts have you put in place to optimize the business’s efficiency, and how prepared are you for a world that runs on more sustainable, cleaner energy sources?

Clearly in Europe, there are moves to run all power generation from renewable sources. However, not enough attention, in our opinion, has been given to setting up a backup plan for that new envisioned system. Natural gas is the only viable option to be used as back up for the system, but this is not clarified well enough in the economic planning coming out of the EU and member state governments in our view.

We are surprised by the European regulations. On the one hand, they are pushing for renewable investment, but on the other hand, they are burning more coal than ever. As operators, we will follow the authorities, but it would be nice to follow a policy that is more consistent and clear. Consistency is important because the energy that they require us to use is not contributing to fighting climate change. Clarity is vital and the pathway for the realisation of the 2030 vision remains undefined in our view.

All of the analysts agree that, along with renewables, natural gas is the energy of the future. We are well positioned, but also waiting to have clarification on the interconnections and on the policies applied to European production countries, which are too vague at this stage. Finally, we are very attentive to IT advances. It will help us to get closer to the clients and create new business opportunities.

How do you assess the competitive edge of the Spanish companies in the region and in the global arena?

There is a lot of competition and the entry barriers to unconventional and non-traditional markets are gradually disappearing, but Spanish companies are comparatively efficient. If we look at the efficiency ratios of the energy companies in both operational and economic terms (the return on investment), our company is well-positioned and top ranked in Europe. In Spain, the competition has been severe and the companies have been implementing remarkable cost-savings measures. A lot of companies are doing the same at a European level but in Spain we started before and were able to ride the early momentum, and this is the key factor of why Spain has internationally recognised companies that are playing an ever more important function globally!

On a more human level you are managing one of the biggest groups in Spain and Europe, some might say a huge “machine”! What are some of the keys of success as a CEO to keeping the show on the road?

The team! Without any doubt, they have been the vital ingredient. 20 years ago, the utilities business was considered a simple task. Now, it is much more complex and sophisticated. The only way of maintaining a line of growth and development is the diversification in business and locations. To do this you require a first-class team with a versatile array of talent.

Having been in the job for 12 years, what are your main priorities for the future?

The main priority remains long-term value creation through disciplined investing in profitable growth, done in a sustainable and environmental friendly manner for our customers, investors, and all stakeholders. Nowadays, we are particularly focused on delivering on our strategic plan, which involves greater efficiency and portfolio optimisation among other key pillars. In our case, we need to continuously analyse our strategic priorities and business portfolio to make sure these are aligned, and decide whether we have to reconsider a position or not.

From a more general perspective, we need to be attentive as to how to bridge the current situation with the visions for 2030 and 2050. Much remains unknown. Ultimately the path we pursue will depend on disruptive regulatory and policy decisions and the advancement of new technology that can trigger new opportunity. Many things can happen.

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