The financial situation of the electricity industry

March 14, 2011 | 00:00

The financial situation of the electricity industry

This report intends to show how the financial crisis has affected the European electricity industry and to provide a view on its ability to meet its future challenges.

Since the summer of 2007, due to unsound risk management practices, too sophisticated and opaque financial products, excessive leverage and too lenient regulation, several financial institutions have entered into severe liquidity problems and have had to be rescued by public authorities. The bankruptcy of a major US investment bank in September 2008 generated an unprecedented crisis of confidence and a general breakdown of the financial system, the effects of which extended to the economy as a whole. The reduction in bank lending resulted in a slowdown of global trade, private investment and household expenditure, leading most economies into deep recession.

The coordinated action of central banks and governments helped to prevent the extension of financial bankruptcies, and made it possible to avoid falling into a deep recession and to reestablish global trade, but, at the same time, led to huge public debt that will have to be refinanced in the coming years.

European electricity companies were affected by the credit crisis not so much in terms of availability of lending volumes, but more in terms of their debt costs, which soared as they had to pay higher risk premiums to refinance their debts. In addition to higher debt costs, the electricity industry had to cope with a challenging macroeconomic environment, derived from the consequences of the financial crisis, which has depressed electricity demand and wholesale electricity prices.

Falling electricity prices affected company margins to a large extent. However, falling fossil fuel and carbon prices and a significant share of regulated activities in their total operations helped some companies to hedge against the negative volume and price effects.  In any case, this economic environment contributed to the spread of a pessimistic sentiment with regard to the future evolution of the electricity industry: expectations about the growth rate of earnings per share and dividends deteriorated abruptly.

Weak electricity demand, falling electricity prices, the need to refinance debt under strained capital market conditions and stringent analysis from financial analysts and credit agencies have obliged the companies to reinforce their balance sheets by setting aside assets for disposal, implementing capital increases and reducing capital expenditure.

Nevertheless, the companies cannot handle these adjustment factors at will. Capital expenditure programmes, in particular, due to their long]term licence and construction periods, are too rigid to permit prompt cutbacks. Therefore, the investment effort of the companies recedes very slowly and their leverage ratios are reluctant to descend.

To read the full report, click here.



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