Jeremy Warner's Outlook: Ofgem reluctantly decides to investigate

Reed is in the right place at right time; Age of the SIV draws to ignominious close
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The Independent Online

If you must have an investigation, then we had better give you one. That broadly summarises last night's grudging announcement from Ofgem, the energy regulator, that it is launching yet another inquiry into the electricity and gas supply market.

This will apparently be the fifteenth official inquiry into the energy market in seven years, and little good have any of them done so far. Ofgem as good as admitted that it didn't think the latest one would serve much purpose either, other than reassuring the public that the market is, in fact, fully competitive.

The energy regulator's chief executive, Alistair Buchanan, repeated his view that there was no strong evidence of market failure, but he had none the less decided to investigate because of mounting public concern which could undermine confidence in competition.

Is this a sensible reason for yet more interference? Whatever the regulator eventually says, it seems to me quite unlikely the public are going to be reassured. The fact of the matter is that people will never passively accept big price rises on products and services that they have no option but to buy.

Some four million households in Britain and growing meet the Government's official definition of "energy poverty", in that 10 per cent or more of their disposable income is spent on energy bills. Yet this is an issue for social policy, not industry or competition regulators. Energy poverty cannot be eradicated by simply abolishing the supplier's profit margin.

The great bulk of the price volatility in energy markets is caused by factors beyond the retail supplier's control. There is no doubt that someone somewhere is profiteering from high energy prices, but they are much more likely to be foreign producers than domestic suppliers.

The £571m British Gas profit that has helped prompt the latest furore is certainly a big number, but can hardly be regarded as excessive for a company that has to invest heavily in long-term sources of supply and in meeting the Government's targets on renewables.

The great bulk of this money was earned in the first half, when suppliers were slow to hand on reductions in wholesale prices to retail customers. By the second half, however, with wholesale prices rising sharply again, the margin on sales was just 1 per cent, giving an 8 per cent return across the year as a whole. That's higher than normal but can hardly be regarded as off the scale.

Ofgem's job is, in any case, not to regulate profits, but to make sure it sets the framework for healthy competition. Barriers to entry are high but not so high as to deter new entrants in the event of the existing six suppliers making excessive profits.

No matter. With inflation rising strongly and the Government determined to deflect the blame, we can expect many more "rip-off Britain" investigations.

If the suppliers are again given a clean bill of health, what then? We've now had nationalisation, so why not go the whole hog and bring back the Price Commission too? Then we would know for sure we were back in the 1970s.

Reed is in the right place at right time

For most established media companies, the transition to the digital age is proving at best traumatic and in some cases positively catastrophic. Yet one player for whom online delivery has worked like a dream, enhancing the revenue stream that can be derived from proprietary content rather than diminishing it, is Reed Elsevier.

In a series of transformational announcements, Reed's chief executive, Sir Crispin Davis, has dramatically accelerated the pace of his online strategy. The stock market seemed to like what it heard, with the shares up 7.5 per cent yesterday.

Out goes the remainder of Reed's business to business publications, including such titles as New Scientist and Farmers Weekly, reducing Reed's remaining exposure to the advertising cycle to virtually zero. In comes Choice-Point, a specialist information provider to the insurance industry which at a cost of £2.1bn neatly dovetails into Reed's existing presence in risk management services. The move will leave Reed almost wholly dependent on subscription revenues, which are growing strongly in the legal and scientific markets where the company operates because of the high level of interaction and accessibility that the internet enables. Sir Crispin admits that the exhibitions business, which he intends to keep, isn't easily pigeon-holed into the new Reed, but insists that it is just too good a business, with high margins and strong growth, to give up willingly.

Market conditions are not exactly conducive to the sale of the trade publications; the credit crunch profoundly hampers private equity's ability to pay top dollar, while anything to do with the print is these days about as fashionable with investors as tank tops and platform heels. Yet Sir Crispin says he is in no hurry to sell and will bide his time until the right solution presents.

In any case, most of these publications have strongly growing websites capable of creating communities highly attractive to specialist advertisers, and should therefore be in strong demand from the likes of David Levin's United Business Media. Mr Levin has hung his whole strategy around the creation of these online business communities.

As for Reed, the company seems to be sitting pretty, with the streamlining of interests allowing for a very considerable reworking of back office and other shared functions along more efficient lines. Copyright remains something of a threat, though most of the information Reed provides is so specialist that it is much more easily defended than in mass, consumer markets. Sir Crispin finds himself in the right company at the right time.

Age of the SIV draws to ignominious close

So farewell then, K2, Whistlejacket, Mainsail and all the other "Structured Investment Vehicles" that have been used to load debt on to the struggling masses. Yesterday, Dresdner became the latest bank to address the funding difficulties of its major SIV by refinancing its senior debt. The aptly named K2 may not have been the largest of all SIVs, but it was certainly a monster which even today is valued at $18.8bn. Only last July, it was worth an astonishing $31.2bn.

SIVs were invented as far back as the late 1980s, but it is only in the last ten years that they hit their stride. At their peak, there were some 30 SIVs and six SIV-lites in existence, collectively accounting for an eye-popping $400bn of assets. By providing an easy, apparently low-risk mechanism for the securitisation of debt, they became a key driver of the credit boom of recent years, allowing banks and others to hive off vast chunks of lending in a manner which freed up balance sheet capital for yet more lending.

SIVs operated by financing their loan books through the commercial paper market. In many respects, they were much like Northern Rock, which was in essence itself just a giant super-SIV whose mortgage lending was financed in the wholesale money markets. As the sub-prime mortgage crisis began to bite, the market value of the SIV loan books fell precipitously, triggering asset sales which further undermined the value of what remained.

At very considerable cost to themselves, most banks are now well on the way to sorting out the problems of their SIVs. Some have brought all the assets back on balance sheet, others have simply allowed the SIV to go into administration, while still others such as Dresdner have provided alternative sources of finance.

Yet nobody should be in any doubt but that the SIV model for credit expansion is dead. The credit crisis has wiped them out as effectively as the giant meteor-ite that brought the age of the dinosaur to a close. With them has gone one of the key drivers of the easy credit conditions which underpinned the econ-omic boom of the last five years, where nobody seemed much to worry whether the borrower could pay back the money so long as someone else was carrying the risk. It was one hell of a party while it lasted. The clean-up may take many years.

j.warner@independent.co.uk

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