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German green policy sapping RWE’s powers

Reuters Breakingviews delivers agenda-setting financial insight. Its global correspondents react to stories as they develop, delivering sharp and provocative commentary on big financial news as it breaks.

RWE has managed a rare thing: It is a leading German utility that has surprised on the upside. Not only did it exceed its profitability targets for 2012 by 10 per cent, it also said it wanted to sell its oil and gas unit. It is a move that will generate about €4-billion ($5.3-billion) of cash – and obviate the need to invest in expensive exploration.

Yet investors have good reasons to be wary. Germany's decision to phase out nuclear power and to promote renewables upsets RWE's established business model. While RWE has swallowed the hit on the value of its four German nuclear power plants, its coal and gas power stations are also impaired. RWE has already written off €1.7-billion of value in its gas power plants in the Netherlands.

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Meanwhile, German law stipulates that energy from renewable sources is fed into the grid on a priority basis. While beneficial for the climate, it's bad for RWE, Europe's largest emitter of carbon dioxide. CEO Peter Terium forecast on Tuesday that in 2013 wholesale prices for energy from conventional sources will fall significantly. If the pattern becomes entrenched, RWE will suffer an extended period of pain.

True, RWE has invested €4-billion in renewables generation. But it still earns 51 per cent of its operating profits from conventional sources and only a small slice of the remainder comes from renewables. RWE's high debt burden of €33-billion – 3.5 times its current earnings before interest, taxes and depreciation – limits its room for manoeuvre. RWE's asset disposal program – launched to bring down debt and originally supposed to generate €7-billion of cash until the end of the year – is also behind schedule.

Investors may be relieved to see that RWE is paying an unchanged dividend of €2 per share. The yield – at 6.9 per cent – is high. It is so high, in fact, as to suggest worries. To be assured of its sustainability, RWE may need to pursue a more fundamental renewal of its resources.

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