British Energy rescue leaves shareholders out in the cold

Government has until mid-February to agree restructuring or generator will be declared insolvent

Shareholders in British Energy are expected to emerge with a stake of just 5 to 10 per cent in the embattled nuclear electricity generator under the rescue deal announced yesterday.

Banks, bondholders and other creditors, including Royal Bank of Scotland and Gartmore, will also face heavy losses under the debt-for-equity swap proposed by the Government. They will only receive back £425m of the £1.26bn they are owed by the loss-making company.

The "very significant dilution" for shareholders which the rescue deal entails caused British Energy shares to fall by more than a half to 7.5p, valuing the company at just £46m. It was privatised six years ago for £2.1bn.

The Government insisted that the restructuring amounted to a private-sector solution for the company in which shareholders, lenders and taxpayers all shared the pain.

However, analysts and nuclear industry observers said it amounted to a de facto renationalisation of the company. In addition to shouldering up to £3.4bn of British Energy's nuclear liabilities, the fine print of the rescue package reveals that the taxpayer could in certain circumstances end up with a 65 per cent shareholding. Defending the deal in the Commons, the Secretary of State for Trade and Industry, Patricia Hewitt, said the Government could not walk away from British Energy and its liabilities. "No responsible government would. This is the reason why the situation with British Energy is so different from any other generator," she added.

But environmental groups criticised the bailout. "Once again the Government has come to the nuclear industry's rescue and used taxpayers' money to pay for an industry the public doesn't want," said Friends of the Earth's Roger Higman.

The Government and British Energy have just two and a half months to persuade lenders to agree to the restructuring otherwise the company will be placed in administration, putting the future of its eight nuclear reactors in doubt. The Government has agreed to roll over a £650m loan until March – of which £382m has been spent.

The crisis at the nuclear generator was brought about partly by external factors and partly by its own mis-management. Ever since privatisation the group's profitability has been hit by the £300m it must pay each year to British Nuclear Fuels for reprocessing its spent fuel. But what pushed the company into heavy losses was the sharp fall in power prices brought about by the new electricity trading arrangements introduced by the Government. These have resulted in a 35 per cent decline in wholesale electricity prices in the last two years.

The company admitted yesterday that its problems had been compounded by a series of strategic errors. It bought but then sold a retail electricity business, Swalec, meaning that it did not have a natural hedge to offset the sharp fall in wholesale prices.

In an attempt to diversify from its inflexible, baseload nuclear stations, it bought a coal-fired power station, Eggborough, at the top of the market. British Energy paid £615m. The station is now worth an estimated £75m to £100m. It also expanded aggressively into North America, buying part of the Three Mile Island nuclear complex in the US through the Amergen partnership and Bruce Power in Canada – two deals which stretched its finances still further.

It emerged yesterday that British Energy was only able to pay a £48m dividend earlier this year by engaging in what one source described as "financial gymnastics" with its corporate structure. "What we found when we got hold of the books and started to delve inside British Energy has been quite extraordinary," said one government source. "This has never been the most transparent of companies."

The Government's contribution to the rescue of British Energy is a £150m to £200m reduction in the annual reprocessing payments due to BNFL for the next 10 years – which will cost the taxpayer up to £2bn. In return, British Energy will pay 65 per cent of its free cash into a nuclear liabilities fund each year to finance a further £1.3bn in decommissioning liabilities. But if electricity prices remain depressed and the group makes no money, then the Government is committed to making up the shortfall.

But whether the company ultimately survives depends on the attitude of other creditors. At 30 September, it had debts of £1bn and owed £1.26bn to creditors, of which its banks are due £490m, its bondholders £408m and counterparties in the electricity market £365m.

The deal with the bondholders relies first on them agreeing to a standstill on further repayments – a £300m bond repayment is due in March – and then accepting shares in what is virtually a worthless company in exchange for the bulk of their remaining debt.