The European engineering sector is worth close to 3,000 billion euros, employing nearly 20 million EU citizens and is comprised of approximately 375,000 companies, according to the European Commission. Interestingly, 90 percent of the European engineering industry’s incumbents are small and medium-sized enterprises, also known as SMEs. Since the early 1990s, these companies have come under immense pressure from increased foreign competition in low-cost centres, cheap imports and from outsourcing. As a result, there has been a massive reduction of around 20 percent in the number of SMEs in the sector. Recently tightened environmental legislation and the associated costs have further squeezed the bottom line. As the sector’s economic base has increasingly withered, many experts have alluded to a terminal decline.

On the bright side

On the other hand, the European engineering industry seems to have weathered the storm and finally returned to its former glory. Even Fiat, which was rumoured to be a takeover target while seriously struggling early in the millenium, turned a profit in 2007 despite cooling demand in many of its main markets. Mechanical and electrical equipment worth approximately 710,045 million euros was manufactured in 2007, according to figures published by the European Commission. In total during 2007, exports of machine tools were worth 471.7 million pounds, while imports were valued at 578.6 million pounds, according to the Manufacturing Technologies Association. As such engineering remains integral to the growth and sustainability of the economies of the European Union, building and maintaining infrastructure that is key to the stability of the continent. Many of the world’s biggest companies — including EADS, Siemens, Philips, Rolls-Royce, Atkins, Daimler, E.ON, Volkswagen, Porsche, Nokia, Gazprom and Shell — are based in Europe.

Combating the crunch

Despite the credit crunch bringing an end to cheap financing and causing a drastic cooling across the eurozone and global economy, 2007 was an extremely strong year for European engineering. The balance of firms recording a rise in orders and output for July, August and September 2007 was up 30 percent, with companies enjoying "sustained" growth, according to the Engineering Employers Federation. Strong demand and full orderbooks both point to high productivity levels and healthy activity. In addition, annual output grew by around seven percent in volume, corresponding to an 8.2 percent growth in turnover, according to the European Engineering Federation. This has led to more job creation, with employment levels rising by 1.6 percent across the industry from an estimated 10.6 million in 2006. All in all, 2007 was the best year for the industry since the recovery of 1995.

Still cautious

Unfortunately, experts believe the crunch will bite hard in 2009, eroding some of the recent success. While growth should continue, it will slow markedly as capacity constraints, the higher cost of capital and currency appreciation all eat into margins. The strong euro, which has been hitting all-time highs against the British pound and US dollar, will lower export demand and thus slow production growth to 4.3 percent. As output slows, job growth will cool to an infinitesimal 0.7 percent in 2008.

Skill shortage

The number of skilled candidates filling these positions looks set to fall. A survey by the Institution of Engineering and Technology (IET) found that 40 percent of UK companies believed they would not to be able to recruit the necessary number of engineers or technicians to meet their needs between now and 2010. The Confederation of British Industry (CBI) has also warned that the fall in graduates with core science and technology degrees will inevitably lead to a real skills crisis. As a result, many European engineering firms look as far afield as the BRIC countries (Brazil, Russia, India and China) to recruit new talent.

The problem can be traced to the number of graduates completing engineering-related degrees at university. In the UK, for example, in the past decade, the number of applicants for engineering courses has decreased from 11 percent to eight percent of the total number of university entrants. According to some estimates, applications to study electronic and electrical engineering were down by 17 percent last year. Applications for mechanical engineering were also down six percent. Close to half of those who do graduate with engineering degrees have been entering unrelated disciplines such as finance, energy, transport and communications.

Oil and gas: cyclical industries

Some suggest it is the cyclical nature of industries associated with engineering that has pushed graduates towards other fields. Oil and gas, probably Europe’s biggest industry and certainly the major employer of graduates, is seen as one of the most cyclical industries in the world, greatly affected by both domestic and external factors, especially geopolitics. In 2007 and 2008, oil prices touched all-time highs as political instability and volatility across major producing regions intensified fears of a supply shortage. At the same time, as many refineries were offline, OPEC could not ramp up production because of capacity constraints. So even though 2007 was a good year for engineering as a whole, some firms in certain industries suffered. For example BP, the monolithic British oil major, was forced to restructure its operations as high oil prices weakened margins and eroded profits.

