European utilities’ generation assets and goodwill have lost value due to the volatile markets, tougher operating conditions and regulatory pressures of the past two years.
The impact of two years’ financial and economic turbulence is laid bare in the 2010 and 2011 annual reports and accounts of European power and utilities companies. Profitability has continued to suffer, leaving utilities forced to sell off assets and scale back capital expenditure, with some assets being written off altogether.
Ernst & Young analysis of the accounts of 16 European utilities1 reveals that almost €17.7b (US$23.4b) was written off balance sheets between 2010 and 2011. A large proportion (58%) of this lost value is concentrated among just three utilities, while only four companies posted impairments of €150m (US$198m) or less.
Where impairment strikes hardest
M&A activity may have left some companies lamenting costly acquisitions, notably those in Southern Europe. Deals concluded at high prices have failed to deliver promised value in the current economic climate, leading to impairments to goodwill. Assets, meanwhile, account for the largest share of lost value, with almost €13.6b (US$18b) written off between 2010 and 2011.
Power generation is the most impacted activity, with close to €8.7b (US$10.8b) written off due to weaknesses in power prices and spreads in deregulated markets.
Unsurprisingly, given the footprints of the European utilities in question, most (80%) write-downs were in Europe. The biggest share was centered in Southern Europe (33% of total impairments), with continental Western Europe and the Nordic region jointly making up 28%. Unfavorable economic conditions, subdued market fundamentals and regulatory changes have quashed asset values in these areas, whereas other developed and emerging markets recorded significantly better performance.
Blame for write-downs
In their 2011 annual reports, utilities give wide-ranging explanations for their impairments.
For most, the current economic climate is to blame. Pessimism about long-term power prices and spreads is triggering impairments, with some utilities, notably in the UK, accelerating plant retirements. In addition to subdued market fundamentals, others cite competition from renewables, which pushes loads lower for thermal plants, prompting impairments.
Meanwhile, some utilities in continental Western Europe point to uncompetitive long-term oil-indexed gas procurement contracts as a factor contributing to asset write-downs.
Increasingly, regulation and national policy are emerging as factors that affect competitiveness and profitability too. In Germany, for instance, the Fukushima incident led to amendments to the Nuclear Energy Act, prompting unplanned shutdowns of nuclear power plants. Meanwhile, reduced government support for renewables projects, due to funding pressures, is also resulting in write-downs.
Utilities not off the hook yet
European utilities have made significant efforts to clean up their portfolios. This has included divesting unprofitable parts of their businesses and writing down other assets. Utilities have also tightened purse strings on capital intensive plans and scaled back or halted projects.
However, since closing their accounts on 31 December 2011, additional risks to asset values have emerged and the situation could deteriorate.
In some geographies, chief among the factors compromising ongoing profitability are subdued prices for electricity and gas. While oil prices continue to increase, companies most exposed to the oil-gas spread will continue to suffer.
Meanwhile, energy demand continues to show few signs of increasing, with Southern European markets most adversely impacted.
And to top it all, the European sovereign debt crisis continues to cast a shadow over utilities' credit ratings. This could, in turn, compromise access to finance, especially in the most impacted countries like Spain and Portugal. This will most likely prompt further scaling back of capital expenditure programs.
The gloom and doom seems well entrenched. Utilities have already written off huge chunks of value and half-year results, due this summer, could possibly evidence further impairments.
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1 Centrica, CEZ, EDF, EDP, E.ON, Enel, Fortum, Gas Natural, GDF Suez, Iberdrola, RWE, Scottish and Southern, Suez Environnement, Vattenfall, Veolia Environnement and Verbund.
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