This year, power prices in Spain rose to more than €100 per megawatt hour (MWh) in the summer as commodity prices rebounded, conventional generation plants closed, and demand recovered. Added to this, carbon dioxide (CO2) prices reached record highs of more than €60 per ton (see "The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update," published Sept. 17, 2021, on RatingsDirect). Households still recovering from the impact of COVID-19 are being hit by soaring energy bills.

In response, the Spanish government passed a decree this month and is proposing a law that allows it to claw back an estimated €3.2 billion from utility companies over 2021-2022. The objective of this is to ease the impact of high power prices on domestic retail electricity and gas customers, and reportedly bring down consumers' monthly bill by about 22%. The measures include a 90% tax on power companies' estimated profits if the gas spot price exceeds €20 per MWh.

But, since utilities have already hedged almost all of their base-load production for 2021 and 2022 at materially lower prices than on the spot markets, this translates into an earnings loss. We estimate that our adjusted funds from operations (FFO) to debt metric for Iberdrola will slip by 300 bps, Endesa's by 750bps, Naturgy's by 170 bps, and Energias de Portugal's (EDP's) by 55bps over 2021-2022 versus our previous base-case scenario.

No other European country has taken such steps so far, instead reducing tax on energy bills or providing subsidies to the most vulnerable households. Spain's National Integrated Energy And Climate Plan (PNIEC) envisages the country becoming one of Europe's "green lungs" by 2030, with renewable energy capacity (including hydro) more than doubling to more than 120 gigawatt (GW) over the next decade. The new measures could reduce power generation companies' appetite to invest in the energy transition and contribute to this goal.

Unique Measures For A Unique Power Pricing Setup

Regulated electricity tariffs in Spain are indexed to daily spot power prices. We believe this creates higher-than-average volatility of domestic energy prices, and is now exacerbated by the recent surge in pool prices to more than €100/MWh. By contrast, tariffs in other European countries are based on long look-back and forward periods. With Spain's unconventional pricing structure, the rise in spot prices has put immediate pressure on households' energy bills.

To counteract this, the Spanish government has temporarily suspended the 7% tax on power generation and lowered the value-added tax on electricity bills to 10% from 21% (not for all customers, and only under specific contract conditions). It is also set to take a share of Spanish utilities' assumed higher profits related to gas and CO2 prices, which it expects will bring consumers the most relief. This will be accomplished mainly through two legal measures, which--combined--could cost the utilities sector about €3.2 billion, affecting key players Iberdrola SA, Endesa SA, Naturgy Energy Group SA, and EDP (see tables 1 and 2):

Royal Decree-Law of Sept. 16, targeting windfall profits of hydro, nuclear, and renewable electricity producers.  

• This piece of legislation will have the most material impact on the sector by far, with an expected total of €2.6 billion over the period to March 31, 2022, assuming a gas price of €60/MWh and about 80% of the daily hours being set by gas. It sets a floor for the gas price of €20/MWh and enables the government to recover 90% of electricity generation companies' windfall profit if spot gas prices are above that threshold. According to the Royal Decree Law, this measure applies to all "non-emitting power generation plants," which allegedly benefit from excess remuneration obtained from wholesale markets but do not experience commensurate increases in marginal costs via higher fuel prices. We understand these measures do not apply to customers with long-term generation contracts (except intragroup), installations with a capacity below 10 MW, or large renewables plants under a subsidy regime and commissioned before October 2003.

A proposed law introducing a CO2 tax on government's estimate of utilities' profits, based on non-emission energy production's impact on power prices.  

• This law, proposed on June 2, 2021, by the Spanish Ministry for the Ecological Transition and Demographic Challenge, aims to introduce a tax on the estimated profit from non-emitted CO2 captured in the price of power generated by nuclear, hydro, and wind assets installed before Oct. 25, 2003. It aims to mitigate the effect of increasing CO2 prices on consumers' electricity bills, particularly in the regulated market. The total impact for the utilities sector in the revised draft is estimated at around €625 million, assuming a CO2 price at €50 per ton and 80% of the daily hours being set by gas. We expect the law to be passed by parliament before the end of 2021 and become effective from 2022.

Table 1

Table 2

The initial earnings' loss estimate of €3.2 billion does not take into consideration potential mitigating actions by operators, such as unwinding hedging contracts and renegotiations with retail end users. However, we believe the claw-back measures will ultimately result in an earnings loss over 2021-2022. We believe the impact will be difficult for Spanish utilities to absorb in the short term, since the decree-law is effective immediately and was enacted unilaterally. What's more, power generation companies won't benefit materially from currently high power prices because they have already hedged and sold their production 18 months to two years in advance, at lower average precontracted prices.

Table 3

Temporary Earnings Dilution Won't Jeopardize Our Spanish Utilities Ratings

The gas price cap will reduce the EBITDA of Spain's largest Spanish utilities, Iberdrola and Endesa, by double digits in 2021-2022. While the drop in EBITDA is significant (see chart 1), it won't erode these companies' credit quality, once the new measures don't last for a long period. In our base case, we consider that the gas claw-back measure will be temporary, and not go beyond the stated expiry date of March 31, 2022.

