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    EPH bets big on fossil fuels [NGW Magazine]

Summary

The central European company is filling its boots with fossil fuel capacity, counting on the need for despatchable generation to endure longer than the consensus. [NGW Magazine Volume 4 Issue 16]

by: Tim Gosling

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NGW News Alert, Featured Articles, Europe, Premium, NGW Magazine Articles, Corporate, Mergers & Acquisitions, Market News

EPH bets big on fossil fuels [NGW Magazine]

EPH sealed a deal in July to buy the French assets of Germany’s Uniper. The acquisition is typical of the high-stakes strategy the Czech-based energy holding has followed in recent years, and which seen it rise to become one of Europe’s largest energy groups.

Loved by lenders, loathed by environmentalists, and clearly confident of its clout in the political arena, the closely-held Energeticky a Prumyslovy Holding (EPH) has spent the past decade raising the stakes on a bet that fossil fuels will remain a necessary evil during the energy transition.

While European energy majors have rushed to distance themselves from coal and gas to embrace renewables instead, EPH has merrily picked up the cast-offs at cut-price rates. The entry into France, which saw EP Power Europe (EPPE) – EPH’s power generation division – buy 828 MW of gas-fired generation capacity, 1.2 GW of coal, as well as a smattering of wind and solar, does not stray far from the blueprint.

“The acquisition of Uniper France perfectly fits with the strategy of EP Power Europe to further expand its presence in the European power generation sector,” said EPH vice-chairman Jan Springl. “We enter the French market with a strategic intention to further develop the business of Uniper France,” he added.

Yet EPH won’t be holding the assets for long. It has agreed to sell the two gas fired plants to French energy group Total, while the French energy ministry has noted that all parties involved in the deal are well aware that Paris plans to phase out coal power generation by 2022.

“The decision by the French government to close our two coal-fired power plants long before the end of their technical operating lives would have affected our entire business. We therefore had to act entrepreneurially,” Uniper COO Eckhardt Rimmler said in a statement as the deal went through. 

‘Active’ role

That’s music to the ears of EPH. A long list of such buys over the past decade has seen the holding rise rapidly to become a major European energy player – for the time being at least.

When founded by the privatisation barons of Slovak financial group J&T and PPF – the investment vehicle of the Czech Republic’s richest and perhaps most secretive businessman Petr Kellner – in 2009, the company boasted just 300 MW of coal-fired combined heat and power plant capacity. The Uniper buyout raised the holding’s generation fleet to a total capacity of 24.4 GW.

The early years saw EPH building its asset base in central and eastern Europe (CEE), buying up major power and heat generation and distribution capacity, as well as strategic gas pipelines and storage, in the Czech Republic and Slovakia. Assets have also been added in Hungary and Poland.

Around five years ago, however, as the European energy transition started to gain traction, EPH spread its wings. Embarking on a western European shopping spree it bought coal- and gas-fired power capacity – the oldest or dirtiest – in the UK, Germany and Italy as E.ON, EDF, RWE and Vattenfall shed them in favour of renewable energy generation.

In 2018, output of 105 TWh made the company Europe’s sixth largest electricity producer. But despite the ongoing acquisition drive, EPH’s ambition is not to grow output but to reduce it.

The bet is on capacity market mechanisms, which pay out lucrative subsidies to the owners of fossil-fuel generation assets. They keep them offline but in working order and bring them online at short notice either to meet supply failures or demand spikes.

“You need to have cheap, stable power plants stabilising the system, and this is what we are operating,” as the vice chairman of EP Power Europe, Tomas David, puts it.

The difficulties Germany has found in trying to implement its energiewende strategy is grist to EPH’s mill, encouraging the company’s belief that Europe’s energy transition will prove more challenging and slower than politicians and reforming energy majors have predicted.

“The market situation and related economic impacts force traditional large utilities to divest power generation assets that are critical for the proper functioning of national markets,” said EPH spokesman Daniel Castvaj. “EPH will play an active role in this transition,” he added.

