Tuesday, 17 April 2018

ESB - A Financial Perspective

This post will be a longer examination into the financials of electricity generation plant around the country (mainly wind). It will get a bit technical in places but I will do my best to explain terms used. 

ESB is the largest energy company in Ireland and is 95% owned by the Irish State. Last year, it recorded a loss of €31 million after writing down the value of their generating assets by € 276 million. The operating profit before the impairment was € 490m, the lowest profit in the past five years.

Following impairment reviews of the generation assets ESB recognised an exceptional impairment charge of €276 million in relation to Moneypoint (€142 million), Aghada Unit 2 (€69 million), Synergen (€30 million), Poolbeg (€21 million), Marina (€1 million) power stations and €13 million across five wind farms

Moneypoint is a critical piece of infrastructure. Without it, the 400kv lines in the west of Ireland will have insufficient voltage to carry the power eastwards.  The impairment now means that Moneypoint coal power station is practically worthless. However, it must be noted that Moneypoint has been around since the 1980s.

Two of their power stations are to close altogether - Marina and Aghada (steam unit)
Capacity contracts were not accepted for ESB’s open-cycle gas unit at Marina and the conventional steam unit at Aghada and, after many years of excellent performance and service to electricity customers, once I-SEM starts in May, there will be no commercial basis for the continued operation of these units. 
The loss of the steam unit at Aghada will increase emissions from the site as this generator would be more efficient than the open gas cycle turbines built there around the same time in the 1980s (there still remains a separate and very efficient CCGT at Aghada built in 2010).

The published accounts do not show a breakdown of operating profit into fossil fuel / renewables (which seems to be a trend among the large energy companies), which would have been very useful.  But there are indications that the renewables part of their business is not performing as might have been as expected. 

Return on Capital Employed (ROCE) 

The Return on Capital Employed (ROCE) is used as an indicator for the Return on an Investment i.e. how much one pound spent on assets generates in profits. I have calculated it by taking the Operating Profit (profit before interest and tax) and divided by total assets less current liabilities.  The sweet spot seems to be in the 14-17% range and this crops up in successful companies from across different industries. Successful Irish companies like Ryanair, Kingspan, Glanbia and Kerry Gold have ROCEs in the region of 14 - 17%. In the UK, Marks and Spencer's recent report shows an ROCE of 14%

The ROCE for ESB seems to be around 6% historically. The highest I can find was 10% in 2007 when the prices of fossil fuels peaked. It now stands at 4.6% for 2017, which is historically low.  It has dropped every year for the past three years from 6.5% to 6.1% to 4.6%. Low wholesale prices are of course a contributing factor. However, the average wholesale price rose from €41.82 in 2016 to € 47.48 in 2017 so we should have in theory have seen an improved ROCE ratio.

Comparable companies like SSE and E.ON have recently reported ROCE ratios in the region of 10% so ESB's ratio is comparatively low.

Interest Cover

A company needs to have enough profit left over from paying normal business expenses to cover interest payments on their loans. From Investopedia:
The interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

ESB in 2016 had a healthy interest cover of 3.5. However, this has dropped below the safety threshold to 1.1 in 2017.

Financial Statements

I will only be taking a look at the Generation part of ESB's business. ESB also have a retail and grid development business. The financial statements for the gas power station and wind farms are published on the CRO website. Only financial reports for 2016 and 2015 are currently available. There was a deterioration in profits in 2016.  Presumably, things got even worse for the company in 2017. 

Gas power

A look at the most recent accounts (2016) of ESB's gas power station in Dublin shows that it was still making good profits despite the low gas prices. Dublin Bay (400MW) made net profits of €28m and €43m in 2016 / 2015. The drop in profits was presumably due to a drop in wholesale prices of 18%. It had very healthy ROCEs of 19% and 29%.  With accumulated profits of €41m by the end of 2016, the power station was doing very well. In 2015, a dividend had been paid out of € 37 million. It proves that the business model for gas generation is still very strong. The power station was built in 2002 so a very strong performance after 13-14 years of operation. 

Of course, it is based in a high demand centre and is generating power to the grid most of the time. I was unable to find financial statements for any other power stations. I presume most of the other ones wouldn't have been as profitable.

