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Have Govts Made The European Utility Sector Un-Investable?

A Very Hostile Political Environment: Have Govts made the European Utility Sector Un-investable?

A Vote of No Confidence — The capital markets have given the European Utility
sector a resounding vote of no confidence. Equity investors are running scared, the
sector is the worst performer in Europe since start 2009, and the underperformance is
actually getting worse. The debt market is also worried, as seen by rising Credit Default
spreads.
Largely a European Issue — The level of underperformance has been unique to
Europe. The Utility sectors in North America, Lat Am, and Asia have performed much
more strongly. Clearly, there are Europe-specific issues at play.
The Flaw at the Heart of EU Energy Policy — Modern govts have three drivers
shaping their energy policy: tackling climate change, affordability, and security of
supply. Most govts try to find a balance, but the EU has given overwhelming weight to
tackling climate change. But the implementation of this policy stance is proving hugely
expensive and politicians are finding that in the real world affordability matters, a lot.
Political Compact Shattered — Since privatization, many Continental utilities in
particular enjoyed a very close and mutually beneficial relationship with their govts.
Investors saw this close political relationship as a given and as insurance against
shocks. But in most countries, the compact has been shattered as govts react to being
squeezed by the recession and the logical outcome of their own energy policies.
27 Political interventions has cost €200bn — We list 27 political interventions since
January 2010 that have had material and negative impacts on the sector. We believe
that the breakdown of the political compact is the main cause of the Europe’s relative
performance vs ROW. We calculate this has cost €200bn in lost shareholder value.
Why don’t companies fight back? — Many companies seem genuinely stunned by
the turn of events. Few have openly opposed their governments and even fewer have
found an effective response. We find it amazing that most managements still act
as if government objectives are reasonable and achievable. We suspect many are
relying upon the capital markets to say no.
Where is risk highest? — The ongoing tariff deficit makes Spain the highest-risk
country, in our view. Portugal and Italy are not far behind, although we may have seen
political risk peak in Germany for now.  France and the UK have been relatively safe
but looming elections raise the risk in France, while we think the risk can only rise in
the UK unless there is a change in govt policy.
And the End Game is? — Governments appear to be effectively re-nationalising
investment decisions. So full re-regulation might be the end game.

Peter Atherton
+44-20-7986-3912
peter.atherton@citi.com

Citi Group, 13 September 2011

Full report available here