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Nordic Utilities Are Suffering From Low Power Prices And Structural Changes


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Nordic Utilities Are Suffering From Low Power Prices And Structural Changes

The year 2020 has not been kind to Nordic utilities. Unusually mild and wet weather has depressed power prices given that the region relies heavily on hydropower. The Nordic power market is also in a state of transformation toward even more renewables, and we see a clear risk that this will make the market even more volatile. This could translate into more demanding thresholds for existing ratings if companies do not successfully reduce and manage volatility with long-term hedges, power purchase agreements (PPAs), and a higher share of cash flow from regulated or long-term contracted activities. Alongside the unusually warm weather in the first part of 2020, the COVID-19 pandemic has further softened power demand. What's more, structural changes, such as increased dependence on intermittent power production, transfer challenges due to grid constraints, and the shift in merit order toward lower marginal cost production, will lead to increased price volatility and eventually weaken the profits of conventional merchant generation activities in the Nordic region.

All these factors have conspired to drag down average power prices in the region to record lows in 2020, despite some recovery in September. As of Oct. 4, 2020, Nordic spot power prices had dropped more than 75% to just €9.6 per megawatt-hour (/MWh) on average, from the 2019 average of €39/MWh (see chart 1). The daily average spot price in July 2020 fell to an all-time low of below €2.4/MWh. At such extreme lows, most power production is loss-making. At some extreme points, prices were even negative for a few hours, signaling unusually high volatility. We forecast average prices will stay low at €10-€15/MWh in 2020 and €17.5-€22.5/MWh for 2021.

Chart 1


Structural Changes Add Volatility

Three major factors are driving the ongoing transformation of the Nordic power market:

Significant addition of wind power capacity.   As an intermittent power supply, we expect greater use of wind power will make the energy market fundamentally more volatile and complex. At the end of 2019, about 9.1 gigawatts (GW) of installed wind capacity produced 19.5 terawatt-hours (TWh) of power, up more than 90% from 11.5TWh over the past five years in total. Wind production is forecast to increase to 29TWh by year-end 2020 (see chart 2). In Sweden, it could therefore in theory approach a meaningful 20% of total power production in 2020. We expect wind capacity growth to accelerate further, although companies are yet to make final investment decisions about capacity additions beyond 2022. The Industry Association for Wind Power in Sweden foresees a massive production increase until 2030 to 45TWh, and in its long-term forecast, production is set to double again to 90TWh in 2040. Still, even though wind technology continues to develop rapidly, with mills becoming taller and the sweep area wider, production will remain highly dependent on wind conditions, which implies more frequent price changes for the rated producers. The rapid technology development also gives rise to risks, as older windparks are not able to generate enough in the currently low-price environment. For these reasons, both Vattenfall and Statkraft have booked impairments in 2020, the most significant being Statkraft(Norwegian krone 2.6 billion or €260 million)--half of it stemming from the Fosen project, the largest onshore windfarm in Europe with a total capacity of more than 1,050MW.

Chart 2


The lack of domestic grid transmission capacity.   This problem, mainly in Sweden, stems from the the transmission operator's underestimation of the speed of the energy transition and hence underinvestment in networks. It has also triggered a debate about power supply in the southern part of the country. Grid transmission deficits have supported a very wide price differences between various regions in the Nordics this year (see chart 3). The lack of transmission capacity in areas with low local generation has increased prices in those regions. Generators in Finland and Southern Sweden have been less affected by the lower prices, while Norwegian generators suffered most. We believe this is why Finland-based Fortum has been able to sign comparably higher hedges than peers. The lack of domestic grid capacity also creates uncertainty for future investments by power generators, as grid stability is paramount to power projects.

Chart 3


The shift in merit order towards lower-marginal-cost, but more volatile, production.   The share of controllable power production--potentially including nuclear power--and types of fossil production is therefore set to decrease meaningfully. As a result, under windy and wet conditions, less controllable and highly weather-dependent production could more often be the price setter and push prices down, making the market fundamentally more volatile. We therefore expect to see more frequent shifts along the merit order, and more volatile cash flow profiles for rated issuers with large merchant exposure. Under peak conditions, however, the system will still need fossil fuel production, assuming generators keep enough reserve capacity, which will be critical for power supply stability. The most obvious challenge is the large variation in wind power and hydropower production, at least until meaningful power reserve technologies, like hydrogen, battery and pump-storage facilities, have been put in place. This in itself is likely to be a good investment case for utility companies over the medium term. It remains to be seen to what extent nuclear will remain part of the Swedish system in the long term. Nevertheless, during periods when production is low and consumption is high, the price setter for baseload capacity may vary greatly. Nordic countries may depend on imports to cover consumption.

