Energising the market - at whose expense?

Electric companies are hot property, as Hanson's bid shows. But, says Peter Rodgers, the consumer may eventually profit, too; Littlechild must judge, up to five years ahead, the speed with which companies can improve efficiency and cut costs
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The Independent Online
The City has not seen a buying spree like it for years. What were once among the dullest companies imaginable, the 12 privatised electricity boards have been at the centre of rampant speculation in the markets since last autumn. Yesterday, Hanson bid pounds 2.5bn for Eastern Group, the third takeover offer now under way. Several other electricity companies may become targets in the near future. Within five years of privatisation, the industry the Government sold off in December 1990 will be hard to recognise.

The takeover fever is embarrassing for the Government on several counts. It created spectacular share-option profits for directors, while raising serious questions about ministers' judgement in selling the companies cheaply five years ago. It also suggests the regulatory system which has allowed them to make fat profits is in need of an overhaul. Furthermore, the bids highlight how little has yet been done to introduce real competition into the industry.

Most fundamental of all, they confirm what investors really think of the present government's prospects. Those electricity companies that are not yet targets of bids are busily giving cash back to their shareholders ahead of an expected clampdown on the utilities by an incoming Labour government, while the timing of the new round of bids may, at least in part, be prompted by the same thinking.

Shareholders have done exceptionally well from the electricity industry - many believe rather too well. Hanson's bid for Eastern, the Ipswich- based East Anglian power company, valued it at about four times the amount the Government received when the company was sold. As a group, the regional electricity companies - or Recs, as they are known in the City - were valued at about pounds 5bn when they were sold but are now worth pounds 16bn.

Even this enormous increase tells only part of the story. To make the dowdy Recs look more attractive to investors, the Government gave them the National Grid, the network of transmission lines that carry power around the country. The grid was thought to be worth about pounds 1bn at the time, but the Recs are planning to sell their shares on the stock market for a total of pounds 4bn or more this autumn. The grid alone has proved to be worth nearly as much as taxpayers received for all 12 Recs in the first place. There is such a thing as a free lunch, after all.

However, these gains are history. The prices of the Recs have already reached such a high level on the stock market that it is hard to stand up the case made by some critics: that they are being bought up by asset strippers simply to make another cheap killing.

Hanson has a reputation for brutal surgey on the companies it buys, but in this case it has other motives. Its bid for Eastern and a bid late last year for Northern Electric by Trafalgar House - which was withdrawn in the spring but could be restarted this month - were largely driven by tax strategy. Both companies can make tax savings if they increase the proportion of their profits from the UK, and few potential targets produce a more reliable income than the solid regional electricity monopolies.

The other two bids came from ambitious companies already in the electricity business which wanted to expand. One was Southern Company, a US producer, bidding for South Western Electricity; and the other was Scottish Power, angling for Manweb, based in Chester. Similar US and UK electricity companies are the likeliest to make further bids.

There is strong pressure from politicians and trade unionists to have all these bids stopped in their tracks with references to the Monopolies and Mergers Commission, but it is proving hard so far to find a serious reason to refer them on competition grounds. Pressure from worried backbenchers could persuade the Government to put a brake on the reorganisation of the industry by asking the MMC to take a long, hard look, if it can find a plausible reason.

Professor Stephen Littlechild, head of Offer, the electricity regulator, has also done his bit, by accident, to make the Recs a sitting target. Because there is no competition in these cosy local monopolies, the regulator's job is to spur the companies to greater efficiency and ensuretheir customers share at least some of the gains with shareholders. He does this by setting price controls five years ahead.

However, Professor Littlechild's first five-year review last year proved far too lenient. There was a huge rise in the value of the Recs, and it brought the predators sniffing around. The crunch came when Trafalgar bid for Northern. In its attempt to stay in control, Northern's board promised to give more than pounds 500m back to its own shareholders if they backed Northern's fight.

With most Recs also considering special rebates to their customers to deflect Professor Littlechild's wrath, the Northern defence opened everybody's eyes to the size of the pot of gold on which the Recs were sitting. Professor Littlechild, realising he had been hoodwinked, reopened his price review. In June, he decided to make the companies give their customers another pounds 1.25bn in price cuts over the next four years, on top of the pounds 2.75bn he announced 12 months ago. The predators, who sat tight while he was deliberating, decided he had not been excessively harsh on shareholders after all and the latest round of bids began.

Suspicions have begun to grow yet again that Professor Littlechild has been too lenient. It would not be entirely his fault. Under the present system of regulation, he has to make an extremely difficult judgement, up to five years ahead, of the speed with which the companies can improve efficiency and cut costs. Miscalculations are inevitable.

The debacle will reinforce Labour's determination to reform utility regulation by introducing profit-sharing between customers and shareholders once profitability exceeds a certain level. This would introduce explicit rules for reassessing the price controls on a regular basis. Labour is also threatening a windfall tax to recover some of the past profits.

And there are other changes proposed for the industry which could one day allow the regulators to take a back seat. They involve the introduction of competition to what are now local monopolies.

When British Gas was forced to open its pipelines for industry and commerce to competing suppliers of gas, it lost four-fifths of its market share and prices are still collapsing. British Gas is about to go through the same gruelling process with its domestic customers. Pilot schemes to open the market start next year.

There is no reason why the electric cables that run up to people's homes cannot be used in the same way as a common carrier for power from competing suppliers. Competition has already begun for some commercial customers of the Recs, and - on paper - the Government has committed them to extending it to domestic customers from 1998. This would put right one of the basic flaws of Rec privatisation, which was the complete absence of competition in their local areas.

But the timetable looks hopelessly optimistic. Last week the Commons select committee on trade and industry said the plans were a shambles, uncosted and a "potential disaster in the making". Even the billing and settlement systems have yet to be developed.

Few would disagree that genuine competition could cut prices and give consumers a better deal in the long term. If only half the effort were put into making liberalisation work that now goes into arguing about new forms of regulation, consumers could eventually be a lot better off.