European utilities: 2016 outlook

This analysis is by Bloomberg Intelligence analyst Elchin Mammadov. It appeared first on the Bloomberg Terminal. 

European power generation outlook

EU generators' outlook tepid on low power pricesThe European power generators' underperformance vs. the broader market this year hasn't stopped valuations from reaching their highest since 2008. The surge stems from investors betting on a power-price recovery before it occurs. Consensus suggests that earnings won't exceed 1% through 2016 as low energy prices continue to dent generators' margins, triggering asset impairments and plant closures. Generators are turning to international investments and renewables for earnings growth.

Utilities facing weak earnings as prices stabilizeEarnings growth at European utilities is unlikely to exceed 1% through 2016. While the commodity-price rout may end in 2016, utilities active in power generation and oil and gas E&P may see the biggest declines in EPS as their hedges expire. Lower gas prices and closure of aging coal plants may boost demand for gas, assuming normal temperatures. Low interest rates and monetary easing may continue to support utility shares, helping them cut debt and boosting the value of assets that they may sell.

Low power prices to drive new utility writedownsLow prices for wholesale power, oil and other commodities will likely remain the cause of new impairments by European utilities in power generation, exploration and production in the next two years. Regulatory changes that curb profits, coupled with deteriorating conditions in Russia, Brazil and other emerging markets may also lead to writedowns. Sluggish demand for power and energy efficiency will also be a challenge. Low interest rates may cushion utilities from the full effect of credit-rating downgrades.

Coal power faces retreat on low margins, EU policyCoal-fired power generation in Europe has undergone a renaissance in the past five years as cheaper coal displaced gas-fired power production. Yet, coal faces a bleak future because of a greater willingness among EU governments to cut carbon emissions by raising taxes on them, or by forcing the closure of facilities. Increased emission standards are also making the cost of refitting plants too onerous. The 50% collapse of oil prices in the past year has narrowed the gap between coal and natural gas pricing.

EU renewables growth may slow as support dwindlesInvestment in renewable energy in large parts of Europe is likely to slow as policy makers gradually cut subsidies for new projects. The U.K.'s plan to curb support for renewables, excluding offshore wind, has prompted a decline in the share price of funds and utilities investing in the industry. In Germany, where subsidies have also been cut, battery storage may offer a growth opportunity for renewable developers. Low interest rates may render high-yielding renewable energy assets attractive investments.

European gas utilities outlook

Gas suppliers hope for cold winter to boost demandPure-play gas-network utilities trade close to five-year highs on EV-to-Ebitda ratios, reflecting the merits of their regulated revenue and long asset lives vs. gas suppliers. It has been a challenge for gas suppliers to earn consistent cash flow, given mild weather and weak usage. Engie, Centrica, EDF and peers with gas-production assets have endured low gas prices which reduced 2015 EPS, though a bounce is likely in 2016, based on consensus. Some companies may start to curb E&P and boost LNG exposure instead.

Utilities face weak earnings as prices stabilizeEarnings growth at European utilities is unlikely to exceed 1% through 2016. Even though the commodity price rout may end in 2016, utilities active in power generation and oil and gas E&P may have the biggest decline in EPS as their hedges expire. Lower gas prices and closing aging coal plants may boost gas demand, assuming normal temperatures. Low interest rates and monetary easing may continue to support utility shares, help the companies cut debt and increase the value of assets that utilities consider selling.

E&P assets disposals by EU utilities to continueDong Energy, E.ON, Enel and other European utilities pondering the disposal of upstream oil and gas exploration and production assets might be advised to wait for oil-price volatility to settle. The benefit to utilities of owning upstream capital-intensive E&P businesses has become less clear. After RWE's sale of Dea AG, more E&P disposals are likely as the reduced profitability of generation and gas-supply units is forcing utilities to seek new capital to finance investments and maintain credit metrics.

LNG trading to change with U.S. export, swap dealsThe start of liquefied natural gas exports from the U.S. will gradually change how LNG is sold globally. The share of LNG traded at spot prices or linked to Henry Hub in the U.S. will increase as buyers seek more supply flexibility, while the share of gas purchased through oil-indexation is likely to wane. The lack of destination clauses for U.S. LNG, accompanied by lower oil prices may result in LNG re-exports from Europe to wane. Traders will increase LNG flexibility further with swaps and joint buying deals.

European gas auctions may allow Gazprom to raise export volumesThe increased adoption of gas auctions by Gazprom may help the company boost exports to Europe by reaching new buyers. Smaller-sized buyers, which shy away from signing long-term supply contracts, can participate in auctions. Gazprom sells most of its gas to large European gas importers on long-term contracts. The company sold at auction Sept. 7-10 less than half the gas it offered for delivery in northwest Europe at a 5% discount to the wholesale Dutch gas price, based on Bloomberg Intelligence calculations.

Source: European utilities: 2016 outlook