Chart 4


An Unusually Wet And Mild 2020 Has Depressed Power Prices

Precipitation is by far the most important short-term price determinant of the Nordic power market because hydro production is the largest contributor of power--it accounts for 50% of total production. Wind generation has also grown from zero to 12% of total generation over the past 20 years, benefitting from very low operating costs, and will continue to increase (see chart 5).

In normal years, reservoir storage mitigates volatility because operators have flexibility when to produce. But the unusually mild weather and high snow- and rainfall in winter 2019/2020 (see chart 6) has allowed water levels to reach extreme highs. We understand that when hydro levels reach about 90% of storage capacity, operators need to reduce water levels, independent of price level. This contributes to flooded supply and volatile prices. Once water levels stabilize well below 90% of storage capacity, as in the third quarter of this year, operators can better manage production and prices can recover.

Hydro production in Sweden and Norway has averaged about 66TWh and 135TWh, respectively, over the past 10 years. But in the first half of 2020, production is estimated to have increased by between 10%-15%, leading to significant price volatility. Because electricity spot market prices are based on marginal production costs, increased hydro production, with typically very low production costs, has pushed prices down severely. We expect spot prices to average €10-€15/MWh in 2020, and to gradually improve in 2021 to €17-22/MWh.

Chart 5


Chart 6


Reduced Rating Headroom For Power Producers; Multi-utilities And District Heating Are Faring Better

In these adverse conditions, credit pressure is mounting on power producers (see chart 7). However, we have not yet taken any negative rating actions, for several reasons:

  • Utilities have taken measures to maintain ratings. For example, Statkraft cut annual capex 20%-25% below its target, while Fortum has disposed assets. Nevertheless, further actions might be necessary for all producers to maintain credit profiles if prices stay depressed over 2021-2022.
  • Many had a good level of financial headroom built prior to the crisis. Vattenfall, for example, had funds from operations (FFO) to debt of 28.5% in 2019 compared with our expectation for the rating of above 20%. Statkraft's FFO to debt was 68% compared with the rating threshold of 20%. Nonetheless, we expect both companies' credit ratios to approach the lowest expected for the rating in 2021, although not to remain so low for a prolonged period.
  • Contracted or hedged revenues provide some time to adjust strategies, and reduce investment levels, if needed. Fortum, for example, has managed to strike relatively high prices for 2021, benefiting from the favorable Finnish price zone, while Orsted enjoys subsidized earnings from its wind projects across Europe. Vattenfall's hedges give good support for cash flow in 2020 and 2021.
  • Some benefit from diversification into other more stable businesses. Vattenfall, for instance, has subsidized offshore wind, district heating operations, and regulated network activities that provide more stable cash flow streams.

In the second quarter of 2020, the first signs of the impact from lower power prices became visible. We believe Statkraft posted the weakest second-quarter result in the peer group (see table 1). Statkraft should have by far the lowest-cost production and the most flexible production facilities because almost all its production stems from hydro, which typically has great flexibility. However, far less of its production is hedged. Furthermore, it is also less diversified than peers such as Vattenfall and Fortum, which benefit from extensive distribution and/or more diversified generation sources. We nevertheless expect Statkraft's credit ratios to remain in line with the rating for 2020.

Table 1

First-Half Reported Underlying Operating Profits 2020 Versus 2019
--Electric generation-- --EBITDA--
H1 2019 H1 2020 % change H1 2019 H1 2020 % change
Fortum 22.7 23.7 4 484 485 0
Statkraft 22.1 25.8 17 702 390 (44)
Vattenfall* 50.2 46 (8) 1,474 1,369 (7)
*Business units Power Generation and Wind.

Chart 7


Utilities with greater exposure to regulated activities are better protected than those more exposed to merchant power. We therefore expect the credit metrics of these three companies to remain comfortably above downside threshold levels for the ratings. Tekniska verken and Kraftringen still have substantial headroom, and Stockholm Exergi should also maintain sufficient margins (see chart 8).

We expect all of them to be only marginally affected by low electricity prices and weather conditions. This is because they all benefit from regulated and semi-regulated activities, which contribute about 70%-90% of their EBITDA on historical average. They can reduce their electricity generation at times of low power prices. Although this means lower revenue (since the cost of heat production is much lower when capacity is lowered), the fuel costs are significantly less, which protects earnings and cash flows. Tekniska verken and Kraftringen also benefit from stable operations as distribution system operators (DSO), although they receive lower state-induced earnings for the 2020-2024 regulatory period. This is because the regulator has lowered the parameters in the permitted weighted average cost of capital (WACC) to 2.35%, from 5.85% in the previous regulatory period, which implies a steep decrease in DSO remuneration (see chart 9). Sweden's WACC is thereby considerably lower than in Finland or Norway. Credit losses from the effects of the COVID-19 pandemic have been marginal so far.

