EPH's high voltage dice roll

EPH's high voltage dice roll
EPH is betting that Germany will move to adopt a capacity market
By Will Conroy in Prague July 27, 2016

The big bank lenders see it as the eminently backable new kid on the energy block. The climate change lobby describe it as a faceless organisation gambling on cheap, dirty power plants on their last legs. Czech-based Energeticky a Prumyslovy Holding (EPH) is out to persuade politicians and consumers alike that it will prove a necessary evil during the transition to renewable energy in Europe.

Formed in 2009, the closely-held Slovak-owned group started out with just 0.3 gigawatts (GW) of coal-fired combined heat and power plant (CHP) capacity in the Czech Republic. Within a couple of years, however, EPH had commenced a huge shopping spree, with major coal-fired portfolios acquired in the UK, Italy and Slovakia in the last 18 months or so.

The latest deal – the acquisition of Swedish state-controlled Vattenfall's German lignite assets – was approved by Stockholm in July, despite lively environmental protests. The transaction is due for regulatory clearance in August; it will see the generation capacity of EPH assets overatke that of CEZ, its long-time Czech state-controlled rival.

Such a rapid expansion clearly brings risk, and the latest acquisition is no exception. The purchase of the Vattenfall power plants and open-cast brown coal mines will boost EPH's power generation capacity by around 8GW to 21.5GW, but also amounts to a big wager that could potentially blow up in the German taxpayer's face.

Until recently, the bulk of the vertically integrated energy company's business strategy risk has resided in gas supply security. Included in the assets of EPH, owned by moguls linked to Slovak financial group J&T, is the Eustream gas transmission grid, which carries natural gas from Russia to Europe after picking it up at Slovakia's border with Ukraine.

Eustream accounts for 32% of EPH's Ebitda, based on 2014 figures; Russia says it plans to bypass Ukraine by 2019. While Moscow clearly hopes to cut the volumes it sends via its neighbour with whom its arguably at war, Eustream also holds a 'take or pay' clause in its contract offering a safety net to 2028. Meanwhile, risk assessments have increasingly turned to EPH's “capacity market punt” on ageing fossil fuel power plants.

Czech analyst Jan Ondrich and German climate and energy policy expert Dr. Sabrina Schulz insisted in a recent report for green think-tank Heinrich Boll Stiftung that “it makes little to no commercial sense to acquire these [Vattenfall] assets”.

With European utilities suffering collapsed wholesale power prices as the unprecedented shift to renewable energy squeezes margins at coal, gas and nuclear plants, that would surely remain the case. Unless, the authors point out, one starts to examine the durability of the Merkel government's refusal to adopt a 'capacity market' of the type already approved by the UK, Spain and Italy.

Pay dirt

The capacity market mechanism pays out lucrative subsidies to operators of shuttered generation assets to maintain them as back-up generation. The justification is that green energy sources such as solar and wind are erratic, meaning conventional generation may be needed to make up shortfalls at times of low supply or high demand.

“EPH’s possible motivation for increasing its exposure to lignite and carbon price risks thus becomes clear,” remark Ondrich and Schulz. The company, backed by Czech financial partner PPF Investments in the Vattenfall transaction, would, they say, “likely benefit disproportionately” should Germany be forced to switch to a capacity market approach.

“EPH might also be betting on the failure of the German Energiewende [“Energy transition”] and the EU’s climate policy, including the Emissions Trading System which currently suffers from a very low carbon price,” the report adds.

But what is the probability of Germany conceding it can't do without a capacity market? Will EPH hit pay dirt? “I actually expect the discussion we had in 2014 and 2015 about the need for a capacity market to appear again in a couple of years,” says Prof. Dr. Manfred Fischedick, vice-president and director for future energy and mobility structures at Germany's Wuppertal Institute for the Climate, Environment and Energy, a scientific research facility that receives basic funding from from Federal State North Rhine-Westphalia.

“At the latest it would be after we have closed the last nuclear power plant in Germany in 2020. Until then, we will have enough conventional power plant capacity in the system,” he adds.