On the other hand, some companies associated with oil and gas flourished in 2007. For example, Atkins, the UK’s number one engineering consultancy, increased its revenues by 20 percent and its profits 19 percent to 81.7 million pounds. Atkins is a key figure in maintaining and modernising key British infrastructure, particularly the antiquated oil rigs of the North Sea. Shell, the Dutch oil major, earned profits of one million pounds a minute throughout 2007 and 3.9 billion pounds in the first quarter of 2008, buoyed by high oil prices and successful trading strategies.

Innovative?

Only ten European outfits made a recent BusinessWeek ranking of innovative companies from around the globe. North American companies dominate the list, with Asian companies second. However European firms still fare very well. Finnish mobile telecommunications company Nokia came tenth on the list, which alludes to Europe’s position as a leader in mobile technology, very much a zeitgeist industry. Europe also leads the way in innovation in the automotive industry: BMW, Daimler and Audi — a member of the Volkswagen group — are all included in the list. These are all German-domiciled companies.

Smaller engineering companies in Europe have profited from supplying the machinery used by manufacturers around the world, including in China, India and Russia. In Germany, for example, the country’s innovative and hardy engineering sector is a primary driver behind the economy’s resistance to global economic turmoil. Britain’s world-class research universities house some of the greatest engineering minds in the world.

Buying power

Talk of M&A activity in the UK mid-market engineering sector was rife during spring of 2008. Enodis, the food equipment manufacturer and supplier of building and consumer products, was reportedly subject to a bid from US firm Manitowoc, looking to cash-in on falling stock prices. Suez, a Franco-Belgian energy group, merged with France's Gaz de France, after shareholder approval was finally given in September 2007. E.ON, the German energy producer, was linked with a bid for nuclear power station operator British Energy, which has a market value of around 15 billion dollars and produces one-sixth of Britain’s electricity. Électricité de France, the French state-controlled utility, was also in talks with Britain’s Centrica to team up and bid for British Energy, which could create a European energy powerhouse.

These rumours sparked speculation among analysts that there could be a spate of deals as the industry further consolidated amid toughening economic conditions, with synergies a primary deal motivator. As well as cheap valuations and strong consolidation prospects, many of Britain’s mid-cap engineering firms are attractive targets as they have strong balance sheets with low levels of debt.

European engineering firms were both eager acquirers and targets during 2007. According to Dealogic, 1,689 deals were completed across the sector at a cost of 262.3 billion US dollars. Metal and steel producers experienced the highest deal value overall, with 94 billion dollars worth of transactions completed. Producers of general industrial machinery were the most active sub-sector by deal volume, taking part in 369 deals worth approximately 22.3 billion dollars. One of the sector’s biggest deals was the planned takeover of Spanish utility Endesa SA by Spanish engineering group Acciona SA and Spanish utility Enel SpA, which experts valued at 66 billion US dollars.

While the first half of 2007 was a big year for buyouts and M&A across all sectors, activity slowed dramatically during the second half of the year as the incredibly well-reported credit crunch brought an end to cheap financing. Most activity within the European engineering sector remained stable however, highlighting its resilience to cyclical economic downturns.

Amidst all this economic change, the future of resources remains a big question: where are future energy supplies actually going to come from? Reserves of North Sea crude oil continue to dwindle. Eight years ago, Britain was the world’s sixth-biggest producer of oil and gas — by 2006 it was the 12th-biggest. In July 2007, the International Energy Agency said the drop in production had been steeper than expected, and it is expected to continue. Spain’s Repsol YPF revealed in April 2008 that its Argentine oil and gas proven reserves had dropped 20.3 percent in the course of two years.

At the same time, major energy producing countries are becoming increasingly unstable. The “Russian Bear” has gotten its swagger back through energy imperialism, using its vast oil and gas reserves to increase its political clout. As a result it has become erratic in its treatment of trade partners. Piracy in Nigeria is rife, with oil rigs and shipping being constantly disturbed. The Movement for the Emancipation of the Niger Delta is frequently claiming responsibility for attacking oil rigs and crews, demanding a share in oil profits, which is adding to the politically unstable mix. Oil is a finite resource and much of the world’s proven resources are embedded in places such as Canada’s oil sands. This means oil is very tough to extract and it is expensive to do so.

