Outlook: Callum McCarthy's Neta starts to fall apart at the seams

Callum Mccarthy's attempt to bury another piece of bad news for his shiny new electricity trading system, Neta, has only been a partial success. The energy regulator will wake up this morning to a few consumerist plaudits for the £2m fine he handed down yesterday to London Electricity and Virgin Energy for mis-selling. But the bigger and more worrying headline for him is surely the one about how Powergen is closing a quarter of its UK generating capacity because it can no longer live with the collapse in prices brought about by Neta.

When he launched Neta 18 months ago, Mr McCarthy's intention was to drive down electricity prices, not drive generators out of business. He has succeeded beyond his wildest dreams. The wholesale price of electricity has fallen by 40 per cent – even though much of this reduction has mysteriously failed to find its way into consumer bills.

No business can survive a 40 per cent price reduction at the same time as its raw material doubles in price, as has been the case for gas-fired generators. Powergen has decided it is cheaper to mothball its plants than run them at a loss, and others may well follow suit. Ultimately, this will defeat Mr McCarthy's objective by forcing prices back up as capacity becomes more scarce. In the longer term there is a California-style energy crisis to look forward to unless someone starts to build new stations at some stage soon to replace capacity that will shortly be coming to the end of its useful life.

In the meantime, Neta is causing no end of pain. British Energy has only escaped insolvency thanks to a £650m government cash injection and the Government can find hardly anyone prepared to put their money into renewable energy.

Powergen and Innogy are insulated to some extent by the deep pockets of their new German owners and the fact that they also run profitable retail supply businesses. Not so all those US utilities who snapped up UK generating assets at what were, with the benefit of hindsight, crazy prices. Those stations now risk going bust, which in turn spells trouble for the banks who lent billions of pounds to finance the spending spree. Some will smile at the evident discomfort of UK power's American and German owners. But no one is laughing at the Department of Trade and Industry, where what passes for an energy policy is fast going up in smoke.

Pru/dividends

Even in the most cash strapped of companies, a dividend cut is never easy to sell to investors, but from a company which through one of its directors has just published an open letter to the City urging potential cutters to show restraint, it would be well nigh impossible. Which is why, despite persistent City gossip to the contrary, Prudential won't be cutting its dividend any time soon.

Michael McLintock, chief executive of the Pru-owned M&G fund management group, has written to leading British companies saying that the payment of decent dividends is "increasingly appreciated in the economic and stock market conditions which we seem likely to face for the foreseeable future". It beggars belief that such a public statement would not have been first cleared with the Pru's chief executive, Jonathan Bloomer. Someone's head will roll if it was not, and it won't be Mr Bloomer's. The Pru has already been accused of double standards on executive pay. It wouldn't want to add dividends to the list.

As it happens, the Pru could do with a bit more capital. Prudential is one of the sector's most financially robust companies, but in these markets no one is immune to the downgrades of the rating agencies and it may be that the Pru does indeed need to raise more capital to stay ahead of the game. Prudential is piling on business in Asia and with so many players closing to new business in the UK, there are big growth opportunities in the home market too. More business equals big cash outflows equals need for more capital.

There are three options. Like Legal & General, the Pru could have a rights issue, or like Arriva it could cut the dividend. Alternatively, it could simply borrow more. The cheapest option, both in absolute terms and in terms of cost of capital, is to cut the dividend. It is also, to be frank, the more honest approach, since any rights issue designed to support dividend payments is merely paying back shareholders with their own money. The reaction of markets, on the other hand, would rather suggest otherwise. Arriva's share price has been severely punished for the dividend cut. Legal & General has fared far less badly with a rights issue.

In any case, the trigger happy Mr McLintock has pretty much closed off the option of a dividend cut, and with the shares trading at close to their six year low, this is perhaps not the time for a rights issue either. Prudential still has the capacity to borrow more without imperilling the business, and that presumably is the approach Mr Bloomer will have to adopt. Unless, of course, the stock market continues to fall, in which case everyone's in trouble.

Colt Telecom

Just another frivolous try on, or something a little more serious? The defensive tone of Colt Telecom's response to a bondholder's threat to seek the appointment of administrators would indicate rather more of the latter than the former.

At first glance, Highberry's stated intention of putting Colt into administration looks like another piece of no-hope greenmail. Highberry is a US-based hedge fund which has built up a holding of about £75m worth of Colt Telecom bonds, all of it picked up at a big discount to the repayment value of the bonds.

By threatening to petition for administration, Highberry hopes to persuade Colt to buy out its position at full value, though in truth it is hard to see how Colt could do that without making the same offer to all bondholders. Alternatively, the company really would be put into administration, giving bondholders first call on the group's £1bn cash mountain and anything realised by selling the telecom assets. In such circumstances there would be easily enough to pay out bondholders in full.

Colt's chief executive, Steve Akin, is filled with righteous indignation. How dare they, he says. Colt hasn't yet missed an interest payment on the bonds, nor is there any likelihood of it doing so. Directors are completely confident that they can repay the bonds, or at least refinance them, as and when they fall due. Fidelity, Colt's 54 per cent shareholder, is even more apoplectic with rage. Fidelity has invested the thick end of £1bn of capital into Colt since its inception and it largely bankrolled a £500m rights issue towards the end of last year. It does not intend to sit back and watch a vulture capital fund like Highberry destroy what directors regard as a perfectly viable business for the sake of a quick turn.

But hold on a moment. Doesn't Highberry have a point? Even on Colt's own projections, the business won't become cash flow positive until some time in 2005. That's an awfully long time away, and in the meantime, the cash will continue to burn until eventually it is all gone. If directors prove to have been overly optimistic, there would then be nothing left for anyone. The fact that the bonds trade at half their face value suggests a high degree of market scepticism that the business plan will be met.

Highberry would set an unfortunate precedent if it managed to persuade the courts to wind up Colt when no act of technical default had taken place. But it has also raised afresh the question of whether alternative network operators such as Colt are worth anything at all. Many of them have already gone bust. Colt is still there courtesy only of Fidelity. It hopes to be one of the survivors but Fidelity may yet have to cough up more to ensure that it is.

jeremy.warner@independent.co.uk