Utilities and Covid-19

The utilities sector is generally regarded as a safe haven during crises. This is due to the facts that its activity is recognised as essential to a country’s ability to function and that energy demand cannot fall to nothing. That being said, the utilities sector is worth another look in light of current risks of weaker demand, unpaid bills and falling prices.

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What is a utility?

The utilities sector includes companies whose role is to provide large populations with public services such as drinking water, electricity and gas. European utilities companies include RWE, EDF, National Grid, Suez Environnement and others.

 

 

Context

 

The coronavirus’s spread since late December 2019 has curtailed activities at many companies. The first companies hit were those operating in China (whether in production or distribution). The virus’s spread throughout Europe and the Americas quickly brought most of the world’s companies’ activity to a standstill. The lockdowns imposed in most European countries triggered a drop in industrial activity, which will show up in 2020 growth figures.

 

 

Risks for the sector

 

• Weaker demand The closing of restaurants, bars, entertainment venues, and so on caused a considerable decline in energy consumption in Europe. Many manufacturing facilities, such as auto assembly plants, were also closed. According to a study by RTE, the company that manages France high-voltage transmission system, power consumption in France dropped by 15% from its normal March levels in previous years.

 

• Inpaid bills Many companies experienced financial difficulties during the lockdowns and will continue to do so. Bills are piling up and some companies are unable to generate sufficient revenue to pay them. Utilities will therefore have to work with their customers who are encountering cashflow problems. European governments will probably explicitly ask utilities to show some flexibility and continue to provide service even when their customers are late paying their bills. France has already taken steps along these lines via emergency Law n°2020-290 of 23 March 2020, passed in response to the Covid-19 pandemic. EDF, for example, has offered a penalty-free grace period on bill payment for those companies needing assistance and has pledged to spread out their payments over a period of six months after the crisis.

 

• Lower energy prices Energy prices have been below their multi-year trend. This is due mainly to a mild winter in Europe, which led to lower consumption. A Copernicus report found that last January was the warmest every recorded in Europe, at 3.1°C above the average between 1981 and 2010. S&P Global Ratings also noted that good weather boosted renewable energy output, with hydropower dams and windfarms able to produce more electricity. And yet, despite the tense environment that utilities have operated in during the crisis, the sector did receive a good deal of support and remains essential to business activity on a national level.

 

Utilities held up better than other sectors

 

• Utilities companies are essential Even at a slower pace, the sector must still meet demand from households, those businesses still operating, and foreign countries. As companies such as RWE, EDF, and others provide essential services, utilities are likely to hold up far better than most other sectors. From a daily peak in consumption that usually occurs around 8am (in France), power distributors were quickly able to adjust to a peak at about 1pm during the lockdowns.

 

• Close ties with governments and local banks Utilities are often well placed to obtain backing from governments and banks to ensure energy distribution, and are unlikely to encounter too many difficulties in providing constant service and securing financing during are after lockdowns in Europe.

 

• Increased liquidity Utilities generally have lots of cash on hand, which allows them to cope with late payments from their customers. Meanwhile, as the current crisis is not a banking crisis, utilities with a high credit rating are unlikely to have financing problems. That’s why ratings agencies are expecting so few downgrades in the sector.

 

• Contracts protected in advance Energy companies generally hedge their positions one year in advance. To do so, they buy short contracts and put options. If energy prices go up, they forego exercising their option, losing the premium in the process. However, they then sell energy at a higher price. Conversely, if energy prices fall, they do exercise their options in order to sell their output at a price stipulated in the contract. As a result, lower energy prices in 2020 are unlikely to have a signifiant impact on the sector. For 2021, however, only 30% to 50% of contracts are hedged, according to S&P Global Ratings.

 

The utilities sector will be squeezed by weaker demand, unpaid bills and lower energy prices. Despite the challenges it will meet, it can count on backing from governments and banks. Moreover, while its activity has slowed, that activity is essential and can never fall to zero. Utilities remain a resilient and durable sector, with solid backing and, without a doubt, will be resilient in the medium and long terms.

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