RWE Profit Falls 67% on Derivatives and CO2 Emissions

By Nicholas Comfort

Aug. 14 (Bloomberg) -- RWE AG, Germany's second-biggest utility, reported a 67 percent drop in second-quarter profit because of derivatives losses, rising costs to emit carbon dioxide and lower grid fees.

Net income fell to 347 million euros ($516 million) from 1.06 billion euros a year earlier. The figure was calculated by subtracting first-quarter profit from half-year earnings released by the Essen-based utility today. That missed the 742.5 million-euro median estimate of eight analysts surveyed by Bloomberg.

Earnings were lower at RWE's trading unit as higher gas prices cut the value of derivatives and gains from power contracts were postponed to the second half. A German regulator reduced the fees RWE can charge for use of its power grid while the cost of carbon permits rose. The company said operating profit will match last year's results as it cuts costs.

``It's a disappointment,'' said Bernhard Jeggle, an analyst at Landesbank Baden-Wuerttemberg who has a ``hold'' on the stock. ``The trust in them has been damaged, but their prospects don't look bad.''

RWE fell 67 cents, or 0.9 percent, to 72.70 euros as of 1:21 p.m. in Frankfurt, extending its drop for the year to 24 percent. That compares with an 18 percent decline for larger German rival E.ON AG, which yesterday raised its full-year profit outlook.

Revalued Contracts

Operating profit at RWE's trading unit slumped ninefold to 68 million euros as the company revalued gas storage derivatives contracts after fuel prices doubled. Accounting rules mean power sales agreed on in the first half can only be booked on delivery in the second, RWE spokesman Harald Fletcher said by telephone.

The company should be able to reach a full-year earnings target of 300 million euros for the unit, Jeggle said by phone from Stuttgart.

Carbon dioxide allowance prices jumped 61-fold in the second quarter to an average 25.61 euros a metric ton, compared with 42 cents a year earlier, when the European Commission allowed nations to hand out too many permits. The allocation in 2008 was slashed by 9.4 percent.

RWE had to buy 276 million euros worth of permits in the period compared with 11 million euros a year earlier. Conditions for buying the certificates are now ``much less favorable for power producers,'' and prices ``will continue to be high,'' the utility said in a statement.

Lower Fees

Lower grid fees cut operating profit by 120 million euros. The utility's grid fees are based on what reimbursement Germany's Federal Network Agency judges appropriate given RWE's level of investment in the infrastructure. Operating profit is calculated by adding pretax results from its holdings in other companies to adjusted earnings before interest and tax.

The authority, known as the Bundesnetzagentur, invalidated 28 percent of the costs the company claimed in March, Renate Hichert, a Bonn-based agency spokeswoman, said by telephone on Aug. 12. The investments determining 2008 grid fees are based on spending from 2006, she said.

The European Commission, the regulatory arm of the European Union, proposed measures to split utilities from their power grids in September to increase competition in the bloc's power market.

Keep Grid

``We still plan on keeping our power grid,'' Chief Executive Officer Juergen Grossmann said on a conference call with reporters.

Paying for the right to burn fuels which emit carbon dioxide and lower fees for use of RWE's transmission grid will cut earnings by about 1.5 billion euros this year, RWE said.

Still, 2008 operating profit is expected to gain as two nuclear reactors that were offline a year earlier continue to boost output at record prices, Grossmann said.

A cost-cutting plan, which includes transferring jobs to reduce any duplication of labor, will save 100 million euros this year and an estimated 1.2 billion euros by 2012. The savings will come mainly from the company's power and gas grid units.

Power generation gained 11 percent in the first half, led by nuclear and gas while energy from plants that burn coal or lignite fell. The utility registered a 9.1 percent drop in the amount of electricity it purchased from others to 55.6 billion kilowatt-hours in the first half.

German electricity for delivery the next day sold for an average of 71.63 euros a megawatt-hour in the second quarter, compared with 35.39 euros a year earlier, according to broker GFI Group Inc.

Sold Power

RWE said it has sold over 90 percent of its 2008 electricity and more than two thirds of the power it will generate in Germany next year.

The company confirmed its outlook for 2008 net income to fall ``marginally'' from last year as it books a charge on the initial public offering of its American Water Works Co. unit.

Sales should rise by 5 to 10 percent this year based on a pound exchange rate of 79.28 pence against the euro. The gain in revenue is down to steeper power prices in Germany as well as higher wholesaling revenue at RWE's upstream gas unit.

Recurrent net income, used to calculate the company's dividend, should rise by more than 10 percent. RWE defines this measure of profit as net income before one-time expenses and discontinued operations.

The company may raise its targets through 2012 next February based on higher power prices, Chief Financial Officer Rolf Pohlig said today.

To contact the reporter on this story: Nicholas Comfort in Frankfurt at ncomfort1@bloomberg.net