Power companies are the new banks as far as the public is concerned — but does that mean they’re not worth putting your money in? In any troubled marketplace there are always stocks to be picked, but current political turbulence makes that an unusually tough challenge in the UK energy sector.
Much anger is currently directed at the ‘big six’ energy groups — Centrica, Scottish & Southern (SSE), Scottish Power, E.on, RWE and EDF — and their pricing power in the domestic market. The recent round of tariff rises, ahead of the winter heating season and in the face of a moderating wholesale market, served to underline the suggestion that they are price-gouging.
Labour leader Ed Miliband harnessed this discontent in his conference speech in Brighton in September with his vow of a two-year price freeze and abolition of the current regulator, Ofgem. In fact, by promising a freeze 18 months before a general election, he may actually have encouraged the big six to gold-plate tariffs now, in case the controls should become a reality.
Without the freedom to raise prices, they claim new investment plans would be postponed, as would plans to bring mothballed gas generation back on line. This is not an empty threat: former regulator Alistair Buchanan estimated last year that the big six would need to find £33 billion in new equipment over the next decade just to keep our lights on.
But Miliband had detonated a political explosion. Initially coalition ministers argued that competition among suppliers and fixed-price tariffs would ease pressure on energy users; and over the longer term, fracking and new nuclear would help meet the country’s energy requirements. However, after the unhelpful intervention of former prime minister Sir John Major, who floated the idea of a windfall tax to subsidise poorer consumers, David Cameron was forced to respond. His answer was to bring forward proposals to lift some of the green taxes that have added £127 a year to the average energy bill.
None of this will be enough to prevent energy supplies running low in 2015-16, especially if Britain’s recent growth renaissance continues. There is little margin for error in the nation’s energy supplies. In March this year, after a long, cold winter and some difficulties in obtaining gas through North Sea pipelines, the volume of gas held in storage fell critically low, leaving the suppliers to dip into a volatile reserve to keep the central heating on and the hobs burning.
So the outlook is uncertain on several fronts — and the impact of the Miliband intervention so far is an across-the-board 10 per cent cut in the market value of the big energy suppliers, in which direct investment opportunities are in any case limited by high levels of overseas ownership. After privatisation in the 1990s, the first wave of foreign investors came from the United States. This group was frightened off in 1997 by Gordon Brown’s windfall tax on utilities. The exit of the Americans created openings for European owners such as RWE and E.on from Germany, EDF from France and Iberdrola from Spain, which brought Scottish Power. That left only SSE and Centrica as the main opportunities to invest in UK energy.
SSE is generally regarded as a well-run enterprise that has battened down costs and runs profitable wholesale and network operations. But retail has struggled because of rising wholesale prices. Now it faces the risk of higher political tension and re-regulation as the battle rages over above-inflation price increases.
Centrica too struggles with returns on its retail business despite its dominant position in the UK gas market. Under chief executive Sam Laidlaw, with his background in oil exploration, it has been investing heavily in its own sources of supply in the North Sea and beyond, with production expected to rise 20 per cent in 2013. It also has become a minority investor in fracking projects in Lancashire and Sussex and has been building a gas supply business in newly unregulated US markets. The company’s strategic vision has impressed, but like SSE the political overhang will not shift easily.
National Grid, which runs the power lines for electricity and the distribution networks for gas, gives investors another angle on the sector. It offers a generous utility dividend of 5.5 per cent and some stability through its regulated operations.
But what of nuclear power, which is suddenly back in fashion? The government’s most far-reaching energy decision since taking office was to set a strike price of £92.50 per megawatt hour for electricity from the new nuclear plant at Hinkley Point in Somerset — effectively a 100 per cent guarantee of the project, given that this is twice the current wholesale price. But direct opportunities for investors to become part of new nuclear are very limited.
Lead investor EDF is 86 per cent state-owned; the technology is to be provided by Areva (100 per cent French state-owned) and the main minority investors are Chinese state-owned. Such British investment opportunities as will come along will be among the subcontractors who will include names such as Babcock, Costain and Rolls-Royce. But we still have little idea how much of the contracts they will win, how profitable that is likely to be for them, and when the eventual pay-off to investors will come.
Elsewhere, there are investment opportunities in new smaller arrivals on the stock market such as Infinis Energy, a £1.5 billion wind farm and landfill gas outfit to be spun out of Guy Hands’s Terra Firma fund. Investors should, however, beware of private equity firms bearing gifts.
Looking abroad, many of the problems faced by UK suppliers, from carbon taxes to rebellious consumers, are faced by continental giants too. The Portuguese utility EDP is favoured by some City brokers because of Chinese interest in the stock. Among the big German firms, RWE (which last year pulled out of participation in UK nuclear, as did E.on) is focusing more closely on the continental market and disinvesting from further-flung activities, making it a more focused company in Europe’s most powerful industrial nation. But it too faces political risk while the euro is still not out of the woods.
In summary, energy shares remain highly vulnerable to political interference — making investment in what has conventionally been thought of as a super-safe sector far more volatile than it ought to be.