Under its last chief executive, Centrica told its shareholders for half a decade that it was absolutely essential that the company should explore for, and produce, more oil and gas while simultaneously generating more of its own energy. Over-reliance on one end of the energy market – the retail business, meaning British Gas – was deemed dangerous. Centrica needed a spread of investments. Integrated Energy – the title of the annual report as late as 2012 – was the philosophy.
Centrica’s new boss, Iain Conn, like his predecessor Sam Laidlaw, comes from the world of Big Oil but he can see, as everybody can, the flaw in the old approach. Centrica, in spending the thick end of £10bn on oil and gas assets, made a bad bet and acquired a habit it can no longer afford.
Most of those fields were bought in the days of $100 oil and returns are miserable at $55. Profits from gas production plunged 90% to £48m in the last half year. Meanwhile, the supposed balance from the supply end doesn’t work like it used to. True, operating profits at British Gas rose 44% to £656m in the six months, but harder times lie around the corner. Prices for customers have been cut 10%, independent suppliers are pinching customers, and regulators and politicians are keener to jump on any sign of high margins.
Add it all up, and Centrica’s arithmetic has gone haywire. Peter Atherton, an analyst at Jefferies, has a striking statistic: in 2006, it took £280m of capital employed for Centrica to generate 1p per share of earnings; by 2013, the figure was £350m; then it was £500m in 2014 as oil and gas prices started to fall.
Conn’s strategic U-turn thus makes sense. Instead of producing 70m barrels of oil equivalent, output will be allowed to fall to between 40m and 50m. Some £1.5bn of capital will be withdrawn from production and generation. Windfarms, and some production assets, will be sold to raise £500m to £1bn. Centrica won’t be a disintegrated energy company, just less integrated than it was. Throw in the cost savings from 6,000 job losses, plus the already announced 30% cut to dividend, and the arithmetic seems to work again.
Remember, though, that Centrica is a company that seems to require reinvention every seven years or so. Laidlaw’s integrated approach was a reaction against a previous diversification model that led Centrica up some strange avenues, such as buying the AA and launching a credit card called Goldfish.
Conn, in pitching Centrica as an energy and services company, has landed somewhere in between – the services, thankfully, will all be energy-related. Perfectly sensible, but note: the company’s past two strategies worked for a while, and then they didn’t.
Play the waiting game on RBS
Roll up, roll up, who wants to buy shares in a bank that won’t pay a dividend until 2017, and where the next big bill for past bad behaviour could be £2bn but might be £8bn?
To be fair to Royal Bank of Scotland, that’s not the whole story. There is firmer evidence (at last) that the core bank, as they call it, is responding to treatment. Ignoring all the restructuring charges and conduct costs, there was an underlying operating profit of £1.8bn in the second quarter, up 11% on the first.
Chief executive Ross McEwan deserves praise for his war on “teaser” rates on credit card transfers; the industry has turned the practice into an unedifying game of pass-the-parcel with the debts of over-extended borrowers.
The BBC’s fly-on-the-wall series, The Bank: a Matter of Life and Debt, filmed in NatWest’s Huddersfield branch, may also help the rehabilitation of RBS’s name. One marvels at the restraint of hard-pressed staff earning as little as £16,000 a year – it’s a wonder they didn’t lynch the bosses of the Fred Goodwin era.
But back to the financials. RBS trades at just 0.8 times its book value, reflecting uncertainties such as the size of the looming penalty from the sale of mortgage-backed securities in the US in 2005-07. Yet, on current form, the bank will surely get to book value eventually. Chancellor George Osborne is gung-ho to start selling the state’s shares soon. Delay still looks wiser.
Will Vlieghe keep living on the hedge?
Gertjan Vlieghe, the new recruit to the Bank of England’s monetary policy committee, sounds like an upstanding sort of chap. And, no doubt, Threadneedle Street will rigorously apply its code of conduct to prevent conflicts of interest.
Even so, it will look very odd to the outside world that Vlieghe is allowed to keep a passive stake in his former employer, Brevan Howard, a hedge fund that likes to bet on interest rate moves. It would be better all round if Brevan could find a way to buy out Vlieghe’s interest at fair value.
