Careful with German power prices

Energy, On the cover, Sin categoría,

Looking at the way German power prices have lagged other commodities over the past couple of weeks, German power looks to be heading into the low €50s/MWh… but NOT higher:

  • Gas prices have stalled and open cycled plants still meet peak demand needs inGermany; and
  • Coal looks solid given ongoing Chinese coal import data and current difficulties in exporting out of South Africa.

However, upside to the mid-€50s/MWh looks too much of a stretch:

  • French supply-demand balances are extremely tight but for transitory reasons;
  • South African coal export difficulties are related to the current expansion project which is said to be about to commission (some 4 months late).
  • Underlying clean dark spreads look high for the oversupplied power market we are currently experiencing.

So targeting a move to just €51-52/MWh makes sense (5-10% upside from 8th October) but not the 15-20% plus that there might be in some other commodities (from early 8th October).

Open cycle gas plants represent about one-fifth of the price setting merit order. Given the six month lag in contract prices, there could be about a €3-4/MWh rise in the contracted gas price (given the lag in the contracted price, it is easy to predict the German gas price going to €18-19/MWh in 3 months), which would equate to about €2/MWh onto the baseload power price. The gas purchase agreements that the German buyers have with Gazprom are under intense renegotiations currently (the buyers can’t take the volumes they’re contracted to take, let alone at the price they’re contracted at) which I expect to be resolved by reducing volumes whilst maintaining the oil price linkage.

Surging spot prices in France have helped German 2010 prices, but that may wane. Spot prices (within day) have hit several thousand euros per MWh in France as capacity failed to meet forecast levels this week. The week ahead French price is up 22% over the past ten days. This caused power prices to surge and has lifted the forward curve, so the French 2010 baseload contract is now over €6/MWh above the German equivalent. This level of premium is not unprecedented (especially for this shoulder period as demand builds seasonally and stations are slow to come back online from maintenance outages); however, a more usual level would be €2-3/MWh.

Clean dark spreads look a bit generous given the lack of capacity tightness in Germany. Clean dark spreads of around €20/MWh would be needed to justify new coal stations (if operators could get comfortable with the carbon risk) but no-one is racing to build so likely to see downside to the spread.

German power is in strong contango. This though can be explained by the contango in European coal. This does not make sense over the medium-term: (a) China will lift domestic thermal output so will no longer be a significant buyer on the seaborne markets, and (b) expansion plans in South Africa will mean exports rise by around 30mt annualized, and (c) renewables will take any medium-term load growth from fossil fuels. However, Chinese coal imports for September may not have fallen (last datapoint on third chart to be confirmed) and there’s no evidence that the export terminal problems out of South Africa have been resolved (the final chart shows how annualized exports out of South Africa have fallen, although the expansion project is lifting throughput capacity to 92mt). The combination of China importing at an annualized rate of 70-80mt (of thermal coal) and South Africa falling 20-30mt short of annualized supply, is likely to keep European coal prices high despite excessive inventory levels in the UK and Europe.

Statoilhydro: Worth a punt

Energy, On the cover, Sin categoría
What is the only commodity that has not been played as a recovery theme? Gas. I am bullish UK Gas winter 2010 as LNG supply dries off and diverts into Asia, and on coal-to-gas switch (those CCGTs will burn gas to 60% utilization)
Statoil is the master hand managing pipeline gas volumes into the UK. Look at NBP pipeline volumes. Statoil is carefully managing up to 40mcm every day… The ONLY UK gas recovery play that trades at 10xPE (15% discount to peers).
I like Statoil ahead of expected bullish Q3 previews (out in 1 week) and Q3 report (out 4 Nov.) And because it’s the only UK gas exposed name that manages the volumes for profit, not cash.
Company specifics set to be great on the parameters that give higher multiples: Q3 production growth (gas) +10%, EPS growth ahead and Reserve Replacement improving for 2009 (to be published in the Q4 report in February).
With gas bottomed down at $4/Mcf and the oil price at $75 and a P/E of 10-11x, the Statoil share should be NOK170-173.

Afren: One to look into weakness

Energy, On the cover, Sin categoría,
The way I see it the stock has short term downside to 80p on fund flows (some large hedge funds are sellers) and technicals… but enters FTSE 250 January or February, RDS are looking to sell them some really cheap assets, small 40-50mnbbls type assets currently too small for the big guys to work and which benefi from better fiscal terms under a Nigerian entity .. ie netbacks go from 2.50-5 per bbl .. so if you are RDS, why not give the assets to Afren, let them get $5 per barrel and take a royalty of around $2 ..less hassle, no political issues , everyone happy !. Ebok field could add 35p/sh unrisked and I am hearing solid things from RDS people. Obviously Addax must have strong views on it too.Expect 6 well exploration program next year targeting 685 bbls vs 129 bbls 2P today (easy 95p valuation then)
The stock, at 80p, will be at 8xPE and 3.4x EV/EBITDA 2010 at $70/bbl, so looks undemanding once we pass the 2009 cornerstone.

ENI and its alleged break-up value

Energy, English, On the cover, Sin categoría
Over recent weeks,Knight Vinke has suggested that splitting the company into utility gas and traditional oil businesses would unlock significant value.
They value ENI between €27.8 and €32.
My biggest discrepancy with them is a) that the issue is not the Gas & Power business but the E&P, and b) I find it hard to believe that both parts would trade at top-of-subsector multiples if separate.
First in the Snam and Gas & Power business… They take the assumption of Snam trading at a 20% premium to RAB, which is crazy compared to other utility stocks. They also use the rest of the gas & power division at a 30% premium to Enel, Edison, Hera, Acea (which all trade at 5.6-6x EBITDA 1yr fwd). They totally disregard the constant process of de-rating of the Italian utilities in the past six years and the impact on power prices of stalled demand and excessive capacity from gas oversupply.
The refining business is put at Neste multiples, which is OK to me
Chemicals are valued at much higher than anyone can imagine (7.5x EBITDA)
Corporate charges are drastically reduced (probably as part o the assumption that, as separate entities, cost savings and job cuts would happen). This is difficult to believe in Italy, but can be acceptable as a thesis.
Then Knight Vinke value the E&P business at the multiples of a BG, which is too radical given the poor growth, high capex and returns.
In essence they use consensus Sum of the Parts, reduce the traditional Megacap oil discount (21% to 15%) to zero by cutting corporate charges and others, pumping up the valuation of the Italian G&P to multiples of non-Italian (and therefore more attractive) utilities and applying a premium to the Snam RAB that it has never enjoyed in the past (Snam is a mature asset and growth RAB is very limited versus maintenance RAB, something that KV seem to value in the same way).
The key, as some analysts (e.g Nomura) point out is that where Eni trades (a 40% discount to its invested capital) is no different to that of other large-cap oils (BP, RDS, FP and STL). I think the value argument can be applied equally to all these companies, but unlocking it is not about addressing a small part (Gas & Power is only 15% of Eni’s invested capital base) but about turning around the core E&P businesses where returns have fallen a staggering 400-500 basis points in four years (while oil prices rose).
That is why, even if separated, it is an illusion to believe that oil investors would see ENI as a high multiple E&P and see it trade at the same multiples as Tullow, Dana, etc… First, because it would still be a State owned entity and its resource base would still be heavily impacted by resource nationalism, low returns and OPEC quotas.
In the meantime, the bet on the stock from here is a full break up not only of the utility assets (which as Scaroni has said, would be regulaywise impossible) but also the disposal (at current market price, no discount) of the Saipem stake.