Wind power

I looked at the financial statements of nine of ESB's wind farms in the South of Ireland. A total of 175MW of wind generation. 2015 is a good year to begin with as most of the farms had high load factors, equal to or above the national average of 33% (except for one - Derrybrien). All wind farms made an operating profit, however two made net losses, most notably Garvagh Glebe, a 26MW wind farm in Leitrim which made a loss of € 480,000 despite having the highest load factor at 42%. This was because of very high interest payments - which were about 45% of turnover. 

The average ROCE was 6%, in line with the overall average for ESB Group. Another Leitrim wind farm, Blackbanks, had the highest ROCE at 11%. Blackbanks has a smaller 10MW output and interestingly has smaller (0.85kw) turbines than nearby Garvagh which has 2MW turbines, yet the smaller wind farm had double the ROCE of the larger one (remember that ROCE is based on profit before interest). This seems to fly in the face of conventional wisdom that says the bigger the turbine, the bigger the return.

Combined operating profits in 2015 for the nine wind farms was € 9.2m and net profits was € 2.1m. Depending on how you measure it, this gives an operating profit of €52,000 per MW and net profit of €12,000 per MW for 2015. Compare this with the gas power station in Dublin which had an operating profit of € 127,000 per MW and a net profit of € 107,000 per MW in the same year. Gas power was 2.5 times more profitable in 2015 than wind before interest and and nine times more profitable after. Operating profit, however, is the best way to compare the two generation sources as the gas power station had paid off most it's loans by 2016 and so had very low interest payments. Therefore, gas, which has fuel input costs, is two and half times more profitable than wind, which has no fuel input costs (and wind gets priority on the grid). This fact deserves a separate article on it's own but presumably the much higher load factor for gas has a lot to do with it.

By the end of 2015, accumulated profits from all these wind farms was € 14 million. One dividend of € 1.5m was paid out by Mount Eagle wind farm in Kerry. Again, this wind farm has the smaller older style wind turbine. 

In 2016, the average load factor was still decent at 31% but the ROCE had switched to negative. All wind farms made a net loss apart from two. Combined losses for the year were € 5m. Over the two years, combined losses were € 3m. 

In 2016, interest cover went from positive to negative. Average interest cover over the two years was 1.09, which falls short of the recommended baseline of 1.5. The ROCE would need to rise to at least 10% to reach a safe interest cover and to 15-16% to reach an ideal one.

The worse performing wind farms were the larger ones built in 2010 and 2011. The larger 2MW turbines on average cost 4.5 times more than the smaller older models for 2.3 times the capacity.  In fact, these newer wind farms had high accumulated losses by the end of 2016 of € 6m and some had notes in their accounts stating that they were dependent on financial support from ESB group, which indicates that the higher output from their bigger turbines was not enough to compensate for the additional associated costs.

Two dividends were paid out, € 1m from Mount Eagle and € 1.5m from Blackbanks, both older wind farms with smaller 0.850KW turbines. They were both in good financial health by the end of 2016. 

In total, ESB group had loans outstanding of €170 million to all nine wind farms by the end of the year. 

In 2017, total impairments for wind farms was € 13 million. In Northern Ireland, the value of a wind farm in Tyrone had been written down by nearly €5m :
A review of the Hunters Hill 20 MW wind farm in Co. Tyrone, Northern Ireland was undertaken at year end. An impairment loss of €4.9 million has been recognised in the income statement in respect of this wind farm. This impairment has arisen as a result of a reduction in load factor.
ESB Networks division were also investing heavily in the grid infrastructure required to support renewables :
The focus of the 2017 investment in the transmission network was on continuing the reinforcement of the system to facilitate the connection of new renewable electricity generation. 
Capital investment in the networks businesses continued in 2017 with €644 million (74% of total capital investment) invested in the networks infrastructure in ROI and Northern Ireland (NI)

ESB's traditional generation model in Ireland has changed from investment in reliable power generation to renewables. However, there are signs that things have not turned out quite as planned with wind energy, in particular the newer and more costly wind farms have built up considerable losses. In essence, the older profit making gas generation fleet is subsidizing the newer loss making renewable generation. The older and smaller wind farms may well be benefiting from better sites, but it could also be the case that the smaller 1MW technology is more efficient. These smaller wind farms have by and large turned out to be good investments.  The same cannot be said for the more recent wind investments.

