Utility Week

UTILITY WEEK | 17TH - 23RD NOVEMBER 2017 | 9 Policy & Regulation Analysis I t seems many years since Centrica was thriving, with a share price pumped up on misplaced rumours of interest from Russia's Gazprom – a barely conceivable sce- nario today. In the late 1990s, Centrica was demerged from British Gas, which had been privatised in 1986. The exploration and production part of British Gas's portfolio, BG, was acquired – controversially – by Shell in 2016. The gas transportation division, Transco, was acquired in 2002 by National Grid. Centrica's plight is illustrated by its lack- lustre share price performance. Over the past year, its shares have fallen by more than 20 per cent; over five years, its shares have almost halved in value. Remember, too, that these share price declines have taken place against a strong FTSE-100 market, which recently achieved another record high. The threat to Centrica's dividend, which has already been cut sharply, lies behind its share price decline. Dividend cover remains low – in the 2016 full year, it was 1.4x. Hence, paying out increasing dividends in the future may not be feasible unless there is marked improvement in financial returns. The much-trailed energy price cap has hung heavily over Centrica's market rating. While it is unlikely to impact for at least a year – and may only be a temporary politi- cal expedient – it goes right to the heart of Centrica's profit centre, its retail gas supply business. By imposing a maximum price, margins will surely be cut – by how much is debatable. Furthermore, the government seems determined to introduce a price cap that applies to many millions of gas consum- ers on standard variable tariffs. Politically, Centrica, like other UK utili- ties, is adversely impacted by a weak govern- ment, a resurgent Labour party – now level pegging in the polls – and the latter's wide- ranging utility renationalisation pledges. Re- nationalisation on the Labour party's terms – with the level of compensation for compul- sory acquisition to be decided by parliament – is a real downer for shareholders. In the short term, Centrica really would welcome a cold winter, boosting gas demand. Cold snaps at weekends are particularly ben- eficial for the company's finances. Instead, we saw an unseasonably warm autumn – bad news for Centrica's shareholders. In the medium term, a sustained recovery in gas prices would benefit Centrica, which still has substantial production assets in the North Sea – these are due to be transferred to the joint venture with Bayerngas Norge, in which Centrica will hold a 69 per cent stake. For some time, gas prices have been weak with demand for gas also being lower than anticipated. Clearly, Centrica cannot simply wait for a sharp recovery in gas prices. A similar conundrum – though on a far larger scale – has confronted the oil majors, such as Shell and BP, in recent years. Given these various challenges, Centrica's incoming chief execu- tive, Iain Conn, presented a new strategy in 2015 – it was supplemented during this sum- mer's Capital Markets Day. At its core is the commitment to grow underlying adjusted operating cash flow by 3-5 per cent a year until 2020: the 2016 growth figure was an impressive 14 per cent. Central to Centrica's new strategy has been downsizing the role of exploration and pro- duction, which had been expanded under Conn's predecessor, Sam Laidlaw. It is being increasingly recognised that the era of high – and sustained – oil prices is probably over. Second, generation returns in recent years have been very disappointing, although a Tough times for Centrica In recent years, Centrica has been struggling. On 23 November, a close-period trading update is due; it may be downbeat, says Nigel Hawkins, especially with the unseasonably mild weather of late. £75 million underlying operating profit from this segment was reported in 2016. Some large plants have now been sold, with renew- able energy generation seemingly no longer on Centrica's radar. Instead, Conn wishes Centrica "to be at the centre of our custom- ers' daily lives". Its role as a major energy services company enables it to be so. However, there is considerable doubt as to whether its much-hyped Connected Home initiative can deliver the ambitious financial returns being sought. In 2016, it reported an underlying operating loss of £50 million. To be sure, energy supply is going through many changes at present, with the advent of smart meters, sophisticated energy man- agement techniques, electric vehicles and distributed generation, among other things. Centrica is in pole position to benefit from these trends. Along with Centrica Consumer, Centrica Business is also seeking to re-establish itself. While its UK business market is far less prof- itable than its UK retail equivalent, the split in the US operations is reversed. Clearly, with this fundamental rebooting of Centrica, investors will need considerable patience, although the depressed share price could be boosted by speculative activity. In any event, the 23 November pre-close trading statement is unlikely to be overly bullish. Nigel Hawkins, director, Nigel Hawkins Associates CENTRICA SHARE PRICE OVER THE PAST FIVE YEARS 400 350 300 250 200 150 pence 2013 2014 2015 2016 2017

• Cover