Pyhäkoski hydropower plant in Finland. Owner Fortum is among the utilities set to cash in on high power and gas prices in Europe. Source: Fortum Oyj

An unprecedented surge in power and gas prices is playing into the hands of hydropower producers in central and northern Europe, allowing them to cash in on their exposure to the wholesale market. Meanwhile, energy supply companies, as well as utilities facing regulatory clawback measures, are under pressure.

Rising gas demand after a prolonged slump due to the coronavirus pandemic pushed electricity prices across Europe to record highs in September. Year-ahead baseload power in Germany surpassed €117/MWh on Sept. 29, up from €72/MWh on June 30, according to S&P Global Platts.

Like fossil fuel generators, hydro plants, as well as nuclear power stations, are benefiting from these high capture prices on unhedged electricity volumes. But unlike fossil fuel generators, these facilities do not have EU carbon emissions fees to pay.

One key beneficiary of the situation is Austrian utility Verbund AG, which has a large fleet of hydro plants. "They ... have a hedging policy that is relatively short-term oriented," Lueder Schumacher, a utilities analyst at Société Générale SA, said in an interview. Finnish utility Fortum Oyj, another company with lots of hydro, is also buoyed by the high power prices, Schumacher added.

Verbund's share price reached a 16-year high in early September off the back of the price surge, while Fortum's stock touched levels not seen since 2008. While a majority of generation is hedged, the higher market backdrop is still set to feed into their third-quarter earnings.

A Fortum spokesperson said a €1/MWh change in the achieved Nordic power price equates to an approximately €45 million impact in its generation segment's annual comparable operating profit, excluding the potential effects from changes in the power mix. Verbund did not quantify the possible earnings impact.

Norwegian state-owned hydropower producer Statkraft AS is also expected to cash in on the high prices, lifting profit levels materially compared to last year, analysts at S&P Global Ratings said. That is because its hedged volumes, including industrial contracts, are relatively low at 35%, likely resulting in a cashflow boost, the analysts said in a Sept. 24 note. Statkraft declined to comment.

Winners and losers

Given the unrelenting price spike, other European utilities like Electricité de France SA, Engie SA and RWE AG will also see earnings uplift eventually, having been left behind so far, analysts at Barclays said in an Oct. 5 note.

Meanwhile, utilities in Spain, including Endesa SA and Iberdrola SA, will feel the squeeze from regulatory measures to combat rising consumer energy bills, which will claw back "excess income" from operators of low-carbon generation benefiting from the wholesale price hike.

Spiking gas prices have also made gas-to-coal switching attractive again in recent weeks, for example in Germany, even with a carbon price of nearly €60/tonne.

"There's a bit of a coal renaissance going on," Schumacher said. "It's an interesting situation: [the United Nations' climate change conference] COP26 is around the corner and German coal output is absolutely booming."

UK energy crunch

In the heavily gas-dependent U.K., the electricity and gas retail market is being rattled by the climbing prices. Energy suppliers are already experiencing fundamental challenges as a price cap in the retail market collides with spiraling wholesale market costs.

In an effort to build customer books, some smaller retailers had historically sold fuel below cost, limiting their ability to absorb any price hike. Suppliers without deep pockets have already gone under, with more expected to follow.

The numbers of players in the U.K. has almost halved in four years, according to Ratings, which expects the four largest energy suppliers — EDF Energy Ltd.; Centrica PLC-owned British Gas Trading Ltd.; E.ON SE subsidiary E.ON UK PLC; and Iberdrola SA-owned Scottish Power Ltd. — to withstand the turbulence.

"All four have prudent hedging policies in place to manage commodity price risks," analysts said in a Sept. 30 note. "In contrast, the smaller operators tend to have limited hedging abilities."

A spokesperson for EDF said the company is ready to support customers in financial difficulty, in tandem with the government. The other three energy suppliers did not respond to requests for comment.

Part of the fallout could be a reduction in demand from energy-intensive industries, indications of which have come from fertilizer companies in the U.K. closing down production facilities. This effect is also evident in other parts of Europe: German chemicals giant BASF AG on Sept. 27 reduced ammonia production at its Ludwigshafen and Antwerp hubs in Germany and Belgium.

PPA deal-making largely unfazed

For its power needs, BASF is opting increasingly for power purchase agreements, or PPAs, with renewables developers such as Vattenfall AB. The green power market is largely unaffected by the short-term volatility and demand is unshaken, according to Flemming Sørensen, vice president for Europe at PPA market and analytics platform LevelTen Energy Inc.

Off-take contracts signed now will not have to deal with the current pricing environment. "If you sign a PPA today it will likely not start generating until 2023 or 2024 ... and won't have any effect on corporate hedging strategies until this has blown over," Sørensen said in a Sept. 22 interview.

While cost stability is an important benefit, corporates off-takers remain motivated mainly by the sustainability credentials in buying renewable power, Sørensen said. The situation, therefore, is not comparable with the early phase of the COVID-19 pandemic in 2020, where concerns over creditworthiness and an uncertain power market outlook after a drop in power prices led to a slump in activity.

Workers at BASF's Ludwigshafen chemicals plant. Source: BASF AG

Since then, the PPA market has rebounded. "We've seen a lot of interest and a lot of transactions come through. The market is in much better shape now and we don't expect that to diminish," Sørensen said.

That said, the deal-making process ahead of a PPA agreement has changed recently, driven by higher costs and supply chain disruptions for equipment. Typically, developers offering PPAs are obliged to hold a price level for 90 days before entering into exclusivity agreements with buyers. "We've had a lot of pushback because they find it difficult," Sørensen said.

Swedish utility Vattenfall has also not seen an impact in its PPA activity. "Regardless of the volatility in the market, we need to always have a view on the long-term price, because we are making business decisions that have a timeframe that goes beyond the five-year horizon," CFO Kerstin Ahlfont said in a Sept. 20 interview, adding that the events of 2020 will not be repeated.

As for the future of the European power market, while the extraordinary price surge is expected to normalize, the long-term outlook is still one of higher power prices compared to pre-pandemic levels.

"We think power prices will continue to increase in 2022-2023, as supply tightens," Ratings analysts said, using a 2019 baseline.

Forecasts are bolstered by more ambitious decarbonization targets, coal and nuclear plant closures, and a renewables build-out that will be unable to cover the loss of capacity. This will tighten the supply-demand balance and underpin earnings for merchant generators providing baseload power, such as nuclear and hydro, the analysts said.