Utility Week

UTILITY WEEK | 30TH AUGUST - 5TH SEPTEMBER 2019 | 27 Customers in Ireland, a market that Centrica entered relatively recently – and one in which it sees real scope to increase gas sales. Within its Business division, problems abound. Indeed, it barely broke even at the adjusted operating profit level. Setbacks in its US operations had been flagged previously. The decline has been sharp, with the H1 2018 £50 million adjusted operating profit figure being converted into a £14 million loss: warm weather has also been cited as a key factor for lower returns. While Centrica has been disengaging from electricity generation for some time, its nuclear power involvement – something it is eager to exit – has also contributed to depressed profits. In H1 2019, there was a 19 per cent decline in its nuclear power generation – down from just over 6,000GWh in H1 2018 to less than 5,000GWh. This pronounced shortfall was mainly attributable to prolonged outages at the Hunterston B and Dungeness B plants. Some years ago, Centrica's Exploration and Production assets attracted punchy valu- ations, especially during the $100+ per oil barrel era. But no longer. H1 2019 showed a 42 per cent decline in adjusted operating profit to £148 million. Clearly, weak global gas prices were crucial in depressing returns. Two further factors contributed. First, there were lower volumes from the Rough gas-field, which is being run down. Second, Spirit Energy, in which Centrica holds a 69 per cent stake, incurred mate- rial dry hole costs as part of its drilling pro- gramme in the Greater Warwick Area near the Shetland Isles. Overall, these three divisions accounted for around £400 million of adjusted operat- ing profit, of which the Centrica Consumer division contributed 60 per cent. In its interim results statement, Cen- trica sought to reassure the market that H2 of 2019 would see slightly improved results. Given the latest share price movements, which admittedly were part-driven by the 58 per cent dividend cut, the market remains unconvinced. Hard sells Aside from the negative impact of the price cap, ongoing warm weather and weak gas prices, Centrica also faces challenges on the financial front. Its June 2019 net debt figure of £3.4 billion is now almost 80 per cent of its current mar- ket capitalisation. Consequently, Centrica is taking radical action to reduce it, predomi- nantly by selling two major assets. It will dis- pose of its 69 per cent stake in Spirit Energy – a pronounced U-turn from a few years ago when exploration and production was both a core activity and, in the era of high gas prices, a major earner. Clearly, the level of disposal proceeds will depend, to an extent at least, on medium- term oil and gas price expectations. However, Centrica should be able to nego- tiate an acceptable deal for this business, with expected proceeds for its majority stake set to exceed £1 billion. Far harder to unload will be its 20 per cent shareholding in the UK's eight most modern nuclear power plants, all of which are now more than 20 years old and most consider- ably older. The obvious buyer, with its existing 80 per cent majority stake, is EDF, a company with very high net debt and nuclear-related issues. Unless the price on offer were mini- mal, it seems unlikely to participate. Few other obvious buyers exist as the UK nuclear power industry focuses – almost entirely – on the circa £20 billion Hinkley Point C new-build project. What next for Centrica? With Centrica's share price at its lowest level for 21 years, it is no surprise that speculation about a possible bidder arises. A decade or so ago, Centrica's name was regularly linked with Russia's Gazprom – but no longer, for obvious political reasons. Arguably, the most obvious bidder now is Shell, whose quarterly results last week dis- appointed the market. However, having entered the UK retail energy market through its First Utility acqui- sition – now rebranded as Shell Energy Retail – Shell clearly has long-term plans for this market, which links in with its declared wish to be at the forefront of the roll-out of the infrastructure to support electrically powered vehicles. Given its projections of organic free cash flow of around $30 billion a year, bidding for Centrica would hardly present financing problems for Shell. For Centrica, testing times lie ahead, with a renewed focus on its core UK gas busi- nesses and its two-pronged disposal pro- gramme, of which the sale of its 69 per cent stake in Spirit Energy is the more important. Although its woes are set to continue, there is the possibility that the more right- wing government of Boris Johnson may scrap the controversial – and arguably inef- fective – retail gas and electricity price caps. Now that would help. Nigel Hawkins is the utilities analyst at Hardman Research and a Utility Week correspondent Consumer: adjusted operating profit drivers Business: adjusted operating profit drivers PROFIT BREAKDOWN UK default tariff cap Commodity/ FX/ inflation Hunterston B and Dungeness B outages EM&T legacy gas contracts North America gas opti- misation opportunities Other margin Efficiency programme Inflation and FX Weather Underlying margin Efficiency programme E&P: adjusted operating profit drivers Commodity/ FX/inflation Spirit volume and cost CSL volume and cost Efficiency programme Spirit dry hole and impairment £430m £96m £11m £148m £256m H1 2018 H1 2018 H1 2019 H1 2019 (£183m) (£45m) (£63m) (£10m) (£44m) (£16m) (£11m) (£50m) (£32m) (£9m) (£37m) £71m £2m £18m £13m £13m £240m H1 2018 H1 2019 Centrica share price, one year Nov 2018 Mar 2019 Jul 2019 160 140 120 100 80 60

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