Utility bond investors suddenly put less emphasis on renewable energy
Last year, at the peak of the energy crisis, we saw that the bond spreads of utility companies that were heavily invested in renewable energy widened less than on the bonds of the peers that did not. However, now that the energy crisis has dissipated, we see that the impact of an issuer having a high share of renewable energy in bond spreads has declined. At the same time, investors seem to be once again more focused on traditional credit metrics, such as financial leverage.
Last year, at the peak of the energy crisis, we saw that the bond spreads of utility companies that were heavily invested in renewable energy widened less than on the bonds of the peers that did not
To verify that, we run a regression where the share of renewable energy within total installed capacity is the independent variable, and credit spreads are the dependent ones
We show that indeed, both renewable energy and issuer ESG risk rating was an important factor to determine credit spreads during the crisis
However, now that the energy crisis has dissipated, we see that the impact of an issuer having a high share of renewable energy in bond spreads has declined. At the same time, investors seem to be once again more focused on traditional credit metrics, such as financial leverage.
Over the course of last year, we showed that integrated/generator utility euro bond issuers that were more heavily invested in renewable energy experienced less widening of their credit spreads in the secondary market than their peers (see chart below). That made sense: besides a general panic amid the energy crisis, investors tried to reduce credit risk by (i) reducing exposure to companies that invested in (Russian) gas and/or (ii) increasing exposure to companies that were invested in fixed cost renewable energy (mainly solar, wind but also hydro). The rationale for the latter was that these issuers would likely benefit from the higher power prices, while securing (in the majority of cases) also a lower fixed cost base. In this update piece, we investigate whether this remains the case.
To evaluate such persistence, we ran a simple cross-sectional OLS regression on the ICE BofA Euro Utilities index (ticker: EK00) where asset swaps are the dependent variable and the share of renewable energy is an independent variable (alongside a range of other independent variables that influence credit spreads). Given that regulated utilities neither have installed capacity nor generate electricity directly, we have also excluded from this analysis all utility companies in the index that are solely either transmission system operators (TSO) or distribution network operators (DSO). We ran the regression for two moments in time: using spreads as of now and as of 1 year ago (early/mid-June 2022, amid the peak of the energy crisis in Europe). This allows us to properly evaluate if there has been a change in investor behaviour, now that the energy crisis has eased. To account for heteroskedasticity in the regression (where the variance of the residuals varies widely in a systematic way), we adjust t-statistics using Huber-White-Hinkley (HC1) consistent standard error. Serial correlation between independent variables is not noted.
Let’s first evaluate the results of our regression using data as of June 2022.
The regression above includes only independent variables that are both, statistically and economically significant. For example, the longer the maturity of a bond, the wider the credit spread. On the other hand, if the bond is in green format, if the issuer has more bonds outstanding (that is, more liquid securities), and a better credit rating (hereby proxied by the variable RATING_SCORE, which is higher the worst the credit rating of the issuer), the bond will trade with tighter credit spreads. Interestingly as well is that the ESG profile of the company (proxied by the Sustainalytics ESG risk rating) also seemed to have played a role in explaining credit spreads. Issuers with a better (that is, lower) ESG rating would also be able to secure tighter credit spreads in their bonds – all else equal. We also note the following from this regression: a higher share of renewable energy within total installed capacity would also result in tighter bond spreads. For example, a one percentage point increase in the share of renewable energy would result (all else equal) in a 0.63bps decrease in credit spreads according to this regression model. While this might at first sign not seem like a big number, this implies that the difference in credit spreads between a company that has no renewable energy installed capacity and one that has 100% would be a whopping 63bps, all else equal. Other variables included in the regression, but that were dropped due to non-significance were: FFO/debt, EBITDA margin, revenues, Net debt/EBITDA and rating of the issuer’s country of residence.
This allows us to conclude that last year we saw significant in the renewable energy share variable. Now let’s move to analyse the current dynamics in credit spread markets:
The first thing we can notice is that investors seem to be placing more emphasis in other factors. For example, credit profile (proxied here by FFO/debt) becomes now statistically and economically significant, while this was not the case last year. Also the credit rating of the country where the issuer is resident becomes a more meaningful variable now. However, the results still seem to not be economically significant. While one would expect an issuer from a higher-rated country to experience tighter credit spreads in the secondary market, the opposite seems to be the case. Certainly, we can think of some exceptions where this metric does not apply indeed, such as with the Spanish issuer Iberdrola, whose bond spreads trade significantly tight within the utilities universe; and the French EDF (country rating: AA2) and the Finnish Fortum (country rating: AA1), whose bond spreads trade wide despite much better country credentials.
We also note the inclusion of the variable IS_IT_ESG_01: this dummy takes the value of 1 if it refers to either a green bond or a sustainability-linked bond (SLB). Clearly, as the sign of the coefficient contradicts with the green format dummy (IS_IT_GREEN_01), we see that possibly issuers that have issued SLBs are biasing the results. And indeed, this is the case with heavy-SLB issuer Enel, A2A and CEZ – all which have bonds trading at relatively wide credit spreads.
Another thing catches our eye in this regression: we can see that both, the ESG risk rating but also the share of renewable energy now have a lower coefficient (hence, a lower impact) on credit spreads. While both are still statistically significant at the 5% level (even 1% level for the share of renewable energy), the influence of these variables seems to have declined. So for example, while a one percentage point increase in the share of renewable energy would result in a 0.63bps decrease in credit spreads back in June 2022, this is now only 0.3bps – nearly half of what it is used to be.
It could be that investors move their focused towards renewable energy growth potential, rather than emphasizing current installed capacity – but more research is required in order to conclude that. On the other hand, such expansion would obviously also require more debt, which would likely adversely affect debt metrics. For now, we clearly see that utility bond investors are less focused on rewarding companies with a higher share renewable energy installed capacity, and have shifted back their attention to other metrics, such as leverage.