As the world switches to low-carbon energy, some oil, gas and coal reserves will become worthless because they cannot be exploited profitably. The phrase ‘carbon bubble’ refers to the possible overvaluation of companies owning these fossil fuels.

But is not just oil, gas and coal companies which are susceptible to the risk. Carbon bubbles also threaten businesses that sell equipment to the users of these fossil fuels. In one of the first examples, the demand for gas turbines has slumped in the last few months, causing dramatic falls in the value of the businesses that make and service this expensive equipment. Many other industries - including the automotive and chemical engineering sectors - will go through the same painful transition.

Installing and servicing gas turbines in power stations to make electricity was a $50bn global industry. Until a few months ago, the three international conglomerates that dominate this business said they were confident of continued demand. Although recognizing that the world is switching to renewable energy, they thought that gas will always be needed as a backup fuel for generating electricity. In the conventional view, the market will also be buoyed by utilities switching from coal to much cleaner natural gas.

So even as late as July 2017, Mitsubishi Heavy Industries (MHI) was predicting that orders in its gas turbine division would be up 15% in the current financial year. Operating profit would rise 31%. GE reported that revenues from its turbine activities were up 5%, surmising that it was gaining share because of its advanced technology. Its published forecasts for 2017 remained unchanged. And although the more cautious Siemens had begun to notice significant falls in orders by mid-year, as late as April it recorded a 4% increase in quarterly sales.

Careful analysis might have identified serious problems with the gas turbine business in the previous year but none of the three major participants expressed any public concerns. Contractions of sales and profits were presented as temporary or cyclical. But by the end of September 2017, a very much sharper fall had set in and the earlier optimism suddenly disappeared. The huge conglomerates which install and maintain turbines were finally forced to admit to intractable problems requiring immediate and painful action.

Over a period of a few weeks in October and November a slew of announcements from all three companies came out, admitting to serious deteriorations in financial performance. Janina Kugel, a Siemens management board member, said ‘the market is burning to the ground’ and that the world was switching ‘extremely quickly from conventional to renewable energies’. In another comment, her senior colleague Lisa Davis said that ‘the power generation industry is experiencing disruption of unprecedented scope and speed’. The company indicated that it would close factories and reduce its staff by about 6,100 people.

GE went further and fired 12,000 people around the world, almost 20% of the staff in its turbine business. The cash flow from the division for 2017 would be $3bn less than predicted a few months before, it announced, explaining that the last quarterly results were ‘sharply lower than we expected’. The company’s overall performance in the three months to the end of September had been ‘completely unacceptable’ and blame was principally laid at the door of the power generation segment. Forecasts for turbine sales in 2018 were reduced by 35% below the already shrunken number for 2017. Expectations for revenues from maintaining and upgrading power stations were also sharply cut. Both the CEO of the division and the chief financial officer of the holding company were replaced.

MHI sharply cut its projections for orders, sales and profits. It had shipped only 4 large gas turbines from April to September 2017, half what it had sold a year earlier. The company announced a change of strategy, promising – in the words of the divisional president - to focus on servicing existing turbines rather than selling new products because ‘all around the world we are witnessing a rapid shift away from fossil fuels and towards renewable energy’.

In early November Siemens published estimates showing that the total number of large gas turbines installed in all power stations will fall from 180 in 2016 to a projected 110 this year, a cut of almost 40% in two years.[i] GE intitally gave some similar figures, suggesting that electricity companies installed just 40 gigawatts of gas turbines around the world in 2017, down from more than 70 gigawatts earlier in the decade and about 130 gigawatts around the year 2000. In its most recent results announcement, it moved its estimate down again and suggested that the figure for 2018 will be less than 30 gigawatts, a multi-decade low.

Source: Siemens AG. Number for 2018-20 is the forecast for each year in this three year period

As importantly, Siemens publicly estimated that the prices it can charge for large turbines had collapsed 40% in the last three years as a result of industry over-capacity. In value terms, gas turbine sales have therefore fallen to a fraction of just a few years ago.

The three dominant suppliers had bought up smaller manufacturers in the last few years and had successfully disguised – to themselves and to most outside analysts – the scale of the drop in the underlying market. Until the last months of 2017, none of the announcements from the three top companies voiced any concern about the resilience of longer-term turbine sales. Similarly, all three had assumed that servicing existing turbines would continue to bring in important revenue.

But by the end of 2017, ancillary revenues were down almost as sharply as those for new large turbines. No-one had predicted this. Existing gas-fired power stations around the world are working for fewer hours each year as renewables ramp up. This is reducing the need for emergency repairs and increasing the interval between regular services. The owners of barely profitable power stations face harsher financial times as wind and solar offer ever-cheaper electricity. So upgrades to the performance of existing gas turbines have been delayed or abandoned. GE had forecast sales of 36 turbine enhancements in the quarter ending in September 2017. Power stations actually bought 13.

Perhaps most surprisingly, the sale of smaller gas turbines, designed to respond quickly at those times when big power stations cannot cope with demand, also collapsed. Sales forecasts for 2017 were cut to half the number GE projected just a few months earlier. In the most recent quarter (ending December 2017), it shipped just 3 small turbines, down 90% on a year earlier. Peaks in demand are increasingly being met by ‘demand response’, or the managed reduction in electricity use at times of scarce supply. In times to come, large batteries will also help match electricity demand to the amount available. Electricity companies are aware of this and are reducing purchases of smaller turbines.

Performance across all parts of the turbine business fell well below predicted levels in all three companies. Share prices went lower compared to major indices. GE suffered the most, with its stock falling almost 30% in relation to the S+P 500 index between the first announcement of problems in late October and the end of 2017. GE has other troubled businesses, but the unexpectedly poor performance in the turbine segment is partly - perhaps largely - responsible for this decline of nearly $60bn in market value.

MHI saw a smaller fall of about 11% of its value against the main Japanese index between the announcement of declining profit expectations and the end of the year, costing shareholders around $1.4bn. Siemens’s share price fell by about 7% in the week after the initial presentation of the turbine division’s problems on 9th November, reducing its value by over $8bn. The share price has recovered somewhat since and the loss relative to the German index was only about $3bn by the end of the year. And, it should be said, problems in the wind turbine portion of its business may also have affected the share price.

It may be that the global gas turbine business will eventually recover. But the head of the Siemens power generation division, Jurgen Brandes, spoke eloquently in a conference call with journalists on 16th November 2017 to suggest that his company has now accepted that many of its factories, skilled people and technical expertise will not be needed in the future. After expressing amazement at the recent decision of a country such as Saudi Arabia to switch decisively to renewables, he went on to say ‘There are global trends coming that really indicate that this is a structural shift, a paradigm shift’ away from fossil fuels.

The decline in the gas turbine market happened quite slowly for several years. The largest participants avoided most of the consequences by buying struggling competitors. But the contraction sharply accelerated in the second half of 2017, sliding at a pace that was shocking to some of the most sophisticated companies in the world. Which global industries are going to suffer next from the swing away from fossil fuels?

(Please contact me if you would like a copy of the full text of the detailed report I have written on the events of September-December 2017 in the gas turbine market).

Chris Goodall

Visiting Researcher, Imperial College Business School

chris@carboncommentary.com

+44 (0) 7767 386696

[i] https://www.siemens.com/investor/pool/en/investor_relations/financial_publications/speeches_and_presentations/q42017/171109_q4_presentation_en.pdf Page 9