Policy and Regulatory Risk for Utilities in Europe from ... · EDF** >17% Significant Vattenfall...

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.

Vittoria Ferraris

Director

Infrastructure Ratings EMEA

May 23, 2013

Policy and Regulatory Risk for Utilities in

Europe from the Rating’s Perspective

2. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

Index

• The Assessment of Regulatory Risk in the Rating Process

• Regulatory Risk vs Sovereign Risk

• Our portfolio of Regulated Utilities in EMEA


Role of Regulatory Risks in the Rating Process

Two basic risk areas are assessed – business risk and financial risk

Financial risk

Financial policies

Accounting and information risk

Cash flow adequacy

Capital structure/asset protection

Liquidity/short-term factors

Financial flexibility

Business risk

Country risk

Industry risk

Competitive position

Profitability/Peer group comparison

Management strategy and corporate

governance

Regulatory risk is an essential feature of our assessment of the Industry

risk and the Competitive position for a regulated entity


Business Risk Profile Assessment—Type of Activity

The nature of operations is a key driver of underlying business risks

The weighting or analytical emphasis that each business profile factor receives is strongly influenced by the type of activity (influenced also by country risk)

Segment risks differ according to function:

1. Transmission system operators (TSOs) – Very low operational risk monopoly service

– No or little commodity risk

– Revenues are generally tightly regulated and stable

– Largely state-owned or controlled

2. Distribution network operations – Generally low risk monopoly service

– Price, performance and quality of service is tightly monitored by regulating bodies

– Generally higher concentration to a smaller service area than TSOs

3. Generation – European power markets are largely liberalized

– Low cost (variable and capital) production key

– Complex operating risks in some instances (nuclear)

– Exposed to wholesale power prices and, sometimes, weather

– Demand, supply, input costs, power prices, and seasonality key external factors

4. Integrated – Integration across the value chain reduce earnings volatility

– Risk depends on the contribution/strength of the company in its various activities

– E&P (mainly gas) activities generally are higher risk due to investment needs and reserve replacement issues

5. Retail (supply) – Competitive and exposure to price/volume risk

– Low margin business, but also low capital intensity

Type of operations

“Industry risk analysis sets the stage for company-specific analysis”

Activity Risk Indication*

Transmission Very low

Distribution Very low/low

Large integrated* Below average

Mid-sized integrated* Average

Merchant generation§ Above average

Retail supply Above avg/high

E&P activities High

Trading High/very high

*Developed, stable markets §Depends on type, size, location,

and age of generation portfolio.


Influence Of Regulation Generally Supports Low Risk Assessment


Supportiveness Of Regulatory Framework Is Key For Regulated Utilities

We assess the:

• Regulatory stability

– Transparency of key components of the rate setting and how these are assessed

– Predictability that lowers uncertainty for the utility and its stakeholders

– Consistency in the regulatory framework over time is crucial for investors in order to be able to more accurately predict

how investments by utilities will be recovered

• Tariff setting procedures and efficiency

– Recoverability of operating and capital costs on a full basis

– Efficiency and ability of the regulator in implementing the framework in a timely manner

– Balance a good regulatory system fairly weigh the needs and concerns of all stakeholders affected

• Financial stability

– Timeliness of adjustment of tariffs to allow for a recovery of costs in full, as time lag in recovery could pressure liquidity

in periods of volatility

– Flexibility to reopen tariffs set when a utility faces unexpected or larger than forecasted operating costs or investments

– Attractiveness of the framework so that investors are more likely to contribute capital in the long-term

• Political independence and insulation

– Risk of political intervention that potentially does not shield regulators from politics to allow them to efficiently protect the

utility’s credit profile even during stressful events

“The primary threat to credit quality is weak regulatory systems that do not

allow for a full and timely pass-through of costs and a return on investments”


Cash Matters

Frequently Asked Questions by Investors:

• How does S&P measure the stability of financial performance for regulated utilities?

–Our main indicator for measuring financial performance of our regulated rated entities is funds from operations (FFO;

operating cash flow before working capital) to adjusted DEBT

–But cash flow after capital expenditure and dividends also important

• Why does S&P not rely on capital structure ratios such as DEBT/RAB?

