JPMorgan is cautious on the European utility sector due to carbon emission pressures; optimistic about select stocks

Investing.com - In a report released on Friday, JPMorgan took a more cautious stance on the European utility sector, stating that potential reforms to the EU Emissions Trading System pose greater near-term risks to the sector than the restructuring of the electricity market. It also noted that increased liquefied natural gas supply and weak electricity demand growth will be additional headwinds for the remainder of 2026.

The firm’s top picks are SSE, rated “Overweight” with a target price of 2,550 pence, and RWE, also rated “Overweight” with a target price of €51.26, both based on the February 19 closing prices.

According to the report, EU carbon futures prices have fallen 23% from their peak in mid-January 2026.

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JPMorgan stated that this decline occurred following political commentary on possible reforms to the EU Emissions Trading System’s linear reduction factor. This factor determines the annual reduction rate of emission allowances, originally planned to be fully phased out by 2034 in line with the Carbon Border Adjustment Mechanism.

German European Parliament member Peter Liese said the linear reduction factor could be lowered from the previous plan of 4.4% to 3.4%, with adjustments possibly as early as 2029, though the European Commission has yet to submit an official proposal.

The report expects a formal proposal for reforming the EU Emissions Trading System to be announced before July 2026.

French President Macron also stated that speculative activity by financial participants has driven the ETS price up to about €80/ton, whereas it should be around €30-40/ton.

JPMorgan noted that reforming the ETS is more feasible than restructuring the electricity market because the relevant legislation is easier to implement, such as increasing allowance quantities or banning speculative participants.

In contrast, electricity market reform faces significant legal hurdles and is difficult to implement quickly.

The firm also pointed out that carbon prices rose about 20% from early 2025 to mid-January 2026, reaching nearly €100/ton, likely driven by political calls for intervention.

Concerns over carbon prices have been exacerbated by a broader downward trend in electricity prices.

Across Europe, the forward curve for electricity remains in a spot premium, JPMorgan said, and even without intervention, electricity prices should decline over time.

Electricity demand growth rates for 2026 and 2027 are about 1%, with stronger demand growth concentrated toward the end of this decade. Additionally, increased LNG supply expected later this year is likely to further depress natural gas and electricity prices.

All power generators covered by JPMorgan have negative exposure to falling carbon prices, as their average carbon intensity is below that of the marginal plant.

Impacts vary by country. JPMorgan estimates that, given Italy’s reliance on gas-fired generation as the marginal price setter, a €10/ton decline in CO2 prices would reduce Italy’s wholesale electricity prices by about €3.5/MWh. The same change in Iberia, France, and Nordic markets would lead to a €1-1.5/MWh decrease, as these markets are more dominated by nuclear and renewable energy.

In terms of earnings sensitivity, JPMorgan’s estimates based on company reports suggest that for FY2028, a €10/MWh decrease in electricity prices would reduce Fortum’s net profit by 42%, Endesa by 17.5%, Engie by 4.7%, and RWE by 7%.

The choice of FY2028 as a reference year is because hedging policies mean that production in 2026 and 2027 is essentially locked in, making 2028 the first year with substantial sensitivity to electricity price changes.

Italy’s actions are more aggressive than any other Western European country, with the government approving a decree to remove CO2 costs from the marginal bid of combined cycle gas turbines in the wholesale power market, with carbon costs to be paid directly by consumers.

JPMorgan estimates this will lower Italy’s wholesale power prices by about €25/MWh. The firm notes that EU approval of this mechanism is far from assured, and since the policy leak to the media, shares of Italian utilities, including the national power company, have remained weak.

The Italian government also plans to increase the marginal tax rate component of the IRAP energy company tax by 200 basis points.

SSE is favored for its network-driven growth story, which is above average. RWE is also viewed positively ahead of its upcoming strategic update, expected to highlight growth primarily driven by long-term contract revenues.

Among grid companies, the target prices for UK National Grid at 1,343 pence and E.ON at €18.60 are both rated “Overweight.” JPMorgan describes this category as a safe haven in the current uncertain environment, despite higher valuations.

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