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Fossil fuel-exposed utilities could be poised for a coronavirus rebound

Q2: U.S. Solar and Wind Power by the Numbers

Essential Energy Insights - September 17, 2020

Essential Energy Insights September 2020

Rate case activity slips, COVID-19 proceedings remain at the forefront in August


Fossil fuel-exposed utilities could be poised for a coronavirus rebound

With pure-play renewable utilities outperforming their more diversified peers on stock markets in Europe amid a coronavirus-induced sell-off, fossil fuel generators hit by lower power prices and retail suppliers coping with a demand crunch could be set for a rebound.

Analysts see promise in stocks from coal-dependent RWE AG to oil-exposed Centrica PLC, after the companies have been battered far more severely than their greener competitors in the wider stock market rout. The two companies are down 17% and 52%, respectively, while wind power generators Ørsted A/S and EDP Renováveis SA are trading at almost the same levels as three months ago, before the crisis hit.

In terms of share price performance, "the pure players have been basically untouched" by the coronavirus pandemic, Deepa Venkateswaran, an analyst at Bernstein, said in an April 23 interview. Venkateswaran pointed specifically to the contrast with RWE and other more diversified utilities like EDPR's parent EDP - Energias de Portugal SA, which is also down by double digits.

"I think the treatment meted out to those companies has been significantly worse," Venkateswaran said. "The defensiveness of the integrated [utilities] has not been particularly appreciated."

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Most renewable portfolios are relatively safe havens thanks to long-term subsidies and off-take contracts. Wind and solar plants also enjoy priority grid access in most European countries, meaning they are somewhat protected from demand drops. Meanwhile, companies with merchant-exposed power plant portfolios and utilities with large retail arms have had to cut their dividends and cancel earnings guidance as they wait for clarity on the length and severity of the downturn.

But analysts are betting the gulf in share price performance could narrow again before too long, spurred by ongoing transformations at individual companies and a renewed focus on climate action after the coronavirus is contained, which should draw investors focused on environmental, social and governance issues to utilities with strong green growth strategies.

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That case can be made for RWE, whose major selling point before the crisis was the vast renewables business the company acquired in a €40 billion asset swap. The segment is expected to continue growing; at the same time, RWE will get paid billions by the state to switch off its coal plants in Germany, removing a major overhang for the stock.

"Of course investors need to be assured that these companies can go through [COVID-19] relatively unscathed. Once people appreciate that, and see that they are continuing to execute [their strategies], that helps," Venkateswaran said.

The same applies to Italy's Enel SpA, which in late April was trading about 30% below its February peak. Given the company's strong balance sheet, which should help it weather losses in power generation, retail defaults and foreign exchange effects over the coming months, analysts at UBS think the shares look "over-corrected."

"With 2020 set to be one of the hottest years on record, Enel's green credentials (the largest renewable generator in the world) may eventually return to focus," the UBS analysts wrote in an April 27 note.

And Barclays analysts wrote in a note to clients April 14 that markets have "overly punished" both Centrica, which has good liquidity and may emerge with a stronger position against some smaller competitors, as well as France's Engie SA, whose current share price did not reflect its outlook for medium-term earnings growth in renewables and energy services. Current market conditions are therefore creating "significant opportunity," the Barclays analysts wrote.

Engie and French peer Electricité de France SA have been among the biggest stock market losers in the utilities sector, as they suffer from lower power demand that is forcing reduced production at nuclear and gas plants.

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Centrica has been hit especially hard because of its large retail business and a majority stake in Spirit Energy Ltd., an upstream oil and gas company. The utility has been trying to offload the stake, which is taking longer than expected amid the current oil price volatility but will eventually put Centrica on a more stable footing, said analysts at Credit Suisse.

"Selling it would take away commodity price sensitivity," Credit Suisse analysts Mark Freshney and Ruisi Liu wrote in an April 24 note. In the meantime, they said Centrica's balance sheet can weather the collapse in oil and gas prices and the impact of the coronavirus.

In contrast to many other utilities with fossil fuel baggage, Centrica has already lost significant value over the previous few years. With a new CEO taking over, analysts hope fortunes could turn around.

Nor are all renewable players insulated from the current market risks. They could be exposed to counterparties defaulting on power contracts and even lower electricity prices for plants under some subsidy regimes like the U.K.'s renewables obligation, which are indexed to wholesale markets. Construction of new assets is also facing delays as companies cope with supply chain bottlenecks and stop-work orders.

"It's not like they're totally immune to everything, especially if they have some merchant exposure," Venkateswaran said of the renewable generators. "I feel like the market is maybe being very sanguine about all of that stuff."