Chart 1

We expect natural gas prices to remain relatively volatile next year, but gradually normalize by 2023, since it will take time to replenish gas stocks given the current supply constraints. Uncertainty regarding when this will happen implies that the government's measures could be extended. We also believe the introduction of measures to recoup excess profit made by utility companies sets a precedent for future periods of volatile commodity prices. As such, it represents a degree of long-term ambiguity for Spain's energy market.

Is Direct Market Intervention A One-Off?

Power prices are approaching new highs all across Europe, and not only in Spain. Yet Spain is so far the only country to take what could be seen as politically motivated actions in response, directly targeting power generators' earnings instead of applying fiscal remedies like other European countries. We expect the gas profit claw-back measures to remain in place only until March 2022, however.

We also view social pressure as relatively high, since households in Spain are currently spending a much larger proportion of their net disposable income on electricity than elsewhere in Europe (see chart 2). The main reason for this is the generally lower disposable incomes in Spain, while the electricity bill in absolute terms is roughly similar to the average for selected rated European countries. This is based on average consumption of about 4,000 kilowatt hours (KWh) per year and an electricity cost of €0.37 per KWh in 2019 (in line with the euro-area average).

Chart 2

In addition, the new measures were implemented rather quickly. The government's June proposal on the new CO2 profit tax is still being discussed in congress, with a vote expected before year's end. However, the legislation with arguably the greatest impact on the utilities sector was unveiled on Sept. 15 in the form of a Royal Decree-Law, and implemented with immediate effect. The decree-law's unilateral enforcement means that key stakeholders such as the regulator, state council, and private power generators targeted were left out of the decision-making process. The gas measures embedded in the decree-law are temporary, covering the fourth quarter of 2021 and the first quarter of 2022, and expire on March 31, 2022.

This situation is uncommon in Europe, where governments tend to favor fiscal measures to ease pressure on consumers' wallets. In France, for instance, the government has announced a €100 increase of the energy check households receive, for the month of December, to counter the expected increase of energy bills. The government has also decided not to raise the ARENH (regulated nuclear power) volume to 150 terrawatt hours (TWh) from 100TWh (versus the ARENH price of €42/MWh), which could have helped reduce the regulated tariff increase related to the rise in electricity prices. This signals the state's reluctance to intervene directly in the power market. Italy's government has allocated €3 billion to cut households' energy bills by about 30%. It will inject €700 million from the sale of CO2 allowances, transfer into the state budget the proceeds of tax on renewables of about €1.8 billion, reduce VAT (totaling about €500 million), and extend social tariffs by about €450 million to be split between electricity and gas bills.

Possible Implications For Spain's Energy Transition

The measures implemented by the Spanish government highlight that affordability remains a key concern for the energy transition, more so in countries with lower disposable income.   They indicate the need to move away from gas as a back-up, price-setting technology. However, such measures could also slow the process down by restricting power generation companies' financial flexibility. This is especially because the new measures penalize companies that have begun investing in producing cleaner electricity, such as from hydro, nuclear, and renewables.

In our view, the longer-term impact on investment sentiment in Spain is also critical.   We believe regulatory uncertainty stemming from the government's actions might lead certain utility companies to review their capital allocation in Spain. The measures come just one year after large Spanish utilities significantly upsized their capital expenditure programs and renewables development ambitions in the domestic market. While too early to draw any conclusion, we believe a reallocation of investments away from Spain, by parent companies that are global renewables players, would hinder the PNIEC's success. We also foresee implications for funding costs and the availability of financing for new energy projects amid the increased operating uncertainty.

Lack of sufficient funding would curb renewables growth in one of the countries leading the energy transition in Europe.   In its national energy and climate strategy, PNIEC, Spain targets to generate 74% of its electricity with renewable sources by 2030, with an estimated €241 billion in related investments needed from 2021-2030. To achieve this goal, the plan includes big changes to Spain's energy mix, with total capacity increasing to 161 GW from 110 GW today: photovoltaic and thermo-solar to 46 GW from 13 GW, wind to 50 GW from 27 GW, and hydro to 25 GW from 20 GW. Gas will remain broadly stable at 27 GW of combined cycle gas turbine power, and nuclear energy production will decline to 3 GW from 7 GW.

Chart 3

We believe the profit claw-back measures could threaten the 2019 nuclear agreement between operators and the state.   The agreement allows a gradual phaseout of nuclear-powered electricity generation over 2027-2035. The proposed limit to the gas price/profit mechanism will make nuclear plants non-profitable, putting into question power producers' ability and economic incentive to operate plants as defined in the agreement.

Editor: Bernadette Stroeder.

Appendix

The Gas Prices Formula In The Royal Decree-Law:

Related Research

• The Energy Transition And What It Means For European Power Prices And Producers: September 2021 Update, Sept. 17, 2021
• What Spain's Slower Phaseout Of Nuclear Energy Means For Power Producers, March 7, 2019