The current standby system, limited to a capacity mechanism, does not provide enough economic incentives to EPH as an investor, Fischedick assesses. The analyst says he can “imagine EPH is hoping for the implementation of a capacity market or a similar instrument within the next few years”.

Although Berlin faces intense environmental pressure to cease all lignite-based generation in the near term, Fischedick says he expects it will be a slow process for the next 15 years or so. Should Germany make a U-turn towards a capacity market, however, EPH will have to compete for the financial rewards with other conventional power suppliers, demand side management, storage systems and other players.

Lignite or lights out?

Meanwhile, EPH – now present in seven EU countries – faces an exacting uphill battle to convince people that its business strategy fits with the bloc's renewable energy drive. The company needs to convince politicians and consumers in Germany, for instance, that during any severe Energiewende lag in generation, the reality will be either drawing energy from its dirty lignite or letting the lights go out. EPH spokesman Daniel Castvaj tells bne IntelliNews that the holding is pushing the case that “in order for Germany's power supply to be sustainable, reliable base load capacity that can produce electricity on demand is an absolute necessity”.

Given Germany's lack of domestic gas resources, lignite is “irreplaceable” on an energy security perspective, Castvaj maintains. And in addressing the environmental fury, he adds that the enterprise “fully recognises lignite will only play a transition role as a bridging technology that will eventually be phased out”.

However, that last response deals with a major concern regarding EPH's strategy. Ondrich and Schulz note that, “given EPH’s high debt level and significant exposure to commodity risks, it is entirely plausible the liabilities of mine closures and reclamation measures will end up with the taxpayer”.

Castvaj counters that EPH's relative indebtedness expressed as net debt/Ebitda lately decreased significantly to 2.8 times, which, “due to the high proportion of infrastructure assets held by EPH, can be considered very conservative”. Long the subject of intense speculation amongst the Czech press, EPH's debt load was announced for the first time in June, at €4.6bn.

The holding, the spokesman adds, has through its seven-year ownership of German lignite miner Mibrag “consistently proved it is a responsible operator and has respected all environmental, social and legal obligations”. But scepticism that EPH won't be far more a profit-greedy hindrance than a help in Europe's pursuit of clean energy runs deep, to say the least.

Who's who?

Sandbag, a UK-based think-tank campaigning for environmentally effective climate policies, is scathing about EPH in a report released in April entitled: “Who are EPH? The Blank New Face of European Energy Companies?”

“It is likely EPH will fight harder to keep power stations open for longer than would have been the case for major utilities. It will be interesting to see how aggressively they lobby to try to make [the adoption of EU capacity markets] happen,” says Dave Jones, author of the analysis.

EPH is already a huge polluter that accounted for 2.5% of all European power sector emissions in 2015, says Sandbag. That figure rises to 6% if you include all the coal the holding mines.

Selling all of its power to wholesale buyers, EPH has no retail brand that makes it answerable to consumers. Neither is there any historical affiliation with governments, which might otherwise bring some influence to bear in its strategy.

Meanwhile, as an entirely private holding – J&T alumni Daniel Kretinsky and Patrick Tkac control 90% since buying PPF out in 2014 – it has no shareholders to answer to either. That ownership structure only deepens the lack of tranparency at EPH, and therefore the suspicion surrounding the company. Those doubts were strengthened earlier this year as a plan to float a spun-off unit holding the group's gas assets in Czechia and Slovakia was pulled almost as soon as it was announced.

A further concern, Jones adds, is that while it is clear EPH pays for acquisitions with multi-billion-euro loans from very visible banks, the accrued debt, “like its electricity, is traded on the wholesale market with no reporting of ownership”.

All of which leaves EPH with the Herculean task of appealing for a fair measure of good faith that it will indeed contribute responsibly to energy security amid the rapidly evolving power mix.

Greenpeace insists the Vattenfall deal “implies a direct subversion of the Paris climate agreement”. But might it be conceivable that EPH could one day be able to fire back at critics with something along the lines of: “Consumers are glad we stuck around now aren't they, and they won't mind paying us handsomely for the business foresight”?