(The following statement was released by the rating agency)
July 16 - Fitch Ratings says that Polish utilities face cash flow pressure and margin erosion on coal-fired and lignite-fired generation, their two main generation sources, in the next several years. This is mainly due to the gradual auctioning of CO2 allowances from 2013, finalisation of compensation payments for the termination of power purchase agreements (PPAs) and a rising share of renewable energy in the country’s generation mix.
Slowing power demand growth on the back of the economic slowdown in Poland could pose additional cash flow and margin pressure. In January-May 2012, demand grew by 0.6% compared with a 1.9% demand growth in the entire year 2011.
These challenges are reflected in the current ratings for the four large Polish utilities rated by the agency, PGE Polska Grupa Energetyczna S.A. (PGE; ‘BBB+'/Stable), Tauron Polska Energia S.A. (Tauron; ‘BBB’/Stable), ENEA S.A. (‘BBB’/Stable) and Energa S.A. (‘BBB-'/Stable) and rating pressure is likely to be largely prevented as a result of a number of risk mitigants. These include the companies’ vertical integration, with the presence of more stable, regulated activities (power distribution) and, to a lesser extent, quasi-regulated activities (renewables and biomass that benefits from a support mechanism through certificates) in their business mix. The distribution segment accounted for 60% of 2011 EBITDA at Energa, 42% at Tauron, 40% at ENEA and 23% at PGE.
An additional risk mitigant is the fact that the four rated Polish utilities currently have solid credit ratios, as they remain unleveraged. Fitch’s ratings for the utilities reflect the agency’s projections for the companies’ aggregated net debt/EBITDA ratio rising to around 2x by 2015 from close to 0x in 2011 due to large investment plans. However, the companies have some flexibility to reduce their capex or postpone some projects in case cash flows from power generation were to materially weaken.
Fitch estimates that margin erosion due to the gradual CO2 auctioning from 2013 to 2020 may be quite substantial. In 2013 Polish utilities will have to purchase about 50% of their annual CO2 allowances (the exact amount should be decided by the European Commission in the coming weeks) compared to only about 10% in 2012. This translates into additional cash operating costs of PLN1.7bn (EUR410m) for the Polish power sector in 2013 based on the average CO2 price for H112. Fitch assumes in its projections that this additional cost for utilities will not be fully passed on to customers and margins will suffer as a result.
The gravity of the cash flow and margin pressure for particular utilities will depend on their fuel mix and the average age of the generation fleet. The best example is PGE, which has a competitive advantage over other utilities as a result of its dominant position in generation and lower-than-average electricity production costs thanks to its lignite-fired plants. More expensive hard coal-fired plants are the largest generation source in Poland and are power price-setters. Furthermore, PGE’s relatively low average age of the generation fleet compared with its Polish peers (about 23 years and 30-40 years respectively) results in better efficiency.
Certain relief to the operating cash flow is expected for those power plants for which the transmission system operator, PSE Operator S.A., may force the production of electricity. PSE Operator covers variable costs including 100% of CO2 costs for such production.
Fitch continues to view the Polish power sector as relatively isolated given its limited interconnection capacity and notes the low risk of substantial changes in the merit order in case of a significant increase in CO2 allowance prices from the current low levels. However, recently a certain process of price reversion towards European levels was observed, which was supported by an interconnector with Sweden and low Nord Pool power prices.
Power generators will also lose additional revenue and income stream from a compensation for the termination of long-term PPAs in the next several years. Cash flow from this compensation will be reported until 2013 by Tauron, 2015 by ENEA and 2016 by PGE (for PGE, revenues from compensation in 2012 are expected to be substantially lower than in 2011).
Another long-term threat for Polish coal-fired plants is a rising share of renewable energy, which effectively pushes out some conventional power units from the merit order given the priority in dispatch for renewables. This is already happening in markets which are more advanced in the development of renewable energy, such as Spain and Germany.
An additional challenge is potential generation overcapacity and changes in the merit order around 2017-2018 when the construction of several planned large new hard coal-fired power units is expected to be completed, in addition to planned capacity replacement units. In the first half of 2012 PGE’s large new-build 858MW lignite-fired unit in the Belchatow power plant changed the merit order and reduced utilisation rates and cash flows of some older, more expensive hard coal-fired units.