When the customer must not be asked to pay

COMMENT: 'Back in the days of rampant corporatism and daily government interference in business, when ministers would raise gas prices to massage the PSBR and lower them again to win election, this would not have looked out of place'
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The Independent Online
Headline: "Taxpayers and customers to bail out British Gas over pounds 40bn of North Sea contracts." Sub head: "Long-term supply contracts likely to cost the company enormous losses in today's oversupplied energy markets."

Er ... hold on a minute. Is this a time warp or what? Back in the age of nationalised industries, rampant corporatism and daily government interference in business, when ministers would happily raise gas prices to massage the PSBR and lower them again to help win an election, it would not have looked out of place. But today? Could this be for real in post-Thatcherite 1996, 10 years after British Gas was abandoned through privatisation to the rigours and disciplines of the market?

The truth, it seems, is that bailing out British Gas has become a very live issue indeed, though the idea of a taxpayer and customer bail-out is for the time being only wishful thinking by British Gas, the result of an internal study and not yet put to the Government.

In the original privatisation prospectus, shareholders were told they were buying into a 25-year monopoly, with competition to be allowed only in the market for large businesses. Indeed, the prospectus said the monopoly could only be terminated with at least 10 years' notice by the Secretary of State for Trade and Industry.

In such circumstances, British Gas managers, who were unreconstructed state industry apparatchiks, saw no undue risk in agreeing the 15- to 20-year take-or-pay supply contracts that are the source of its present troubles. These stipulated that the company must pay each year for a certain volume of gas, whether or not it took delivery. Though 55 per cent of the contracts were agreed before 1986, the company went on buying, and the last three take-or-pay contracts were signed after 1991.

The argument for a bail-out is quite simple: the Government, the Monopolies Commission, the Office of Fair Trading and the gas regulator changed the rules progressively between 1988 and 1993 to introduce greater competition. As a result, British Gas was faced with a falling market share which turned the take-or-pay contracts into a nightmare - an enormous liability because it could not sell enough gas to take all the contracted spplies. Worse still, open market gas prices also fell sharply, allowing new competitors to undercut by a wide margin.

Given that this debacle was a result of government action, British Gas argues, why should shareholders bear all the pain? This is as clear a case of false prospectus as they come. Instead of 10 years' notice, British Gas was given little more than two years' warning of the pilot scheme for the introduction of competition in the domestic market, which is to begin in the South-west this spring.

But, like much in the gas business, these claims should not be taken at face value. What changed after privatisation was the regulatory framework, and that happened because it was gradually realised that too little had been done to introduce competition into the industry.

The prospectus made perfectly clear that British Gas was subject to a regulator - and at the time of the sale the financial risk of arbitrary actions by Ofgas was at the forefront of the debate in the City. Indeed, the prospectus spelt out the penalty for disobeying the regulator or ignoring the competition authorities, which was draconian - the loss of the monopoly.

In the electricity and water privatisations, regulatory risk has proved far less severe than investors thought at the time of privatisation, and enormous profits have been made. But with gas, and arguably telecommunications, it is considerably worse, and the shares have performed relatively badly. Indeed, the gas share price trend over the years shows how early the City grasped the scale of the risk.

The idea of roping taxpayers and consumers into a rescue plan for gas, simply because there was more interference from the regulator than expected, is a case of ''heads I win, tails you lose'' and is not acceptable. This is a matter between British Gas and its suppliers; the Government's role should be as a referee and no more.

And if it wants to get its offshore suppliers to the negotiating table, it had better be a lot clearer about its own objectives. In particular, it must tell them whether any savings would be passed on to consumers. They are hardly likely to negotiate if they suspect the savings will be used to intensify competition from British Gas in exploration and production.

Stock Exchange should have asked the market

Nice document, shame about the timing. Had the Stock Exchange the nous to ask the market some while ago what sort of share dealing innovations it actually wants, much grief could have been spared. It might not have saved Michael Lawrence's job as chief executive, for there were so many disagreements that finally led to the cup of bile running over last week. But it would have spared the City unnecessary embarrassment as the Exchange lurched publicly from one faux pas to another, mostly connected with its clumsy efforts to push ahead with a share dealing revolution without any clear idea of the backing for its plans.

There was always plenty of evidence that big institutions wanted to see an order-driven facility for the big FT-SE stocks because they know it will cut their dealing costs. They are certainly not interested in helping the market-making middlemen improve their livelihoods any more than absolutely necessary. As one of Britain's biggest institutional investors put it: "Clearly what the market-makers are interested in is the dealing system which maximises their p & l. For the investment community, we want that p & l to be as small as possible."

Three years ago there is no doubt the big market-makers would have dismissed out of hand an order-driven alternative. But already by last year their position was fast becoming more nuanced. Knowing the options on offer, the Stock Exchange should already then have found out what the market, and that means institutions, securities houses, big corporate lenders and small investors, favoured. It is only common sense to proceed with radical reforms on the basis of clear backing, rather than telling the market what you think is best and then hoping it finds support. If the consultation had shown broad support for the order-driven option, the market-makers would have adjusted to that. They may be powerful, but they cannot defy their clients.

The market-makers know they are heading for big changes. There will be fewer of them, and order-driven dealing will place a premium on distribution to offload risk, along with a small number of high-powered block traders. Most importantly, the coming months will reopen the thorny debate about market-making privileges and how they fit into a new system. That should see some fur flying.

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