David Prosser's Outlook: No need for a shotgun wedding at Rock

Higher energy bills on the way; Bond investors still have the blues; Bond investors still have the blues
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The Independent Online

Is Northern Rock slipping from Sir Richard Branson's grasp? When the debt-stricken bank announced Virgin Money's status as preferred bidder last week, Sir Richard looked to have pulled off yet another coup. Now there are question-marks about the finances he has in place for the bid, and mounting evidence that the Treasury, far from a disinterested party, is still very much considering other offers.

For now at least, Virgin Money retains its preferred bidder status. But JC Flowers, Cerberus and Luqman Arnold's Olivant all remain in the hunt. That's as it should be. Clearly, it's in everyone's interests to resolve the Northern Rock crisis as quickly as possible, but Virgin's promotion to pole position was made with indecent haste. No doubt Northern Rock's board is coming under huge pressure from the Treasury to sign a deal, but it's worth taking a little time to make sure it's the right one.

That's not to say that Virgin Money isn't the right choice. There's good reason to think it offers many of Northern Rock's interested parties as good an outcome as they could hope for from this crisis. It's interesting, for example, that notwithstanding the opposition of Northern Rock's two largest shareholders to Virgin's bid, shares in the mortgage bank fell yesterday on the suggestion that Sir Richard might be less likely to win the day.

That might seem counter-intuitive given that one reason to think Virgin Money could lose out is that the Treasury seems determined to ensure there will be some sort of auction for Northern Rock. The market's reaction, however, suggests that shareholders' calls for a better offer from rival bidders in particular Olivant, which has yet to finalise its proposals may be more in hope than expectation.

The 250m valuation attached to Virgin Money in Sir Richard's proposals has certainly raised eyebrows, but Northern Rock is clearly prepared to take a generous view of such a rating, particularly given the prospect of the jobs this deal would preserve.

Customers also have reason to be positive about a Virgin Money bid. It seems a long time ago now, but Sir Richard's entry into the financial services market in the mid-Nineties, with a low-cost index tracking investment fund that trounced much more expensive actively managed rivals, was a watershed for the industry. Who's to say he won't do great things with the Northern Rock operation?

The suspicion, however, remains that Virgin is attempting to exploit an opportunity to pick up assets on the cheap. Indeed, for investors prepared to take a long-term view, there's certainly some reasonable arguments for subscribing to the rights issue that Sir Richard proposes, because at such a bargain-basement price, Northern Rock's business should eventually look cheap.

It's important therefore that the Treasury does everything in its power to ensure that the taxpayer also benefits from any future uplift in the value of Northern Rock, given that our money has kept the bank from going under. Sir Richard may yet prevail, but all the offers on the table and those still to come need much greater scrutiny before the prize is delivered.

Put another way, the benchmark for bidders should be higher. The Treasury has risked a great deal of public money keeping Northern Rock afloat. Any other supporter acting in this fashion would require a decent profit on such a gamble, not simply a return of the stake.

Higher energy bills on the way

Another problem looms large for hard-pressed consumers: energy bills are set to soar in the new year and not just because of proposals from Ofgem yesterday to relax price controls on gas distribution networks. Ofgem has brokered a deal with the gas sector that enables suppliers to raise prices in return for operating efficiencies and a much-needed 5bn infrastructure investment programme two-thirds of the money will be used to replace crumbling gas mains.

The regulator says its proposals will add 2 a year, in real terms, to the typical household's gas bill. That's an increase that all but the most strapped of customers should be able to accommodate. Unfortunately, however, it's just the beginning by February, warn analysts, UK suppliers will all have raised their prices. And bills will go up by 15 per cent or more.

An increase in the cost of wholesale gas is to blame. This affects the price customers pay for their domestic gas, but it also pushes up electricity prices. This is because gas-fired power stations are such a crucial part of the UK's energy generating infrastructure, supplying 40 per cent of electricity.

Wholesale gas prices have been creeping up since the summer, but are now reaching the point where energy suppliers feel compelled to begin reversing some of the price cuts they made in the first quarter of 2007.

And since energy bills have only fallen by around a fifth since the peak of the cycle, late last year, despite wholesale prices still being 50 per cent lower, expect the coming round of increases to trigger another round of angry exchanges between consumer groups and the suppliers.

As ever, the former will complain that energy suppliers are quick to pass on increases in costs, but much slower to act when the wholesale market falls. Energy companies, naturally, will point to falling margins and the fact that they must contract six months or more in advance in order to secure gas supplies.

For customers on a tight budget, changing energy supplier will probably save some money, but in most cases a switch is unlikely to be massively valuable. This is because the benefits that privatisation of the energy industry was supposed to deliver have not materialised.

Far from a market in which competition forces down prices, household energy bills in this country are among the highest in Europe. A handful of huge companies dominates the market, with power over energy production, supply and distribution concentrated in the same hands. This wasn't how the free market was supposed to operate.

Bond investors still have the blues

With confidence in global debt markets at an all-time low, brave investors have an opportunity to go bottom-fishing. Step forward Warren Buffett, the sage of Omaha, who yesterday invested a tidy $2.1bn in junk bonds issued by TXU, the Texas-based energy company, taking them off the hands of Goldman Sachs.

Was Mr Buffett calling the bottom of the market? Sadly for beleaguered investors in corporate bonds of all types, the great man was at great pains to stress not. This was a straightforward bet on the utility sector, he said, an area in which his investment company Berkshire Hathaway has specialised.

Indeed, Mr Buffett was pretty disparaging about some of the paper issued elsewhere on the debt markets: it gives a new meaning to the term junk, he warned.

Britain's biggest pension funds should take note. Their fondness for the corporate bond sector rather than safer government-issued debt has cost savers more than 500m this year, according to analysis from the actuarial consultancy Hewitt Associates. That's the difference between the returns generated by pension funds' investments on UK corporate bonds in 2007 and what they would have made had they bought gilts instead.

It's a bitter pill to swallow for scheme trustees. Having been persuaded to move from equities into gilts in recent years, in order to better match pension fund assets to liabilities, many schemes have more recently begun to judge the returns on offer from government bonds just too pedestrian. Now they've lost out twice over missing out on a strong performance from equities since the end of 2003 and buying the wrong type of bond over the past 12 months.

d.prosser@independent.co.uk

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