December 29, 2023 - PEGRF
Pennon's Desalination Gamble: A Hidden Climate Change Risk Investors Are Missing
The world is changing, and Pennon Group Plc (OTCPK:PEGRF), a U.K. water provider, is betting big on desalination as a solution to the growing water stress in their service area. On the surface, it seems like a logical move, especially in the face of the hottest, driest year on record in the Southwest. However, a deeper dive into their recent earnings call transcript reveals a concerning reality: Pennon's reliance on desalination might be a significant climate change risk that investors are overlooking.
Pennon's strategy, as outlined by CEO Susan Davy, is to diversify their water sources. With 90.5% of their supply relying on surface water – rivers and reservoirs heavily impacted by the drought – desalination seems like a lifeline. But this seemingly innovative approach masks a fundamental issue: desalination is energy-intensive. While Davy mentions exploring renewable energy options for powering these desalination plants, the specifics are vague. This lack of detail should raise red flags for investors.
The transcript highlights Pennon's commitment to mitigating wholesale power market risk by investing in renewable energy projects. They plan to deploy £160 million in such projects and are targeting generating 50% of the group's energy needs through these initiatives. But here's where the potential conflict arises: how will Pennon balance the competing energy demands of their core business and the burgeoning desalination operations?
The transcript lacks concrete data on the projected energy consumption of the desalination plants. Without this information, investors are left in the dark about the true impact on Pennon's energy portfolio and their overall carbon footprint. If Pennon fails to adequately power these plants with renewable energy, they risk exacerbating their carbon footprint, especially considering the UK's energy mix still relies heavily on fossil fuels.
Hypothetical Scenario: Desalination's Impact on Pennon's Energy Consumption
Let's consider a hypothetical scenario. If the desalination plants require, for example, 10% of Pennon's total energy consumption, and only half of that is met through renewable sources, it would significantly impact their 2030 net-zero target. This potential increase in carbon emissions could attract negative attention from environmentally conscious investors and lead to potential divestment.
Furthermore, the transcript downplays the cost implications of desalination. While it is portrayed as a solution to water resilience, the long-term operational costs, especially in an environment of rising energy prices, are largely unaddressed. This lack of transparency regarding operational cost projections might be masking a significant financial risk associated with the desalination strategy.
Pennon's proactive communication about their environmental performance, including their WaterFit program and achieving 100% bathing water quality, might be overshadowing this hidden climate change risk. Investors, impressed by the positive messaging on environmental initiatives, might be failing to see the potential downside of the desalination strategy.
Pennon's Financial Performance
The transcript is filled with positive messaging about efficiency and outperformance. They boast a £225 million outperformance in K7, allowing for reinvestments and customer benefits. However, this outperformance, used partly to fund the desalination projects, might be masking the true cost of their water resilience strategy.
| Metric | Current Transcript | Previous Transcript | Performance Change |
|---|---|---|---|
| Underlying EBITDA | Down slightly YoY due to higher costs | Not available | Not available |
| RORE | 7.9%, doubling base returns for K7 | Double base returns for 2022/23 | Potentially stable |
| Capital Investment | Up 87% in the half year | Up 30% in the half year | Significantly increased |
| Gearing | Stable at 61% | Water business degeared to 58% | Slightly increased |
Pennon Group's history is deeply intertwined with the region's industrial past, having once been involved in China clay extraction, a process that reshaped Cornwall's landscape. Now, their foray into desalination represents another significant intervention in the region's environment. While this might seem like a necessary step in the face of climate change, the potential environmental and financial risks, particularly regarding energy consumption and carbon emissions, cannot be ignored.
Investors need to demand greater transparency from Pennon regarding the specifics of their desalination strategy. Without detailed information about the energy consumption of these plants and their impact on Pennon's carbon footprint and financial performance, the company's seemingly innovative approach to water resilience might be a gamble with far-reaching consequences.
"Fun Fact: The energy required to desalinate one cubic meter of seawater can power a 100-watt light bulb for almost 7 hours! This highlights the energy intensity of desalination and the crucial need for renewable energy sources to power these plants."
