European utilities face a resurgence in political and regulatory risk in 2019 just as the rebound in commodity prices, responsible for improving profitability and leverage ratios of most power generators in recent years, levels off, says Scope Ratings.
Scope has changed its outlook on the sector to Stable from Positive. Utilities most at risk of feeling financial strain and pressure to their business profiles are those holding heavy CO2-emitting assets and those exposed to nuclear and coal generation, such as EDF, DEI, RWE, PGE, EnBW or CEZ. While many utilities have re-established some financial headroom for mergers and acquisitions--one of the possible responses to further pressure to adjust their portfolios--growing competition for infrastructure assets from institutional, foreign and often state-linked investors and oil & gas companies has helped push asset prices higher.
Scope says that overall European utilities’ credit quality will remain solid on average. Most power generators have succeeded in preserving credit quality amid multibillion-euro asset-rotation programmes, aimed largely at enhancing low-CO2 generation and growing regulated or contracted activities. The rebound of wholesale prices has helped further, with average 1-year-baseload-forwards in Germany closed in 2018 being 33% higher than the average in 2017 or even 60% higher than the average in 2016. Similar patterns hold in other European markets. Such improvements in cash-flow profiles are reflected in the ratings. Lower wholesale prices are a threat to future cash flow, though only likely after 2020 when utilities’ recent hedges run out.
Grid and network operators also face continued heavy capital expenditure, resulting in many cases high capex/revenue ratios above 40% and negative free cash flow. This should be just temporary until compensating regulated tariff increases kick in.
“The big change is that political risk is back centre stage, in the form of stricter environmental regulations and a more nationalist tone to energy policy which risk squeezing credit metrics in the years ahead,” says Sebastian Zank, analyst at Scope.
The EU has adopted a tighter binding renewable-energy target of 32% for 2030, up from the previous goal of 27%, without setting priorities for how future power will be generated or issuing tenders for new capacity. Various EU members have also pledged to phase out coal power.
Discussions continue about the safety and perceived need for reduced dependency on nuclear reactors in Belgium and France, the two European countries which both derive more than half their electricity from nuclear power. EU countries are also considering limiting which power plants can take part in capacity schemes according to stricter CO2 emission criteria.
“Electricity price caps are again on the agenda,” says Zank. Popular concerns about rising electricity prices and utilities profits, may empower regulators, such as Ofgem in the UK, to set ceilings on price increases.
The rush of foreign-investor interest, particularly from entities from China and the Middle East, in European infrastructure assets, notably in the energy sector, has led some European governments to re-assess the strategic importance of the energy sector. Preventing foreign takeovers or re-nationalising energy companies may deter further foreign investment.
“Rising political and regulatory risks have a double impact: As well as putting off some potential investors, they raise the risks for existing investors who may discover they have mispriced energy assets, resulting in lower-than-expected returns if not losses,” says Zank.
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About Scope Ratings GmbH
Scope Ratings GmbH is part of the Scope Group with headquarters in Berlin and offices in Frankfurt, London, Madrid, Milan, Oslo and Paris. As the leading European credit rating agency, the company specialises in the analysis and ratings of financial institutions, corporates, structured finance, project finance and public finance. Scope Ratings offers a credit risk analysis that is opinion-driven, forward-looking and non-mechanistic, an approach which adds to a greater diversity of opinions for institutional investors. Scope Ratings is a credit rating agency registered in accordance with the EU rating regulation and operating in the European Union with ECAI status.
