RWE could lose one fifth of value by pursuing coal – report

London, 21 December: RWE's plan to replace its aging power stations with coal-fired generators could wipe up to 17% from the value of the company if the price of carbon rises, according to a report by SAM Group and WWF.

RWE is currently planning to build a 1,500MW coal-fired plant in Hamm, and a 2,100MW lignite-fired plant in Neurath.

Carbonizing Valuation concludes that the EU Emissions Trading Scheme (ETS) – under which power stations and other industrial installations must submit allowances to cover their carbon dioxide emissions – is not yet providing a sufficient incentive for utilites such as RWE to invest in power stations that burn less polluting fuels.

But it argues utilities should shift their investments towards less polluting gas-fired power stations anyway, in anticipation of future restrictions.

"Clearly, the failure of incentivising utilities to build low carbon-intensive capacity has to be corrected for. Investors need to deeply reflect on the situation as a material risk factor," the report says.

Taking RWE as an example, SAM and WWF estimate that the firm will have to replace 80% of its capacity by 2020. Although current prices of allowances in the EU ETS suggest that RWE would be better off building coal-fired generation, the report says this strategy could take a chunk out of its valuation in the long term.

Yesterday, the price of allowances for Phase II of the EU ETS closed at €17.10 per tonne. But the report notes that Germany may have to cut its emissions by 80%, to 100 million tonnes of CO2 by 2050, driving allowance prices much higher. RWE alone emitted 114 million tonnes of CO2 in 2005, and the report suggests that it will be required to make substantial cuts of up to 50% in the future.

"Our model shows that, at a long-term carbon price of €30/t, RWE and its shareholders are, all else being equal, clearly better off replacing the entire generation capacity with coal," the report adds. "This finding mirrors well the actual situation today. Of new plans currently under construction or planning in Germany for the period 2006-20, 70% of new capacity is either coal or lignite."

But the report finds that, at a price of more than €33/t, it becomes economically viable to replace aging power plants with gas. At €45/t, replacing RWE's generating portfolio with the same mix of fuels as today – largely dominated by coal – would slash 17% from the value of the company.

SAM and WWF urge utilities to consider this long-term risk when making investment decisions. But the report authors also take the EU ETS to task for failing to provide the incentives the industry needs to justify investment in less carbon-intensive power generation.

Bjørn Tore Urdal, senior equity analyst at SAM, said that the current system of distributing the majority of allowances for free has created windfall profits for the sector, while failing to induce a shift towards lower-carbon generation. The German Federal Cartel Office yesterday told RWE that it must not pass the full cost of CO2 allowances onto its customers.

"They have actually had windfall profits, which is a bit paradoxical. These utilities [are getting] fatter on their profits and still building polluting power plants," Urdal said.

"I frankly think that today these utilities do not consider a stricter carbon future in their investment decisions," he added.

RWE was not available for comment before this issue of EFP Online went to press.