The energy sparks in the stock market

The rise in the price of electricity, which undoubtedly increases revenues for energy companies, has turned this week against the sector. The Government has announced a draft law criminalizing the electricity production of pre-2005 facilities, mainly hydraulic and nuclear. These facilities, which do not emit greenhouse gases, benefit from the increase in the tariff caused by the sharp increase in the price of _CO2 emissions.

The price of electricity is set by the latest technology to enter the system to cover the electricity demand, that is, the most expensive. And if electricity prices rise due to the rebound in _CO2 and gas – combined cycles are more expensive technologies – nuclear or hydraulic production receives what is known as a profit fallen from the sky. “By not emitting _CO2 , they do not bear that cost in their generation and enjoy a greater margin,” explains Xavier Brun, director of the European Stock Exchange at Trea AM.

The price of electricity in the wholesale market has risen compared to June 2020 from 30 euros MW per hour to the current 80 euros. And before a receipt of electricity that has climbed 44% in the last year, the Government has therefore decided to suppress that excess remuneration, estimated at 1,000 million euros per year. In short, 1,000 million less profits for Endesa – which will be the most affected company – Iberdrola, Naturgy and Acciona, a list to which Are added in a more secondary place Enel – Endesa’s controlling shareholder, with 70% – and the Portuguese EDP.

“The marginalist system, by which the price of electricity is marked by the most expensive type of energy to produce, allows hydraulics and nuclear to benefit from the rise in _CO2. Now they will apply a kind of tax for it. It makes economic sense, although the impact on results is going to be noticeable,” says Arturo Rojas, energy expert at AFI. And the effect on prices has also been immediate, also opening Pandora’s box of the regulatory risk always present in the electricity sector and the concern about what will be the playing field in an environment of higher electricity prices.

For now, the shares of the affected companies have suffered in the week. Endesa, which is most affected by the measure, has fallen almost 8% on the stock market and in Monday’s session, its first reaction was a fall of 5.7%. The Ministry of Ecological Transition led by Teresa Ribera has presented the measure in a draft law submitted to public consultation until June 10, which must then receive the approval of Parliament and European authorities. The journey until it is a reality promises to be tortuous and long, but it has already caused a first adjustment of valuations and some recommendation reductions.

The annual impact is 1,000 million euros, although perhaps it will be higher if _CO2 rises more

“The long-built stock market history of global growth and leadership by the sector must be rewritten and could include a moderation in the dividend,” Citi said this week in a report, adding that “consensus valuations and earnings estimates are unjustified.” Consequently, it has lowered Endesa from buying to neutral and cut the target price of this company and also of Iberdrola and Enel.

For Bank of America, the cut in those profits fallen from the sky for the electric companies completely nullifies the positive effect on revenues of the recent rise in the price of electricity. The firm has also cut target prices for Endesa, Iberdrola and Naturgy by 7%, 4% and 3% respectively, reflecting what it considers a “regulatory risk discount”.

In fact, it points to the concern shared by many investors about whether electricity prices will remain at current high levels and whether the penalty now established will be even greater in the future. The estimated impact of 1,000 million euros takes as a reference the current price of _CO2 of 50 euros per ton, but with a price of 100 euros, the cut in excess remuneration would be 2,100 million per year, according to calculations by the Ministry of Ecological Transition.

“We do not know for sure what the amount of that penalty will be, if the price of _CO2 is going to rise much more or how quickly and to what extent that cut to nuclear and hydraulic could fall in the event that _CO2 falls,” they point out from Goldman Sachs. They also point to the great doubt of what the final legal text will look like or whether it will achieve parliamentary approval. And they warn of the regulatory risk that the measure has uncovered. “This unexpected regulatory intervention could result in a further discount,” the U.S. bank said.

Citi and Bank of America have already cut target prices to Spanish utilities although the falls in the stock market also offer a possible buying opportunity

“Intervening in the electricity market to prevent its normal functioning is counterproductive because it creates legal uncertainty,” criticizes Alberto Martín, partner responsible for energy at KPMG in Spain. The expert recalls that the high electricity prices that occur throughout Europe are due to the 60% increase this year in the price of gas – in 80% of the hours gas marks the price of electricity – and CO emission rights₂ . “But the price of CO2 emission rights is controlled by the European Union, which decides what volume of them to emit. And the EU wants a high price of rights precisely so that the high price of electricity encourages investment in renewables and self-consumption, as well as energy efficiency, “explains Martín.

In short, while the time comes for the energy transition to end up lowering the price of electricity, given the low cost of wind and solar energy, the increase in CO emission rights₂ causes more expensive electricity, against which the Government has decided to act.
“The measure introduces uncertainty in the sector and loss of confidence. Foreign investors can undo their positions in the Spanish electricity sector,” adds Xavier Brun, from Trea AM. But the manager also admits that the final legal text could be softer than known so far, adding that, once 100% of the measure is collected at average _CO2 prices, it may even be a good buying point for the affected securities.

“In electricity companies, the investor seeks security, visibility, dividends… and the regulatory risk plays against it,” says Ángel Pérez, of Renta 4. This analyst is reluctant to modify his valuation model of Spanish electricity companies until he has more certainty about what the definitive terms of the measure will be, which, in any case, does not foresee entering into force until 2022. First, the consultation period must end, to find the text that will be put to the vote in Parliament, where the Government is in the minority and needs support from key parties such as the PNV, with strong links with Iberdrola. The Executive affirms that the measure complies with Spanish and Community regulations, although the appeal by the electricity companies is taken for granted.

“In Spain there is no more regulatory risk than in other European countries,” defends José Ángel Fuentes, an analyst at Mutuactivos, who also does not believe that the measure will cause a special deterioration in the valuations of Spanish electricity companies, in his opinion, not exactly high. “The market has reacted well, without great nervousness. The impact on the stock market seen in the quotes is limited to this specific measure and is not discounting an additional regulatory tension,” he argues.

Despite this regulatory setback, of limited effect as they point out in Mutuactivos, the Spanish energy sector is in a solid position, as the results have revealed in a year of crisis as hard as 2020. “The power companies have held up very well and that slack now betrays them. The political moment is not good for regulated companies,” concludes Arturo Rojas.

Source: Five Days