Will the EU price cap create investment opportunities?
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The uncontrolled raise of gas prices and its volatility are putting Utility companies under unprecedented financial pressure. Extraordinary credit lines to guarantee wholesale purchases will have to be put in place
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Governments are trying to impose a limit (cap) on the purchase price of Russian gas but the agreement is unlikely to become operational before January 2023
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The risk is to be in a situation like that of post Lehman bankruptcy, Utilities will need emergency intervention by central banks and governments. A situation that which might create the right conditions for equity and bond investments
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It is also likely, in perspective, that investors and industrial customer demand will move towards the incumbent suppliers, giving way to a consolidation of the sector
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“History Doesn’t Repeat Itself, but It Often Rhymes”, even when it comes to finance. In the period following the bankruptcy of Lehman Brothers (September 2008), a systematic approach to bailing out American and European banks was finally established in the United States and Europe. It worked: the markets calmed down, setting the stage for few months, if not years, of opportunity in bank bonds.
Today Europe is potentially in a similar situation. The raise, the sharp and unforeseeable movements of the price of gas created financial stress in the Utilities sector. Amid a critical situation, the countermeasures seem to be designed and agreed more orderly than in 2007 for now. A common proposal has been drafted (the EU price cap), although not totally agreed by the members has the needed political support. In short, a framework for investing could take shape quickly but also before a deep crisis creates the opportunity of the decade.
At the moment, the problems appear to be of enormous size. It is not only the price of gas that weighs on the P&L but also, and probably, especially the increase in its volatility. A spike in volatility implies that the margins requested for wholesale purchases (and therefore necessary credit lines) have increased greatly, in a sector that has never seen such peaks. This event putting the Utilities under unprecedented financial pressure: the risk is to be suddenly short of cash to operate on the Amsterdam gas exchange. As if the pressure on the capital front (the need to provide increasing collateral) were not enough, the gas and electricity utilities also face the potential risk of substantial insolvency on the side of the final consumers, especially is these are families or small companies.
Liquidity needs for the entire sector in Europe are estimated to be up to $ 1.5 trillion by the Norwegian giant Equinor. In Germany we saw already the first sings of the problem, the market leader Uniper, required an extraordinary credit line of nine billion euros on top of four billion already used, the German government promptly stepped in. The Swedish parent company Fortum will also need to be supported and dozens of other smaller operators who are in difficulty in Europe.
The EU is designing a limit on the purchase price of Russian gas (price cap) which should curb both the cost of gas distribution and the cost of producing electricity, thus helping families and businesses and ensuring some price stability.
In Great Britain, the new government has promised to take on a large part of household extra spending with a mechanism that, if actually implemented, will be unprecedented: almost 7% of GDP. The measures initially announced by Liz Truss, the new prime minister, provide for aid to families to support the payment of bills by placing a maximum ceiling of 2,500 pounds while the price of gas will be left free to fluctuate so as not to distort the market.
Austria has put two billion euros on the plate for the municipal government of Vienna. Sweden and Finland jointly announced joint interventions worth € 33 billion (likely absorbed by Fortum / Uniper).
Reaching the price cap agreement will take time: it will hardly be operational before January 2023. We could therefore experience a phase like the post-Lehman of 2008. This would open the doors for purchases, equities and bonds.
Extraordinary credit lines to guarantee the liquidity of utilities and aid to end consumers are, in fact, two (unexpected) sides of the same coin. Finally, while there is very little that can be done to make up for the physical shortage of gas, the good news is that, gradually, the whole of Europe is completing the supplies needed for the winter and recruiting alternative suppliers. Once the issue of temporary liquidity is resolved, the capital position of utilities could quickly re-stabilize.
Additionally, it is probable that, once this phase of insolvency risk has been overcome, an new one will open in which investors and the demand of industrial customers will focus towards the main suppliers, putting out the market those of smaller dimensions that are potentially less reliable (operationally and financially), which would lead to market consolidation as well as clearly indicate investment opportunities.
Short term, expected disinflationary effect of the measures to calm the price of gas should not change the restrictive orientation of central banks to face inflation that is no longer temporary but rooted in the system though. After the increase announced on 8 September, the ECB will most likely intervene with another 75 bps increase, taking into account the start of a phase of very low growth (baseline scenario of the ECB) or negative (worst case scenario, again according to ECB forecasts). This will maintain “the risks skewed downwards” as President Mario Draghi used to say.