City watchdog launches investigation into financial crisis at British Energy

Generator 'days away' from insolvency; energy regulator rejects market overhaul

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The main City watchdog last night launched an investigation into British Energy as talks continued with the Government aimed at rescuing the beleaguered nuclear electricity generator from collapse.

The inquiry by the Financial Services Authority came amid indications that British Energy may have only a matter of days to secure a cash injection from the Government or go into insolvency.

A deal to reduce the £300m-a-year cost of its spent fuel reprocessing contracts with the state-owned British Nuclear Fuels may form part of the rescue package. However, the energy regulator, Callum McCarthy, ruled out sweeping changes to the wholesale electricity trading regime – one of the factors blamed by British Energy for its sudden crisis.

The credit rating agencies Standard & Poor's, Moody's and Fitch meanwhile downgraded British Energy's debts to junk bond status. It has £1bn in borrowings including £408m in bonds, of which £110m is repayable in march next year.

The FSA will be examining whether British Energy misled investors in the period leading up to its dramatic announcement on Thursday night that without "immediate financial support" it was likely to go bust.

In particular, the FSA is likely to focus on a conference call British Energy held with analysts on 14 August, the day after it announced it was closing its Torness reactor in Scotland, prompting a collapse in the share price.

During the conference call the British Energy chairman, Robin Jeffrey, sought to reassure investors about the state of its finances, saying: "We do not face a financial crisis and we have a clear and well thought out way forward."

But in Thursday's announcement British Energy said that if the discussions with the Government were not successful, it was likely to have to take "appropriate insolvency proceedings". Mr Jeffrey added: "Having reviewed the longer-term prospects for the business, the Board has concluded that we had no alternative other than to seek government support."

An FSA spokesman said: "In line with normal practice, the FSA is looking into the circumstances of British Energy in the last few weeks."

There are already indications that investors will sue British Energy. Even if the rescue talks with ministers succeed in throwing the company a lifeline in the short term, Mr Jeffrey's position as chairman is looking increasingly untenable. "This is a company which has gone from being a boring utility with secure cash flows and a fully maintained dividend one minute to a busted company the next with no stages in between," said one source close to the government negotiations. "I have never seen a ship go from being on course one moment to being on the rocks the next. At least Marconi had the decency to precede its collapse with a few profits warnings."

As late as Wednesday of this week, brokers at Morgan Stanley issued a "buy" note on British Energy, on the strength of the company's reassurances about its financial health. On Thursday, 26 million British Energy shares were traded – a far higher volume than usual – before the stock was suspended at 80.75p and British Energy dropped the bombshell that even if the rescue talks succeeded there was no certainty the shares would be left with any value.

A spokeswoman for the Department of Trade and Industry said that talks with British Energy about a short-term cash injection, likely to run into hundreds of millions of pounds, were continuing.

She declined to say how much support British Energy would get or how soon it was required but she said the intention was not to renationalise it. "Our objective it to secure a private sector solution for British Energy. This is a commercial company."

BNFL sources said that a deal to renegotiate its reprocessing contracts with British Energy could be completed quickly if ministers deemed it necessary. But they insisted any agreement had to be on commercial terms.

Talks between BNFL and British Energy collapsed on Wednesday after BNFL refused to cut its annual charges from £300m to £50m as demanded by the nuclear generator.

British Energy has blamed the burden of the reprocessing contracts for its plight. But it has also cited the new electricity trading arrangements which have cut the price of wholesale electricity to 1.6p a unit – far below British Energy's cost of production, making its eight UK nuclear stations unprofitable.

Mr McCarthy, the director general of Ofgem hit back, saying: "If you look at the objectives set by Ofgem and the DTI when Neta was broached in 1998 they have all been met. We now have a market which is genuinely driven by competition. I do not see any evidence of that market operating in ways which are unexpected or illogical."

Mr McCarthy is thought to be vigorously opposed to changing the way the market operates and so driving up wholesale electricity prices in order to bail out one particular generator.

Ofgem officials point out that since Neta was introduced only 4 to 5 per cent of the UK's generating capacity has been mothballed, suggesting that most generators, including British Energy, are making money. "If they weren't they would not be running their plant," said a senior official.

However, the Electricity Association, which represents all of the big UK generators, said the problems afflicting British Energy were hitting all power producers and calling for a shake-up of Neta. It said that the pain resulting from the 40 per cent decline in wholesale electricity prices was being shared by all generators and was not sustainable. Paul Golby, its president, added: "The current situation of British Energy highlights that there are very real issues which need to be faced by the Government. If fuel diversity, security and the environment are to be given higher prominence then the electricity industry will have to be restructured accordingly."

The environmental group Greenpeace said that none of the longer-term solutions to British Energy's crisis – such as exempting it from the climate change levy, renegotiating reprocessing contracts and removing some of its £14bn in waste management and clean-up liabilities – could disguise the fact that nuclear power was uneconomic.