The British Labor Party, headed by Jeremy Corbyn has announced plans to re-nationalize the nation’s electric, gas and water utilities that were privatized by Prime Minister Margaret Thatcher in 1990. In particular Labor has its eye on the gas and electric transmission lines, the international interconnections and the local gas and electric distribution companies.
If adopted this would reverse a great deregulatory experiment that placed almost the entirety of the UK’s utility infrastructure in private ownership. Once privatized, the UK’s utility managers were permitted to operate under a generous regulatory formula allowing rather handsome profits in a notoriously low risk business with completely captive customers. For years the Labor Party claimed, not without some justification, that utilities were “ripping off” UK consumers. Nevertheless Tony Blair’s “New Labor” government kept the Thatcherite deregulatory structure in place.
Despite all the hyperventilating from UK utility executives and investors, Corbyn’s proposal raises several questions. The first is why now? Rebecca Long Bailey, the shadow business secretary stated that one of Labor’s principal goals was an attempt to accelerate the transition to a low carbon emissions electricity grid. Her additional claim was that only a state-owned system is capable of rapidly integrating all of the new wind, solar and tidal power generating resources.
Second, we should ask how does Labor plan to compensate the existing owners of these assets? And this is where things take an interesting turn. It was reported last week in the UK press that Labor wanted to nationalize the utilities in a manner similar to the government takeover of Northern Rock bank. Northern Rock was a mortgage lender which experienced a bank run and loss of public confidence in the 2008 global financial crisis. It was nationalized in February of that year. Related: Bank Of America: $90 Brent May Be Around Corner
We fail to see the connection between relatively prosperous utilities and a failed financial institution. However, Labor seems to be making precisely that case. Their goal seems to be avoiding compensating investors at current market prices due to three main reasons. First, the utilities have experienced “asset stripping since privatization.” Second, these for-profit businesses continued to receive extensive state subsidies since the 1980s. Third, existing pension fund deficits would also justify a less than full market according to Labor.
A separate critique of private sector utility managements cited extensive reliance on financial engineering (i.e. adding considerable amounts of debt to balance sheets that were unlevered at the time of privatization) as well as value extraction via dividend payments to shareholders and share buybacks. To provide some sense of the bid-ask spread here, shadow chancellor John McDonnell suggested that nationalizing the water industry could be done for less than £15 billion pounds. A study conducted by the water industry itself last year suggested a fair market value roughly three times higher than that suggested by Labor’s representatives or £44 billion pounds.
Naturally, this brings up the question: where will the money come from? The Laborites answer is simple. We will issue government bonds in exchange for both debt and equity securities of the newly nationalized utilities. When we consider for a moment that there are over $10 trillion of negatively yielding securities, perhaps a debt financed takeover isn’t so crazy. And the government would be purchasing a slew of operating companies with both considerable real assets and income streams. Related: Total Declares Force Majeure On German Refinery After Russian Oil Contamination
The utility owners (and their bankers, no doubt) will develop their own notions of value. Acquisitions usually come with a premium over market price (not a good argument given that only two of the companies are traded). They require even a bigger premium to take control (is this double counting?), except the government always had control through regulation and the franchise. Renationalization would simply transfer ownership from existing shareholders, the nominal owners of the utilities, to the government outright. Then there is the argument that most of the utility owners are foreign, and renationalization would discourage future foreign investment in the UK and raise UK bond rates.
Most asset owners are willing sellers if they get the right price or did not pay the wrong price when they bought the property. And, there’s the rub, as Hamlet put it. Many current owners bought their utility properties at a substantial premium to the regulatory asset value on which the utilities earn their return. As financial theory tells us, utility stocks that sell above the equivalent of regulatory asset value are earning more than cost of capital. These investors bought into an industry earning handsome returns probably in excess of cost of capital, apparently on the assumption that they could do so indefinitely. They would not want to sell the assets at regulatory asset value (or worse at a substantial discount) because of probable and considerable financial loss. But if the government pays more than regulatory asset value, it rewards the current owners twice over for earning a return over cost of capital.
We don’t pretend to know if Labor will win or whether the country will benefit from a change in utility ownership, but we do think that the discussion will lead to a reexamination of what privatization actually accomplished.
By Leonard Hyman and William Tilles for Oilprice.com
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