The credit quality of European utilities is likely to be more resilient to the effects of COVID-19 than many other sectors, says S&P Global Ratings in a new report.
“We currently expect only a limited number of rating downgrades in the sector given the essential service they provide, the regulated or long-term contracted nature of a portion of their activities, and their relatively better access to capital markets,” said S&P Global Ratings credit analyst Pierre Georges.
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Coronavirus in the energy sector
Nevertheless, the pandemic and recent oil price collapse have triggered a wider economic shock and uncertainties over the timing of a recovery, thereby increasing earnings risks for utilities with large exposure to merchant power activities.
“We expect power demand to decline by 5 per cent – 7 per cent this year on 2019 and power prices to be down 20 per cent in 2021 from our previous assumptions,” said Mr. Georges. This will affect earnings on generation and supply activities, while regulated networks are better protected. Lower investments in 2020, and eventually some flexibility on dividends may ease pressure on credit metrics.
More generally, we see weaker macroeconomic fundamentals affecting ratings on utilities, owing to political and commercial pressure to support weaker customers and suppliers, increased sovereign risk, and in certain cases refinancing challenges.
“We also see increased risks that pension and asset-retirement obligation deficits will widen, which could weaken the credit health of some companies,” Mr. Georges said.
The report states that the European utilities sector “has so far been more resilient to the economic effects of COVID-19 than most other corporate sectors. This is because of the essential service that utilities provide, the regulated nature of their network business activities, and the largely hedged or contracted nature of their power generation for 2020.”
It explains that most generators in Europe hedge a large part of their merchant power exposure at least a year ahead. “What’s more, most companies we rate in Western Europe have reduced their merchant power exposure in recent years, turning instead to long-term fixed-price renewables. On average, we estimate that European integrated utilities maintain an exposure to merchant power generation of about 15-25 per cent of EBITDA.
S&P adds that operationally, most utilities have developed and unveiled contingency plans to manage such a disruption and protect critical infrastructure. “We therefore do not foresee any disruption in the network operations or any risks related to continuity of supply. Measures include team rotations, reduction of staffing needs to critical services, and use of digitalization to work remotely, when feasible. We understand that such reorganization of work can be sustained over prolonged periods of several weeks or months. We also believe that utilities currently have some degree of flexibility on their investment program and dividends, which can therefore be cut to accommodate lower earnings and cash preservation.”