– A company’s capacity to service and repay debt (or any other obligation) ultimately reflects its ability to generate

cash flows

–For this reason, we use ratios such as adjusted FFO to debt as critically important across all sectors, including

regulated utilities

–Nevertheless, balance sheet gearing metrics, such as debt/RAB, could be important for lenders and, thus, access to

capital and are sometimes considered in our analysis

“A credit supportive regulatory framework should be reflected in stable credit metrics”


High Financial Stability And Performance Lower Ratio Expectations*

Company FFO/debt req. FRP National Grid (~100%) >12% Significant Snam (~100%) 13%-15% Significant Terna (~100%) 13%-15% Significant GDF Suez >23% Intermediate Iberdrola ~18% Significant (BBB ICR) EVN >25% Intermediate Enel ~20% Significant (BBB+ ICR E.ON 23%-28% Intermediate EDF** >17% Significant Vattenfall ~20% Significant (bbb+ SACP) Centrica (0%) >35% Intermediate

Le

ve

l o

f r

egu

late

d e

arn

ings

* Illustrative, based on observations. Only if relevant regulatory framework is deemed credit supportive

** Most of EDF’s French generation earnings are also regulated

Regu

late

d m

etric

s

Ind

ustria

l me

trics

FFO/Debt

(%)

Debt/Total

cap (%)

Debt/EBITDA

(x)

Minimal More than 60 Less than 25 Less than 1.5

Modest 45-60 25-35 1.5–2.0

Intermediate 30-45 35-45 2.0–3.0

Significant 20-30 45-50 3.0-4.0

Aggressive 12-20 50-60 4.0-5.0

Highly leveraged Less than 12 More than 60 More than 5

FFO--Funds from operations.

Key Ratios

Financial Risk Indicative Ratios

Financial Risk Profile

Elia Fingrid Alliander RTE EDF Statnett National

Grid

TenneT Terna

Rating as of March 7, 2013 A-/Stable/A-2 AA-/Stbl/A-1+ A+/Pos/A-1 A+/Stbl/A-1 A+/Stbl/A-1 A-/Stbl/A-2 A-/Stbl/A-2 A-/Neg/A-2

SACP -- a a+ a bbb -- bbb a-

Likelihood of GVT Support -- High Moderate High Very high -- Mdrtly High Moderate

Business Risk Profile Excellent Excellent Excellent Excellent Excellent Excellent Excellent Excellent

Financial Risk Profile Significant Significant Intermediate Significant Aggressive Significant Aggressive Significant

FFO/debt 2011 (%) 11.1 10.2 33.2 12.4 13.0 14.3 11.2 13.9

Target FFO/Debt (%) >10 13-15 >20 13-15 5-6 >12 >5.5 13-15

DCF/debt 2011 (%) (0.6) (14.6) (0.2) (3.8) (9.4) (1.9) 1.6 (10.3)

Debt/EBITDA 2011 (x) 5.8 8.4 2.6 5.2 5.1 4.7 5.3 4.3

Debt/capital 2011 (%) 59 68 37 61 62 71 63 66

FFO interest coverage 2011 (x) 3.0 4.4 5.2 3.4 5.4 3.3 3.4 5.5


Regulated vs Sovereign Risk


Regulatory Risk vs Sovereign Risk

• We generally use the sovereign rating (our foreign currency rating) as a proxy for

country risk

• In our opinion a supportive regulatory framework may mitigate exposure to country risk

to the extent it:

– Insulates the regulated entity from demand risk;

– Insulates the regulated entity from political intervention on tariffs;

– Limits exposure to counterparty risk in quickly deteriorating economic environments;

– Provides a natural hedge against increase of country risk premia; and

– Allows revision of parameters to reflect higher volatility of macro/market indicators.

• Nevertheless, not all regulatory frameworks adequately protect against

– The risk of deteriorating fiscal environment;

– The risk of comparatively higher average cost of debt; and

– The risk of negative political interventions (such as fiscal transfers).

“Regulated utilities have high exposure to country risk, in our view”


Supportiveness Of Regulatory Framework Is Key For Regulated Entities

• Regulatory Reset Risks

– UK Water Sector (2010): Water companies downgraded on expectations of weakening credit metrics linked to our view

of a challenging 2010-2015 pricing period.

• Low Regulatory Predictability

– Israel Electric Corp. (2011): earnings exposed to regulatory uncertainties on the setting of future tariffs by the regulator.

