EMEA power utilities will get a larger benefit from the high-price environment in 2023 as legacy hedges expire, Fitch Ratings says. Regulatory measures implemented or under consideration, such as price caps and windfall taxes, will not prevent the sector generating improving cash flow. Supply will remain the most vulnerable segment.
We expect gas and electricity prices to stay well above historical levels in 2023. The 2023 electricity forward prices are about EUR300/MWh in most western European countries, compared to the historical averages of EUR50-EUR60/MWh, supporting utility companies’ profits. Clean generating companies benefit the most as significantly increased input costs partially offset high energy prices for thermal generators. Profitability will be further supported by the gradual expiry of legacy hedges with prices set much lower than current market prices, which have been limiting the revenue upside for utilities in 2022. We expect some companies to opportunistically increase the proportion of unhedged merchant positions.
We estimate that cash absorption related to net margin calls, driven by the delta between market electricity prices and hedged prices, peaked for most utilities between August and September 2022 and will largely reverse in 2023, leaving most utilities with healthy liquidity positions and solid operating cash flows during 2023.
Rising energy prices have led to various regulatory measures to curb the impact on end-markets or to raise funds to finance consumer support schemes, with many of these measures not yet fully defined. The EU aims to reduce energy demand and support consumers. Its electricity price cap recommendation of EUR180/MWh will apply from December 2022 to June 2023 for inframarginal generators. Additional measures, such as gas price caps, are being considered for 2023. We expect these measures, if approved, to reduce energy market volatility and liquidity needs for hedging.
Some countries, including the UK, Spain and Italy, have introduced or are planning to roll out windfall taxes on utilities, while Spain and Portugal jointly set a cap on gas prices for electricity generation. We therefore expect political risk to remain high in 2023 with other potential measures being considered, such as instalment payments of energy bills.
We use conservative price assumptions of well below the proposed cap of EUR180/MWh when we rate utilities, and price caps or windfall taxes would not affect the credit ratios and ratings. There is material short-term upside potential compared to our projections, but we tend not to upgrade companies if this action would be based on unsustainably high prices.
Supply security remains an issue in case of a colder-than-usual winter or problems with alternative gas suppliers, even though a warmer autumn and ample LNG supplies have allowed European countries to successfully replenish gas storage ahead of the 2022-2023 winter. The gas market will remain very tight even assuming no problems in security of supply, implying affordability issues for customers and industries and persisting political scrutiny for utilities.
The high-inflation environment is generally positive for networks with regulatory asset bases indexed to inflation (the UK and Italy). For countries with nominal returns and regulatory asset bases not indexed to inflation, the key challenge will be linked to how frequently allowed returns are updated, to promptly reflect a changing macro environment.
High energy price volatility makes the supply segment most risky, especially where there is no effective back-to-back hedging or in the event of abnormal weather patterns. We also expect working-capital requirements related to supply to increase materially, exacerbated by potential bad-debt increases. This could be mitigated by the shift to variable-price contracts for most utilities’ supply portfolios. In the current environment we see increasing benefits in integration between generation and supply, enhancing visibility on future performance.
Source: Fitch Ratings