Jeremy Warner's Outlook: Calculated gamble in Centrica's price rises

Savings/housing; DFS Furniture

Centrica has got off lightly in depicting swingeing increases in domestic gas and electricity prices as the inevitable result of rising energy costs. Its declaration that the age of cheap energy prices is at an end has been widely accepted at face value, and there has been little questioning of the company's underlying motives. Yet the truth is that rising wholesale energy prices is only part of the explanation. The other is that Centrica is determined to defend and enhance its profitability, and if that means sacrificing customers for margin, so be it.

As a big producer of both gas and electricity, Centrica is a major beneficiary of rising wholesale prices. Unfortunately, what it gains on its upstream activities, it loses on its domestic supply business, where cut-throat competition has kept the price it is able to charge relatively low. It's the reverse problem as that which beset the energy supply market a couple of years back, when an excess of electricity generating capacity brought the producers to their knees even as the domestic distributors made hay. Today, the opposite problem applies.

Hard though it is to believe, Centrica claims to have lost money on domestic energy supply in the all important second half of last year. Since then, the wholesale price of gas has eased a bit, as it usually does over the summer months when demand is at a low point. Ironically, it fell sharply again yesterday as a pipeline which had been closed off came back on stream.

However, the futures market shows the price soaring into unprecedented territory over the months and years ahead. Britain is fast losing self sufficiency in natural gas, forcing it to fall back on foreign imports. For all sorts of reasons, these have always been more expensive than our own North Sea gas, which is cheaper than international oil prices would warrant. Increased reliance on imported gas also requires the construction of expensive new infrastructure.

The wholesale price of gas accounts for about a half the cost of the average domestic bill, with the rest taken up by distribution, storage, administration and billing. Centrica is still the dominant supplier of gas, with around 60 per cent of the domestic market, and it is also one of the biggest suppliers of electricity. The cost to the bottom line of leaving prices where they are would therefore be a whole lot more than the inevitable loss of market share that will result from being price uncompetitive. Centrica's earnings are more sensitive to rising wholesale prices than they are to customer loss.

Even if Centrica were to lose more than a million customers, the price rises announced yesterday will still more than wash their faces in terms of shareholder return. In the event, the loss of market share is unlikely to be as large as that. Customer inertia still counts for something, even in the promiscuous domestic gas and electricity market. Most competitors will in any case be only too happy to follow Centrica's lead in raising prices. Those that don't risk playing a very expensive game indeed.

Ofgem, the energy regulator, was again busy washing its hands of the whole affair yesterday. Shop around, it said, and find a better deal. Price regulation for gas and electricity was abandoned two years ago on the insistence of Ofgem, which pronounced the market fully competitive. Centrica's price rises give cause to doubt that assertion.

Savings/housing

According to a survey by the Birmingham Midshires building society, nearly half of all adults in the UK have saved nothing at all in the last three months. The average across the population as a whole was a paltry £84 a month, or less than 4 per cent of gross average earnings. Regrettably, the survey was not as scientifically conducted as it might have been. For instance, the questionnaire failed to stipulate that respondents should include contributions to a pension plan. Some would have included these monies and others wouldn't.

All the same, the findings are quite worrying enough, even if they do overstate the size of the problem. The savings industry is always banging on about the £27bn annual savings gap. Now it transpires that a large number of people aren't saving for the future at all.

It is impossible not to juxtapose this finding with another piece of somewhat questionable research published yesterday (yes, it's that time of year, when any old socioeconomic assertion can expect to command acres of column inches in our news-starved press). This concludes that one in 20 householders in London are now millionaires. Unfortunately, this has little to do with increased earnings and wealth creation. Rather, it's nearly all down to the soaraway housing market, which has turned many of even quite moderate means into property millionaires.

So what's the link? Some people may not be saving because the increased value of their houses gives them comfort that they can afford not to. Large numbers of people have come to regard their houses as their pension. I don't want to moralise about this. In fact, the decision to cease saving and instead sink any surplus income into property is a perfectly rational response to the big macro-economic and investment trends of the past five years.

During that period, credit has become both cheaper and more widely available, driving property prices northwards. The stock market, by contrast, has bombed, demolishing many savings plans in the process. The savings industry has also discredited itself with some highly publicised mis-selling scandals. The Government has further muddied the waters with a pensions and benefits policy that seems to provide the greatest possible disincentive to save.

It has therefore made a good deal more sense to borrow to spend on consumption or to invest in property than to save. Both the stock market and the traditional deposit account - the natural repositories for most savings - have represented particularly poor value over the past five years.

With rising interest rates, this should change. Higher interest rates should in theory encourage people to borrow less and save more. Yet it doesn't so far seem to be working as the textbooks say it should. Both the housing boom and consumption growth have moderated, but as yet there is little sign of a higher savings rate.

Nor does the Government or the Bank of England, given its remit, particularly want to see a higher savings rate, this side of the general election at least. If people save more, they spend less - something which John Maynard Keynes called "the paradox of thrift". Consumption is the thing that's kept the economy going during the business downturn of the past four or five years. Take that prop away, and Britain will cease to look like the miracle economy ministers like to boast of.

It's a right old mess we are getting ourselves into, and for obvious reasons, nobody wants to call time.

DFS Furniture

The three independent directors of DFS are threatening to resign if shareholders don't vote by the required 75 per cent margin in favour of Lord Kirkham's takeover bid. Good riddance. They've served shareholders appallingly in not wringing a better price out of their chairman, and they have shown themselves to have no judgement whatsoever in their decision to recommend his low-ball offer.

Lord Kirkham only had to pay a little bit more and he'd have been home and dry. The independents have proved weak and compliant in not holding out for more. All it requires is for Morley and Schroders to vote against, which at this stage they fully intend to do, and the whole endeavour collapses. In theory, Lord Kirkham could bypass their opposition by switching his bid from the present scheme of arrangement to a simple takeover offer, which requires a lower level of approval.

But it would be expensive and time consuming, and in any case is probably unacceptable to his financial backers. Nobody has emerged well from this bully-boy attempt to buy the company on the cheap. Lord Kirkham threatens to walk too if the bid is unsuccessful. Shareholders should face him down.

Comments