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Markets & Finance

Europe's High Cost of Power


From Standard & Poor's RatingsDirect

For power utilities in Europe's deregulated markets, 2005 was a year of strong financial performance, as electricity prices soared. The prospects are for continued high prices and strong earnings in 2006, driven largely by continued high natural-gas prices and the EU's greenhouse gas Emissions Trading Scheme (ETS). These factors in particular benefited hydro and nuclear generators, which saw windfall gains.

With soaring gas prices linked to recent record oil prices, the high price of oil will continue to be an important driver for power prices in the near to medium term, and electricity futures for 2006 are trading even higher than last year. Although high power prices are raising numerous long-term issues in the EU energy sector, Standard & Poor's Ratings Services believes that in the near term, high power prices will continue to support the ratings of utilities in deregulated markets.

RECORD PROFITS. Prices at most Western European power exchanges more than doubled over the year in 2005, due largely to the significant increase in the price of natural gas. This is because wholesale electricity prices in Europe's deregulated markets are mostly set with reference to gas-fired peak load generation. The price of carbon dioxide (CO2) rights under the ETS and significant demand for these also contributed to the high power prices. Security of supply concerns in the region, limited investments in new capacity, and growing demand also supported prices.

Consequently, 2005 saw record profits for many utilities in Europe's deregulated markets such as Britain, Germany, and the Nordic region, with free-floating wholesale prices and a liberalized end-user market. E.ON (S&P credit rating, AA-) saw its profits rise by 71% on the previous year and was Germany's most profitable company in 2005. Spain-based Endesa (A) recorded a 60% increase in profits.

The introduction of the ETS at the start of 2005 has resulted in windfall gains for utilities with a large portion of emissions-free generation, mostly in the form of hydro or nuclear power. Utilities that have benefited include Sweden-based Vattenfall (A-), whose net profits doubled year on year principally as a result of its large proportion of hydrogeneration, and Electricitée de Frances (EDF; AA-), whose largely nuclear generation contributed to its profits more than doubling.

NATURAL HEDGE. Such companies' margins increased because the market price of electricity to consumers, to a large extent, now includes the price of emissions rights, regardless of how it was generated. Furthermore, emissions-free generators have also been unaffected by the high fossil-fuel prices.

Most integrated utilities also benefited from a natural hedge, with pressure on margins in the retail supply operations more than compensated by prices achieved in the wholesale market. Companies such as E.ON, Vattenfall, and Denmark-based DONG (BBB+) also benefited from having part of their own fuel procurement within the group.

In the longer term, the high power prices and utilities' large profits are raising numerous issues regarding competition in the EU energy market, possible political intervention, and security of supply. European energy policies in these areas are currently undergoing review. Europe's utilities are preparing themselves for changes, but a fully integrated European power market with the necessary cross-border connections, increased competition, and lower power prices will take some time to become a reality.


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