Burning issue

IFR Germany Report 2012
10 min read

Despite the headline-grabbing prospects of green energy, new conventional power plants will be needed to meet German demand but indebted utilities may be reluctant to invest and some are issuing exotic hybrid bonds to address shaky finances.

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Bold plans to shut 17 nuclear plants by 2022 has focused attention on Berlin’s commitment to renewable energy, but the success of this radical green agenda will depend on investment in new conventional power stations.

The ambitious experiment will force the country to find a low-carbon energy source to replace nuclear – which meets about a quarter of Germany’s electricity demand – likely to be natural gas.

A global abundance of gas is fuelling an exploration bonanza, yet the cost of nuclear decommissioning, tough market conditions and high debts mean Germany’s energy giants will fight shy of investing in gas-fired power plants.

Existing strains on a fragile electricity network has prompted some commentators to question both the decision to switch off nuclear and the 2022 deadline.

In an apparent effort to demonstrate that sufficient capacity is planned to replace it, on April 23, Germany’s main energy lobby group BDEW put a positive gloss on plans by utilities to invest up to €60bn in 84 new plants – conventional and renewable – by the end of the decade. But BDEW managing director Hildegard Mueller admitted the list presented “an optimistic view of investment developments” and that many projects may not materialise.

The closure after last year’s Fukushima crisis in Japan of eight nuclear reactors has placed Germany’s grid under pressure, underlining calls to build new gas plants, which have competitive advantages over coal.

No rush to build

But the big corporations that dominate the market – local players RWE, E.ON and EnBW along with Scandinavian Vattenfall – are in no rush to build them.

Bad results last year underlined how the days of debt-fuelled expansion are over and restructuring is under way. As renewables gather pace, the utilities fear gas plants will be seen merely as a standby to fill gaps left by clean energy. Renewables now have supply priority over fossil fuels, undermining the competitiveness of gas and making the high cost of constructing and operating new plants unattractive.

Dr Matthias Lang of Bird & Bird, a lawyer who specialises in the energy market, said new regulatory rules might now be required. “The statutory priority for renewable power under the Renewable Energy Sources Act means that as long as renewable power is available, you cannot sell your conventional power. The higher the percentage of renewables, the lower the remaining quantity for conventional. Anybody – not just established utilities – will only invest if they think the regulatory environment makes it likely that there will be a sufficient return on the investment.”

Essen-based RWE has already said it would not build new gas and coal plants after 2014, Düsseldorf’s E.ON is intent on expanding outside Europe, and other operators are delaying decisions until the investment climate improves. In January the municipal utility Rhein Energie postponed a decision to build a new gas-fired power plant near Cologne, and in February Statkraft said it would shut its gas plant in Emden.

“The statutory priority for renewable power under the Renewable Energy Sources Act means that as long as renewable power is available, you cannot sell your conventional power. The higher the percentage of renewables, the lower the remaining quantity for conventional”

And after lobbying against renewables subsidies for years, the big utilities want a piece of the action: RWE has committed itself to investing more than €1bn a year in renewables, and E.ON plans to invest €7bn in clean energy during the next five years. EnBW and and 19 municipal utilities are building Germany’s first offshore wind farm with EIB financing.

Nuclear repercussions

The nuclear announcement had dramatic repercussions, with industry reports putting the cost of the decision to RWE of more than €1bn in lost earnings and to E.ON of €2.5bn in Ebitda, exacerbating losses from the economic downturn and high gas prices and straining relations with the government.

In March, RWE reported that net profits in 2011 fell 45% to €1.8bn from €3.31bn a year earlier, largely on the back of the nuclear decision. E.ON reported its first annual loss of €2.2bn in 2011, dropping from a profit of €5.9bn in 2010.

The most urgent measure by which the utilities should be judged, however, is debt, which is likely to rise in a context of falling nuclear sales and decommissioning costs.

