I do not remember the various price caps employed by Ted Heath's government in the early 1970s...but the history books tell me all I need to know as to their impact which was a mega policy failure and contributed to the election of a Labour government (of course it also led to the monetarist/free market revolution that ultimately led to the rise of Mrs T). Price caps distort markets and give incorrect incentives, a point made multiple times over the last year by the management of Centrica (CNA), concerning the introduction of energy price caps by Ofgem following agreement by the government.
I have argued before that 'all this price cap will do is deepen the reluctance for utility corporations to invest in UK gas and electricity supply networks. And if you build up sufficient of a disincentive...then ultimately hello brownouts and blackouts'. You can see the first cracks in this policy appearing at the moment with the announcement that this Thursday, around 15 million households will be told that their gas and electricity bills can go up around £100 a year. That is a 10% rise which is quite proportionately striking...and of course flies in the face of the fundamental notion of a price cap.
It is true that no regulator can control wholesale price changes but the funny thing about energy prices is that they go up and down and in a free market they provide incentives to change behaviour and strategy. Distort the market with a price cap though and that flexibility starts to disappear. You can see this already by the failure of a bunch of smaller energy names as well as the proposed Scottish & Southern (SSE) / nPower hook up. The incentive to push the envelope and risk capital at the margin is decreasing as pricing becomes very, very uniform and you end up with an oligopoly and patchy service...and if you want to double down on this then you nationalise the space (hello Jezza!).
Centrica's management - highly experienced in dealing with irrational governments and regulators - are playing the long game. Keep costs tight, make a couple of selective disposals and note that the rationale for big capex does not exist. This is why the current 8%+ dividend yield is sustainable as all of these initiatives are good for the balance sheet and cash flow. Longer-term, Mr Market will put them again back in the box seats as the need for energy pushes up realisable returns and they can talk about growth and investment again. This is why I own the shares and regard them as good total return value here. The biggest risk is the election of a very socialist idealistic Labour government...but for me peak Jezza has come and gone. I mean, if you cannot be definitively in the lead of the polls after the Brexit-related omnishambles of the last year or two, then you are never going to taste real power in my view. I am sure Centrica's management will like the sound of this too.
Filed under: Centrica, financial scandal, FCA, Oracle Power, First Derivatives, Big Sofa, Centamin, Bearcast
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