Jeremy Warner's Outlook: Recessionary forces are bringing the oil price back to reality, despite China

Punch axes the dividend to conserve cash; Scandal of Britain's energy crisis
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The Independent Online

The oil price has taken longer to start falling back to earth than any of us who have long believed commodities to be the next big investment bubble would have thought, but finally the process seems to be under way. Since the peak a couple of months back, the price has already fallen some 25 per cent.

Not that we in Britain are enjoying the benefits of this phenomenon. Oil is universally priced in dollars – one of the reasons the price rose so high is that oil was seen by traders as a hedge against the collapsing dollar. The fall in the pound against the dollar that has occurred over the past few months has therefore cancelled out most of the effect. In sterling terms, we are still paying nearly as much for our oil as we were when the price was above $130 a barrel.

All the same, things are not quite as bad as they were. How low might the price go? One thing seems clear. Despite the now global nature of the downturn, it's not going to go back to previous cyclical lows. In previous cycles, new investment in capacity prompted by high oil prices has tended to come on stream just as demand begins to slow, compounding the subsequent collapse in prices.

What makes things very different this time around is the new ingredient of Chinese and Indian demand, which, even if it slows in the short to medium term, must further out continue to accelerate.

For these fast industrialising societies, the alternatives to hydrocarbons are still very limited, and even where they do exist they tend to have a higher marginal cost than oil even at present elevated prices. Most of the world's cheap reserves of oil are already being tapped. The much higher costs of developing new sources of supply have to be paid for somehow or other.

Even so, as the world economy slows, production and supply may for the first time in years be starting to outstrip demand. This may be only a temporary phenomenon, which will reverse if the Asian supertanker manages to steam through the economic woes afflicting the developed world. But for the time being, if there is more of the black stuff being produced than we actually want to use, then logically the price must fall, whatever the longer-term fundamentals. Already some producer nations, both Opec and non-Opec, are talking about cuts to production to support the price above $100 a barrel.

Neither Hurricane Gustav, which in any case managed to inflict only minor damage on Gulf of Mexico production, nor reports of a fire at a key Middle Eastern installation, have managed to halt the slide in the oil price as economic worries gain the upper hand.

The oil price is not alone. Virtually all commodity prices have been on the slide in the past few months. We must assume that the determination of the developing nations to achieve Western standards of living will put a floor under these prices which is much higher than previous cyclical downturns. Even so, prices may slip quite a bit further than commonly assumed.

There has been extreme speculative activity in these markets as still buoyant levels of worldwide liquidity, burnt by the experience of the sub-prime meltdown, has sought out high-yielding alternative homes. It seems that these days there are no safe havens left, or none that provide a decent return, in any case.

Punch axes the dividend to conserve cash

Congratulations to Giles Thorley, chief executive of Punch Taverns, for axing his dividend. This was not only brave, but the right thing to have done, and he'll be pleased to know that investors in Punch, having seen the shares plummet over the last year, are fully supportive of this further damage to pocket.

No, seriously. Mr Thorley was quoted by Reuters yesterday as saying that major shareholders backed the dividend move. Over the summer, he's met with 70 per cent of them, and, according to him, they are very supportive. This I very much doubt.

It is rare to virtually unheard of for shareholders to be happy about a dividend cut, and I see no reason why they would change their minds for Punch, a hugely over-indebted company, which the way things are going will be lucky to survive the downturn intact.

From my admittedly limited soundings yesterday, shareholders can just about understand why the dividend has gone, but to say they are happy about it, or even supportive, is ludicrous.

Only last April, the interim dividend was raised, and the mood music was that, though the pubs trade was plainly entering tougher times, everything was basically fine on the ranch.

Now the company wants to conserve cash so as to be in a position to repay its convertible bonds in 2010 and help its licensees through the downturn with extra investment in the pubs estate. Mr Thorley insists there is no breach of bond conditions, or any impending breach, but, given the current financing climate, this is the prudent thing to be doing.

The point is, however, that even with falling beer sales and footfall – one of the ways people cut back when incomes are being squeezed is by drinking at home, rather than going to the pub – Punch would be essentially fine but for being weighed down with nearly £5bn of debt.

This is the legacy of repeated securitisations, under which clever financiers extracted capital from pub chains by mortgaging off the assets and securing the debt against the supposedly predictable cash flows of the pubs. Now that people aren't spending as much, the cash flows are proving not quite as predictable as claimed.

I've never understood why anyone would want to invest in companies with virtually no assets and a mountain of a debt. In a downturn, such companies are almost bound to struggle in servicing the debt. They've also got nothing to sell to help pay the bills. The slowdown is exposing the financial engineering of capital extraction as a zero-sum game. There is no such thing as a free lunch, or even a free pint, and pub chains such as Punch and Enterprise Inns are busy proving the point.

Scandal of Britain's energy crisis

Here's a provocative thought for those who accuse the energy utilities of profiteer-ing at the expense of hard- pressed consumers. If gas and electricity prices were still regulated, as they used to be and as some politicians believe they should again, the regulator would in all probability have allowed even bigger prices increases than the ones that are now being implemented.

Britain faces a massive programme of energy investment, made all the more burdensome by the Government's environmental targets. The renewable and nuclear programmes promise to be particularly expensive. The existence of competition in the provision of gas and electricity may have delivered a better result for the consumer than the regulator would have done, as some companies seem willing to sustain poor returns for a while to gain market share.

Small wonder that some utilities are so resistant to the Government's proposed levy to help alleviate energy poverty. The demands being placed on them are already extreme. The real culprit in the present row about high energy prices is not profiteering utilities, but the Government's abject failure until it was too late to recognise the massive investment programme faced by the industry to deliver energy security and environmental goals.

The Government simply buried its head in the sand and hoped the prospect of steeply rising fuel bills would go away. If it now whacks the industry for a windfall tax, having failed to persuade utilities to cough up the money voluntarily, it will only provoke higher bills still.