Gas cash cow

Analysts note that a handful of other groups – many privately-owned and from CEE – are also eyeing a similar strategy. However, it’s clearly a short-term gambit. For EPH the risk is raised further by the fact that it is underpinned by the highly politicised European gas sector.

EPH transmitted more than 59bn m3 of natural gas last year, distributed another 5bn m3, and filled its storage capacity of 5.6bn m3. Most of that business was conducted by Eustream.

The Slovak TSO, held in the EP Infrastructure (EPIF) division, accounts for over 30% of EPH's pre-tax earnings (Ebitda). However, this cash cow faces potentially huge geopolitical challenges.

Stefanie Voelz at Moody’s worries that while EP Infrastructure – the vehicle which holds EPH’s Eustream stake – boasts strong operating cash flows, the “key cash contributing entity Eustream” is subject to geopolitical risk.

The vast bulk of business for operator of the Slovak gas grid comes from collecting Russian natural gas exports headed to Europe at the eastern border with Ukraine and carrying them to Austria’s Baumgarten hub. The TSO shipped 64bn m3 in 2017.

However, Gazprom’s contract with Ukraine expires at the end of 2019, and the Russian giant is rushing to complete Nord Stream 2 and Turk Stream in order – it hopes – to dump the Ukrainian route. EPH notes that utilisation of its 80bn m3 transmission system capacity fell by 7% year on year in 2018.

Eustream has some assurances for the meantime. The first line of defence is a 50bn m³/yr ship-or-pay contract it holds with Gazprom. However, that deal will run out in 2028.

Second, growing European demand and delays to the new pipeline projects will allow for short-term agreements to extend the use of the Ukrainian network, while the TSO is working on gas links with its neighbours in the hope of expanding its regional role. It has also launched some small efforts to start prospecting for gas in Ukraine.

Nicolo Meroni at Fitch Ratings warns that while he expects “Eustream's east-to-west relevance will be maintained” in the short-term, Russia’s plan to circumvent the Ukrainian route and the development of alternative routes – especially Nord Stream 2 – is a “material potential threat… in the medium to long term”.

Political clout

While tricky to account for on an excel sheet, political clout is a key element in energy and it’s a commodity EPH appears to have in buckets – in CEE at least.

The holding’s partner in Eustream is the Slovak government, and that has helped protect the TSO from the fallout of Moscow’s proxy wars with Kiev, the EU and US.

Alongside other eastern EU member states, Bratislava was originally a fierce opponent of Nord Stream 2. However, it has dropped its lobbying in Brussels as Gazprom has handed over concessions, including a discount on gas and role in distributing gas flows from the pipeline.

“Good relations with the government are a must for the well-being of any big energy company in Slovakia,” saidMartin Vlachynsky of Bratislava-based Institute of Economic and Social Studies (Iness), noting recent lessons learned by Enel.

The Smer government, long suspected of strong links with J&T, all but forced the Italian utility to sell its stake in the country’s dominant power company Slovanske Elektrarne – of which the state owns the remaining 34% – to EPH in 2015. The Czech-based company had by then already proved itself a reliable partner on strategic assets. Bratislava holds 51% in Eustream; EPH’s 49% stake brings with it management control of the TSO.

The holding has also proved its reliability in the Czech Republic in the past. The European Commission fined EPH €2.5mn ($3.3mn at the time) in 2012 for blocking an anti-trust raid by deleting emails. Chairman Daniel Kretinsky said he took the action to protect the details of private banking clients of J&T, said to include senior politicians. Former prime minister Mirek Topolanek now heads Eustream’s PR operation.

Still, as EPH-competitor CEZ discovered during a disastrous attempt a decade or so ago to build itself into a regional giant, it is one thing to work one’s political clout at home but quite another when straying further afield.

In addition, the geopolitical forces that overshadow the region’s gas industry are clearly far from any regional government’s control.