There are still gains to be made from conventional baseload generation. As the grid becomes increasingly unstable in the future, there will be gains to be made for ESB in building fast acting fossil fuel generators that can be switched on quickly. If Moneypoint is converted to gas, it will certainly be profitable like Dublin Bay, but will leave ESB (and Ireland) increasingly dependent on gas lines from the UK which may not be as dependable in the future

Wholesale prices are recovering so we should be seeing better profits for ESB. Investing in large loss making wind farms may be negating some of the benefits from higher wholesale prices. Other benefits from investing in wind farms such as carbon credits are no longer financially lucrative as the carbon price has fallen too low. ESB's investment in wind energy should be reviewed.

ESB Financial Report for 2017 : https://esb.ie/docs/default-source/investor-relations-documents/annual-report-and-financial-statements-2017-single-pages.pdf?sfvrsn=dae93bf0_2


  1. Given its current business strategy it is unlikely that the ESB has a commercial future.
    Much research has been published on the actual performance of wind farms and the technical deficiencies of wind turbines .It seems to be confirmed in the research that wind turbines of over 1 megawatt have distinct problems operating in turbulent environments. Leading to reduced operating lives and performance. There is also the issue of Transitional Torque Reversals, which wrecks wind turbines transmissions systems, a consequence of high Wind Over Power factors .T.T.R.'s impact wind turbines with these long blades and a wide range between nominal power and their cut out speed. In turbulent conditions. These wind turbines were designed to operate in relatively low wind speed areas. For their wind farm Raheenleag, co owned with Coillte, the ESB chose a wind turbine with the recommend Wind Over Power Ratio.This design modification, to achieve the recommended W.O.P.R., dramatically reduces output and reduces the range in which this particular model can operate with something close to decent output.
    With regard to their older wind farms with lower capacity wind turbines . These wind turbines will produce decent output for about 8 to 10 years. But capacity factor drops of up to 40% has been seen in The Danish Data as they get old.They generally get decommissioned in Denmark at 15 years from commissioning .So the older ESB wind farms like Derrybrien should be decommissioned relatively soon.Therefore the ESB should take a financial hit by having to write off the asset valuations written into their accounts.Given the technology problems with these large multi megawatt wind turbines faster asset value write downs will be needed for their newer wind farms . Like they have done with their Norther Ireland Wind Farm. This will further impact their bottom line. Given the output profile of Raheenleag Wind Farm it is likely that it is one of the highest producers of Infrasound Low Frequency noise in Ireland.Which then brings up issues of nuisance.
    One other observation in the Danish Data. It is about the scalability of the Danish Concept 3 bladed wind turbine. Strict scalability ceases at about 300 kilowatts
    " Therefore the likely poor operational performance of these larger WT’s certainly raises a major question mark of the ability of the Danish Wind Industry to achieve the target, of 50% wind penetration by 2020, set by the Danish Government.. It certainly makes its achievement extremely expensive as these larger wind turbines will likely show significant drops in output over their relatively short live’s. Significantly increasing the capacity required to be installed by 2020 to meet the specified target." Yr 2014
    From "Danish wind turbines 1977 to 2014"
    By the way in attempt to refute observation , that 20% is the maximum wind penetration that the Danes achieved, claimed in the "Case of Denmark". The Danes ceased quoting actual Danish internal wind penetration figures. They just quote output figures. 50% of which is exported. Much of it at negative prices.

  2. The article above relies on the tried and tested double entry accounting system used for centuries. The main disciplines are historical accounting, quantitative methods and principles of costing. These can be divided up into sub-groups of mix and yield, probability, the learning curve etc. Wittingly or unwittingly every person uses them when paying for goods, services, insurance etc. It could be said they are where good intentions meet the anvil of reality.

    Professor Gordon Hughes of Edinburgh University and I have examined the likely load factors and came up with 24% and 24.1% respectively. Factors obtainable in Donegal are no more than 27% with the rest of Ireland on 25% down to 22% and less. Gort accounts gives the factor @ 24% and Gartnaneanne @ 25%. So I deeply suspect reported factors above that.

    One other technical point is that the tip speed of the blades must be kept below the speed of sound, above which shock waves cause a sonic crack and can damage the blades. The tip speed is found by multiplying the diameter by 22/7 (3.14). The bigger the blade the slower it must revolve and the higher the gear ratio to the generator must be. That causes greater stress on housing, gear trains and bearings. There is also the increased differential between the top and bottom f the blades. All wind turbines at Mountain lodge and Bindoo (Cootehill) and 7 of the ten at Gartnaneane were stopped during excellent winds this morning at 10.30am. (About 30 turbines. It appears the entire world economy is in a weird phantom state right now. Depositors are getting low interest, Japan is charging to keep money and the Irish government's semi state ESB is engaging in the caper we see here.

