Centrica gets its nuclear fix

Tuesday, November 4, 2008

It’s not only banks that are asking investors for billions of pounds these days. Last week Centrica, the energy company behind British Gas, tapped its shareholders for £2.2 billion in what will be one of the biggest rights issues outside financial services this year.

Unlike the banks, Centrica doesn’t need the money to save itself from destruction. In a harking-back to precredit crunch times, Centrica wants the cash to invest in a new business. City institutions are relieved. “They [Centrica’s large shareholders] have all said thank goodness you are here to talk about that and not another recapitalisation,” said Sam Laidlaw, Centrica’s chief executive.

The new business in question, nuclear power, should finally tackle the problem that has dogged Centrica for years - the mismatch between the size of its retail arm (it sells energy to 20m customers) and its relatively puny power-generating capacity. The disparity between the businesses has made the company vulnerable to swings in energy prices, forcing it into an uncomfortable squeeze between the demands of its power suppliers and its customers.

Laidlaw vowed to fix the problem when he took the top job two years ago, and the opportunity has finally presented itself. Centrica plans to buy a one-quarter stake in British Energy (BE), Britain’s only generator of electricity from nuclear power stations.

It will purchase the stake from Electricité de France (EDF), the giant French utility group that last month agreed to buy BE for a little over £12 billion. EDF will form a new holding company in the UK and Centrica will pay £3.1 billion for 25% of it. The plan was revealed by The Sunday Times in May after Centrica’s own efforts to buy BE came to naught.

The British group will also take a quarter share of the new nuclear power stations EDF plans to build here. The French group intends to construct two twin-reactor plants, one at Hinkley Point and one at Size-well. Centrica will have an option to participate in their development “from the ground floor”, said Laidlaw.

Centrica will not get guaranteed access to the power produced by the BE stations but its exposure to power generation through the shareholding – and the profits the new company will generate – will give it what Laidlaw terms “a structural hedge”.

Neil Woodford, fund manager at Invesco Perpetual, which owns 4.5% of Centrica, said he was delighted by the Centrica plan. “It’s not immediately earnings enhancing but should lead to a rerating of the company because it removes that imbalance between retail and power generation. It increases the value of the business,” he said.

Laidlaw’s target is to have Centrica generating about half its power and gas in-house. Two years ago it was only about 25%, mainly from Centrica’s own UK gasfields. Since then the company has bought more gas, taking it to 35% as it races against the rapid dwindling of the reserves in its huge Morecambe gas fields in the Irish Sea.

“Nuclear will take our structural hedge from 35% to 45%. Ideally we would like to get ourselves to a little over 50%. The rights issue, together with any asset sales if we choose to do them, should allow us to buy more gas assets to get us past the 50% mark,” he said.

Some analysts have raised questions about how safe it is to rely on power from existing BE stations. They are old and have been prone to unexpected shutdowns.

“We’ve been cautious in our forecast outputs,” said Laidlaw. “The fleet is old and it is one-of-a-kind technology, but it has been safely and prudently managed.”

BE’s creaking fleet of nuclear reactors is not the company’s only worry. The credit crunch has finally found its way to the utility sector. Laidlaw was forced to postpone a separate £1.5 billion fundraising effort this month. Centrica had hoped to first raise debt and then attract either private-equity or infrastructure investors to help fund its £3 billion programme to build a portfolio of offshore wind farms. “We’ll come back to that in the first quarter of next year,” he said.

Ministers have shown little sympathy for the difficulty that the financial crisis has caused for utilities. Gordon Brown has called for energy companies to pass on the plummeting price of oil to consumers in the form of lower energy bills. Gas and power prices are closely linked to oil. Wholesale gas contracts, however, are bought on a forward basis and thus tend to lag six to nine months behind the movement in the oil price, Laidlaw said.

That is bad news for customers hoping for some relief this winter. “As soon as sustainable wholesale gas prices come down we’ll follow them down. But the reality is, and we have explained this to the government, wholesale gas prices for the first quarter [of 2009] are 77p per therm, compared to 48p this time last year. Hopefully in six to nine months’ time wholesale gas prices will come down and that will give us the opportunity to move on retail prices, but it’s too early to call.”

Getting a slice of BE’s output will help to shield Centrica from the swings in the wholesale gas market, but it does not address a more fundamental issue. Centrica looks increasingly isolated in an industry that has come to be dominated by a handful of acquisition-minded continental giants like EDF, Iberdrola and RWE.

Every one of Centrica’s UK rivals, bar Scottish & Southern, has been gobbled up in recent years. Laidlaw has spent the past two years building up defences: establishing a high-margin services business, increasing its presence in North America and Belgium, and now the BE deal.

Will it be enough for Centrica to keep its independence?

“I think so,” said Laidlaw. “We’re changing the model. It’s a very different model than all other utilities because it’s deregulated. It’s higher risk but it has been, and I think will continue to be, higher return.”

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