German utilities spook investors with nuclear gamble

Tuesday, October 5, 2010

FRANKFURT, Oct. 4 (Reuters) - German utilities' gamble of sacrificing near-term profits in exchange for extending the lifespans of their 17 nuclear plants is pressuring shares and may misfire if the political situation changes.

Last month, the government agreed with the four operators of Germany's nuclear power plants to extend the plants' life by 12 years on average in exchange for at least 31 billions euros ($42.45 billion) of payments.

Profit margins of more than 50 percent at the 17 plants, owned by E.ON, RWE, Energie Baden- Wuerttemberg and the German unit of Sweden's Vattenfall make for a big incentive to keep the plants operational for as long as possible and overturn a 2002 law to shut them down by the middle of the next decade.

But the four utilities are committing to burden their profits with higher taxes, levies and security expenses for at least six years.

And a change in government or lawsuits from opponents of the agreement could prevent them from cashing in on their most profitable large-scale power plants after that period.

Since June 1, when news of the new tax burden first emerged, shares of E.ON and RWE have slumped by 8 and 15 percent respectively compared with a 1 percent fall in the STOXX Europe 600 utilities index.

"It's a bad deal that they have been dealt," said Richard Budgett, who helps manage more than 1 trillion euros for Allianz Global Investors in London.

"Unfortunately there is this mismatch between the impact in the very short term on their earnings and the longer-term benefits that may not come through."

Under the pact, power providers agreed to a tax on fuel of their nuclear power plants for the next six years and payments into a renewable energy fund, levies that analysts estimate will take away most profits from the nuclear power plants for years.

Analysts from UniCredit, WestLB and Societe Generale are amongst those who gave a thumbs down to the deal, at least for the first couple of years.

Ratings agency Fitch said even cutting dividends would not make up for the shortfall in earnings.

"The flexibility of German utilities to take such measures is limited, which might lead them to adopt more extreme actions, such as asset disposals or capital injections," in order to keep their credit rating, said Fitch analyst Jacek Kawalczewski.

Operators are betting on the decades afterwards, when income from the plants will soar to a total of at least 54 billion euros, according to think tank Institute for Applied Ecology.

Environmental groups such as Naturschutzbund estimate the last nuclear power plant may be shut down as late as 2050.

Parts of the agreement - a law extending the lifetime of the plants, one covering the nuclear fuel tax and one about the safety of the nuclear power plants -- still have to be passed by parliament, and a contract between the government and utilities still needs to be signed in its final version.

There are many opponents to the agreement. They include a majority of the German public -- according to a survey by Infratest Dimap from early September -- renewable energy companies and opposition parties, which pollsters Allenbach, Emnid and Forsa say are leading in opinion polls.

Their threat is the most imminent as the chief of the opposition Social Democrats (SPD) said last week he aims to get the country's highest court to force the government to get the upper house of parliament to vote on the deal.

A vote in the upper house would likely deal a deadly blow to the pact because German states opposed to the lifetime extension -- either because of party policies or coalition agreements -- have a majority there.

"The market has little confidence that the utilities will benefit in the end," said a Frankfurt-based fund manager, who declined to be identified.

The fund manager is amongst those who say that any court ruling and ensuing vote may come only after the nuclear pact has come into force. Utilities would then have to start paying the fees from the start of 2011 but forego longer-term benefits if the pact is ultimately blocked.

A second risk is a change in the federal government, which is now more likely than ever. All opposition parties in the parliament -- the SPD, the Green Party and the Left Party -- have vowed to abolish it should they return to power.

The next parliamentary elections take place in 2013, when utilities will already have paid more than 5 billion euros as part of the pact with the current government.

"Who guarantees that we won't get a new government in 2013 that abolishes the lifetime extension, but keeps the fuel tax?" said Raimund Saxinger, who helps manage 16 billion euros at Frankfurt Trust in Frankfurt.

That is particularly painful for utility investors, who count on reliable dividend payments -- a trademark of the industry due to the stable demand for power and gas -- to meet pension obligations.

"The cuts to the dividend are a sword of Damocles that's hanging above the share," said the Frankfurt-based investor who declined to be identified.

With the agreement German utilities could suffer from an extra burden in an already hard-hit sector:

Gas and power suppliers are suffering from an unprecedented slump in demand due to still- recovering economies, which have made the sector the worst-performing for the second year in a row.

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