European utilities, which have lost investors money for the past three years, can expect nothing but more pain after the European Parliament rejected a proposal to support prices in the world’s largest carbon-credit market.
Germany’s EON SE, GDF Suez (GSZ) SA of France and CEZ AS (CEZ) from the Czech Republic are among power suppliers whose earnings will drop because a majority of their energy comes from wind, natural gas and uranium, meaning they will be undercut by coal-fired plants, JPMorgan Chase & Co. (JPM:US) said. Burning coal benefits most from cheaper carbon permits because the fuel emits about twice as much carbon dioxide as natural gas.
The European Parliament on April 16 rejected a proposal to delay the issuance of some carbon credits, or allowances, triggering a record 35 percent drop in permit prices and sending the stocks of utilities down. Falling carbon prices weaken the incentive to invest in low-emission technologies such as wind, solar and nuclear power.
“The competitiveness of our gas plants is seriously undermined by coal,” GDF Suez Vice Chairman Jean-Francois Cirelli said at a shareholder meeting in Paris yesterday. “CO2 is a major difficulty for us, and it’s a major failure of European policies.”
The continent’s biggest utilities, already struggling to increase revenue amid a stagnant economy, have to contend with a new damper on electricity prices because the market is tethered to coal, one of the most commonly used fuels for generation. Forward electricity prices, which give an indication of future earnings, dropped 3.7 percent since the April 16 decision.
“Lower carbon prices will tend to reduce long-term earnings,” said Chris Rogers, utility analyst at Bloomberg Industries in London. “The weak power price environment may require writedowns at utilities.”
Every 1 euro drop in the cost of carbon permits cuts earnings per share 2.3 percent at CEZ, 1.8 percent at EON and 1.5 percent at GDF, JPMorgan estimated. Hedging means the full impact is likely to be felt from 2015, the bank said. Prices have fallen 1.50 euros since the vote not to delay permit issuing, called backloading.
“The failure of backloading is a clear negative for CO2 prices, power prices and northern European generators,” JPMorgan analysts led by Vincent de Blic said in a note. The vote left the European carbon trading situation “very messy and uncertain.”
Europe’s cap-and-trade program was designed to make investing in low-carbon generation profitable. Instead it has presided over sliding CO2 prices after a recession curbed industrial output and demand for pollution rights. Also, utilities such as Italy’s Enel SpA (ENEL) and Endesa SA (ELE) of Spain invested in emission-reduction projects in developing countries that generated new supply of credits to Europe.
Europe’s economic slump aggravated a growing oversupply of permits that swelled to about 1 billion metric tons last year, or half the average annual pollution limit in the EU emissions market. A permit to emit 1 ton of carbon dioxide cost about 34.90 euros in 2008, according to broker data compiled by Bloomberg. Today, it’s trading at 3.06 euros after falling 35 percent on April 16, the day of the European Parliament vote.
The slide in permit prices has come in tandem with European power prices. German power prices for the year ahead, a benchmark for the region, have dropped from 90 euros a megawatt- hour in 2008 to a record 38.85 last week.
The impact of the European Parliament’s decision isn’t just financial. The vote shows European policy makers are becoming less interested in curbing emissions of gases that cause global warming, EON said.
“The decision of the European Parliament is a bitter setback for European climate protection,” said Fabienne Twelemann, a spokeswoman at EON in Dusselsdorf. There would be no impact on earnings in the short-term, she said.
The parliament’s decision isn’t final and plans to fix the carbon trading system have been sent back to its environment committee for further dicussions. Tomorrow a group of European parliamentarians is set to have their first meeting to discuss new proposals.
In Germany, EON will probably suffer more than RWE AG (RWE), which generates 62 percent of its power from coal, said Thomas Deser, a portfolio manager at Union Investment GmbH, which is a top-10 holder of both utilities. Cheaper carbon costs reduce the penalty for burning coal, he said.
“The competitive disadvantages of gas-fired power plants compared to coal-fired power plants continue to widen,” Sven Diermeier, an analyst at Independent Research GmbH, said by phone from Frankfurt. “For EON it is negative because they have a high share of power from gas-fed plants.”
The Stoxx 600 Utility Index, which includes 26 of Europe’s largest power generators, dropped 2.1 percent on the day of the vote, the most since July. It has fallen in each of the past three years, a streak not seen since at least 1987.
The index gained 0.5 percent today.
Less income from carbon trading and low power prices may hurt profits at Czech utility CEZ from next year, Trading Director Alan Svoboda said in an interview on April 19. As an eastern European utility, CEZ still receives a portion of carbon credits free of charge during a transition period that will last until 2020.
The drop in carbon prices may also prompt utilities to review investment programs.
CEZ’s plan to build two new nuclear reactors at its Temelin power plant could be one casualty as the emissions-free power now looks less attractive versus coal-generated power, according to J&T bank analyst Michal Snobr. The company may revise investment plans, Svoboda said without giving details.
EON said in March it will lower clean-energy investments to less than 1 billion euros in 2015 from 1.79 billion euros ($2.3 billion) last year. RWE will cut annual renewables spending in half to about 500 million euros in the next two years.
“The failure to pass this resolution does not bode well for the future of the carbon market,” Rogers said. “There’s widespread concern that the failure to deliver backloading reduces the chances for any kind of broader, long-term reform of the carbon market that’s so vital for prices to recover.”
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