RWE, the German energy giant making a grand pivot towards renewables, is captivating investors with its green growth story. The company's narrative, painted vividly at its recent Capital Markets Day and reiterated in the Q1 2024 earnings call transcript, focuses on a massive €55 billion investment program aimed at creating a renewable energy behemoth. However, a closer examination of the Q1 transcript, paired with RWE's publicly available financial data, reveals a potential blind spot that could significantly impact the company's long-term profitability: the "green premium" mirage.

RWE boasts about securing attractive returns on its renewable projects, often exceeding the 10.5% EBITDA yield hurdle rate set at the Capital Markets Day. The company attributes this success, in part, to the strong demand for green Power Purchase Agreements (PPAs), particularly from data centers. RWE claims that these PPAs are being signed at "unchanged price levels," despite a 30% drop in European power prices since December 2023. This suggests RWE is securing a "green premium" from buyers willing to pay a significant price above market rates for renewable energy.

However, a potential flaw emerges when we look at RWE's projected net debt trajectory. The company expects net debt to remain at approximately €11 billion by year-end, similar to the Q1 level. This projection assumes a normalization of working capital and a reversal of variation margins related to hedging activities. Crucially, it also assumes a similar CapEx run rate for the rest of the year, implying a total spend of roughly €10 billion in 2024. This figure is significantly lower than the €13.3 billion annual average needed to meet the €55 billion investment target by 2030.

The discrepancy raises a critical question: if RWE is truly capturing a "green premium" and securing superior returns on its renewable projects, why is the company slowing its investment pace?

One hypothesis is that RWE's "green premium" narrative is not as robust as it seems. The company may be facing resistance from PPA buyers who are increasingly price-sensitive, particularly in the face of falling power prices. RWE's recent 400 MW PPA with a "big tech company," while touted as a success, might represent a compromise on price, potentially dragging down the overall portfolio return.

Further bolstering this hypothesis is RWE's ambiguous response regarding PPA pricing in Continental Europe. While acknowledging ongoing requests from data centers, RWE declined to disclose the volume of PPAs signed in Europe, suggesting the picture might not be as rosy as in the US.

Moreover, RWE's focus on "maximizing EPS" through various capital allocation options raises eyebrows. While the company insists it's not ruling out any instruments, the repeated emphasis on EPS optimization, coupled with a slowdown in CapEx, subtly hints at a possible shift in priorities. Could it be that RWE is quietly acknowledging that the "green premium" is shrinking, making investments less appealing relative to other options, such as share buybacks?

The "green premium" mirage poses a significant risk to RWE's long-term profitability. If the company is unable to secure favorable PPA prices, its ambitious investment program could become a burden, dragging down returns and potentially jeopardizing its EPS targets.

Scenario Analysis: Impact of Shrinking Green Premium

Here's a potential scenario to consider:

Assuming a 10.5% EBITDA yield target, this price decline could necessitate a 10% reduction in project CapEx to maintain target returns. This CapEx reduction further slows down RWE's investment pace, potentially delaying the achievement of its 2030 capacity target and jeopardizing the long-term earnings trajectory.

Projected Net Debt Trajectory

This chart showcases RWE's projected net debt based on Q1 2024 earnings call transcript data.

Investors, captivated by RWE's "green growth" narrative, might be overlooking the potential impact of a shrinking "green premium." The company's ambiguous messaging around PPA pricing and the slowdown in CapEx warrant further scrutiny. While RWE claims to be committed to its EPS targets, the potential for a merchant risk time bomb lurking within its portfolio cannot be ignored.

"Fun Fact: Did you know that RWE is a major player in bird conservation efforts? The company has implemented numerous programs to protect birdlife around its wind farms, including habitat restoration and monitoring programs. This commitment to environmental stewardship goes hand-in-hand with its renewable energy ambitions."