On a general level, many venerable companies have suffered of late from the impact of market disruption. And, while it’s true that the advent of the electricity minnows has taken market share away from the big six – the latter now control just 80 per cent of the electricity supply market compared with virtually 100 per cent in 2010 – the challenges are more fundamental.
This conclusion is based on analysing share price performances since 2006, when the energy sector was peaking. Subsequently, investors have suffered real harm, especially if they were long-term holders in Eon and RWE.
In 2007, Eon was riding high with a strong balance sheet. Thereafter, problems piled up as the company’s net debt rose very sharply: RWE was in a similar position. Neither company prospered during the credit crisis and the ensuing recession – as defensive utility stocks are supposed to do. Energy demand fell, along with profits.
The German government’s highly controversial – and unexpected – decision in 2011 to discontinue nuclear power generation by 2022 has caused both companies immense problems. In effect, they are now the owners of stranded assets – with high decommissioning costs to finance as well.
The share prices of Eon and RWE has fallen by over 80 per cent from their peak, although there has been a modest rally of late.
After considerable analysis, Eon addressed its deep-seated problems by going downstream. It foresaw better prospects in regulated energy markets – with their assured cash flows – and in exploiting its formidable customer base. As such, its generation interests have been heavily reduced, all the more so following the sale of its demerged Uniper business to Finland’s Fortum.
Despite a similar lineage to Eon – both companies operate out of Essen in the Ruhr – RWE has decided on a very different route. Having been founded as a generator, it has resolved to remain that way. It has, though, rather belatedly recognised the attractions of renewable energy. As such, it owns a near 77 per cent stake in the demerged Innogy business.
Furthermore, Innogy, the owner of Npower, has agreed a complex deal with Scotland’s SSE to become a minority partner in a new energy supply business. Approval has been granted by the Competition and Markets Authority (CMA) but the deal has run into trouble recently on several counts.
First, renegotiations are taking place to address the financial impact of the long-flagged energy price cap that is to be applied to the standard variable tariff (SVT).
Second, Npower’s ongoing financial returns are dire – Innogy has taken a €748 million impairment charge in respect of its wilting Npower operations.
Third, RWE recently announced that it had agreed the sale of its near 77 per cent stake in Innogy to Eon; the latter already holds a sizeable share of the UK supply market.
For SSE, these developments are highly unwelcome. Its share price has been weak of late as it seeks to curb its net debt and to avoid any dividend cut. Indeed, it has expressed real doubt that the combined finances of SSE/Npower are robust enough to enable the initial public offering slated for next year.
The planned demerger of its energy supply business was designed both to improve SSE’s finances and to focus its interest on the most profitable opportunities – regulated network returns in Scotland being high up the agenda.
There must be some doubt whether the SSE/Npower demerger proceeds. In any event, its recent experiences will probably dissuade SSE from attempting further radical restructuring.
Its UK big six counterpart, Centrica, remains “under the cosh”. Its share price has fallen by about 60 per cent since 2013. Furthermore, it is under real political pressure to raise its game. The strategy of chief executive Iain Conn seems to replicate that of Eon rather than that of RWE in that “downstream retail is good but upstream generation is not”.
Improved financial results have, though, proved elusive.
The new price caps on retail energy sales are hardly likely to help, while Centrica’s US operations have run into problems in recent months. The focus on retail customers sounds good in theory but whether it translates into serious profitability is a moot point.
A shake-up within Centrica is not widely expected but at the core of its strategy should be how – given its dominant share of the UK gas market – it can achieve far better returns. And, against that background, Centrica remains a bid target for an ambitious international energy company.
For EDF, with net debt of €31.3 billion, its finances remain as stretched as ever despite a government-supported €4 billion fund-raising last year. For varying reasons the company is in effect a nationalised business – and is beholden to the French nuclear industry. Its building programme for the third-generation EPR reactor continues to face massive cost and time over-runs.
The new EPR plant in Olkiluoto in Finland is now almost a decade behind schedule, while its domestic counterpart at Flamanville is also way behind its due completion date – and its costs are still soaring.
Of course, UK interest will focus most on Hinkley Point C and its infamous 35-year £92.50 per megawatt-hour contract for difference strike price. The latter should, though, underwrite EDF’s investment in the project.
Looking forward, EDF has two obvious priorities – neither of which envisages acquisitions.
First, it must take a firm grip of its nuclear new-build programme. Second, it needs to turn round its very stretched finances – and cut its net debt.
Of the big six, it is Spain’s Iberdrola, which can report the best share price performance – up by c15 per cent over the past decade. Given that Spain was especially hard hit by the credit crisis, this is impressive.
In the UK, following its Scottish Power acquisition, Iberdrola’s operations are predominantly north of the border. But, unlike SSE, its vista is expansive – and well beyond its core Spanish business.
Iberdrola has various renewable power operations in the US. Furthermore, it is involved in several major projects including the 1,158 MW Tamega hydro-power complex in Portugal, the 800MW Vineyard Wind scheme some 14 miles off the US East Coast and the 714MW East Anglia One offshore wind project in the UK.
With these – and many other projects on the go – Iberdrola seems unlikely to pursue radical changes to its very successful strategy. After all, the company vigorously backed wind power – and especially solar power – far earlier than most. Its current share price rating underlines how these technologies have come of age.
More generally, its profitable international operations – short of any major failings – provide a template as to how large EU energy companies should have developed over the past two decades.
While the big six may become the “big five”, the surprising acquisition of energy supply minnow First Utility by Shell warrants comment. Of course, for Shell, this acquisition barely features in its vast cash flow.
However, the deal seems to be about positioning as electric vehicles become more widespread. In time, millions of motorists will be using more power to charge their electric cars. It will certainly be interesting to see whether Shell – and BP – become more closely involved in the UK energy supply market. The momentum for change is certainly there.
Nigel Hawkins is a financial analyst and Utility Week correspondent