Municipality Owned Utilities and Stadtwerke · 2014-12-10 · Municipality Owned Utilities and...

Municipality Owned Utilities and StadtwerkeMoody‘s view on the Utilities sector and its approach to determine Credit Ratings

1. Stadtwerke-Finanzforum, 27th November 2014, Frankfurt

Matthias Heck, Vice President – Senior Analyst

Municipality Owned Utilities and Stadtwerke, November 2014 2

Agenda

1. Key market drivers and political environment

2. Moody’s rating approach for “unregulated utilities” and government

ownership

3. Summary


Key market drivers and political environment1


-10

-9

-8

-7

-6

-5

-4

-3

-2

No

v-0

1

No

v-0

2

No

v-0

3

No

v-0

4

No

v-0

5

No

v-0

6

No

v-0

7

No

v-0

8

No

v-0

9

No

v-1

0

No

v-1

1

No

v-1

2

No

v-1

3

No

v-1

4

Aa2

Aa3

A1

A3

Baa2

A2

Baa1

Aa1

Baa3

Moody’s utilities universe is mainly Investment Grade

European Utilities: Ratings Distribution

Slowing shift towards Baa

Unreg Utilities: Outlook distribution, November 2014» Moody‘s rates 86 European utility groups - approximately $456

billion of rated debt; 66% by largest 10 issuers

» Subsidies continue to support further deployment of

renewables

» Over-supplied coal market, weak CO2 and high reserve

margins negative for power prices

» Affordability concerns keep political and regulatory risk high

» Easing sovereign peripheral pressures

Source: Moody‘s Investors Service

EMEA E&G Utilities: Ratings Migration

Moody’s EU utilities universe


Limited financial headroom despite lower debt levels

Sector indebtedness has fallen from 2009 peak» Debt has declined

» asset disposals, capex cuts, hybrids,

dividend cuts

» .. . but financial flexibility limited

» Metrics tight vs guidance

» Cash flows still pressured

» Fewer non-core assets to sell

Source: Moody‘s Financial Metrics ™

Falling profitability keep financial metrics tight

Moody’s EU utilities universe


EU and National Policies: Areas of Conflicts

» European unregulated utilities find themselves at a political and regulatory crossroad

– EU policy has driven the expansion of renewables and the closure of older coal plants

– Response of EU member states to these challenges has given rise to a number of conflicts

– Creates uncertainty and thus risk for unregulated utilities

» Conflict 1: Capacity payments versus interconnection for security of supply

– Some countries prefer capacity payment mechanisms (e.g. UK, Italy, France)…

– …but the EU prefers interconnection

– Capacity payments could fall foul of EU state-aid legislation and may not be a game-changer

» Conflict 2: Affordability concerns versus the cost of decarbonisation

– Renewables continue to drive electricity tariffs upwards across Europe

– Exposes to utilities to political / regulatory interference

– Tariffs are increasingly ‗fixed-cost‘ in nature – undermines EU energy efficiency efforts

Political Environment in the EU

Political uncertainties persist


» Generation: Debate about capacity market and new market design

» Government is reluctant on implementing a broad capacity market, given related costs and

intervention into existing system

» Publication of Green Book on German power market design in October 2014: Possibility of

capacity payments, but implementation unlikely before 2017

» Given their exposure to (old) conventional thermal generation, German Stadtwerke would likely be

winners of capacity payments. Impact on large integrated players could be positive or negative

» Networks: Need for investments limits political pressure

» Government is generally supportive regulated networks, given their role to safeguard security of

supply and integrate renewables (especially offshore wind) into the German electricity network

» Supply: Affordability concerns lower than in other countries

» Affordability of energy bills in Germany remains above EU average

» Political pressure remains modest, little risk of price regulation

» “Energiewende” on top of political agenda

» ―Energiewende‖ strategie envisages further expansion of renewables

» EEG reform aims to control renewables expansion, limit price increases and improve allocation of

cost to end consumers

» The allocation of renewable cost has virtually no impact on utility companies. It is only a ―pass-on‖

from the perspective of network operators.

