Editorial: Utilities in the modern age [NGW Magazine]

The UK’s biggest utility Centrica never became a takeover target during the UK energy privatisation boom of the 1990s, but now as its share price languishes at a 22-year low, the question has opened up once more.

It was too big and expensive back then, with the hugely valuable Morecambe Bay swing producer fields on its balance sheet. But these fields are emptying and the reservoir pressure is low, and it does not have the Rough storage asset to offset peak winter gas demand either. It has become much more vulnerable to cold winters and high prices than it was seven years ago.

Its peers, such as Powergen and National Power, were much smaller entities and among the safe purchases that national champions overseas could pick up. The UK companies represented perfect long-term investments, yielding steady cashflow from an unsophisticated customer base, while the buyers’ own markets abroad remained closed.

The straightforward commodity markets of the day meant that a few coal or gas-fired plants, some storage contracts or assets and some offshore production and some smart traders were all that were needed to pay shareholders healthy dividends.

So inert in fact was the customer base that there were long-held suspicions that the Big Six vertically integrated companies were somehow colluding to retain a mutually satisfactory market share, hiking and cutting prices almost simultaneously and to equal degree.

But that has all changed now. For years, the utilities have been saddled with the task of collecting a load of unpopular levies to suit the government’s subsidies for renewable energy, for which the ‘greedy’ utilities have taken the blame. Despite the slim reserve generation capacity margin, that part of the business is so risky that companies need incentives to build plant. And the government has recently interfered with the utilities’ tariff structure, costing Centrica, the largest of its kind, a few hundred million in lost earnings just in the first half of this year.

Switching supplier has also become an easier process for even the most reluctant customer; and there are more suppliers to choose from, even allowing for the sudden rise in bankruptcies in that sector. Eleven companies went under in the 12 months to July at a cost of some £100mn. This all had to be recovered through additional charges on bills. Many of the new entrants failed to foresee the rise in wholesale prices, especially in the wake of the Beast from the East (February-March 2018), and more creditworthiness will be required of future entrants.

Centrica’s one quick route to restoring balance-sheet strength – the disposal of its nuclear and upstream oil and gas portfolio – will bring one-off gains. They could fetch £2bn, two thirds of which would come from its majority stake in Spirit Energy, the upstream oil and gas business, according to Bernstein analysts.

Centrica’s exploration and production adjusted operating profit was down 42% to £148mn out of a total £399mn, coming from its majority-owned joint venture Spirit Energy and its other UK assets, chiefly Centrica Storage, operator of the Rough field and the Easington terminal. Low wholesale prices, declining output from Rough and a dry well in Norway all took their toll, but it was still a useful share.

While CEO Iain Conn might not want to sell them, his board has not found a better idea to prop up the share price either. Neptune might be interested in the upstream business, its CEO having run Centrica just before Conn; and Conn himself is to leave next year.

So it is not the safe business it once was, energy retail. Sometimes, one is tempted to agree with the Labour Party that the government might just as well take over the onshore energy sector lock stock and barrel, returning to the pre-privatisation days, and take the flak itself when things go wrong. Among the upside factors could be closer co-ordination and knowledge-sharing with the offshore, simplifying transmission capacity planning and perhaps even maximising the economic recovery.

And again, aiming for net-zero carbon emissions by 2050 requires such close co-operation between funders, investors, operators and consumers that one has to ask whether the market can be devised that will deliver it, or if it needs strong government involvement: state-run carbon capture and storage springs to mind. Of course, bad management would be a major downside risk for taxpayers.

And what about the main business of Centrica? After outlasting its corporate siblings – BG is now a part of Anglo-Dutch Shell and Transco is very much the junior part of National Grid – there might be some other customer-focused company with an eye on it, subject to anti-trust regulations.

E.ON for example sold its upstream and generation business Uniper to concentrate on smart grids and mobility, not that different from Centrica’s technology-driven ambitions. E.ON might well see it as a natural partner, depending of course on what happens after the UK leaves the EU, a possibility this year.

Or French Engie might be interested: like Centrica it is another former big gas producer, now focusing on decarbonising and setting up a retail business in the UK. Or Shell, whose First Utility could find Centrica’s customer base a welcome outlet for all its gas and power generation. Centrica also has a North American business that both Shell and Engie could reach. The embattled utility might not need to engage a headhunter at all, but a good broker.