What does all this mean for engineering? First, that the industry has an absolutely central role to play in securing energy supplies at a most challenging time. With climate change increasingly seen as a real political and social issue — even Richard Branson has tried flying his Virgin fleet on nut oil — those supplies need to be renewable. In Germany, for example, renewables already represent a significant portion of the energy industry’s income and expenditure. Renewables now account for 6.7 percent of total energy consumption in Germany, up from 5.5 percent in 2006. Turnover of the German renewables industry was up ten percent at 24.6 billion euros in 2007, nearly four times the figure of 2000. Electricity generated from renewable sources reached 14.2 percent in 2007. E.ON, the country’s predominant energy producer, is actively expanding its renewable energy business. Most recently, E.ON announced its interest in Babcock & Brown Ltd’s European wind park division, valued at approximately three to four billion euros.

The search for renewable energy sources and development of infrastructure is a major opportunity for the industry to combat the tougher economic conditions that will confront it through 2008 and 2009. Leading firms need to work to develop the technology that can make biofuels and renewables efficient for the benefit of the environment, society and their own coffers.

However, immediate profits are still coming before the environment according to some experts. BP recently considered floating or selling its renewable operations, which it values at 3.5 billion pounds. And the sustainability of the world’s offshore wind farm, and a major contribution to Britain’s renewable future, was called into question in spring 2008 after a primary investor pulled out. Shell announced it was selling its 33 percent stake in the two billion pound London Array off the coast of Kent to invest in more lucrative oil projects. Environmentalists criticised the firm for selling off its solar and wind businesses to invest further in Canada’s distinctly environmentally unfriendly oil sands (Canada’s oil sands, primarily in Alberta, are allegedly home to the second-largest reserves of oil in the world after Saudi Arabia).

According to E.ON, the London Array was under threat after Shell’s announcement, as rising steel prices, bottlenecks in turbine supply and competition almost completely eroded profit margins.

Finding food

The food crisis is the biggest challenge facing humanity. More than 100 million people could be forced into deep poverty by rising food costs, according to the World Bank. Decreased rainfall, linked to climate change, and a world population expected to grow from six- to -nine billion by 2050 means food supply and prices will be further squeezed.

While developing countries, particularly those that rely on imports, face famine and economic ruin, the west are at risk as never before. Urban sprawl, biofuels and the growing appetite for meat among the emerging middle classes of China and India are limiting the amount of land available for food crops: while more space is required for cultivation, available land is actually decreasing. This is where engineering comes in. New processes such as precision farming and technologies that reduce external crop reliance need to be developed if the crisis is to be effectively tackled

Going forward

Prospects for 2008-2009 still appear to be positive for the engineering sector, led by both direct and indirect export demand from Europe. With credit problems expected to recede by the end of 2008, boosted liquidity should allow firms to take advantage of cheaper financing again. As a result, current rumours of a buyout bonanza may become reality. The energy sector looks especially ready for a bout of consolidation as unbundling continues. At the centre of these deals will be EDF, the biggest European energy group by market capitalisation. EDF is, of course, immune to takeover as 85 percent of its shares belong to the French government. As a result it can cross national boundaries, and after being thwarted in Italy, Britain and Spain look likely targets.

However, protectionism is notoriously rife when it comes to cross-border energy deals. State intervention was commonplace in prospective energy deals during the 1990s and this continues to the current day. In the spring of 2008, Spain’s prime minister, José Luis Rodríguez Zapatero said he wanted utilities firm Iberdrola to combine with Gas Natural in order to fend off a bid from EDF. France is planning to create an energy giant through a link-up between Areva, the world's biggest nuclear company, Alstom, an engineering group, and Bouygues, a construction and telecoms conglomerate, in order to fend off cross-border bids for any of the firms.

Protectionism aside, a new cross-border European energy powerhouse may well be a reality by the end of 2009, as unbundling continues apace. Such a move could signify a change in protectionist attitudes and further breakdown of trade barriers in the EU.

All in all, European engineering has defied its critics. Those who sounded the death knell of the industry have been unequivocally proven wrong, as major European companies have continued to succeed despite intense competition from low-cost countries. Although many jobs have been outsourced to these regions, the high-productivity and high-technology core of most firms remains in Europe. As this technology becomes increasingly important in addressing some of the world’s major problems, and European engineering firms, such as Corus and ThyssenKrupp, continue to supply the world’s biggest manufacturers, the redefined sector looks set to prosper.