The energy sector has already taken a hit in recent weeks given talk of price freezes, business renationalisation’s and greater regulation, from both main political parties.
Whether or not you believe the opinion polls last week’s surprise YouGov poll, has certainly shaken up the natural consensus which suggested that the Conservatives would win easily. Given this change in electoral dynamics there is a risk that some of the radical measures in the Labour manifesto might become a reality, which means that investors may well head for the exits in the event of a Labour win, or a minority government propped up by a combination of any of the SNP, Greens and Liberal Democrats.
As a key contributor to UK pension funds as well as a staple of small shareholders wholescale interference in this sector could well seriously impact valuations, and prompt some significant volatility.
The energy market is likely to be affected no matter who wins, but it will be about degree more than anything else. The Conservative party has already pledged to bring in a price cap on variable tariffs, which would be subject to review on a six monthly basis, and this has already prompted some weakness in the sector as a result.
Labour will introduce an immediate emergency price cap, to ensure that the average dual-fuel household energy bill remains below £1,000 per year, while they transition to a fairer system for bill payers. They will also take energy back into public ownership to deliver renewable energy, affordability for consumers and democratic control. Labour would also retake control of the energy supply networks and control grids, and would also ban fracking.
With lower oil and gas prices, it is important not to underestimate the impact here given that future infrastructure spending could well be affected, along with the profitability of the industry as a whole, if government intervention sees these companies cut future investment on the UK’s future energy requirements.
Centrica (current dividend yield 5.9%)
Headquartered in Windsor, the company is the largest supplier of gas to UK businesses and households, as well as a key electricity supplier. The company is also a key player in the areas of exploration and production, and given the looming power crunch towards the end of the decade is a key player in keeping the UK’s heating and lights on.
It also has operations in the Netherlands, Norway and the US and has sizeable interests in renewables, with a wind farm development with a number of new developments in the pipeline. It also operates the UK’s largest storage facility for gas, which is located in the North Sea, off the east coast of Yorkshire.
In 2014 the company posted a pre-tax loss of £1.4bn, and cut its dividend by 21% on the back of the recent sharp falls in oil and gas prices. It also posted a loss in 2015, before returning to profit last year, due to reduced investment in capital expenditure and cost savings.
The shares have dropped sharply from highs of 400p since the Labour leader at the time, Ed Miliband, announced his intention to freeze energy prices in September 2013. These declines gained traction in the middle of 2014 when oil prices started to fall, dropping from 330p to multi year lows just above 180p, where they have been for the last year or so.
The current dividend is covered at 1.4 which does make it vulnerable to further reductions, unless the company is able to improve its operating margins, which is likely to be difficult if the companies can’t raise their prices in line with the broader market.
SSE (Scottish & Southern Energy) (current dividend yield 6%)
With ita HQ in Perth, Scotland, the company is involved in the generation and supply of both electricity and gas, and is the second biggest supplier of both in the UK.
It includes Southern Electric, SWALEC and Scottish Hydro Electric. The company also has significant interest in renewables projects including wind and biomass.
The share price performance since 2013 has been much steadier but the outlook remains no less uncertain with the dividend cover also on the low side at 1.4, and expected to fall to 1.2, though operating margins are expected to improve.
National Grid (current dividend yield 4%)
Headquartered in London, its principal activities are in the transmission and distribution of electricity and gas in the UK, while it also has operations in the US, predominantly in the North Eastern US.
In running and attempting to keep up to date the UK’s creaking energy infrastructure the company could still find itself under scrutiny in the context of what it charges the utility companies to use its networks. The SNP argued in its 2015 manifesto that transmission charges should be reduced for renewable energy sources like off shore and on shore wind power. This could be significant if the SNP helps prop up a Labour administration.
Recently the company sold off a 61% stake in its gas business to an international consortium which included the Qatari’s as well as a Chinese sovereign wealth fund for about £13.8bn, which given the extent of Qatari investment in the UK could present a problem if a Labour government tries to follow through on its nationalisation plans.
The company has been one of the better performers on the FTSE 100 with its share price higher than it was in 2014, and has invested significant amounts in upgrading the UK’s power networks in its last financial year. The fall in the pound against the US dollar has seen its profits improve over the last 12 months, however the plans outlined in the Labour manifesto to “regaining control of energy supply networks” and control grids could well change the investment dynamics here.
The current dividend is covered at 1.3, which is border line but could be vulnerable to further reductions, unless the company is able to maintain its operating margins, which could well be difficult if the company has to deal with governmental interference in how it sets prices in line with the broader market.
Heightened market volatility is likely over the election period, which could result in widened spreads. We recommend that you monitor positions carefully, consider the use of appropriate risk management tools and maintain a sufficient account surplus throughout this period.
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