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Is the post-credit crisis zombie economy the get out of jail card the energy sector has been waiting for?

17 November 2009

PA Consulting Group launches new book The zombie economy: leadership in times of uncertainty  

The UK energy industry is facing its biggest challenge to date, a zombie economy and a chronic need for new power generation.  About 50 % of the UK’s generation capacity will close by 2020 and the industry is tackling this problem in a new reality of half alive, half dead zombie banks, governments, consumers and companies. This raises the risk that the liquidity required to fund these investments will not be present, will be highly risk averse, or will be expensive.  

This creates a real threat of the lights going out, creating a true ‘Night of the zombies’. But this threat could also be an opportunity to the sector according to PA Consulting Group’s book ‘The zombie economy: leadership in times of uncertainty’. 

What is the zombie economy?

The zombie economy is made up of not quite dead banks, governments, consumers and companies staggering along, struggling to function in the new world:

  • Zombie banks whose balance sheets are too weak to support sufficient lending.  Banks may be declaring huge profits but their recovery is partly an illusion.  Losses of $3.4 trillion in the financial system have still not fully unfolded.

  • Zombie governments whose finances are too stretched to sustain expansionary policies. Highly expensive government intervention means debt to GDP rates are set to rise to levels not seen outside war-time.

  • Zombie consumers whose wealth is too depleted to allow them to consume. Because of the state of the economy in general, and bank lending in particular, US consumers are spending 5% less of their disposable income – they will be unable to act as the world’s ‘consumer of last resort’.

  • Zombie companies the combined impact of zombie banks, governments and consumers is exerting a powerful negative force on companies. They are saddled with debt that they cannot comfortably service, impeding growth and investment. UK Corporate insolvencies are now at record rates. 

The threat of the zombie economy on the energy industry

Ofgem estimates that £200bn needs to be spent by 2025 to secure the UK security of supply. Privatised energy companies have already strained balance sheets and will need to find investment.  In the highly illiquid world of zombie banks this will be a challenge. Zombie governments also have large fiscal deficits and private equity is a shadow of its former self. The International Energy Agency estimates that $90bn of projects were cancelled last year and that renewables were worst hit with a 19% drop and the difficulty of raising finance in the markets is exacerbating the challenge of security of supply. 

The opportunities

This slowdown however creates an opportunity for the industry.  Energy demand has dropped by 4.5 per cent this year as both major companies and consumers tighten their belts in the face of high energy costs.  This decrease in demand reduces the risk of power shortages and gives the industry the time and breathing space it needs to plan and implement the low carbon energy economy. 

Ted Hopcroft, energy specialist at PA Consulting Group, says:  

“As it stands the UK energy sector is in a twilight zone and is faced with the very real prospect of the lights going out.  An already challenging investment programme is made more onerous by the lack of liquidity and investment funds in a zombie economy. 

“However, the zombie economy presents an opportunity for the sector to take stock and become the phoenix, re-inventing itself for a new diversified business, based on low carbon sources, localised generation and a smart grid. The zombie economy could return the sector to good health.”  

You can request a copy of The zombie economy: leadership in times of uncertainty here

-ENDS-

 

Notes to editors

About Living with Zombies: Leadership in times of uncertainty

Living with Zombies: Leadership in times of uncertainty is written by Mark Thomas, head of strategy and marketing at PA Consulting Group, with contributions from PA sector and function specialists.  The book is based on a detailed analysis of the 2009 half-year results for over 600 US and UK companies, using data drawn from the Bloomberg database.

Who are the zombies?

We use the term ‘zombie’ because these individuals and institutions do not cease to exist, but they do become unable to perform the functions that we expect of them in supporting growth of the economy: zombie banks cannot lend as we need; zombie governments whose finances are stretched, zombie consumers cannot consume and zombie companies who are saddled with debt that they cannot comfortably service.

The book identifies winners and losers and the likely impact on industry restructuring, sector by sector.  This analysis is based on two critical factors – the liquidity factor and intrinsic value. The liquidity factor is a compound index made up of a weighted average of: Acid-test ratio; Dividend cover; Gearing; Interest cover; with the greatest weight on interest cover. Intrinsic value is estimated using a simplified (and slightly conservative) form of the discounted cash-flow model assuming: long-run ROE equal to the average of the last 5 years’ ROE for each company; long-run growth rate in line with economic growth at 3 per cent nominal; cost of equity at 10 per cent.

About PA Consulting Group

PA Consulting Group is a leading management and IT consulting and technology firm. Independent and employee-owned, we operate globally in more than 30 countries and transform the performance of major organisations in both the private and public sectors.

From initial idea generation and strategy development through to detailed implementation, we deliver significant and tangible results. We have outstanding technology development capability; a unique breadth of skills from strategy to performance improvement, from HR to IT; and strong expertise in communications, media and entertainment, defence, energy, financial services, government and public services, healthcare, international development, manufacturing, transportation and logistics, and water.

   
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