Europe’s energy industry has grown accustomed to constant change. Yet it has been rocked by a new shift that is both tectonic and Teutonic.
In Germany two of the sector’s biggest players are plotting a £38bn shake-up that could trigger aftershocks across the continent, including in the UK.
RWE and E.on last week set out plans for a complicated asset swap designed to rebuild international strength that has been sapped by Germany’s pro-renewable energy policies. The move tears at the heart of one of the UK’s biggest energy deals since privatisation, however, and could spell trouble for the rest of Britain’s big players as well.
E.on will take on RWE’s network and supply arms in exchange for its large-scale electricity generation assets, including renewable power projects. Each will become a dominant player in their more focused business.
The details are less simple. E.on will snap up RWE’s 76.8pc stake in the supplier Innogy, which owns Britain’s Npower. In exchange RWE will take a 16.7pc stake of E.on as well as ownership of its renewable assets, while keeping the wind farms and biomass plants held by Innogy. RWE also plans to pay E.on €1.5bn in cash to plug a gap in the value of the assets being swapped.
The deal is complex, but Innogy is clearly at its centre. Meanwhile the owner of big six energy supplier Npower is already embroiled in plans to merge with the supply business of SSE to create a new mega-player in the UK energy market. But under the terms of the German deal Npower’s parent could soon be E.on, meaning the Germany utility would inherit a stake in the new SSE while still controlling its big six rival E.on UK.
In a market already under scrutiny for failing to offer fair competition to consumers watchdogs are likely to object to a single player with such sway. The Competition and Markets Authority has already begun talks with the tangle of companies involved.
One outcome, according to sources, could involve Innogy undertaking a speedy sale of its stake in the new SSE company once the merger is approved and before the E.on-RWE tie-up is sealed.
An Innogy exit has always been on the cards, according to the company, and could comfortably meet the deadline given the complexity of the E.on deal which could drag to the end of 2019.
Still, plans to sell its stake may need to be a promise rather than an ambition. It would mean a sooner than expected end for Innogy, which itself was formed only two years ago in the wake of a German energy policy U-turn.
The Fukushima nuclear disaster seven years ago triggered changes which have reverberated across the global energy landscape ever since. Germany’s government announced a shock shut down of the country’s nuclear power plants after 40,000 protesters formed a 28 mile chain to call for an end to nuclear power. In its place came an aggressive push towards renewable energy.
For RWE and E.on it spelt financial meltdown. They were forced to begin shutting down the nuclear plants which once generated billions of euros. Meanwhile, as subsidised renewable energy spread throughout the market their traditional gas and coal-fired power plants became uneconomic in the market, in a second major blow to the German giants.
The utility death spiral led both to embark on painful restructurings to survive. E.on split off its loss-making power plants in 2016 to form Uniper, a company focused on large centralised power generation and trading. The spin-off freed E.on to focus on energy networks and customers.
Months later, RWE took an opposing bet. It formed Innogy in April 2016 to focus on customers and networks while the core business held its ground by holding on to traditional power generation. Two years later, the deal struck between the titans deepens the wager each is taking on areas of the energy market which are both in flux.
Ahmed Farman, of brokerage Jefferies, explains that the deal would help E.on achieve scale and efficiencies in networks and retail, and transform RWE into a leading generator with a healthier balance of fossil fuel and renewable projects.
“However, this would involve another two years in costly re-structuring,” he warns.
This could be a particularly heavy burden for E.on as it inherits €18bn debt from Innogy. “Our first view is that new E.on would have an EBITDA of €7bn excluding synergies, but would have debt in excess of €40bn. Therefore, it is unclear to us how the new E.on balance sheet would work,” he says.
But experts believe the shake up could herald a fresh chapter for European energy companies.
“Expect more deal-making to come in the European power sector,” Sebastian Zank, of Scope Ratings, says. “This deal could lead to a new transaction record in 2018 in the European utility landscape.” Scope Ratings believes that after a period of regulatory gloom for Europe’s utilities there could be a dawn about to break the almost £40bn M&A record set last year.
Against that backdrop of multi-billion euro power grabs the RWE-E.on deal shows its worth.
Greater financial flexibility may also fortify their defences against falling prey to takeovers, and safeguards the wider German market against “the risk of further intrusion by foreign companies”, says Zank.
It will now be more difficult for either RWE or E.on to be acquired by outside investors such as Engie, Enel or Iberdrola. Instead, the hunted may now emerge as the hunter. There is little doubt that the hunting grounds will include the UK.
RWE boss Rolf Martin Schmitz fuelled expectations that the company will target the UK energy market for future power generation acquisitions in an public statements made last year. For E.on, Britain’s retail energy market offers rich pickings. Despite Government misgivings over the “broken” market the landscape is littered with firms developing new technologies and homes service offerings which are ripe for deal hunters and – crucially – far more affordable than snapping up major generation assets.
E.on UK has kept a relatively low profile within the market for years and itself may be overdue a deal which reboots the business and sharpens its competitive edge against its existing rivals and those new players, including the likes of Royal Dutch Shell, which are vying for a piece of the market.
For the uber-utilities the game is on and there’s everything to play for.