• 3 minutes 2nd Annual Great Oil Price Prediction Challenge of 2019
  • 6 minutes "Leaked" request by some Democrats that they were asking Nancy to coordinate censure instead of impeachment.
  • 11 minutes Trump's China Strategy: Death By a Thousand Paper Cuts
  • 14 minutes Democrats through impeachment process helped Trump go out of China deal conundrum. Now Trump can safely postpone deal till after November 2020 elections
  • 34 mins Shale Oil Fiasco
  • 6 hours USA v China. Which is 'best'?
  • 26 mins Everything you think you know about economics is WRONG!
  • 6 hours Wallstreet's "acid test" for Democrat Presidential candidate to receive their financial support . . . Support "Carried Interest"
  • 2 hours My interview on PDVSA Petrocaribe and corruption
  • 15 hours Wonders of US Shale: US Shale Benefits: The U.S. leads global petroleum and natural gas production with record growth in 2018
  • 7 hours Quotes from the Widowmaker
  • 1 day True Confessions of a Billionaire
  • 6 hours Global Debt Worries. How Will This End?
  • 13 hours Petroleum Industry Domain Names
Alt Text

Bullish Sentiment Is Back In Oil Markets

Optimism has returned to oil…

Alt Text

Cautious Canadian Oil Majors Forced To Cut Spending

Canadian oil majors continue to…

Alt Text

Six Oil Stocks To Survive The Shale Bust

The U.S. shale patch is…

Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

More Info

Premium Content

Is Centrica’s Business Model Sustainable?

The UK’s biggest energy retailer, Centrica had another bad year. Earnings and operating profits declined. And since 2015 Centrica’s share price has almost halved. So, what is the problem? Selling electricity and gas should be a secure, steady business. For an investor seeking yield plus price appreciation this has been a disaster.

Let’s go back to the heart of the matter. When the British electric industry was privatized, it was divided up into generation, transmission, distribution and supply (retail) businesses. Initially, analysts had serious doubts about the long term viability of the supply business as a standalone entity. It was not clear why any anyone would willingly incur the risks of matching volatile wholesale prices with slow moving, retail prices. And all this business risk for a thin margin that evaporates at the slightest miscalculation.

Eventually power generators in the UK saw value in the supply business. It provided a useful hedge against price volatility in the wholesale generating market. Wholesale prices change quickly. Hourly in fact. Retail prices were steadier. They changed only as the customers’ contracts expired.

When wholesale power prices rise, the generating company's profit margins also rise. But margins fall by a corresponding amount at the supply business. And vice versa. A power generator owning a supplier reduces earnings volatility. And the combined generating/supply business can earn a steady profit. In addition, British power generators thought it advantageous to have a lot of retail customers, to have a guaranteed market for their output. As a result the big power generation companies in the UK merged with big power suppliers.

Related: Peak U.S. Shale Could Be 4 Years Away

Not so with Centrica, which had already established itself as the biggest retailer of natural gas in the UK. Centrica's management assumed that the company already had adequate scale with its millions of customers. The strategy was to cross sell electricity to gas customers and vice versa and perhaps sell other products and services to consumers as well.

Fast forward to the return of the pro-business, pro-market Conservatives to Number Ten Downing Street in 2010.  The Conservatives of course, privatized the utility industry in the first place. Shortly after the new Conservative government moved in, retail electric prices shot up (reflecting higher generating costs). Neither Conservatives nor the opposition Labor Party were pleased with that result. They threatened to impose controls on retail prices.

Then when fuel costs dropped and so did wholesale power prices, the politicians wanted to know why supply prices did not immediately reflect the drop in costs. On top of that, they accused the suppliers of issuing confusing tariffs and bills, making it difficult for consumers to figure out how to get better prices.  

So back to the hedging concept. The government, via legislation proposed late last year, wants a cap on the so called Standard Variable Tariff (SVT) under which about 4.3 million UK customers are served. The proposed bill would give regulator Ofgem the ability to place price caps on all default energy tariffs. Related: Crucial U.S. Pipeline In Legal Limbo

It looks as if UK politicians wants retail energy price to reflect changes in wholesale costs--at least when they decline. That is, the retailer loses when wholesale prices rise but cannot recover when they decline. What kind of business is that?

Now back to Centrica which just reported last year’s results--not a good showing. Aggressive cost cutting, various asset dispositions including its 20 percent stake in EDF’s UK’s nuclear generating fleet, and a 4,000 employee headcount reduction sort of sums it up.

What does Centrica do that makes a unique and productive contribution to society? It neither produces nor delivers the electricity or gas it sells. It purchases a commodity product, in this case wholesale electricity and gas, in the same national, wholesale power and gas markets as its competitors, from a limited number of sellers. In return for purchasing electricity and gas for customers Centrica adds a margin of roughly 7.5 percent to the average bill. Do customers really care about this service? Does supply still constitute a sustainable business model? We have begun to doubt it. As a result, management claims that the dividend is secure till 2020 must be viewed with some suspicion.

By Leonard Hyman and William Tilles

More Top Reads From Oilprice.com:




Download The Free Oilprice App Today

Back to homepage



Leave a comment

Leave a comment




Oilprice - The No. 1 Source for Oil & Energy News
Download on the App Store Get it on Google Play