– S.N.T.G.N. Transgaz (2012): revision of the group’s business risk profile from fair to weak on failure to complete the

revision of the existing tariff-setting mechanism by the beginning of the third regulatory period.

– ENEMALTA Corp. (2012): Revision of business risk profile from weak to vulnerable on challenges in passing on rising

input costs to consumers in a hightariff environment.

• Sovereign-linked Regulatory Risks

– Red Electrica (2012) : business risk profile constrained by lack of visibility on announced regulatory measures to

address the costs of the Spanish electric system and the tariff deficit.

– Enagas (2012): business risk profile constrained by increasingly uncertain regulatory environment in Spain where the

government decides on gas infrastructure regulation.

“Rising regulatory risk may trigger negative rating actions”


Regulated Utilities in EMEA


Our portfolio of Regulated Utilities in Europe

0

2

4

6

8

10

12

14

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+

(No of Ratings)

Regulated EMEA Utilities Long-Term Ratings Distribution (as of May 2013)

31-Dec-09 31-Dec-10 31-Dec-11 31-Dec-12 29-Apr-13

0

2

4

6

8

10

12

14

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB-

Dec. 31, 2008 Dec. 31, 2009 Dec. 31, 2010 Dec. 31, 2011 May 11, 2012

Regulated EMEA Utilities Long - Term Ratings Distribution (as of May 2013)

(No of Ratings)

• Rating transition over the last years was mainly sovereign linked;

• The average rating for regulated utilties remains firmly in the investment grade area;

• The median rating for regulated utilities in the BBB+/BBB range reflects a large

concentration of ‘Excellent/Strong’ Business Risk profile and ‘Significant/ Aggressive’

Financial Risk Profiles.


Our Portfolio Of Regulated Utilities In EMEA

0

5

10

15

20

25

30

35

40

Credit WatchNeg

Negative Stable Positive Credit WatchPos

Regulated EMEA Utilities Long-Term Outlook/Credit Watch Distribution (as of Aprily 2013)

31-Dec-09 31-Dec-10 31-Dec-11 31-Dec-12 29-Apr-13

0

5

10

15

20

25

30

35

CreditWatch Negative Negative Stable Positive

Dec. 31, 2008 Dec. 31, 2009 Dec. 31, 2010 Dec. 31, 2011 May 11, 2012

Regulated Emea Utilities Long-Term Outlook/ Credit Watch

Distribution (as of April 2013)

• 70% of ratings in our regulated utilities portfolio have stable outlook

• 20% of ratings maintain negative outlook (among them the peripherals)


Pure regulated Gas players in Europe

COUNTRIES PURE GAS PLAYERS RATING BUSINESS

RISK PROFILE FINANCIAL RISK

PROFILE STRENGHTS WEAKNESSES

Germany OPEN GRID EUROPE GROUP A-/Stable Excellent Significant

Natural monopoly position, low risk earnings

profile, no time lag for the remuneration of

investments

Uncertainty on the efficiency factor for the

recovery of the cost base and reset risk on

productivity factor and efficiency factor. Large and

partially debt funded capex program.

Italy SNAM A-/Negative Excellent Significant

Natural monopoly position, low risk earnings

profile, supportive regulator framework for gas

operations.

Generous dividend policy, large capex program

resulting in negative net cash generation. High

exposure to country risk.

Spain ENAGAS BBB/Negative Strong Significant

Near monopolistic market position with no

exposure to demand nor commodity risks.

Increasingly uncertain regulatory framework

surrounding rising political and economic risks in

Spain. Partial hedge against inflation and

sovereign yeikld increase.

Netherlands N.V. NEDERLANDSE GASUNIE AA-/Negative Excellent Significant

Dominant position in the Dutch natural gas

market as the national gas transportation and

infrastructure company. Stable regulated

network revenues and earnings from 2012.

Supportive owner underpinned by reduced

dividends.

Expansion of higher risk non regulated activities,

non regulated activities and operations outside its

home country, sizeable partially debt-funded

capex program.

UK NORTHERN GAS NETWORKS

HOLDINGS LIMITED BBB+/Stable Excellent Significant

Natural monopoly in its serice area, stable

and predictable cash flow from gas

distribution operations, generally credit

supportive regulatory framework, eight year

earnings visibility under the new RIO

regulatory regime.

