The weak link in the German economic engine is fraying

(Bloomberg) – Germany’s energy security hinges on a utility whose bets on Russian energy backfire in the geopolitical impasse over President Vladimir Putin’s invasion of Ukraine.

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Amid volatility in gas markets, Uniper SE – set up six years ago to manage aging fossil fuel assets – has shown growing signs of financial stress, raising the possibility that Chancellor Olaf’s government Scholz and parent company Fortum Oyj may have to expand the Düsseldorf-based company with even more money.

The latest blow came earlier this month when S&P Global Ratings downgraded Uniper to the lowest investment grade, with a “negative” outlook. The energy company had previously warned that such a move could prompt lenders to restrict access to credit and peers to demand more collateral to back deals.

“This war in Europe is a turning point – also for Uniper,” chief executive Klaus-Dieter Maubach said at the company’s annual general meeting on May 18. “Nobody can predict how the situation will develop in the weeks and months to come.”

The utility, whose name is a mashup of “unique” and “performance”, has become the weakest link in the network that powers Europe’s biggest economy. If tensions with Moscow lead to a further cut in gas supplies, Uniper would suffer and the ripple effects would hit the industrial companies and local utilities it supplies.

Uniper epitomizes Germany’s warm energy relationship with Russia, a problem Berlin didn’t see until tanks rolled into Kyiv three months ago. Scholz’s government is now trying to untie decades of dependency, with plans to phase out Russian coal and oil imports by the end of the year. Gas is trickier, however, and Uniper is at the center of that dependency.

Read more: Cold War relic threatens Europe’s plans to ditch Russian oil

The company’s problems stem from its founding in 2016. As Germany set the wheels in motion to gradually transition to wind and solar power, the towering power plants that burned coal and gas were no longer fashionable. To focus on exploiting renewable capacity, EON SE bundled these assets into Uniper and separated it.

With its mission focused on operating these facilities until the end of the fossil fuel era, Uniper had little incentive to do anything but seek out the cheapest energy available.

The company has continued to cultivate ties with Russia, with huge supply deals and an investment in Gazprom PJSC’s controversial Nord Stream 2 pipeline – which would have bypassed Ukraine to send Russian gas directly to Germany if the certification had not been halted amid tensions over Ukraine. Uniper bought coal in Moscow and its gas purchases were 13 times greater than those of its great German rival RWE AG before the Russian invasion.

“Uniper is facing some real problems right now,” Bloomberg Intelligence analyst Patricio Alvarez said. “He’s too exposed to the threat of Russia turning off the taps.”

Germany can ill afford to let Uniper stumble. It already sent that signal in January when state-owned development bank KfW gave the company 2 billion euros ($2.1 billion) in loans to help cover margin calls as gas prices soared. soaring, even before the war in Ukraine.

Since then, gas transit through Ukraine has already been curtailed after a major receipt point was taken out of service amid fighting. Russia, which has cut off Poland, Bulgaria and Finland, has also curbed flows to Germany in retaliation for Berlin’s seizure of local Gazprom units.

Read more: Germany prepares for judgment day in Russian gas showdown

While the cuts haven’t had a major impact on Europe’s supply, they are disrupting energy markets and the volatility is making Uniper’s trading counterparts nervous as the company would have to cover any shortfalls. up for grabs as prices go up.

“The market fears that if Russian gas stops being delivered to Western Europe, for whatever reason, Uniper would still be required to deliver that gas to its customers,” said Sam Arie, head of services research. European audiences at UBS.

The turmoil for Uniper is compounded by its Unipro unit, which operates five power plants in Russia and accounted for almost a fifth of utility profits last year. Sanctions, which block access to these profits, and international pressure prompted the company to relaunch a process of selling the unit.

“Even if Uniper found a buyer for its Russian business, it’s unclear how or when it would be able to get the money outside of Russia,” said Andrew Moulder, senior European utilities analyst at CreditSights. “The variation in margin payments in energy hedges is also putting pressure on the company’s liquidity.”

Uniper’s net margin requirements stood at 4.5 billion euros at the end of March, and liquidity will continue to be a challenge for the company, S&P said. The company said its discussions with counterparties over additional collateral will determine its liquidity position.

Shares of Uniper have fallen 27% since Russia invaded Ukraine, while Fortum has fallen 15% and former parent company EON is down 19%. RWE actually climbed 8%. Bonds issued by Fortum and maturing in 2029 lost 12% of their value over the period and were trading at around 89 cents on the euro on Friday, a value generally seen as hot territory.

Fortum owns approximately 75% of Uniper. The Finnish government in turn owns 50.8% of Fortum and cannot reduce its stake to less than 50.1% without parliamentary approval. That means it would have to buy shares in any rights issue, but state loans might be easier, if an influx of capital is needed.

This is currently not the case. At the end of March, Fortum – which granted 8 billion euros of credit to its subsidiary in December – had access to 5.9 billion euros of undrawn financing and had liquidity of 6.4 billion euros. Although this is a significant cushion, Uniper had a negative cash flow of almost 1.9 billion euros in the first quarter and had approximately 3.8 billion euros in cash at the end. of the month of March.

Read more: How Europe became so dependent on Putin for its gas: QuickTake

Regardless of Fortum’s exposure, Germany has too much at stake to let Uniper fail. Besides its market power, the company plays a key role in helping the government set up infrastructure to import liquefied natural gas to offset Russian deliveries through pipelines.

“There is a very good established contact and alignment with the German government,” a Uniper spokesperson said in response to questions from Bloomberg about whether it was seeking more financial assistance. As the country’s largest gas import and storage company, Uniper is “very relevant for Germany’s energy supply in the future”.

Uniper says it is stronger financially than it was in December, thanks in part to financial headroom from KfW and Fortum loans. And the low credit rating is familiar ground as Uniper started its journey at the same level and kept the rating until 2018. Additionally, the German government is rolling out legislation to allow gas companies to reset prices to customers in the event of a supply emergency, which could give Uniper a relief valve.

“We will continue to strive for and are committed to taking all necessary actions within our authority to protect our investment grade rating,” Chief Financial Officer Tiina Tuomela said.

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