European utilities face relatively minor short-term economic and financial consequences from the Covid-19 pandemic beyond the constraints on employees from lockdowns and sickness, says Scope Ratings.
However, much depends on the longevity and depth of the crisis, which might yet change the still stable credit outlook for the sector. Ultimately, a deep and prolonged recession would have repercussions on electricity demand and prices and the ease with which the capital-intensive sector can secure funding if the healthcare crisis triggers a deeper financial crisis despite policymakers’ best efforts. The ECB announced an EUR 750bn new bond-buying program late Wednesday.
“For utility executives facing a recession, the main economic uncertainty surrounds the impact of lower demand for energy – for electricity and gas – from the industrial and commercial sectors, considering that they are the main drivers of demand,”Sebastian Zank, an analyst at Scope
“Cash is king for any business facing a crisis, and here the significant cash cushions held by the 32 European utilities we track, plus their access to committed multi-year credit lines, should serve them well,” says Zank. Dividends could also be held back for 2020, if deemed necessary. Most utilities – let’s not forget – have outstanding subordinated hybrid debt that could defer interest payments. Liquidity issues due to upcoming refinancing, made more difficult under current conditions, are nonetheless unlikely to be severe given the reserves held by most utilities.
“Most utilities also have a large unencumbered asset bases; many are government-backed, which reduces the risk of liquidity shortfalls, while reducing or suspending dividends in 2020 would also free up cash,” he says. “Falling asset prices might open up defensive merger and acquisition opportunities too.”
“Still, we do not want to underplay the seriousness of the challenges the sector faces as Europe falls into recession amid significant economic and social dislocation.”Sebastian Zank
Industrial, commercial and public-services sectors are responsible for 60% of electricity demand. The industrial sector, excluding power companies, is responsible for around 30% of natural gas consumption in the EU. The pandemic has so far had a drastic impact on Europe’s automotive sector, for example, with Volkswagen AG, Europe’s largest manufacturer by sales, and much of the rest of the sector, suspending production at factories in Europe for want of components amid plummeting demand for new vehicles.
Zank says that the short- and medium-term effects will likely vary significantly across the energy utilities’ value chain: from generators with regulated and/or unregulated generation assets to energy transmission and distribution system operators and suppliers.
“Regulated grid operators and generators with a high proportion of regulated business in renewables are least affected from potentially decreasing demand,” he says. For example, Scope affirmed the A-/Stable issuer rating of Italy’s Terna SpA on 13 March and updated its rating case and financial forecasts for Encavis AG (held at BBB-/Stable) on 6 March.
Grid operators benefit from regulated tariffs, which are often based on load rather than on delivered volume. Regulators in many jurisdictions allow the recovery of lower volumes in later periods in case transmission and distribution volumes deviate from usual levels. Power generators that benefit from a guaranteed feed-in of generated electricity and fixed remuneration or remuneration for reserve capacity are also spared the risks associated with volatile pricing and volume risks.
Integrated utilities and generators with a large share of unregulated generation capacity are relatively more vulnerable to the impact of the pandemic as demand drops, putting downward pressure on commodity prices. Well established hedging by the sector will minimise the impact in the short to medium term, given the high proportion of one- to three-year hedged output. For example, France’s Engie SA hedged 80% of 2020’s outright production and 54% of 2021 production. Germany’s Uniper SE (rated BBB+/Stable) hedged 100% of outright production in Germany and 75% in the Nordics for 2020 and 45% and 15% for 2021. Finland’s Fortum Oyj hedged 75% for 2020 and 40% for 2021.
“Energy suppliers – those utilities closest to end-customers – are comparatively vulnerable to falling demand, prices and diminished cash flow as customers find it harder to pay bills on time or are unable to pay at all,” says Zank. Changes in bad debts (receivables write-downs) and working capital requirements, if receivables are collected later than usual, are trends to watch, he says.