As European utilities prepare to report first-quarter results, analysts expect a comedown from 2022 records but strong performance compared to previous years.

Electricity and gas prices have continued their decline in the first quarter, with gas storage facilities well-filled and demand depressed by industrial shutdowns as well as a mild heating season. That means assets such as Germany's coal fleet, which ramped up to cover the energy shortfall in 2022, will not benefit to the same extent.

"2022 was an abnormal year, but earnings should still be robust when compared to 2021," said Patricio Alvarez, energy and utilities analyst at Bloomberg Intelligence.

Power generation was lower compared to first-quarter 2022 in Europe's five largest markets — Germany, France, the UK, Italy and Spain — data from S&P Global Commodity Insights shows. Gas-fired generation declined in most countries, and nuclear reactor maintenance by key producer France meant output by Electricité de France SA also dropped.

Barclays analysts wrote in a note that they are upbeat for European utilities in the first quarter, particularly for integrated utilities and generators that have hedged earnings to high power prices. "The macroeconomic backdrop remains supportive, and we see government focus on energy security and decarbonization as affordability concerns abate," the analysts wrote.

"We argued in our 2023 outlook that the sector could moderately underperform the market this year, although we now feel more constructive," analysts at Deutsche Bank wrote in an April 21 note. "We continue to see integrated utilities as the most compelling investment opportunities, with Enel SpA and RWE AG standing out."

Despite robust gas storage levels in Europe, the analysts point to upside risks from gas and power prices, for instance, if demand in China rebounds from pandemic-related sluggishness or in the event of a cold winter.

The gas price cap, set by EU lawmakers in 2022 at €180/MWh, is unlikely to be triggered in 2023, Alvarez said.

US exposure boosts outlook for European players

Incentive plans in major global markets remain a driver for performance outlooks in analyst assessments.

According to Barclays, utilities with existing and future activity in the US bagged a strategic advantage via the Inflation Reduction Act (IRA). The $369 billion support plan is expected to incentivize the ramp-up of both mature renewables such as wind and solar and, perhaps even more significantly, the emergence of a green hydrogen market.

EU lawmakers responded with the Green Deal Industrial Plan (GDIP), which will leverage existing funds and tackle key industry hangups like permitting delays in a bid to sweeten the investment case for renewables in Europe.

"The US IRA is an impressive piece of legislation which is superior to the EU GDIP, in our view. We favor stocks with existing US exposure and future growth plans in that market," Barclays analysts wrote. Such names include Drax Inc., EDP - Energias de Portugal SA and RWE.

Alvarez also sees Denmark's Ørsted A/S and Spain's Iberdrola SA benefitting from their renewables drives in the US. Europe's policy response "didn't move the needle" to the extent that the IRA has, mainly because of the US law's uncomplicated incentive disbursement, the analyst said.

"Companies like the regulatory visibility; it's straightforward, fast and streamlined compared the what the process is in the EU," Alvarez said, adding that questions on permitting and bureaucracy in Europe continue to loom large.

Part of the EU cleantech plan contains new domestic manufacturing targets for wind and solar, among other energy transition technologies. While Enel is building a solar panel factory in Italy alongside a similar plant in the US, Alvarez does not expect this type of activity to take hold in utilities' strategies.

Having earned record profits through 2022, some utilities may be able to accelerate spending in new business areas in the coming quarters.

For companies such as Britain's Centrica PLC, which raked in record profits thanks to upstream gas exposure, the question for 2023 may be what to do with their hoard, analysts at UBS said in a note.

"Perhaps the solution is for Centrica to focus on the core concepts of flexibility and energy security, eschewing the big-ticket items and seeking to build a diversified portfolio of smaller, mostly UK projects contributing to system security — think gas peakers, batteries, storage, small renewable projects and trading."

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