European utilities: continued electricity price hedging promises producer gain, consumer pain
By Sebastian Zank, Managing Director, Corporate Ratings
While new hedges are likely to be closed at lower price levels than last year, the favourable impact of closed positions will likely be material for the earnings of utilities with significant hedged positions at least until 2024.
What is good for the earnings and credit metrics of the utilities in question is detrimental for the off-takers of generated electricity – e.g., traders and ultimately industrial/commercial/private consumers – which will have to bear the cost of elevated prices for an extended period.
Utilities reduced hedging activities on future markets during the energy price crunch last year in which they had to put up large amounts of cash as collateral. However, their hedged volumes for 2023, 2024 and 2025 remain significant. Some of Europe’s largest European energy producers such a CEZ Group, Engie SE, Fortum Oyj, Vattenfall AG and Verbund AG had hedged 60% or more of electricity generation volumes for the current year (see Figure 1) at year-end 2022.
Figure 1: Hedging volumes of outright generation volumes of major European utilities
* Axpo with deviating business year which ends in Sep; estimated hedging volumes based on total recurring generation volumes.
** EnBW reports ranges for hedged volumes. Column reflects midpoints.
Sources: company reports, Scope
Lower spot prices could give consumers false sense of security
We assume that many more electricity utilities have similar levels of hedging though some big players such as Eléctricité de France SA, Enel SpA and Iberdrola SA no longer disclose such information. Utilities typically hedge a large portion of their generation expectations over one- to three-year time horizons. They sell most of the electricity they generate in advance on futures and/or OTC markets to smooth cashflow amid often volatile market prices as well as hedge commodity market risk.
As a result, the recent decline in spot market electricity prices and likely prices for new hedges are misleading to the degree that they suggest immediate relief for electricity consumers. Consumers should beware of thinking that the worst of energy inflation is over.
Utilities have locked in prices at significantly higher levels than those of previous years and will be charging accordingly (see Figure 2). Still, despite the relaxed picture on the spot market, current one-year or two-year ahead wholesale prices of significantly more than 50 EUR/MWh are something that few utility CEOs would have dared hope for until recently.
Figure 2: Hedged prices locked in (EUR/MWh) compared with past average achieved prices
Sources: company reports, Scope
Favourable hedged prices will provide prolonged support for utilities’ EBITDA from generation assets, which will overall strengthen credit quality as only a part of extra earnings will be taxed away. We presume that a significant portion of net earnings will be accrued and not distributed to shareholders via dividends/share buybacks, thus reducing external funding requirements within the changed interest-rate environment. Hence, we expect pricing to be credit-supportive for electricity utilities, particularly those with a strong position in low-carbon power generation.
The durable nature of the improved pricing for European utilities’ performance is visible in our rating actions, with several positive changes in Scope’s portfolio which comprises more than 50 European utilities, of which 32 relate to integrated utilities and power generators (see Figure 3).
Actual and forecasted leverage metrics (Scope-adjusted debt/EBITDA) of utilities with significant electricity generation will likely benefit at least until 2024, resulting in credit metrics, such as leverage, that are expected to come in below the historical average (see Figure 4). Norway’s Statkraft AS reported a net cash position, Verbund AG and CEZ a.s. have reported record-low leverage at YE 2022.
Figure 3: Rating actions for utilities with significant power generation exposure in 2022 and YTD 2023
Under review placements not included
Figure 4: Leverage (Scope-adjusted debt/EBITDA) for European utilities with significant exposure to electricity generation under Scope’s coverage
32 European utilities excluding pure grid operators
One possible cloud on the utilities’ horizon is the planned reform of Europe’s energy market which is aiming at reducing dependence on fossil fuel prices, fostering investment in renewable energy and keeping electricity prices at a digestible level of consumers. However, any redesign is most likely to be evolutionary rather than revolutionary, judging by the current EU proposals (Revision of the EU Electricity Market Design, and unlikely to change the short- to medium-term pricing outlook for the utilities and their customers.
New measures, with defined proposals due by May next year before elections for the EU parliament, will likely aim at the price regulation in any renewed energy price crisis and accelerated usage of power purchasing agreements. This will still allow utilities to earn healthy margins on generation capacities with low levelized costs.
Scope currently rates a portfolio of 53 European utilities on a public, private and subscription basis. Subscription ratings can be found exclusively on the investor platform ScopeOne.