RWE’s net debt hit 3.7 times likely Ebitda in 2011, and by March this year stood at €29.9bn, and E.ON’s net debt was €36bn at the end of 2011 – just under four times Ebitda.

These conditions help to explain why in December RWE’s attempt to raise €2.5bn in the equity market fell short and it achieved just €2.1bn after it was forced to discount. It also explains why the utilities are experimenting with exotic hybrids as part of a trend towards riskier products in the corporate markets.

EnBW led the way in October, pricing a €750m 60.5 non-call 5.5-year bond in line with guidance to yield 7.5%, equivalent to mid-swaps plus 540.1bp. Books closed in excess of €1.5bn and in March the utility opened books on a tap of the bond.

In October, RWE also issued a hybrid 60-year bond aimed at Swiss investors mixing equity and debt, as subordinated resettable notes, for SFr250m and coupon of 5.25%. Then on March 13, RWE also priced the first hybrid in the European market since the EnBW issue – a £750m perpetual non-call seven hybrid at 7% – which was comfortably oversubscribed. Later in the month, on March 29, it followed this with a US$500m 60-year non-call 5.5 Reg S hybrid bond priced to yield 7% which was tightened to 7.25% on the back of strong demand.

Asset disposal

The utilities have also been trying to dispose of low-profitability assets. In 2011 RWE unveiled a disposal programme of up to €11bn through 2013, but increased cost cutting has reduced this to €7bn. In September, it sold a 74.9% stake in grid company Amprion, and it is now giving priority to the sale of parts of its DEA exploration unit.

E.ON is well advanced in a disposal programme aiming to raise €15bn by the end of 2013. In March it launched the sale of its waste energy unit that could fetch up to €1.8bn, and this month (May) binding bids are expected in the €3bn sale of its open gas distribution network. EnBW is reportedly seeking advisers for the sale of its €300m power transmission network.

The big utilities are also trying to slim the balance sheet. RWE has also set a new cost-reduction target of €1bn for 2013–14 and there has been speculation that it could announce job cuts. E.ON aims to save €1.5bn per year by 2015, and in January it announced a deal with German unions to shed 6,000 workers as part of 11,000 job cuts globally. In March E.ON and RWE ditched multibillion-pound plans to build nuclear reactors in the UK.

Issues, disposals and cost-cutting are having an effect – shares of E.ON and RWE have clawed back some of the ground they lost last year but are still between 23%–25% down – yet optimism about a turnround will not resolve tricky investment issues.

Nerves in Germany’s energy sector have fuelled calls for a capacity market based on subsidised construction of a new gas-fired plants and some reports suggest that Berlin has earmarked finance for subsidies.

Germany’s energy revolution also offers new inroads for Russian suppliers. Gazprom already has a big stake in Germany’s market through Wingas, its joint venture with BASF; and RWE and E.ON are tied into an uneasy marriage with the Russian monopoly through unfavourable long-term gas contracts.

A significant price difference between oil-to-gas pricing, which these contracts are based on, has squeezed the German utilities. Closer links could help them renegotiate these contracts but in December, in a setback for its efforts to seek Russian-funded growth, RWE curtailed talks with Gazprom about a venture to run power stations.

E.ON is one of the German shareholders in Gazprom’s Nord Stream pipeline – controversial for deepening concerns about European energy dependence – but is likely to resist an asset exchange, although in early April a joint venture with the Russian operator and BASF at a gas field in Siberia started pumping. There have also been unconfirmed reports that EnBW had offered Novatek – Russia’s second-largest gas producer – a stake in supplier VNG.

So despite a political commitment to reducing dependence on Russian energy, strengthening co-operation with Gazprom would improve the security of gas supplies for Germany, while greater diversification through renewables and projects such as the Nabucco gas pipeline strengthen Berlin’s negotiating hand, making closer ties more likely.

An image taken with a thermographic or infrared camera shows the reactor building of the EnBW nuclea
Burning issue