German utility deal turns fossil-fuel veteran into green giant

[LONDON] Germany's biggest energy producer is grabbing onto a lifeline from the clean energy business in the utility industry's biggest shakeup in years.

RWE AG's move to take renewable power generation assets from Innogy SE in a complex asset swap agreed on Sunday morning puts the German utility back in a business that it shed when it spun off Innogy in 2016. That would help bolster earnings that face decline in coming years as the government forces nuclear and coal plants to shut.

While RWE is forecast to report an increase in full-year earnings on Tuesday, Chief Executive Officer Rolf Martin Schmitz has been searching for way to find growth as Chancellor Angela Merkel pushes Germany's utilities to switch to less polluting forms of generation. Embracing green energy may offer a path toward higher profits.

"For RWE, it is a game changer - it was a dying business, now it has a life," said Per Lekander, a fund manager at Lansdowne Partners UK LLP. The deal, he said, will help RWE build a "more sustainable generation business.

At the moment, RWE's biggest power generation assets in Germany are the ones that pollute the most, using a soft form of coal called lignite. Lignite and hard coal plants account for more than half of its power generation capacity, with nuclear plants another big chunk as shown in the chart above.

Mrs Merkel has vowed to close both nuclear and coal power plants in Germany's ambitious transition to a green economy. RWE spun off Innogy to concentrate on traditional power plants.

"This deal would transform RWE into a leading European utility for renewables and security of supply," Ahmed Farman and Charlotte Chiew, analysts at Jefferies International Ltd, said in a research note. "The ability to extract greater value by the combination of holding renewable and thermal assets in the same portfolio may also be part of the motivation behind the deal." While Germany's new government indicated it wants to wind down coal use, uncertainty remains on the date and pace of any shutdowns, unsettling the outlook for RWE's earnings. The coalition has said it's seeking a role for coal to fill a power gap when nuclear energy is shuttered in 2022, while still eliminating the fossil fuel.

"The phaseout of coal and lignite power would trim RWE's own generation capacity," Elchin Mammadov and Amira Waziri, analysts at Bloomberg Intelligence, said in a note. "The proposed asset swap with EON would allow RWE to partly offset the planned closure of its thermal power plants." The departure of Innogy's Chief Executive Officer Peter Terium in December revived speculation that the company could be a subject to a takeover by a larger European rival, such as Engie SA or Enel SpA. RWE had said it kept its 77 per cent Innogy stake as a financial asset following the spinoff.

The deal is still subject to the approval by the supervisory boards of both companies and requires regulatory and anti-trust reviews. In addition RWE is yet to overcome a number of obstacles such as possible resistance from unions to the deal, said Sven Diermeier, an analyst at Independent Research GmbH in Frankfurt.

"Management appears to have found a workable solution to the conundrum of what to do with its Innogy stake," Lueder Schumacher, an energy analyst at Societe Generale SA, said in a research note. "This should finally allow investors to focus on RWE standalone, where we would see value."

BLOOMBERG