Spanish utilities in rating agency crossfire on tariff reform

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LONDON, July 19 (IFR) - Spanish utility companies face the prospect of credit rating downgrades and potentially higher funding costs following electricity sector reforms that place the onus on energy providers to foot a EUR26bn tariff deficit shortfall.

The impact will probably be most brutal for renewable energy firms like Abengoa, although Iberdrola, Gas Natural, and Endesa could also suffer downgrades within the next three months after Fitch placed them on Rating Watch Negative this week.

Portugal's EDP and Italy's Enel have also been dragged into Fitch's review due to the former's significant Spanish exposure through a controlling position in HC Energia, and the latter's majority stake in Endesa.

"I wouldn't be surprised to see some more ratings action," Duncan Sankey, London-based head of credit research at Cheyne Capital said. "The state is going to end up carrying less of the costs than anticipated which is unsurprisingly having a negative impact on some companies."

Since the measures were announced last week, Iberdrola's senior bonds have widened by as much as 14bp versus swaps, while its hybrid deal has broadened by 32bp. Enel's curve has widened by 25bp, Gas Natural's by 20bp, and EDP's by 17bp.

Under the reforms, the state will pay a less-than-anticipated EUR900m a year to plug the multi-billion shortfall, which has ballooned after years of mismatched energy prices and costs. Consumers will also contribute EUR900m annually.

But it is companies that will bear the brunt, Fitch says, paying a hefty EUR2.7bn at a time when the operating environment in the sector is worsening.

"We expect a significant reduction of investments in the sector as this would be one of the few countermeasures that companies will use to off-set further deterioration of their credit profiles."

Moody's and S&P have so far declined to comment, but strategists expect some action from those agencies too.


One credit strategist at BNP Paribas said the impact on Red Electrica would be proportionately the highest, while JP Morgan strategists said the consequences for Gas Natural would be a lot worse than expected due to a severe cut in capacity payments.

Capacity payments refer to the subsidy paid to a generator to ensure the availability of that facility for a given period of time. Iberdrola would be hit hard because of subsidy cuts to its wind business, JP Morgan highlighted.

Strategists at CreditSights, meanwhile, stressed that the reductions would impact the renewable sector the most. They cite the government's plan to scrap automatic subsidies to renewable power producers, and to bring in a new system of what they call "reasonable profitability", which would cap the annual profits of renewable power companies at 7.5% a year.

In 2012, Abengoa already posted a 50% decline in net profit to EUR125m, and its stock has lost 24% since the start of the year. Its EUR250m 8.875% five-year bond issued in January, meanwhile, has dropped almost four points to 96.5, signalling that it would have to pay even more next time to access the bond market for funds.

That would certainly be the case if predictions prove correct that the company's ratings - currently B1/B+ - could be pushed further into junk territory.

Some analysts say that small companies may even be barred from the primary market altogether.

Goldman Sachs highlights unrated Acciona as a potential victim too, which - like Abengoa - has traditionally relied heavily on government support and subsidies.


One silver lining is that these measures will likely be enough to plug the gap without having to increase cuts in future.

"We believe these measures will be sufficient to bring the deficit to zero from 2014 and beyond and, as such, should reduce the risk of further government actions for the foreseeable future," Goldman Sachs analysts Fred Barasi and Manuel Losa wrote in a note. JP Morgan analysts echoed that this could be a "definitive solution" to tariff deficits.

On the back of the reform, the Spanish government has also announced that additional utility taxes announced earlier this year will only raise EUR2.6bn as opposed to the EUR2.9bn initially expected.

"I suppose the shortfall is something that has built up for such a long time and even though the reforms will be a bitter pill to swallow, they are necessary," one syndicate banker said.

"With a little luck it will be a case of intense short term pain, for lasting long term gain," he said.

Find out more about Cheyne Capital.

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