Spain’s new tax on nuclear and hydro power plants is credit negative

Spain, September 15, 2021 – The Spanish government published Royal Decree Law 17/2021, implementing measures to limit the effect of rising wholesale gas prices on consumers’ electricity and gas tariffs. The law follows a government proposal, currently being debated in parliament, to claw back incremental profits that owners of Spanish nuclear, large hydro and large renewables plants would have gained from higher carbon prices under a no-subsidy regime commissioned before October 2003.¹

The new law is credit negative for Spain’s unregulated electricity and gas utilities because it introduces a revenue deduction that will weaken utilities’ credit metrics, heightens political risk and diminishes the opportunities for arbitrage for hydropower generation.

Based on current spot gas prices, the new law will incrementally weaken the financial profiles of Enel SpA (Baa1 stable), Iberdrola SA (Baa1 stable), Naturgy Energy Group SA (Baa2 stable) and EDP – Energias de Portual SA (EDP, Baa3 positive). Their ratios of funds from operations (FFO) to net debt would fall by 20-130 basis points, all else equal, in 2021-22 (see exhibit). Endesa SA (Baa1 stable), whose credit quality benefits from being 70%-owned by Enel, would record a 550-600 basis point decline in its FFO/net debt ratio, given Endesa’s larger proportion of earnings coming from Spanish nuclear and hydro generation.

The new tax does not take into account the level of hedging already implemented by Spanish utilities for their 2021-22 output at power price levels reflecting gas prices below current levels. Assuming the Spanish government does not extend the tax beyond March 2022, the effect of the clawback on FFO/net debt ratios would be more muted in 2023 at 10-40 basis points (excluding Endesa, for which the effect would be closer to 300-350 basis points). In addition, the negative effect of the tax could be more than offset by higher realized power prices in the generation business.

The law is also credit negative for owners of Spanish nuclear, hydro and large merchant renewables plants because there is a risk that the government will extend the tax if gas prices do not come down materially by March 2022. Additionally, the limit on the increase in TUR will have a modestly negative effect on Naturgy’s debt position, and to a lesser extent Endesa’s, because of a resulting working capital deterioration. Sales and EBITDA should continue to reflect a full cost pass-through, however.

Spain’s new measures include a revenue deduction on nuclear, large hydro and renewables plants not benefiting from a specific remuneration scheme. Indexed on Iberian spot gas prices from 16 September 2021 until 31 March 2022, affected power plants will be taxed under a formula reflecting Iberian spot gas prices as long as spot gas prices exceed €20 per megawatt-hour (MWh). Under that formula, 90% of the estimated upside in wholesale power prices attributed to the wholesale gas price increase will be taxed. The government estimates that the total tax collection, which will be used to reduce consumers’ electricity bills, will equal €2.6 billion.

The measure includes a cap on the increase in the protected gas tariff (TUR), limiting the fourth-quarter 2021 TUR to 4.4% instead of 28% if the TUR were to reflect current wholesale gas prices. The law also limits to 15% the next planned TUR tariff revision for the first quarter of 2022. The Spanish government also plans to implement forced auctions, whereby major power generators must auction some baseload power generation in the forward markets to improve liquidity and open the market to new suppliers. However, it is unclear how utilities that have sold in advance their power plants’ output can offer capacity in an auction without breaking existing contracts.

The law also imposes changes to Spain’s water law, implementing monthly discharges for hydropower plants and minimum volumes of water stored in reservoirs each month. This is to avoid unwanted environmental effects on reservoirs’ plant and wildlife. These changes will reduce arbitrage opportunities for hydropower plant operators and likely trim their profitability.

The Spanish government’s new law illustrates the increasing risks of political intervention related to affordability faced by unregulated utilities, and comes at a time when wholesale power and gas prices are rising significantly. Other EU countries are likely watching the Spanish example closely and may consider similar measures given the electricity sector was prone to political intervention 10-15 years ago, when power prices last spiked. Other countries’ inclination to follow Spain’s example will also reflect each government’s desire to signal energy policy stability and predictability in the context of material investments required to decarbonize Europe’s electricity systems.

_Endnotes:

¹ _{See Proposed profit clawback on nuclear and hydro is credit negative, impact modest, 4 June 2021.}

Credit Outlook: 20 September 2021. Pg. 8
Moody’s Investors Service