Germany: little support, little intervention

Energy policy is more favourable for Stadtwerke as opposed to large players

Political Environment in Germany


Commissioning of New Generation Capacity Will Keep Power Prices Low, Despite Nuclear retirements

» Ongoing pressure on power prices

– Small additions to generation capacity (renewables

and conventional thermal, partially offset by nuclear

and thermal retirements)

– Wholesale power prices expected ~ €30-35/MWh

» Current market design provides little protection

for power plants

– Government reluctant to intervene

– Implementation of capacity mechanisms unlikely

before 2017

» What could change our view on power prices

– Upside: tightening of the carbon market, reform of

the emission trading scheme, stronger economic

growth, increase of commodity markets

– Downside: decline of commodity prices, stronger

than expected growth in renewables, implementation

of capacity markets

Sources: Bloomberg, Moody‘s Investors Service

Sources: BDEW, BNetzA, Moody‘s Investors Service

German power prices (1-year baseload forward)

Development of German Installed Capacity

Conventional Generation in Germany


EMEA unregulated utilities sector outlook changed to stable in November 2014

» We think underlying business conditions overall underpin a weak but stable outlook for

the sector over the next 12-18 months

» Earnings from generation have further to fall as hedges roll off; but steepest declines are

behind us and should be offset by profitability growth in other businesses

» We expect conventional generation output volumes to stabilise, helped by slowly

recovering economies, and a slowdown in the pace of renewables installations

» We expect power prices will trade in a narrow range, based on our commodity price

views and narrowing reserve margins

» Political uncertainties persist in certain markets, but measures taken to address tariff

deficits and signs of recovery in euro-periphery economies reduce risk of adverse

intervention in the sector

» Sector‘s longer-term challenges remain

Moody’s Sector Outlook


Moody‘s rating approach for ―unregulated utilities‖ and government ownership2


Moody’s Rating approach

Rating methodology for unregulated utilities

Baseline Credit Assessment (“BCA”)

+

Joint Default AnalysisRating methodology for “Government Related Issuers”

(“GRIs”)

=

Final issuer ratingto be determined by Rating Committee

Moody’s Rating Approach


Overview Unregulated Utilities Methodology

Business Profile

Weighting

10 %

10 %

Scale

Financial Policy

Leverage &

Coverage

Factor Sub-Factor

Market Diversification 10 %

Hedging and Integration Impact on Cash Flow Predictability

Market Framework and Positioning

Capital Requirements and Operational Performance

Business Mix Impact On Cash Flow Predictability

5 %

10 %

5 %

10 %

40 %

(CFO Pre-W/C) / Debt

(CFO Pre-W/C + Interest) / Interest Expense

RCF / Debt

10 %

15 %

15 %

40 %

» Methodology provides guidance on Moody‘s approach to assigning credit ratings to unregulated

utilities and power companies

» Published in October 2014



Other rating considerations include, but are not limited to:

» Management Strategy

» Corporate Governance

» Liquidity Management

» GRI Methodology

» Event Risk

Stadtwerke specific factors are also taken into consideration, if applicable:

» Quasi-regulated activities, e.g., water supply, subsidised renewables

» Non-regulated but low risk activities, e.g., district heating

» Specifics of power generation assets, e.g., CHP subsidies or other exception rules

» Long-term contracts, e.g., at waste-to-energy, power generation

» Concessions on distribution networks

Consideration of other factors

Stadtwerke may have a lot of specifics, which are not explicitly captured by our global Methodology but taken into account within the analytical process



GRI-Methodology: Joint Default Analysis (“JDA”)

Final Rating

BCA

Dependence

Rating of government

Probability of support

Many utility companies are Government-related issuers (GRIs) and quite often benefit from a rating uplift. The rating of the owner is usually the key driver

Probability of support driven by:

Ownership structure & Corporate Governance

Strategic relevance of utility company for municipality / city

Ability to support

Political implication of a potential insolvency of the utility company

Dependency between municipality / city and

utility company driven by:

share of revenues generated locally

strong correlation of risks



Summary3


Summary

» Weak but stable Sector Outlook for EU utilities

» Fundamentals for Stadtwerke are particular driven by

– Political environment

» Usually strong political support from municipality as the main shareholder

» Well positioned for concession renewals

» Potential benefits from GRI uplift

» Financial situation of municipality could also weigh on credit profile

– Higher level of diversification

» Vertically (i.e., to regulated networks but also supply)

» Horizontally (―multi utility‖)

– Specifics of the business model

» Long-term contracts

» Quasi-regulated activities, e.g., water supply, subsidised renewables

» Non-regulated but low risk activities, e.g., district heating

Credit analysis of Stadtwerke needs to consider many company specifics


Appendix


Political uncertainties persist, but downside has reduced» Fiscal/regulatory measures have cut energy system tariff deficits: Spain, Portugal

» Sovereign crisis has eased, reducing need for measures to support public finances in

euro-periphery countries: Italy‘s Robin Hood tax lowered from 10.5% to 6.5%

» Policy makers listen more, but direct support for generators still limited

» Affordability concerns remain high on the political agenda: France and UK; government

ownership can mitigate risks

» Risks remain:

