James de Candole of Candole Partners -
Czech energy group EPH is on a spending spree for old coal- and gas-fired power plants across Europe. Meanwhile, Germany’s E.ON is selling these plants as fast as it can. Both firms are gambling, but on very different futures.
EPH, jointly owned by Daniel Kretinsky and Patrik Tkac of J&T Group, lat last year acquired a conventional coal-fired power plant in the north of England at Eggborough. This latest acquisition, at a cost of some €100mn, more than doubles EPH’s current installed capacity of 1.75 gigawatts (GW).
In addition to Eggborough, EPH is rumoured to be looking at E.ON’s Italian gas-fired fleet, with a total installed capacity of 3.5GW, as well as Vattenfall’s 9GW of coal-fired plants in Germany. If EPH got them all, it would have over 16GW of installed capacity, making it larger than its domestic competitor, the state-controlled utility CEZ (which has around 13GW in the Czech Republic). E.ON’s Italian assets are estimated to be worth some €2bn, and Vattenfall’s €4bn. This would more than double EPH’s current debt level, which is reckoned to be as high as €5bn according to the Czech media.
The Eggborough deal, which was closed in November, came just in time for the ageing North Yorkshire power station. Its chief executive warned earlier in 2014 that rising carbon tax, together with the requirement to invest to meet EU emissions standards, made immediate closure the only “rational economic conclusion”.
So why has EPH decided to acquire this uneconomic base load fossil fuel plant? Its chairman, the 39-year-old Kretinsky, (who in addition to the energy utility part owns a Prague football club called Sparta and a Czech tabloid newspaper, suitably enough called Blesk –the Czech for ‘lightning’) explains: “The acquisition of Eggborough power plant reflects our genuine interest in the UK market. At the same time, we recognize existing difficulties of conventional power generation. The currently announced form of capacity market unfortunately does not seem to be a real option for existing hard coal fleets. Our strategy is to keep existing units operational for as long as it is economically viable, and subsequently to build new capacities in the mid-term, assuming adequate functioning of the capacity market or other regulatory support.” [My italics]
EPH, in other words, is betting on massive ‘capacity market’ payments for its growing conventional fleet in the future. The capacity market scheme would reward conventional base load generators like Eggborough for their potential to dispatch electricity, or so-called ‘installed capacity’, regardless of how much they actually sell. EPH is hoping to ride out the difficult economic conditions in anticipation of securing payment through the UK government scheme that will take effect in 2018. It is gambling on the assumption that EU discussions on capacity payments will be won by those who argue that these payments are essential to ensure sufficient conventional generation needed to deliver security of supply. According to this camp, wholesale prices of electricity are too low to cover the costs of these plants, which will have to be mothballed or decommissioned without capacity payments.
But others argue that low wholesale prices are evidence of too much installed capacity. If so, then the last thing governments should be doing is bailing out uneconomical plants such as Eggborough. Jan Ondrich (my colleague at Candole Partners), in a forthcoming post on the Heinrich Böll Foundation’s Energy Transition blog, explains why: “A precipitate and ill-conceived introduction of the capacity market could petrify current market inefficiencies, hampering innovation and providing economic rent to Europe’s ailing utilities...If a capacity market is to be introduced, it should reward flexibility and low emissions. It must be transparent, with low barriers to entry. The capacity market must allow participation, not only of power generation and demand, but of transmission grids as well if it is to ensure unbiased allocation of resources within the power sector. Limiting the capacity market to power generation would have the unwanted effect of creating incentives to build even more power plants, the last thing Europe needs now.”
EPH’s acquisition strategy was always going to be risky. But after the announcement in December by the German energy utility E.ON that it will hive off all its conventional base load generation assets to focus on grids, customers and renewables, the Czech energy group’s gamble on conventional generation is breath-taking.
E.ON has clearly and publicly discounted the value of its fossil fuel generation fleet, declaring to the market that it expects future growth to come, not from megawatt hours in base load fossil fuel power plants, but in consumers, distributed power, grids, renewables and innovation. Market sentiment shares E.ON’s assessment, whose share price shot up 14% on the announcement of its decision to divest.
Clearly, E.ON’s assumptions about the imminent arrival of a functioning capacity market are very different to those of EPH. It has decided to bundle these assets into a ‘bad’ E.ON, which will now be offered up to investors. Regardless of when and in what form capacity markets are introduced, E.ON’s move will have the effect of drawing those investors seeking exposure to continental European coal-based generation away from EPH.
According to Ondrich, “investors wishing to bet on the failure of the German Energiewende, or on the introduction of an across-the-board capacity market to keep conventional base load capacity online, or as a way to short carbon credits, now have a choice.”
That choice, he implies (he is too polite to mention Mr Kretinsky by name), is unlikely to favour EPH and companies like it, and this for at least three reasons: inferior corporate governance; illiquid stock traded on weak domestic exchanges with poor oversight; and political risk imposed upon the domestic energy sector by the state as a dominant owner of power generation.
E.ON’s divestments offer the benefits that come with effective corporate governance – or as Ondrich puts it, “it would be easy to perform a meaningful due diligence of E.ON’s assets. Investors could trust the audited annual report. There is abundant data provided by the company management.”
There is also the considerable competitive advantage afforded by liquid stock traded on an exchange with robust rules and strong oversight. But CEE energy firms, as Ondrich points out, “if listed at all, trade on local exchanges with weak rules, ineffective oversight and in low quantities. This means that their share price may be manipulated by a handful of traders and the share price exhibits greater volatility.”
A further disadvantage of Central Europe’s energy firms – at least in the eyes of investors looking for exposure to conventional base load generation – is the incompetent policy making such firms are subjected to by the region’s politicians. Bad policy combined with a lack of transparency and unpredictability together undermines the attractiveness of these ‘energy champions’. Investors in E.ON’s divested conventional assets would not face these kind of political risks.
So while E.ON is giving up on conventional base load generation and is unwilling to gamble on the introduction of capacity payments, others, like EPH, are on a spending spree to acquire conventional power plants in the expectation that capacity payments will come to their rescue. They might still do so, but this does not alter the fact that EPH’s pitch to investors has just become much less credible.
In short, why would investors such as China’s Shanghai Electric Power, which is in talks to acquire E.ON’s Italian fleet, prefer Czech energy assets when they can acquire German energy assets?
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