Jeremy Warner's Outlook: Headwinds becoming ever stronger at BA

Ofgem orders price cap review; Today's rich are miles behind past peers
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The Independent Online

Standby for more fuel surcharges from British Airways. As the oil price surges ever higher, we can expect a lot more of them.

You might have thought that the crippling costs of higher fuel prices and the likely impact of a slowing world economy were already reflected in the BA share price, which has halved over the past year, but apparently not to judge by the stock market reaction to yesterday's "investor day".

The shares fell a further 7.6 per cent as the company warned that profits would be quite a bit lower this year because of higher costs and slower growth.

Here's a frightening statistic to illustrate the nature of the problem. If the oil price were to rise to $120 (£60) a barrel, it would completely wipe out BA's operating profits, all other things being equal. The price is already above $105.

So far, BA has been able to recover around two thirds of these rising costs through surcharges, but, the way prices are climbing, it is plainly only a matter of time before the company runs into the law of diminishing returns.

BA's finance director, Keith Williams, warns that a price of $120, if sustained, would force "fundamental change" in the airline industry. The world economy has so far weathered the high oil price surprisingly well, but, judging by BA's comments, it is on the cusp of causing real damage.

As it is, the double-digit operating margin target, which BA is likely to achieve for the first time since anyone can remember in the year to the end of this month, is toast for next year, when it is expected to sink back to 7 per cent, or even less if fuel prices continue to motor upwards.

Premium traffic – up 15 per cent in February – is still holding up remarkably well, but there are already signs of the slowdown in non-premium, both short and long haul. On the plus side, BA flies into the turbulence in much better shape financially than it has been in most previous downturns. Operational flexibility is also much improved, allowing capacity to be easily switched to where it can be applied most effectively. Yet ultimately, no company as heavily geared to the business cycle as BA can entirely beat it.

Ofgem orders price cap review

You probably didn't realise it, what with the shock of getting the last electricity and gas bill, but a substantial part is actually price-regulated. This is the bit that relates to the costs of transmission, or the wires and the pipes down which the electricity and gas flow. Typically, this accounts for about 25 per cent of the total bill, though with high energy costs, it is much less at the moment.

Worried that the system for regulating these prices has become out of date, and may not encourage sufficient infrastructure investment for a low-carbon economy, the industry regulator, Ofgem, has announced a review of the way the price regulation works.

Historically, transmission charges have been controlled through the time-honoured system of price capping, an invented-in-Britain mechanism now much copied around the world whereby prices are allowed to rise each year by the rate of inflation minus or plus a number determined by the regulator.

This gives the companies involved an incentive to become more efficient, as, by bettering the regulator's assumptions on cost, they can earn themselves a higher rate of return. On the whole, it has worked well in all the industries it has been applied to – telecoms, water, gas, electricity and airports – leading to very substantial cuts over the years in the cost of these services to consumers.

Yet there obviously comes a point where even a previously fat utility cannot cut cost any further without damage to quality of service. Many energy companies believe that point has already been reached. Recent price reviews have allowed charges to rise in real terms, so as to pay for substantial investment in renewal and improvement. The system has thereby evolved into a more old-fashioned, rate-of-return, form of price regulation.

Nuclear renewal in combination with the development of substantial offshore windfarm capacity will require very substantial parallel investment in transmission. One of the things the regulator will be examining in its review is whether higherrisk, speculative forms of investment in transmission shouldn't be encouraged by allowing higher rates of return to be earned.

These are worthy issues for examination, but perhaps not the best time to air them given the implication that companies should be allowed to earn more. Still, the review is expected to take two years and the wholesale price of electricity and gas may by then be falling again, making the cost of new investment in transmission easier to bear.

For the time being, the problem with excessive energy bills lies not in transmission, but in the unregulated markets of generation and supply. The Government has hinted that some form of price regulation might be reintroduced into supply, at least in so far as concerns those deemed to be living in "energy poverty".

For the life of me, I cannot understand how such a discriminatory form of price regulation could be made to work. The proposed vouchers scheme would be an administrative nightmare, wide open to fraud. Yet the Government is obviously determined to do something. I guess we'll find out what horrors await in next week's Budget.

Today's rich are miles behind past peers

The annual rich list published by Forbes magazine is an unscientific and faintly vulgar affair, yet even so it continues to exert a certain voyeuristic fascination which earns it acres of coverage.

The news this time around is that last year's second most wealthy individual, Warren Buffett, has overtaken the long-standing number one, Bill Gates, to become the richest. Mr Gates is meanwhile relegated to a humbling number three, with Carlos Slim of Mexico, who has made his money out of telecommunications, taking the second slot.

A much more interesting though little appreciated thing about today's super-rich is they are not nearly as wealthy as many of their past equivalents. Adjusting for subsequent inflation, the wealthiest person ever was John D Rockefeller, the oil tycoon. At its peak, his fortune would have been worth $318bn in today's money, which makes Mr Buffett's $62bn look positively pedestrian by comparison.

Andrew Carnegie, the Scottish-born steel baron, similarly puts today's business titans in the shade, as does Henry Ford, the Bill Gates of his day. In today's money, Mr Ford was worth more than three times Mr Gates. As a proportion of contemporary GDP, these entrepreneurs were hugely bigger than their modern-day equivalents.

Yet if today's most wealthy are relatively a lot poorer than past peers, there are also a lot more of them. Businessmen and financiers of extreme wealth, even during the industrial revolution, were comparatively rare. Today, billionaires are two a penny, while those worth £100m or less scarcely count as super-rich at all.

This means that the rich have to fight that much harder for recognition. Simply being wealthy no longer commands prestige, influence or even grudging respect. As for being remembered beyond your death, or even retirement, forget it. Very few business leaders achieve worldly immortality, and even those with lasting impact on their age, such as Henry Ford and today Bill Gates, rarely merit much more than a footnote in the annals of popular history.

Mr Buffett certainly won't be remembered beyond his death, despite his present notoriety. Only the rogues can be guaranteed lasting recognition. For some reason, it is easier for a camel to go through the eye of a needle than a rich man to achieve a place in history.