Counting the true cost of nationalisation

Despite claims to have a fully-costed manifesto, the Labour Party has given little indication of the price tag attached to one of its flagship policies – renationalisation. As part of Utility Week’s Election 2019 coverage, Nigel Hawkins analyses the numbers behind the party’s plans to take energy and water networks, as well as the supply arms of the largest energy retailers, back into public hands.

“Tory privatisation of our utilities has been a disaster.”

This unequivocal view is set out in the Labour Party’s recently published manifesto entitled It’s Time for Real Change.

The manifesto lists some radical proposals, including widespread re-nationalisation of the utilities sector, much of which was privatised in the decade spanning 1984 to 1994.

If the opinion polls are anything like accurate – they are currently projecting a Conservative overall majority – the policies within it will not be implemented.

And even if the Labour Party led a coalition government, it is unlikely that many of its utility policies, such as its wide-ranging renationalisation programme, would be introduced given the Parliamentary arithmetic.

However, this does not mean the industry can be complacent and it is worth examining the potential impact of what Labour is proposing.

The overall cost of nationalisation would be massive. Whilst the actual costs are hotly disputed, the Confederation of British Industry (CBI) has pinned a £196 billion price tag on Labour’s plans.

In terms of Corporation Tax, the Labour Party is planning a rise in the rate from 19 per cent to 26 per cent by 2022 – a policy that will not exactly help the balance sheets of individual utilities.

And there is a proposed Windfall Tax on oil companies, with BP and Shell being obvious targets. The 1997 Windfall Tax on the utilities sector will be seen as a precedent in this respect.

More specifically, the manifesto contains pledges for individual utility sectors, with the UK’s leading energy companies sitting at the top of Labour’s shopping list.

The UK assets of National Grid would be requisitioned by a new UK National Energy Agency; including its valuable US assets, National Grid is currently capitalised at over £30 billion.

Aside from its UK electricity transmission business, National Grid also owns and manages the Transco gas transportation network – both are pivotal to UK energy supply.

DNOs in the cross hairs

Also on Labour’s hit list are the 12 Distribution Network Operators (DNOs) in England and Wales as well as the two in Scotland, owned by Scottish Power and SSE respectively.

Taken together, renationalising these energy businesses would cost many tens of billions, even if a future Labour government paid very modest compensation.

By contrast, the supply businesses of the ‘big six’ are worth far less, as demonstrated by the modest price that SSE achieved in reaching agreement to sell its retail-facing supply business to sector upstart, Ovo Energy.

For Centrica, whose share price remains depressed due to the price cap, a declining market share and a 58 per cent dividend cut amongst other negatives, Labour’s proposals add a further risk.

Although the water sector is earmarked for renationalisation in the foreword by Labour leader, Jeremy Corbyn, the manifesto itself makes scant reference to it.

However, previous Labour Party publications have proposed the establishment of publicly-owned Regional Water Authorities to replace private water companies. Scottish Water, which was not privatised, or the not-for-profit Dwr Cymru could be used as a template.

Seemingly, at the last moment, British Telecom’s (BT) Openreach business has been added to Labour’s shopping list. Renationalisation details are vague but Openreach is the key component of BT’s earnings and sagging share price, not forgetting its pension fund contributions.

Implementing such a widescale renationalisation policy would be a herculean task, even if utility share prices plunged – as they assuredly would – before legislation was put before Parliament.

Shadow Chancellor, John McDonnell, has stated that compensation levels would be set by parliament and would be paid in the form of gilt-edged stock, thereby adding appreciably to the already enormous £1.8+ trillion national debt figure.

Defensive manoeuvres

Utility shareholders do have some protection, whether through ownership rights prescribed under the Human Rights Act 1998 or, in some jurisdictions, by Bilateral International Treaties (BITs).

The one certainty is that specialist lawyers would be very busy.

Importantly, there are few recent precedents for setting compensation levels.

Over the last two decades, both Royal Bank of Scotland (RBS) and Railtrack have been nationalised.

In the former’s case, a vast capital injection of £45.5 billion of taxpayers’ money took place to prevent its bankruptcy.

In 2001, the then Labour Government suddenly renationalised Railtrack, as concerns about its heavy under-investment deepened.

Despite its share price peaking at over £17, investors finally received around two-thirds of the 380p flotation price.

It is likely that the water sector would be near the front of the renationalisation queue, with Regulatory Capital Values (RCVs) possibly being used.

Currently, for the 10 privatised companies, RCVs total almost £75 billion. If compensation were given at just 20 per cent, this would broadly equate to the c£15 billion valuation that the Labour Party has placed on the sector.

For United Utilities and Severn Trent, currently valued at £5.9 billion and £5.5 billion, this would give renationalisation compensation of just £1.2 billion and £1.1 billion respectively.

For National Grid, its US assets would need to be stripped out, thereby reducing its UK value to below £20 billion. Add in a hefty renationalisation discount and shareholders will inevitably not be happy.

Renationalising the 14 DNOs would be immensely challenging, given the diversity of their ownership: RCVs would again be an obvious starting point. The key company is probably UK Power Networks, currently owned by a leading Hong Kong consortium.

Acquiring BT’s Openreach, with annual revenues of c£5 billion, would also be very costly, especially with BT being pivotal to the £30+ billion full fibre broadband roll-out.

Of course, if current opinion polls hold up, all these issues would be academic.

If not, Labour renationalisation of UK utilities would be a disaster for their shareholders.

Nigel Hawkins is utility and renewable energy analyst at Hardman and Co Investment Research