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.
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.
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.
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.
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.
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)Conclusion
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