The toll of democracy on utility share prices

It looks as though this May’s general election will be too close to call until the results are in, but what is the fallout of this uncertainty for utility share prices? Nigel Hawkins reports.

Many political commentators, as well as chancellor George Osborne, expect May’s general election to be a rerun of the tight race fought in 1992. That one was won – narrowly – by the Conservatives under John Major (now Sir John Major).

Bookmakers expect May to deliver another multi-party government, although its constituents are far from certain. One favoured outcome is a minority Labour government supported by the Scottish National Party (SNP). The only permutation ruled out is a grand coalition between the two leading parties.

In the lead-up to 7 May, stock markets are bound to be volatile, with the utilities sector being especially vulnerable to political uncertainty, as the response to the unexpected 1992 result vividly demonstrated. On the day after polling day, water stocks rose by c20 per cent as investors piled in. Electricity shares also moved sharply upwards.

By contrast, the election of the Labour government in 1997 had less of an impact, since the opinion polls consistently showed a formidable Labour lead throughout the campaign. And it was widely known that the Labour party had pledged to introduce a utility tax, which it wasted little time in levying.

Importantly, though, this tax was a one-off hit to utility balance sheets, which were generally robust. Only Welsh Water found itself exposed, partly because the tax liability formula used was based on the price/earnings (P/E) ratio at flotation. Welsh’s P/E ratio had been particularly low, which inflated its utility tax liability. Combined with other adverse factors, this contributed to the demise of Hyder, its parent company.

In 2015, the utility focus will be far more on the energy sector rather than on the water companies.

Back in 2013, Labour leader Ed Miliband announced that a 20-month freeze on energy prices would be imposed on entering office. At the time, this pledge was widely seen as a political coup, with the coalition struggling to respond meaningfully to it.

However, it has been subsequently overtaken by events, most obviously the plunge in oil and gas prices: the Brent crude per barrel price has more than halved since last summer. Furthermore, the energy companies are now announcing price cuts, with Centrica confirming a 5 per cent reduction in domestic gas prices.

Importantly, too, a Miliband-led government would introduce powers requiring Ofgem – or, given Labour’s commitment to scrap it, presumably a successor body – to impose energy price cuts if the companies fail to pass on lower input costs. Such a proposal is halfway towards a formal re-introduction of energy price regulation, which was effectively scrapped in the late 1990s.

Many uncertainties, including the forthcoming election, have already deterred several planned investment projects. And, if a second general election becomes necessary – shades of 1974 – investment levels may fall even further.

Utility investors will be particularly concerned about the durability of the various renewable subsidies, most notably the payments for coal conversion at Drax and those for the evolving high-cost offshore wind sector.

It seems inevitable, too, that the controversial Hinkley Point C nuclear project will feature during May’s campaign. With plunging oil and gas prices, the £92.50 per megawatt-hour 35-year price guarantee now looks inordinately generous even though no output is expected until 2023.

To date, the Labour party has held the coalition line on Hinkley Point, but – on entering office – may decide that the detailed numbers in the contract for difference do not stack up.

With four of the big six integrated energy suppliers being overseas-owned, there will be close scrutiny as to how they respond to the election result. In particular, RWE’s future prospects look grim, while EDF could exit the UK if Hinkley Point C, for whatever reason, is pulled.

Centrica’s management will be closely analysing political events: Centrica’s shares are expected to be particularly volatile during the campaign itself. Miliband’s price freeze pledge, which – if implemented – would seriously dent Centrica’s margins, has already depressed its share price. Some concerns remain about its ability to sustain its current level of dividend payments and, with the arrival of a new chief executive, Ian Conn, a reassessment of its long-term strategy is widely expected.

However, this process may be deferred until the Competition and Markets Authority has reported – and, even more importantly, until there is certainty as to whether the new government will seek to implement its key recommendations or simply kick them into the long grass.

Having survived the result of the Scottish referendum, SSE’s share price is still affected by political issues: it remains dependent on renewable subsidies. A Labour-led coalition with the SNP could result in a second independence referendum. As for National Grid, Europe’s most valuable utility worth c£35 billion, the election should pass it by since it has no domestic customer base.

Unlike in 1992, the water sector is now far lower profile. With the periodic review broadly complete – apart from possible CMA referrals led by Bristol – and modest price cuts being implemented, political intervention is far less likely.