In another sign of the turbulent times for the renewable energy sector, Spain’s Abengoa has declared bankruptcy. The bankruptcy is notable for several reasons. First, it suggests how difficult the transition from conventional energy firms to solvent and stable renewable energy companies will be. Second, it shows how connected the economy is and how turbulence in the energy sector could easily spread to other sectors of the economy creating a broader economic slowdown at any point going forward.
Abengoa’s problems today stem from overly aggressive decisions made during the years of heavy expansion that renewable power saw in Spain. Abengoa’s bankruptcy is significant given the size of the company; the firm employs 24,000 people and is involved in a range of renewables businesses from biomass conversion to seawater desalinization. U.S. investment bank Citi led a secondary shares offering earlier this year which looks like a major embarrassment for the firm as this point. While Abengoa’s shares have had a tough year thus far, investors still appeared to be caught by surprise to some extent by the bankruptcy filing as its Spanish shares plunged by more than half after the filing.
Abengoa’s financing has been something of a black box according to analysts and that certainly has led to greater confusion among investors. Still, the firm is not alone in that approach to its capital structure as a number of other companies in the renewable sector follow the same pattern. Broadly speaking Abengoa’s bankruptcy suggests the renewables space is still more dependent on subsidies than many firms would like to admit. It’s unclear what it will take to get many firms operating on their own in a stable and solvent fashion. Renewables in general tend to require large amounts of upfront investment and hence often require significant amounts of debt investment. The problem is that debt becomes an anchor anytime a subsector becomes oversupplied with output or when demand falls due to recessions or secular changes in energy consumption.
Conventional energy companies avoid these issues in one of two ways. Utility companies are generally granted a local monopoly, which enables them to regulate supply based on demand in exchange for some degree of government oversight. Oil and natural gas companies have some upfront costs, but their production costs overtime are also substantial and can be adjusted based on demand conditions. In both cases, conventional energy firms have advantages not available to renewable energy companies.
There is another reason to be concerned about the Abengoa bankruptcy though. One fact that many observers do not realize is how interconnected global economies are today. These connections of course extend between firms in different countries and the same industry, but also between firms in different industries and the same country. The Abengoa bankruptcy illustrates this point. The firm’s declaration of bankruptcy sent Spanish banking shares tumbling over concerns that the lenders who are left holding Abengoa’s 9B+ Euro’s in debt may now face heavy losses and low recovery rates. This is a broader issue for the banking system in Spain.
According to the FT, “We don’t believe that this should be viewed as a one-off. To our minds the events here show that Spanish banks have yet to take losses on a lot of debt,” said Andrew Lowe, an analyst at Berenberg. “While they’ve cleaned up the real estate problems, they now have to tackle the forbearance issue in Spain.”
The banking systems in Spain and across Europe are still reeling from the Eurozone crisis and these developments will not help in their quest for stability and profitability. It’s unlikely that Abengoa by itself will bring down any major Spanish banks, but if Abengoa is a canary in the proverbial coal mine and more renewable firm failures are ahead, then all bets are off. Investors should hope this is not the case.
By Michael McDonald of Oilprice.com
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