· A transforming deal in the German utilities sector is indicative of radical reshaping of the structure of the European and possibly global sector—it may spell the end of vertical integration where one company owns and operates all assets through the value chain from power generation over networks to retail & supply

·  Scale matters for risk mitigation, profitability, innovation and growth

The deal and why it matters

E.ON is Germany’s second largest power supplier with 5.3m customers. In 2016, the company has spun-off its power generation business into a separately listed entity, Uniper, in which it kept a 47% (sold to Fortum early 2018). E.ON still owns a portfolio of nuclear plants and renewable assets. It operates 19% of Germany’s power distribution networks.

RWE is a power generator with a large thermal asset base dominated by coal plants (lignite/hard coal). The company spun-off its networks, renewables and supply business into a separately listed entity, Innogy, in 2016.

Innogy is Germany’s largest utility by market capitalization.  It is largest power retailer with 6.8m customers and the largest grid operator in Germany. It was spun-off from RWE in Q4 2016 (see above). The company owns Npower, one of the big six energy suppliers in the UIK.

RWE will sell its 76.8% stake in Innogy, the renewables and network business that RWE spun out in 2017, to E.ON in exchange for a 16.7% stake in E.ON by means of a 20% capital increase by E.ON. RWE will further receive E.ON’s renewables business.

The transaction is important for Germany and the sector in the sense it aims to achieve what has been longed for since the 1990s: a stable structure for the German utilities sector, with sustainable market leaders. The German sector has turned in circles from the nascence of E.ON through the merger of former Veba and Viag in the late 1990s, over attempts of external growth within Europe and beyond (RWE/Thames Water, E.ON/Endesa), to the corporate splits of this decade and finally the return to larger entities.

The German utilities have had to compete with national champions in other European countries and been subject to takeover speculation at times when strategies were particularly muddled and unsuccessful as the industry needs to get to grips with energy transition. On the road, several solutions have been thought up. This transformational deal could lead to recovery in a sector that was at risk, in a challenging external environment (political risk, energy transition and overcapacity). Euler Hermes currently rates the wider energy sector in Germany as 3 or sensitive.

This restructuring set the base for the bricks and mortar assets of German utilities, conventional power generation, to be brought back to economic sustainability. This does, however not mean, that smaller actors will not continue to struggle with profitability and become victims of market forces or consolidation.

Large scale centralized power generation, and consumer-focused supply business

The deal could set a precedent outside of Germany, in Europe, and the world. Traditionally, power and gas were vertically integrated across the value chain from production all the way to retail and supply. We expect that this integrated value chain will break up and two very distinct businesses will emerge: Large scale centralised power generation, and consumer focused supply business. While the details are by far beyond the horizon of this paper, each of those businesses likely will change beyond recognition from their current state.

Figure 1 Streamlining of the industry