Europe’s Unloved Utilities Eye Redemption in Commodities Boom

(Bloomberg) -- European utility stocks -- the region’s worst performing sector this year -- are set for a boost from soaring power and gas prices as the economy emerges from the pandemic.

German power producer RWE AG posted first-half profit that beat analysts’ estimates on Thursday, a day after compatriot EON SE increased its outlook for the year. They join France’s Engie SA, Britain’s Drax Group Plc and Austria’s Verbund AG in releasing improving earnings as energy prices rally.

So far, the post-pandemic equities boom that pushed global stocks to record highs hasn’t benefited European utilities, which, as a sector, have been broadly flat as coronavirus lockdowns damped consumption. But the combination of increasing energy demand and the prospect prices will keep rising is prompting some to say investors are overlooking the positive impacts for the industry.

“The performance of energy utilities’ shares hasn’t been good, given weak electricity demand during coronavirus,” said Fernando Garcia, an analyst at RBC Europe Ltd. “But that has already started to change as demand keeps improving and clean energy has became more profitable. In the medium and long term, if high power prices sustain, they will benefit energy utilities.”

Europe’s utility sector has only gained about 1% this year, a fraction of the 19% gain in the overall Stoxx-600 index of European companies.

To be sure, some utility stocks have registered double-digit gains this year, including EON, Uniper SE and Helsinki-based Fortum Oyj. However, the biggest companies by market capitalization, such as Italy’s Enel Spa, Electricite de France SA and Denmark’s Orsted A/S, have underperformed, some by a wide margin.

The surge in gas, coal and carbon permits is boosting the cost of electricity and underpinning utilities’ earnings. Front-year German power futures, a benchmark for Europe, are trading at the highest level since 2008. The elevated prices are expected to be extended at least into winter, when colder weather will increase the need of energy for heating.

Utilities with nuclear, hydroelectric and renewable power generation will benefit most from the rally because they produce low-carbon electricity and don’t need to pay the record high costs for emission permits, a key driver in this year’s power market gains. RWE, Madrid-based Naturgy SA and the U.K.’s SSE Plc are some of the companies positively impacted, according to RBC.

Still, the rising cost of carbon permits -- up 75% this year -- could drag on power producers with portfolios of fossil fuel-fired stations. Uniper’s first-half profit tumbled as the German utility had to buy carbon allowances to cover power plant emissions that exceeded even its own estimates.

Rising power prices may prompt utilities to reassess their system of locking-in, or hedging, prices for forward sales of electricity. The full benefit of higher market rates will apply to generation that hasn’t been hedged.

“Higher power prices will probably attract more investors to some of these assets, and they will be looking at hedging policies,” said Nicolas Bouthors, an equity analyst at Alphavalue SAS in Paris. “Some utilities in Europe are seeing improving margins already now, but current booming prices will really have an impact in two, three or even four years.”

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