  3. If you look at Irish semi states with idiotic business plans. The one that takes the biscuit is Bord Na Mona. Turnover €460m or thereabouts profits most recent less than €50m. Mount Lucas and other wind farm investments cost €200m +. Add in Cloncreen,Derryadd and the others planned. Probably the same again.All these will be loss making or making such small profits thay will be unable to finance their capital investment. So wind farm investment in the near future will exceed their current turnover. Looking at the C.R.O. filed accounts of a wind farm of similar size of Mount Lucas and of similar age. Losses per 100 megawatts installed should be around €5.00m per annum Good old soon to be has been Bord Na Mona?. Attempting to get moon beams out of cucumbers. Irish Semi States turning them selves into insolvent irrelevancies. Not before time.

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  5. It really looks like there are only two outcomes: Bankers take a hit or shareholders take a hit. It will be interesting to see if banks lend to any more new wind farms when they can buy Gaekectric's fire sale assets.

  6. Gaelectric wind turbine asset valuations should be taken at scrap value. Given the profitability seen in the filed accounts of other wind farms. Many have listed asset valuations that exceed liabilities . Given that they are loss making and unlikely to make adequate profits to pay off creditors and these assets will be depreciated out. Scrap value is probably the only cash that these wind turbines will generate . Attempting to operate them as going concerns would be very risky. That is if your want a return on your investment.

  7. My guess is that in early summer there will be some offers for Gaelectric's assets. The sellers are really the bankers who will have to be paid off first. Shareholders don't have to be paid. As crunch time approaches, there will be a lot of glorious coverage in the press to try to hype up interest. The financial press shamefully allows itself to be used in this way. I believe the model used in the attempt to sell to the Chinese will be used again and that if there is any local Irish (or UK) interest it will be backed up by some Asian brand name with money to throw around. Car manufacturers spring to mind, because they cannot get a home for their money. Generally, the better a share is, the more expensive it is to buy. I would ask the question, why was the 1st stage of the Chinese buy out of Gaelectric successful and the second stage not? My guess is that it was only when they parted with their money and got a good look around that they realized they had bought a pig in a poke. The art of wheeling and dealing is much more developed in western countries and as someone who have been active in agricultural fairs and markets in Ireland for decades, I would say it is more developed in Ireland than elsewhere.
    The first task of the seller is not to strike a deal, but to establish if the buyer has any sense. Most have, but a few will be inexperienced (with money). If that is the case the task is to get all the money he/she has form him, irrespective of whether it is a fair deal or not.
    In the end of the day, many of Gaelectric's wind turbines have been churning away for years and years, there will be cracked casings, cracked bearings, oil leaks, nuisance claims, poor output, frayed blades and administration headaches. If that happens Gaelectric will be a memory of yesteryear, the buyer will be on his own. If the Chinese consortium had been happy with their purchase, they would have consolidated the lot by buying it all. For those who really are interested in buying into Irish wind, my advice is this. Ask the vender how mush he wants, divide it by 3 and offer that. They will grab it with gusto. If the wind farm at Gartnaneanne near me were offered to me free, with a 3 million euros gift, I would not buy it. Its accounts clearly show it would lose 4 million in 18 months. Its worth is negative. It is junk.

  8. The best way to value an Irish Wind is to ask a scrap merchant is the scrap worth anything . If the wind turbines contain rare earth metals they might give you some money for it. If not they might ask you for a subscription to haul it away .

  9. My local politician tells me that Ireland has always subsidized its utility services including electricity. The state had to step in to develop its resources. This includes the peat power plants which were heavily subsidized and provided substantial employment. I argue that the state was entirely in charge and it built only enough peat plants to do the job of providing some indigenous fuel generation. With wind, the State is inviting the whole world, their bankers, pension funds and vulture funds to feed out on the trough with provides our electricity. The State was in it for the public good, to provide jobs and support rural communities. The money stayed locally. Now there are no jobs, and rural communities are being driven out. Our electricity payments go to foreign bankers and investors. We now see they are getting out too at our expense. It looks like another version of the Bertie bowl to me.