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Scope Ratings says the sector’s ratings headroom will shrink in 2021 and 2022 given high capex and temporary pandemic-related pressure on operating cash flow. Scheduled capex stands at more than EUR 100bn this year, led by France’s Electricité de France SA, Paris-based Engie SA, Italy’s Enel SpA, Spain’s Iberdrola SA, and the UK’s National Grid. About 20% of the total is earmarked for power grids while investment in generating capacity and other utility segments makes up much of the rest.

“Corporate treasurers will need to use all the funding tools at their disposal to ensure credit ratings are not put at risk,” says Sebastian Zank, analyst at Scope. “In addition to greater use of equity-linked funding including hybrid debt, we expect increased asset rotation and more conservative shareholder remuneration,” Zank says.

Take grid operators. Netherlands-based TenneT NV has turned to hybrid bonds to minimise the impact of rising capex on leverage ratios. Enexis, another Netherland-based firm, raised a subordinated shareholder loan from its sub-sovereign shareholders. Italy’s Terna SpA (A-/Stable) may consider a first-time hybrid issue.

“Upgrading and expanding power corridors and integrating increasing renewable-energy capacity, notably offshore wind, will ensure capex requirements run high, constraining free operating cash flow for years,” says Zank.

Integrated utilities are also under pressure to increase capex to defend market positions in electricity generation and distribution from the encroachment of integrated oil & gas companies, looking for new sources of long-term cash flow as environmental regulations bite, and financial investors.

The sector can withstand temporary pressure on free operating cash flow and greater indebtedness during the current capex phase, given the likely recovery of investments in the foreseeable mid-term future. As such, negative rating actions in 2021 will tend to be the exception than the rule, unless Europe faces an extended period of lockdowns with a prolonged adverse impact on industrial production and commercial activity. In this bearish scenario, utilities would have to contend with more downward pressure on prices, volumes and difficulty in collecting receivables.

Utilities will continue to be big users of hybrid bonds – making up 16% of the sector’s overall debt capital market funding in 2020, with large issues from EDF, Enel, EnBW, Engie, Iberdrola and Energias de Portugal SA.

“Utilities will exploit investor appetite for sustainability-linked securities by issuing more green bonds and hybrids to meet capex commitments and contribute to Europe’s ‘green’ post-pandemic recovery,” says Zank.

Green bonds issued by utilities, no longer the main source of ESG-related debt instruments, still make up around 40% of the total. European utilities placed about EUR 25bn of green and ESG-linked capital market debt in 2020, around one third of newly issued capital market debt placed by the sector.

Among the biggest issuers were Alliander NV, EnBW, Engie, E.ON SE, Gruppo Iren SpA, Terna and Vattenfall AB. Smaller utilities were also active, such as Spain’s Audax Renovables SA, France’s Neoen SA and Voltalia SA, plus Norway’s electricity suppliers including BKK (BBB+/Stable) and Lyse (BBB+/Stable).

Pressure on public finances after the unprecedented emergency fiscal support for business and households in 2020 could open more room for privatisation as governments look at ways to finance a post-pandemic recovery, says Zank.