(The following statement was released by the rating agency)
Nov 13 - Fitch Ratings believes that the negative outlook for the Spanish utility sector will persist in the medium term. This is due to multiple detrimental effects of the second round of regulatory measures introduced by the Spanish government in an effort to eliminate the tariff deficit and despite the consequent strategic actions that companies have announced to mitigate immediate negative effects.
In Fitch’s view, the government’s measures significantly reduce the short-term tail risk of a partial or full write off of past deficits. However, there is a very strong possibility that additional costs deriving from the introduced measures will eventually be largely passed through to final customers and further undermine demand. The reduction of investments in the industry is not good news for the economic growth, but is a needed measure in a situation of weak electricity demand (a year on year decrease of 1.6% in the ten months to October 2012). The agency also questions the government’s ability to eliminate further tariff deficit from 2013.
Spanish utilities are already under pressure due to weak electricity demand, significant overcapacity and thin spark spreads that have depressed profit margins. In addition, the companies will now have to bear the costs of tax charges introduced by the government on electricity generation. A first round of regulatory changes was introduced in April this year and impacted revenues of regulated assets (networks and storage) and capacity payments.
Integrated utilities, such as Endesa (‘BBB+'/RWN), Iberdrola (‘BBB+'/RWN) and Gas Natural (‘BBB+'/RWN), were the most affected as they are exposed to both regulated and generation segments, which resulted in recent negative rating actions.
The second round regulatory measures were published in September 2012, but are yet to be approved by parliament by year end. The package envisages a tax scheme for the electricity generation segment. It introduces a 6% flat rate tax for electricity sold, a tax on radioactive waste, a tax on hydropower for inland water use, and a green cent scheme for coal and gas. According to the government, these measures, together with EUR2.2bn contribution of deficit annuities in the electricity tariff passed to the state budget and c. EUR0.5bn generated from CO2 rights auctions should contribute to reducing the tariff deficit for 2012 to EUR1.5bn and down to zero from 2013.
The first and most common reaction by companies to adapt and defend shrinking profits in a new and less predictable environment was a freeze of investment spending, as demonstrated by reported and expected capex figures during the first nine months of 2012 versus previous period (9M11). Red Electrica -21%, Enagas -30%, Endesa -7%, Iberdrola -67%, EDP -11%. However, the picture is worse when looking at slashed budgets for investments for 2013-2015.
Capex for the next two years are likely to be limited to the bare minimum and below maintenance level in some cases. While this is a common and very effective strategy to protect companies’ cash flows and provide near-term relief for credit metrics, in the medium term, given the very long lead time for construction of generation and infrastructure assets, it impairs the ability to support future growth. Additionally, it may result in stranded costs on abandoned projects.