– Weaker than expected demand could cause tariff deficits to re-emerge

– Underlying contradiction between market liberalisation and decarbonisation

Source: Moody‘s Investors Service

* Based on15 leading unregulated utility groups

Merchant generation EBITDA* decline should flatten from 2015

56% 60% 62% 63% 66% 69% 70%

44% 40% 38% 37% 34% 31% 30%

€102.4bn €111.0bn €105.1bn €109.3bn €103.3bn €95.1bn €96.3bn

Moody’s Sector Outlook


Decarbonization policies have created new problems

» Around 90GW of renewables have been

added since 2009

» Reserve margins have widened out

significantly

» Thermal generation has decreased by 17% on

average (gas -35%) since 2009

European Reserve Margins

Gas and coal generation output in Western Europe since 2009Renewable additions in Western Europe since 2009

EU and National Policies: Areas of Conflict


Conflict 1: Capacity payments vs. interconnection

» Capacity payment mechanisms conflict with

EU ‗Target Model‘ – given impact on flows

» May potentially fall foul of State aid laws

» EU‘s preferred solution is interconnection

» TEN-E regulation / Projects of Common

Interest have removed some barriers…

» …but national energy policies create

uncertainty around costs and benefits

United Kingdom France Italy

Implementation date 2014 - 1st delivery 2018/19 2014 - 1st delivery 2016/17 2014 - 1st delivery 2017/18

Mechanism Auction Model Capacity Certificate Market Auction Model

Centralised / de-centralised Centralised De-centralised - obligation is placed on

supply companies

Centralised

Manager of scheme Government (amount of capacity) Government (amount of capacity) Terna (amount of capacity / auction

National Grid (auction admin) RTE (auction admin) AEEG (regulation)

Power Plant Eligibility All plants (excl. subsidised) All plants All plants (excl. subsidised)

Demand Side Response Yes Yes No

Length of contract Existing capacity - 1 year (default) 1 year 3 years

Existing capacity - 3 year (refurbishment)

New-build - 15 years

Funding of scheme Electricity consumers - costs are passed

onto retail suppliers in-line with their

market share

Electricity consumers - provided that

the tariff formula reflects costs at the

outset

Final mechanism is uncertain although

existing scheme allowed for pass-

through

No in 2014 Implicitly at the outset No

Longer-term - potentially / tbc

Interconnected

participation

Capacity payment mechanisms vary greatly in their design and complexity

CO2 as an example of policy uncertainty that affects interconnection investmentImport interconnection capacity remains below EU targets



Conflict 2: Affordability vs. cost of decarbonisation

» Increase in electricity tariffs has outstripped

disposable incomes across much of Europe

» This trend is likely to continue given 2020 targets

» Existing policies have not been watered down

since the credit crisis / sovereign debt crisis

» Future tariff increases (renewables, networks &

capacity payments) fixed-cost in nature with

variable element of tariffs decreasing

» Reduces the financial benefit to consumers of

efficiency measures / decreasing consumption

» In the long term this issue becomes worse as

more customers go ‗off-grid‘ – who pays?

» Could lead to a change in the market design or

risk the wide-scale stranding of electricity assets

Power prices have fallen, particularly in Europe…

…but end user tariffs have continued to rise (e.g. DE)



Factor 4 – Leverage and Coverage

(CFO Pre-W/C +

Interest) / Interest (CFO Pre-W/C) / Debt RCF / Debt

Aaa > 18x > 90% > 60%

Aa 13x - 18x 60% - 90% 45% - 60%

A 8x - 13x 35% - 60% 25% - 45%

Baa 4.2x - 8x 20% - 35% 15% - 25%

Ba 2.8x - 4.2x 12% - 20% 8% - 15%

B 1x - 2.8x 5% - 12% 3% - 8%

Caa < 1x < 5% < 3%

The weights of the subsectors are:

10%, 15% and 15% for Utilities

Leverage and coverage measures are

indicators for a company’s financial flexibility

and long term viability. Financial flexibility is

critical to unregulated utilities and unregulated

power companies given the cyclical and capital

intensive nature of the business and potential

for volatility in cash flows.

Methodology Factor 4 – Leverage and Coverage (40% weight in total)



FFO (Funds from Operations) Interest Coverage:

(CFO Pre Working Capital + Interest Expense) / Interest Expense

FFO / Net Debt:

CFO Pre Working Capital / ( Gross Debt – Cash)

RCF (Retained Cash Flow) / Net Debt:

(CFO Pre Working Capital – Cash Dividends) / (Gross Debt – Cash)

Calculation of key ratios



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