Regulator steps up the voltage

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If they did not know it already, investors in the privatised electricity industry must by now be painfully aware of the crucial importance of the regulator. Shares in the sector have crashed since Professor Stephen Littlechild, the regulator, indicated earlier this month that he was minded to reopen his review of the industry's price formula.

That decision knocked a cool £3bn from the value of regional electricity company shares, which suffered further falls yesterday as the professor deepened the gloom by confirming the decision. Coming little more than six months after he apparently fixed the price formula in stone for five years, that bodes ill for the future.

Bill Dale, an electricity watcher at brokers SG Warburg, believes he could be very tough. "Put it this way, even a year ago, even if Littlechild came out with quite tough proposals, the RECs would prosper," Mr Dale said. But since the outcry over top salaries and big payouts to shareholders, "he now wants to make them hurt". Few doubt that last year's price cap, based on the retail price index less 2 per cent, RPI-2, is going to be tightened. The question is how deep the pain will go and whether it will be accompanied by one-off rebates to customers.

As our table shows, the extent to which the professor throws his weight around could have a dramatic effect on the companies' prospects between now and the end of the century. Philip Hollobone of Williams de Broe believes the worst case - RPI-8 plus £100 rebate - would threaten the financial stability of the industry and prompt a reference to the Monopolies and Mergers Commission.

It is partly for this reason and the short time-scale Professor Littlechild has given himself - he aims to have the whole review wrapped up by June - that the view is growing in the City that he will be relatively benign. After all, if he oversteps the mark again, the regulator is going to get caught up in disputes that could drag on for months.

Mr Hollobone speculates that he will go either for RPI-6 on its own or for RPI-2 with a rebate of between £25 and £50. Kevin Lapwood at Smith New Court plumps for RPI-4 plus £50. Such calculations reckon without further political and media furore over excess profits. A year's hard work on costs could probably recoup the effects of RPI-4, while the industry could comfortably cope with the £1.1bn or so cost of a £50 rebate.

Even after spending £900m rewarding shareholders with share buybacks and another £370m on "super-dividends" since last year, the industry's gearing is still probably under 10 per cent on average.

Mr Lapwood believes investors could still enjoy real dividend growth of 2 per cent a year on his best guess of the outcome of the review. That compares favourably with British Gas, where dividends are expected to be stuck in a rut for the next three years. But that analysis presupposes that Professor Littlechild will get the politics right this time. Although starting to look cheap on fundamentals, share buyers should be ready to hold on to their hats.

The Littlechild Factor

One-off Total cost over four years

Profits to £50 RPI RPI RPI

March `94 rebate -4% -6% -8%

Eastern 177 -155 -86 -165 -245

E Midlands 52 -110 -69 -140 -205

London 187 -100 -67 -125 -185

Manweb 126 -65 -40 -75 -110

Midlands 195 -110 -59 -115 -170

Northern 129 -70 -43 -80 -120

Norweb 178 -105 -63 -125 -180

Seeboard 132 -98 -42 -85 -120

Southern 222 -125 -70 -135 -200

Swalec 104 -45 -32 -65 -95

South Western 117 -65 -31 -63 -95

Yorkshire 149 -100 -58 -110 -165 Source: Williams de Broe all figures in £millions