EVERY so often, financial markets spectacularly misjudge an issue. One such blunder took place immediately after Ed Miliband announced his policy to freeze gas and electricity prices for the first 18 months of a Labour government.
Instead of heading for the exits, investors sat on their hands. Shares barely fell that first afternoon, despite extensive coverage online and on news channels. It was only after the big TV news bulletins that evening and the newspapers the next day that the City realised it had missed a trick. Shares in energy firms started to slump as soon as the markets reopened; those few bright sparks who had understood what was happening the previous day made a killing.
Fast forward two and a half weeks, and the City has now finally digested the policy, which could cost the supply companies at least £4.5bn over 2015-17. It is now widely accepted that the political risk facing all players in the UK power market has increased substantially; there is also a better understanding that the Labour party remains ahead in the polls and is serious about this policy. Last but not least, it is clear that the threat of a price freeze will chill investment in new generating capacity, regardless of what some in Westminster may hope.
Equity investors have reacted as they ought to have on day one: they have been selling out of the entire UK gas and electricity sector (and not just supply companies) and switching their money into utilities based in safer countries, as an excellent research note from Liberum Capital explains.
Peter Atherton and Mulu Sun, the note’s authors, remind us that the consensus trade ever since 2010 has been long UK/short Europe, fuelled by a very gradual improvement in Britain’s prospects on the one hand and the Eurozone crisis on the other – and not just in utilities. But given the sharp rise in UK political risk, that trade could now be unwinding, inflicting great harm on UK Plc. This is certainly true when it comes to utilities; I remain more optimistic when it comes to other sectors (until the housing, debt and consumer-fuelled recovery eventually ends in tears in a few years’ time, that is).
Yet the damage to investors’ pockets has already been huge, the business climate in Britain is now seen as far more volatile and uncertain and one key, capital-intensive part of the economy will now find it much harder to raise finance.
Since Miliband’s speech, the wider UK electricity and gas sector has suffered a 5.4 per cent fall in stock prices, whereas the same sector in Europe (ex-UK) is up around five per cent, implying a 10.4 per cent swing. Looking just at Britain’s SSE and Centrica versus Germany’s RWE and E.On since the speech, the swing ranges from 14 per cent to 17 per cent in favour of the latter. SSE and Centrica have lost seven per cent and six per cent of their value respectively against the FTSE 100 – a combined £3bn hit to their market cap relative to the market.
Many of the large UK energy companies are arrogant organisations that routinely treat customers badly. But that is no reason to rob their shareholders of billions of pounds in this way. Instead, the market needs two reforms: the government must remove the green taxes and obligations that are pushing up prices and hurting the poor and manufacturers the hardest; and it needs to make it easier for customers to switch firms and for new entrants to shake-up the market.
Sadly, the former strategy seems to have been ruled out again by the Liberal Democrats, who remain wedded to making energy prices as unaffordable as possible in their quest to unilaterally decarbonise the UK economy, and the coalition’s latest nuclear plans will also involve hugely costly subsidies. As to greater competition, this is unlikely following the coalition’s own half-baked reforms.
What a mess.