Energy

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

Two is often better than one, at least for European utilities grappling with massive upheaval in energy markets and dwindling profits.

German utilities have shown the way by splitting themselves up in recent months. Now, Electricite de France should consider such a split to shore up its balance sheet, attract more capital and fund large investments.

To recap: earlier this year, Eon separated its fossil fuels business into a new unit, Uniper. Meanwhile, RWE is poised to offer a 10 percent stake in its renewables, grid and retail operations in an initial public offering -- providing it with a cash injection and a separate way to tap capital markets. The latter approach is the one best suited to EDF.

EDF is 85 percent owned by the French government. Fortunately for a company that generates 77 percent of its electricity from fission, France remains committed to nuclear power, unlike Germany. EDF is also still profitable, which is more than can be said for Eon.

Still, tumbling wholesale power prices are putting EDF's nuclear business under pressure, and liberalized energy markets leave it increasingly exposed to competition.

Power Down
Weak demand and growing competition have caused French electricity prices to tumble
Source: Bloomberg

Meanwhile, the company's gargantuan liabilities and spending plans have made EDF uninvestable for all but the bravest shareholders.

EDF faces a 50 billion-euro ($55.7 billion) bill by 2025 to overhaul its fleet of aging nuclear plants. It's also buying a majority stake in Areva's reactor unit. UBS estimates EDF's long-term spending obligations at almost half a trillion euros.

The company has burned through 15 billion euros of cash  over the past six years, according to Bloomberg data. That has obliged it to fund dividends with new borrowings. Net financial debt has already climbed to more than 37 billion euros, or more than twice Ebitda, and is set to increase further. In May, Moody's downgraded EDF from A1 to A2, with a negative outlook.

Debt Burden
Falling earnings and large investment obligations are putting a strain on EDF's balance sheet
Source: Bloomberg and RBC Capital Markets Estimates
Nb. Actual result in blue, RBC estimates in yellow

EDF's stock has tumbled 46 percent over the past year, and the company has been removed from France's benchmark CAC-40 index. The cost of insuring its debt against default has also widened.

Nuclear Deterrent
EDF's shares have tumbled due to falling power prices and worries over its massive investment plans
Source: Bloomberg
Wall of Worry
EDF is state-backed but that hasn't stopped the cost of insuring its debt against default from rising
Source: CBIN

In this context, EDF's backing of an 18 billion-pound ($26.3 billion) nuclear plant at Hinkley Point in the U.K. looks misguided.

The French government and EDF seem to have twigged that the status quo isn't sustainable -- in April, the company announced a 4 billion-euro rights offering (most of which will be bought by the French government). EDF is also slashing capex and will sell 10 billion euros in assets by 2020 to help fund the Hinkley project.

As the majority owner, government is within its rights to ask EDF continue with the Hinkley project. But it can't expect risk-averse pension funds and other minority investors to come along for the ride.

Time to think bigger. Instead of just selling assets, why not give minorities a new, less risky way to invest in EDF by selling shares in the company's non-nuclear assets: renewables, power distribution, and energy services, for example. Such an IPO would unlock value. According to UBS analysts, it could raise as much as 7 billion euros for the company.

EDF has already said it's looking at selling a stake in grid company RTE , so it's not outlandish to think it could combine it with other assets in a listing. EDF also has form here: the renewables business previously had a separate stock market listing but was reabsorbed in 2011

Minority shareholders need the lifeline -- because the prospects for core EDF are far less encouraging. France's plans to impose a carbon price floor should make the electricity generated by the country's nuclear reactors more competitive with coal, but may not be enough to reverse the destruction of shareholder value over the past two years. Meanwhile, the government's plan to accept dividends in shares, rather than cash, is set to dilute EDF's minority investors.

Hinkley looks increasingly like a last throw of the dice, a project kept aloft by political considerations, rather than cold hard economics. In theory, EDF could reap large rewards from Hinkley -- but the cash won't arrive for a decade and it's doubtful EDF will deliver the project on time and on budget.

The U.K. government has guaranteed EDF the right to sell power to UK consumers for 92.50 pounds ($135) per megawatt hour (in 2012 prices). That's almost three times the current market price, and equivalent to the right to sell oil at $230 a barrel for 35 years, according to Peter Atherton, analyst at Jefferies.

But EDF, and especially its minority shareholders, should be deeply wary of Brits bearing gifts.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. That estimate includes the cost of renovating and then one day decommissioning France's nuclear plants, as well as about 350 billion euros to build replacement plants.

  2. That estimate includes the cost of renovating and then one day decommissioning France's nuclear plants, as well as about 350 billion euros to build replacement plants.

  3. At Hinkley, the company intends to deploy the new European Pressurized Reactor, which has already caused huge delays and cost overruns at pilot projects in Finland and France. EDF's chief financial officer, Thomas Piquemal, quit in protest in March and EDF's employees have urged EDF to delay Hinkley by at least a couple of years -- to no avail. A final investment decision is due in September.

  4. The other 50% of RTE's shares are allocated to a portfolio to finance the decommissioning of nuclear power plants.

  5. Allowing for inflation, the Hinkley strike price might be worth about 120-125 pounds per MWh in 2025. Jefferies is assuming a gas price of about $25 per mmbtu.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net