Utility Week

UTILITY Week 2nd May 2014

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20 | 2nd - 8Th MaY 2014 | UTILITY WEEK Finance & Investment Market view T hirty years ago, power and utility com- panies were largely state-owned and integrated. The sector was dominated by monopolies and oligopolies, while growth and earnings were relatively stable. This allowed for good financing of capital expenditure through debt, and prices were set against a backdrop of minimal competi- tion and reasonably low volatility on com- modity prices. All that has changed. European member states privatised the companies involved and the EU pushed for the generation, distribution and selling of gas and electricity to be largely separated. Utilities extracted costs from inefficient, nationalised enterprises and increased lever- age from frequent issuance in the debt capi- tal markets – where investors offered cheap financing for what was seen as a low credit risk. To enhance earnings from operational synergies and multi-utility models, power and utility companies conducted a large number of mergers and acquisitions between 2000 and 2008, with a lot of cheap financing available. However, European power and utility companies' business models are broken fol- lowing historic GDP contraction, oversupply in key generation markets and direct politi- cal and regulatory intervention. They are focused on de-leveraging to overcome historically high-priced acquisi- tions and a significant capital expenditure burden, forcing energy firms to look at how they manage their funding needs. The need for more liquidity has led to a drop in the sector's working capital efficiency, falling by about 25 per cent globally between 2002 and 2012, according to Ernst & Young. This is the largest fall of any sector over that period, alongside mining. It increased the operating cycle – the time it takes to get paid aer providing the gas or power – by 3.5 days, which led to a €5.5 bil- lion (£4.5 billion) drain on trade working cap- ital across the sector over the same decade. Greater regulatory demands and unfa- vourable market dynamics have resulted in a negative ratings outlook for companies in the sector across Europe. Almost a third of rated issuers have negative outlooks or are on negative watch by rating agencies. Working capital initiatives could free as much as €16 billion from companies' bal- ance sheets, according to Pricewaterhouse- Coopers, and this money could go towards de-leveraging, investment and complying with increased regulation. Power and utility companies are looking at efficiency initiatives as a top priority. They are investigating better invoicing structures, centralised procurement and more efficient just-in-time management. New financing schemes being considered include buyer led supplier finance (BLSF), where the buyer's bank lends the supplier what it is owed based on the buyer's credit. The supplier gets the money it needs on day one and the buyer can extend payment terms to keep the cash on its balance sheet longer. This is useful for large capex programmes or outsourced opex contracts. Another option for releasing cash is com- modity monetisation, a form of commodity financing. Through this structure, a genera- tor finances its commodity feedstock, such as gas or coal, through an off-balance sheet structure. This involves a financial institu- tion buying what they have in storage or are transporting and selling it back as and when it is needed. As utilities struggle with the economics of power generation, particularly continental combined cycle gas turbine plants, gas mon- etisation is growing in popularity. This popu- larity is heightened by US shale gas leading to cheaper coal and the more prominent role of renewable energy. Other areas that treasurers in the sector are focusing on include direct debits, intan- gible asset monetisation and supplier-led receivables financing. Power and other utility companies now face the enormous challenge of getting more from their working capital and funding large investment requirements while keeping reg- ulators, investors and customers happy. Smart financing and better internal pro- cesses could be part of the answer. If they get it right they can release billions of pounds in an increasingly difficult credit environment. Working capital efficiency must become one of their top priorities. Richard Saint, head of power, utilities and infrastructure, and Ugur Bitiren, director, corporate advisory, at RBS. Billions up for grabs in power Energy companies could release billions of pounds with improved working capital management. Richard Saint and Ugur Bitiren say they should look for new forms of financing – now. A+/A1 A/A2 A-/A3 BBB+/Baa1 BBB/Baa2 S&P Moody's Source: S&P, Moody's, Brokers 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 The capital agenda • European power and utility com- panies need to get more from their working capital while keeping regula- tors, investors and customers happy • Smart financing and better internal processes will help • Working capital initiatives could free €16 billion from their balance sheets Many European utilities face downward pressure or at best have limited financial headroom at their current rating level Average rating in European power and utility sector

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