Highly leveraged capital structure and relatively

weak cash flow coverage of debt, persistent

negative cash flow after capex and dividends.

UK SOUTHERN GAS NETWORKS BBB/Stable Excellent Aggressive

Natural monopoly in service area, transparent

and predictable regulatory framework.

Weak cash flow coverage of debt and negaive net

cash flow generation due to high capex and

increasingly higher dividends.

Romania S.N.T.G.N. TRANSGAZ

MEDIAS BB/Negative Weak Intermediate

Sole licensed natural gas transmission

operator in Romania with relatively stable

regulated activities. Robust credit metrics,

characterized by low debt-to-EBITDA.

Lower-than-expected predictability of the

regulatory environment. Old asset base requiring

significant maintenance and development

expenditure. High dividend policy.


Regulated Gas and Electricity Networks in Western Europe

COUNTRIES GAS & ELECTRICITY NETWORK

OPERATORS RATING

BUSINESS RISK PROFILE

FINANCIAL RISK PROFILE

STRENGHTS WEAKNESSES

UK NATIONAL GRID PLC A-/Stable Excellent Significant

Operating, market, and regulatory diversity, achieved

through dual-market focus on the U.K. and U.S. with a

focus on low-risk monopoly electricity and natural gas

transmission and distribution operations. Relatively

supportive regulatory environment in the U.S. and eight-

years earnings visibility under the new regulatory

regime fot the U.K. regulated business.

Relatively high consolidated financial leverage as a

result of pas acquisition coupled with persistent negative

discretionary cash flow generation on the back of large

investments in the U.K. And high dividend payout. Some

volatility in metrics, due to foreign exchange metrics.

Netherlands ENECO HOLDING NV A-/Stable Strong Intermediate

Strong market position in the Dutch energy market as

the monopoly owner and operator of regional electricity

and gas distribution networks. The distribution network

operator, which is the third-largest network operator in

The Netherlands, accounts for over 60% of Eneco's

annual EBITDA, providing relatively stable and

predictable earnings.

Regulatory reset risk every third year, with the current

regulatory period being 2011-2013. Exposure to

competitive and volatile generation and supply activities.

Company's sizable and partially debt-financed capital

expenditures (capex) program.

Netherlands ALLIANDER NV A+/Positive Excellent Intermediate

Low-risk regulated electricity and gas distribution

network businesses, stable and predictable operating

cash flow, high quality network assets, and

strengthened financial profile

Regulatory reset risk in 2014, exposure to incentive-

based regulation that can impose challenging efficiency

requirements.

Denmark ENERGINET.DK AA/Stable Excellent Intermediate

Excellent market position as Denmark's monopoly

electricity and gas TSO with a transparent and

supportive regulatory scheme. Access to funding at

short notice from the government via the National Bank

of Denmark and no distribution of dividends to the state.

Sizable investment program, resulting in continued high

leverage and relatively weak credit metrics.

Netherlands ENEXIS HOLDING NV A+/Positive Excellent Intermediate

Natural monopoly status in its license areas with low-

risk regulated electricity and gas distribution network

businesses, and good quality of network assets. The

majority of Enexis' activities, including its electricity and

gas tariffs, are regulated by the Dutch Ministry of

Economic Affairs and the Dutch regulator,

Energiekamer.

Regulatory tariff reset risk every three years. Exposure

to incentive-based regulation that can impose

challenging efficiency requirements; and potential for

further consolidation in the Dutch energy network

sector, in which we anticipate Enexis would take an

active part.

UK SCOTLAND GAS NETWORK

PLC BBB/Stable Excellent Aggressive

Natural monopoly in service area, transparent and

predictable regulatory framework.

Weak cash flow coverage of debt and negative net cash

flow generation due to high capex and increasingly

higher dividends.

PORTUGAL REDES ENERGETICAS

NACIONAIS SGPS BB+/Stable Strong Aggressive

Monopolistic market position in a well-established and

supportive regulatory regime with regulated asset-

based revenues. Good cost discipline, defensive

business model and solid operating performance.

Deteriorated of Portuguese sovereign creditworthiness,

a fairly low level of returns on regulated assets, and

some

appetite for international expansion in potentially less

supportive jurisdictions.


Focus on Gas Utilities


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Policy and Regulatory Risk for Utilities in Europe from ... · EDF** >17% Significant Vattenfall...

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