So too, the regulatory environment extending over its capacity market strategy, as policy emanates from Brussels. Capacity market mechanisms were halted in late 2018 as the European Commission investigated their potential to breach state aid rules. Lobbyists continue to oppose the idea, insisting that technology and demand side innovation can cope with the challenges of the energy transition. Meanwhile, recommended CO2 emission limits on participating power plants have now been introduced into EU regulation.

Italy has said that while the limits are not compulsory, it will include them in its mechanism to “prevent high-emission electricity generation, such as coal-fired power plants,” from participating.

EPH announced in February that it will close the 2-GW Eggborough coal-fired plant after failing to win an agreement from the UK government to use it as back up. That’s despite company spokesman Castvaj insisting that across Europe, “the most critical state has been reached in the UK where a capacity shortage is a real threat.” Prescient words, given the power cut of August 9 (see box).

Pressure also persists from environmental groups, who continue to try to push Europe’s high-profile energy majors to shutter their coal-based assets rather than selling them to the likes of EPH.

Pressure points

Some note, however, that it’s not just EPH but banks and taxpayers that bear the risk that overshadows the holding’s strategy. High leverage means lenders could end up on the hook. Net debt stood at €5bn – or 2.9 x Ebitda – in 2018; outstanding loans came in just short of €6bn.

While bond-issuing entities such as EPIF, EPPE, and Eustream maintain disciplined financials, Moody’s Voelz notes that around 70% of debt sits in the holding.

Others worry about the holding’s planned end game. Will EPH fulfil its obligations on shuttering its fossil fuel assets when the time comes, they wonder?

Analysts at German green think-tank Heinrich Boll Stiftung suggested in a 2016 report that “given EPH’s high debt level and significant exposure to commodity risks, it is entirely plausible the liabilities of mine closures and reclamation measures will end up with the taxpayer.”

However, there are few levers to rein in EPH on risk or the environment. The holding has no retail arm, selling all its power wholesale, and therefore no direct exposure to public opinion on climate issues. Fully privately-owned – Kretinsky bought out the last of his partners, J&T founder Patrik Tkac, in 2016 – there are no activist shareholders to press for a more environmentally-friendly business approach.

But J&T alumnus Kretinsky does appear to have started eyeing his public image, in a bid perhaps to boost his political power in western Europe. As EPH was busy sealing its deal to enter France, its billionaire owner was seeking to take control of Le Monde, the country’s highly respected newspaper of record.

Also owner of Sparta Prague, the Czech Republic’s biggest football club, Kretinsky has collected a string of major media assets at home. His media holding Czech Media Invest now also own several magazines in France.

However, after buying a 49% stake in Le Monde, Kretinsky’s bid to take full control provoked a storm of protest. Eyeing EPH’s penchant for wheeling and dealing, journalists at the paper warned that the Czech suitor might seek to ride roughshod over the prestigious paper’s journalistic standards and ethics.

Western European media raced to dig the dirt on the unknown 44-year-old eastern European mogul – who, Forbes suggests, is worth $2.9bn. There were even suggestions that Kretinsky was a Russian agent.

For his part, Kretinsky claims his media drive, like his energy gambit, is motivated by the face-off between traditional and new business models. He insists he sees opportunity in the traditional media space. Perhaps less plausibly, he also claims that he hopes to try to help shield the freedom of the press as global internet giants such as Google and Facebook begin to take over the sector.

The billionaire has also been seeking to employ the deal making acumen he has practiced in energy to push into still more new sectors. In early August, a €5.8bn offer from EP Global Commerce (EPGC) for German wholesaler and hypermarket operator Metro was rejected by shareholders.

Once one of the world’s largest retailers, Metro has been hit hard by competition from online sales, as well as discount chains. However, the company’s board insisted the offer from EPGC, founded by Kretinsky and Tkac in 2018, was too low and warned minority shareholders that it would also come highly leveraged and would “burden the company with a significantly increased debt level,” if accepted.