Squeezed At Home And Abroad, O&G Exit Makes Cents
BMI View: RWE's move to sell its upstream oil and gas business will raise funds in a difficult period for European utilities. While the move will see RWE part with a profitable business unit that could be used to offset loses elsewhere, we view the move as a wise one given the costs that would be necessary to bring new production online.
German y 's RWE annou nced that it would move to sell of f its upstream oil and gas business in bid to raise funds as it struggle s to adjust to a bleak outlook and heavy debt burden in its utility business. Germany's largest power producer by capacity has moved to focus on its generation and supply business in the wake of a largely pessimistic outlook for European utilities. Fellow German player E.ON and France's GDF Suez have similarly moved to sell o f f assets as the industry faces pressures from high costs, rising debt and policy changes.
The knock-on effect of the nuclear phase out has had acute implications for German utilities that were heavily exposed to their domestic nuclear sector - most notably E.ON and RWE. This, coupled with the cost and regulatory uncertainty related to the renewable energy business and waning demand at a time of rising competition in the European power market have hit profits at RWE and E.ON. This is evidenced by the dwindling share prices of both companies since the game-changing Fukushima nuclear disaster in 2011.
|German Utilities Hit Hard|
|E.ON and RWE, Rebased As Of January 2011|
For 2012, RWE reported a 28% fall in net profits from EUR1.31bn from EUR1.81bn in 2011. Looking ahead to 2013, the company reported operating profits would likely fall a further 8% with losses set to continue into 2014. The company's net debt also rose 10% from EUR29.9bn in 2011 to EUR33bn by the end 2012. While the company has embarked on a strategy to cut costs and sell off assets in order to weather the financial turmoil, it previously announced in August 2012 it was considering only a partial sale of its upstream oil and gas business known as RWE Dea.
The announcement of its intention to divest the upstream business, which could net some EUR7bn according to widely cited estimates, came after weaker than expected interest in the company's assets in Egypt ( see our online service, August 13 2012, 'Failed Sale Blow For Recovering Sector'). It is hoped the full sale will generate more interest, and help RWE reach the EUR7bn divestment target it had previously hoped to achieve by end-2013. In announcing the sale of RWE Dea, the parent company moved away from the previously stated target, citing a need to ease pressure on the company given the current environment.
Leveraging BMI's analysis of the Renewables, Power and Oil & Gas sectors, we see both risks and rewards in RWE's decision, making its impact on the company's long-term outlook a mixed but necessary decision. While the divestiture of RWE Dea will alleviate the costly future capital expenditures necessary in the oil and gas business, it will also take away the segment's profits that have helped to offset losses in operations elsewhere. Indeed, RWE Dea saw a 23% rise in operating profits to EUR685mn 2011, boosted by higher oil prices and a stronger US dollar. A September 2012 company presentation had earmarked 30% of the company's planned capex for the upstream oil and gas business to 2014. The asset sale will therefore free a significant amount of cash, given RWE had already planned to reduce overall capex spending moving into 2013 and 2014.
However, while it may be wise to alleviate itself of the spending burden necessary to sustain growth in the oil and gas business, other utilities such as Iberdola have chosen to focus on disposing of non-strategic renewables assets, most recently wind power assets in Germany, France and Poland ( see our online service, February 27 2013, 'Iberdrola's Polish Exit In Line With View'). Indeed, with a more than 12% fall in revenues from EUR443mn in 2011 to EUR387 in 2012, the sale of additional renewable assets may have allowed RWE to raise cash while holding on to a larger share of its upstream a business. Holding on to a profitable business unit would have acted as a hedge against a challenging regulatory and cost environment for its renewables and utility business in Europe.
RWE O&G Exit Comes With Risk Now As Payoffs Come Later
RWE's domestic market in particular presents the most sizeable challenges in terms of renewables, despite Germany's grand ambitions for a green energy expansion. The cost of implementing the energy U-turn, or 'Energiewende', is becoming increasingly unsustainable and the difficulties with connecting the renewable electricity into the national grid is severely hampering the industry, and negatively affecting the utilities operating within the sector. Furthermore, dismally low carbon dioxide prices, stemming from the failures of the EU's emissions trading system, has meant that coal continues to be the most profitable way to produce electricity within Germany, further jeopardising the German renewables market.
Yet, the failed sale of its Egyptian assets highlights the risk that RWE would face were it to maintain its oil and gas business in the North Sea, Africa, Libya, Turkmenistan, Algeria and elsewhere. Growing the business from its current output of 84,000 barrels of oil equivalent per day (boe/d) would have required farm-ins to existing projects, the development of existing prospects at cost (RWE would need to spend EUR2.4bn to bring fields in Egypt into production), or the longer-term strategy of acquiring new acreage and proving up its commercial potential. In view of these realities, and considering that new production would be necessary simply to offset natural declines elsewhere, let alone boost overall output, we view the RWE decision as a necessary one that, while wise, will leave the company more exposed to an uncertain energy market in Europe.