Centrica feels the heat as British Gas heads for heavy losses

Gardner leaving to become Compass chairman. Onetel sale spells end of multi-utility strategy
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The warning came as Centrica confirmed that its chief executive, Sir Roy Gardner, will step down next summer and the group's telecoms business Onetel was formally put up for sale. Sir Roy, who has led Centrica since its creation in 1997, is leaving to become non-executive chairman of the catering giant Compass.

Despite announcing a 14.2 per cent increase in domestic bills less than a fortnight ago, Centrica said operating profits in the six months to the end of December would be much lower than the £967m achieved in the first half.

This is because the company has passed on only part of the increase in wholesale energy prices and expects to continue losing accounts. A further 505,000 households deserted British Gas in the first half, on top of the 1 million who switched to rival suppliers last year. This reduced operating profits from Centrica's residential energy business by 24 per cent to £165m, and Sir Roy said he expected it to plunge into loss in the second half. Centrica has 11.4 million domestic gas customers, giving it 55 per cent of the market and 5.6 million electricity customers, equal to a 23 per cent share.

Although profits from selling gas and electricity were down sharply, Centrica's gas production division more than made up for this, increasing profits by 40 per cent to £540m on the back of soaring oil prices and shortage of supplies. Profits from Centrica's home-services business rose 44 per cent to £59m. The division has 6.7 million customers covered for everything from central heating breakdowns to blocked drains.

The new chief executive is likely to be an external appointment, although Sir Roy maintained that the managing director of British Gas, Mark Clare, remained a contender despite losing his title of deputy chief executive in a management shuffle announced yesterday.

Whoever gets the top job will inherit a tough task. Wholesale energy prices are going through the roof - up 50 per cent from where they were at the start of the year. Centrica's share of the domestic energy market is in decline and it is making slow progress in breaking into Europe. Its multi-utility strategy is in effect dead after the sale of the financial-services division Goldfish, the AA and now Onetel. Meanwhile, the threat from overseas is increasing. E.ON, which owns Powergen, may add ScottishPower to its portfolio, creating a large and very dangerous competitor with deep pockets in Centrica's own backyard. Centrica may even disappear, swallowed up by Gaz de France, Gazprom or perhaps Petronas, the state-controlled Malaysian oil company which popped up with a 4 per cent stake in Centrica last week.

Sir Roy says: "If you ask whether I'm getting out just in time, the answer is no. This is a great business with a fabulous management team and great prospects going forward. We have a few issues in the short term but I'm still going to be around when some of them get sorted out."

Whether his successor will have time to get their feet under the table is a moot point. Petronas has said its investment is a long-term strategic one and it has no plans to bid for Centrica. Gazprom has also sought to play down takeover speculation. But as Centrica's finance director, Phil Bentley, says: "What does any of that mean? They could change their minds tomorrow."

Sir Roy denies that Centrica has manned the barricades and is now on bid alert. He is also keen to defuse the speculation that Centrica will enter the fray if a bid battle opens up for ScottishPower, which has 5.5 million customers to Centrica's 17.2 million. "Do you think we would be allowed to?" he asks incredulously. "We have enough to do without thinking who we could buy or not buy."

No one underestimates the challenge Centrica is facing. It has to strike a delicate balance between staunching the loss of customers on the one hand and, on the other, protecting itself from the unprecedented rise in wholesale prices. So far, British Gas has deliberately avoided passing on the full impact - to have done so would have meant domestic bills rising by more than 20 per cent. But as its chairman Roger Carr said yesterday: "We have the opportunity to revisit our pricing again in the coming year."

Even though it has absorbed some of the increase in wholesale prices, it appears resigned to "further material erosion in the customer base" as Sir Roy put it.

Faced with this Centrica has developed a threefold strategy: buy more gas-production assets to provide a natural hedge against rising wholesale prices; grow the home-services division while expanding further into Europe and the US; and, thirdly, cut its costs.

Centrica produces about 25 per cent of its own gas, but output from its main asset, the Morecambe field off the North-west coast, is in steep decline. To compensate for this, the company embarked on a five-year £5bn plan to buy more upstream capacity after it sold the AA last year. So far it has spent about £1bn of that and committed a further £500m to £750m. Recently, for instance, it bought Kerr-McGee's North Sea assets for £316m and committed a further £400m to £500m to secure supplies of liquefied natural gas from the planned Isle of Grain terminal.

The US is an often overlooked part of the group but it accounts for nearly one-quarter of turnover and five million of the 32 million "customer relationships" Centrica boasts. Europe, meanwhile, continues to grow steadily with some 1.4 million customers, although it will take much more liberalisation of the market for Centrica to make serious inroads.

Back home, it has set itself a target of cutting £150m from British Gas's £1bn of annual costs in the three-year period up to 2007. After the sale of Goldfish, AA and Onetel, it intends to embark on further cost reductions at a corporate level.

After eight years with Centrica, Sir Roy, now 60, shows no signs of tiring. A fitness fanatic, he runs marathons, works out every morning in his own gym and drives his management team equally hard. The challenge facing him at Compass may prove even bigger than the one he is leaving behind. But, for the next nine months at least, there is still plenty of work to be done.