European Infrastructure Finance Yearbook - Investing In Bonds ...

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UTILITIES EUROPEAN UTILITIES Once again, while the European utility sector continues to exhibit generally strong credit characteristics, credit quality has come under pressure--with increased debt-financed M&A activity and heightened levels of regulatory risk the principal drivers of this pressure. Favorable operating conditions have, however, continued for many utilities--particularly among generators and vertically integrated power companies in the deregulated markets, where high power prices and strong free operating cash flows have remained a source of credit strength. M&A activity has continued at a high level since 2006, and has resulted inseveral downgrades--at E.ON, EDP, Enel, and Iberdrola for example--and a number of CreditWatch listings across the sector. Crucially, these negative rating actions have been catalyzed byaweakening of companies’ financial profiles following debt-financed acquisitions, as exemplified by Enel’s downgrade to‘A’ from ‘A+’, with all ratings remaining on CreditWatch with negative implications, following its acquisition of Endesa. We believe that the consolidation trend will continue and is likely tokeep ratings under pressure. Of the top 20 European utilities, five companies are on CreditWatch negative as a result ofM&A activity (Enel, Iberdrola, Endesa, Scottish Power, and Gaz de France) and a further four companies have negative outlooks. Meanwhile, the European Commission’s ongoing scrutiny of European utilities, together with the recently announced legislative proposals to further liberalize the internal energy markets, has highlighted the regulatory and political risk many companies remain exposed to. In particular,ofthe measures proposed, any forced ownership unbundling of transmission grids would have the greatest impact on credit quality, affecting vertically integrated utilities in Germany (such as E.ON and RWE), France, (EDF and GDF), and Greece (Public Power Corp.). At this stage, we do not factor in any assumption that those companies that currently own and operate transmission networks will be forced to sell their networks. We believe there continues to be significant uncertainty about both the final form of any legislative package and whether ownership unbundling will be required, asthere is no unanimity between the ECand the member states about whether unbundling is necessary. The future direction of climate change policies adds a further layer of uncertainty and risk to the utility sector. Phase 2 of the EU’s Emission Trading Scheme comes into force from Jan. 1, 2008. Given the high level of uncertainty over future climate policy initiatives and long-term carbon pricing, this issue will remain asignificant challenge for generators, especially when taking long-term investment decisions. Nevertheless, it is clear that the outlook for both renewable and nuclear energy investment has improved and will continue to do sodue to the heightened global focus on environmental issues, while that of coal--the most CO2-intensive fuel--has weakened. The need for technological developments to reduce the CO2 intensity of coal will be key to the future of coal-fired generation. Accordingly, the articles included here provide animportant insight into the current environment European utilities face, as well as detailed analyses of the resulting credit issues. Based in London, Paris, Frankfurt, Madrid, Milan, Moscow, and Stockholm, our regional utilities infrastructure analysts welcome your feedback; their contact details are listed at the end of this book. Please do not hesitate to contact me, or any of the analysts, if you require further information. Peter KKernan Managing Director and Team Leader European Utilities Team 12 ■ NOVEMBER 2007 STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
Publication Date: Sept. 21, 2007 Primary Credit Analysts: Peter Kernan, London, (44) 20-7176-3618 Beatrice de Taisne, London, (44) 20-7176-3938 CREDIT FAQ: ASSESSING THE CREDIT IMPLICATIONS OF EC LEGISLATIVE PROPOSALS FOR THE INTERNAL ENERGY MARKET On Sept. 19, 2007, the European Commission (EC) published a package of legislative proposals for the internal energy market. One of the EC’s principal goals is to correct what it sees as structural failings in some EU electricity and gas markets. According to the EC, “the current rules on the separation of network activities from supply and production of energy do not ensure proper market functioning.” The EC recommends that this be remedied either through ownership unbundling, so that a single company could no longer own transmission and generation or supply activities, or by implementing an independent system operator (ISO) model that would make it possible for existing vertically integrated companies to retain network ownership, provided that the assets are operated completely independently from the generation and supply operations. To highlight the potential implications of the EC’s findings for the credit quality of European utilities, Standard & Poor’s Ratings Services addresses below some of the most frequent questions we have been receiving. Frequently Asked Questions What are the key potential credit stress points in the draft legislative package? The measure that could have the most marked effect on credit ratings would be the unbundling of network assets by vertically integrated utilities. The EC’s current proposals include unbundling as the default option, with the possibility for member states to apply for a derogation and use the ISO model. What is the next stage in the process? The EC’s proposal now has to go through the normal codecision process with the European Parliament and European Council, whereby both institutions can amend the current text in the course of two readings. A third reading allows for formal negotiations between the two institutions if they cannot agree. Standard & Poor’s understands that there are some strongly divergent views within and between the member states on the proposals, and specifically on the subject of ownership unbundling. As such, we believe that some member states and EU parliamentarians could work to alter or remove STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK UTILITIES some of the proposals--specifically to take out one or both of the proposals for the ownership and operation of transmission networks. Which member states would be most affected? A number of member states, including the U.K., Sweden, Portugal, Italy, and Spain, have already implemented ownership unbundling of transmission networks. For these countries, a legal requirement to unbundle would have no impact on domestic energy markets. Some member states, however, such as France, Germany, and Greece do not currently require ownership unbundling of transmission networks. The domestic energy markets of these countries could therefore be significantly affected by any obligation to implement ownership unbundling. When would the member states have to implement the legislative package? The earliest member states would have to implement the unbundling and/or ISO requirements is likely to be around 2012 on the basis of a normal legislative procedure and assuming that the current text is the one that is finally adopted. The text could change during the course of the legislative debate, however, and implementation could be delayed beyond 2012, as it is the member states who determine the timing of their domestic legislative programs. What assumption do the ratings on affected companies make about the likely outcome of the legislative process? At this stage, we do not factor in any assumption that those companies that currently own and operate transmission networks will be forced to sell their networks or will pre-empt a potential legislative requirement by unilaterally deciding to sell their networks. We believe that there continues to be significant uncertainty about both the final form of any legislative package and whether ownership unbundling will be required, as there is no unanimity between the EC and the member states about whether unbundling is necessary. For example, there is significant opposition to forced ownership unbundling in France and Germany, two of the largest and most influential member states, which, if sustained, increases the likelihood that an alternative NOVEMBER 2007 ■ 13
Page 1 and 2: November 2007 Infrastructure Financ
Page 3 and 4: CONTENTS Introduction STANDARD & PO
Page 5 and 6: INTRODUCTION 2007: New Challenges A
Page 8 and 9: ject Finance Rating Distribution: I
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CONTACTS KEY ANALYTICAL CONTACTS Fr
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ARGENTINA AUSTRALIA BRAZIL CANADA C
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