January 21, 2014 / 12:17 PM / 6 years ago

German power sector troubles trigger big and 'bad' ideas

BERLIN (Reuters) - Big problems are prompting big ideas about reforming Germany’s utility sector ranging from a super-merger among players in the “big four” to creating a “bad” utility to take over loss-making plants.

The business model for German utilities has crumbled over the last three years, rocked by the country’s decision to drop nuclear energy by 2022, record-low wholesale power prices and a boom in solar and wind power capacity that is pushing coal and gas plants off the grid.

Shares in top listed utilities E.ON (EONGn.DE), RWE (RWEG.DE) and EnBW (EBKG.DE) have shed a combined 40 billion euros ($54.25 billion) in market value since Japan’s Fukushima disaster in March 2011 which prompted Germany to spur its exit from nuclear.

Their value is down 35-47 percent versus a 15-percent decline on the broader STOXX European 600 utility index .SX6P over that period.

“The pressure for consolidation is building up and will result in takeovers, mergers, other forms of cooperation, but also in players dropping out of the market,” said Norbert Schwieters, head of global power & utilities at PwC.

Peter Terium, chief executive of RWE, has said the energy industry remains “too fragmented” and faces a wave of consolidation.

Some signs of movement are already emerging.

Sweden’s Vattenfall VATN.UL this month agreed to sell its majority stake in Hamburg’s electricity grid back to the city, giving Scandinavia’s biggest utility a capital gain of at least 300 million euros.

However, finding buyers for other assets, including loss-making power plants, could prove harder, financial and industry sources said.


Some argue a better approach would be a merger to create a German super utility better able to compete internationally.

EU Energy Commissioner Guenther Oettinger has voiced support for a merger of E.ON and RWE, for example, to ensure Germany remains a player in global energy.

In terms of valuation, E.ON and RWE look cheap compared with international rivals. They trade at an average EV/EBITDA multiple of 3.5, less than half the 7.5 for the global utility sector, according to Thomson Reuters Starmine data.

One senior source close to both companies, who declined to be named, said there was sufficient overlap between the two companies that a merger would make sense.

E.ON and RWE both declined to comment.

A combination of the two would create a utility with a market capitalisation of $59 billion, second only to EDF (EDF.PA) as Europe’s largest utility by market value, which is 84.44-percent owned by the French government.

While critics have argued that such a merger would do little more than lump together companies facing the same structural crisis, and create anti-trust issues, proponents see it as a necessary step.

“In the medium-term or long term, something bigger may happen on the generation side,” said Frederic van Parijs, senior portfolio manager at ING, a holder of E.ON shares.

“I would not be surprised if the landscape looks very different in 5-10 years.”

Germany’s utility sector is no stranger to big M&A deals. Its biggest utility, E.ON, was created through the merger of industrial giants VEBA and VIAG in 2000.

In 2011, RWE and Spain’s Iberdrola (IBE.MC) came close to a 60-billion-euro tie-up, sources said, but the plan was scrapped due to unresolved shareholder issues and RWE’s already gloomy business outlook.


Government could also play a role by creating a “bad utility”, an idea inspired by the crisis in the financial sector where billions of toxic assets were taken off banks’ balance sheets and placed in so-called bad banks, government-backed warehouses for foundering assets.

E.ON and RWE alone are mothballing or closing more than 15,000 megawatts (MW) of capacity, the equivalent of about 15 nuclear plants, citing low power prices and operational hours for gas and coal plants shortened by surplus renewable capacity.

With thousands of megawatts in the red, industry experts are discussing whether a “bad bank” model might make sense for the energy sector.

“As part of this scenario, you would have a big publicly owned utility, which unifies loss-making plants similar to a public financing fund,” said Michael Salcher, partner at consultancy KPMG.

For the time being, Germany’s ruling coalition has mooted a plant-by-plant approach under a so-called ‘capacity mechanism’ that would compensate utilities for keeping loss-making plants online.

Yet even that could be a long way off, said Roland Vetter, head of research at CF Partners, a financial advisory firm.

“It is understandable that politicians would like to push such a big decision as far away as possible because it most likely will lead to additional system costs,” Vetter said.

Editing by Jason Neely

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