Chart 8


Chart 9


Signs Of Hope Post 2023

Over the next few years, power prices are set to improve, even if weather conditions do not return to historical levels. We therefore believe the rated issuers in the region over the medium term should benefit from increasing prices. Our view is based on the following two major reasons: First, demand for power is likely to rise and outpace supply growth; and second, new transmission lines imply that the Nordics will be more aligned with power markets in Europe, which typically have higher prices.

Electrification trends increase demand

Electricity demand in the Nordic market is likely to increase over the medium to long term because electrification of the transport sector and increased electrification of the industry will be necessary for the region to comply with its ambitious decarbonization goals. However, it is uncertain by how much consumption will rise (see chart 10). New data centers, battery manufacture, additional power-based heating, and different types of industry processes are likely to mean that demand growth will surpass GDP growth and efficiency gains, in contrast to the past. Various industry experts expect that industrial and transportation sectors could increase demand about 30-40TWh in the next decades in the Nordics. While we don't forecast future demand, we see good prospects for increased consumption rates from the approximately 380 Twh in 2019 that should reduce the impact on generation volatility and support power prices. However, this will also require massive investments in the sector to maintain security of supply, as well as interconnecting capacity.

Chart 10


New transmission capacity opens new markets

A massive increase of transmission capacity due to come on stream by 2024 is also likely to improve power prices in the coming years. This will further support ratings on power generators in the region. This will make the market less decoupled from continental Europe than in the past (see chart 11) because import/export capacity will increase about 90% from 6.9GW to about 13GW, and will also connect the Nordics with the U.K. The largest cables, NordLink, North Sea Link, and Viking Link, each costing about €1.5 billion-€2.0 billion and with a capacity of about 1,400MW each, are comparable with the largest nuclear power plant in the Nordic region, which has a capacity of 1,400MW. As the Nordic system benefits from a larger share of low-cost generation in the form of hydro and wind power, this extra transmission capacity should be supportive of power prices in general, and will imply that Nord Pool prices will approach prices in Germany. Still, it also implies that the Nordic region, which still has a higher share of renewables than rest of Europe, will depend on German baseload capacity in peak hours.

Chart 11


Table 2

Nordic Diversified And Power Generators
Issuer Long-term issuer credit rating Outlook Country Business risk profile Financial risk profile Volatility table Modifiers Management & governance SACP Likelihood of government support

Vattenfall AB

BBB+ Stable Sweden Strong Significant Standard Satisfactory bbb Moderate (+1 notch)

Statkraft SF

A- Stable Norway Strong Significant Standard Satisfactory bbb Moderately High (+2 notches)

Orsted A/S

BBB+ Stable Denmark Satisfactory Intermediate Standard Strong bbb Moderate (+1 notch)

Fortum Oyj

BBB Negative Finland Satisfactory Intermediate Standard Fair bbb- Moderate (+1 notch)


BBB Positive Iceland Fair Aggressive Standard Satisfactory bb- Very High (+4 notches)

Teollisuuden Voima Oyj

BB Watch Neg Finland Strong Highly Leveraged Standard Fair bb
Multiutility companies

Kraftringen Energi AB (publ)

BBB+ Stable Sweden Satisfactory Intermediate Medial Negative CRA (-1 notch) Fair bbb- High (+2 notches)

Tekniska verken i Linkoping AB

A+ Stable Sweden Satisfactory Modest Medial Satisfactory bbb+ High (+3 notches)

Stockholm Exergi Holding AB (publ)

BBB+ Stable Sweden Strong Significant Medial Satisfactory bbb Moderate (+1 notch)
Network operators (DSO/TSO)

Caruna Networks Oy

BBB+ Stable Finland Excellent Aggressive Low Positive CRA (+1 notch) Satisfactory bbb+

Elenia Verkko Oyj

BBB+ Stable Finland Excellent Aggressive Low Satisfactory bbb SED +1

Ellevio AB Class A

BBB Negative Sweden Excellent Aggressive Low Negative CRA (-1 notch) Satisfactory bbb- SED +1

Fingrid Oyj

AA- Stable Finland Excellent Intermediate Low Satisfactory a+ High (+1 notch)

Statnett SF

A+ Stable Norway Excellent Aggressive Low Satisfactory bbb Very High (+4 notches)

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Per Karlsson, Stockholm (46) 8-440-5927;
Secondary Contacts:Daniel Annas, Stockholm +46 (8) 4405925;
Pierre Georges, Paris (33) 1-4420-6735;

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