This week was a ground-breaking week for the UK energy industry. After months of speculation and investigation, the energy regulator Ofgem, referred the UK’s energy industry to the newly created Competition and Markets Authority for a full investigation.
Ultimately, this investigation could lead to the breakup of the UK’s big six power companies, or millions in fines. However, just before this decision was announced, SSE’s (LSE: SSE) (NASDAQOTH: SSEZY.US) management took a bold step, announcing a price freeze and the separation of its wholesale and retail arms, along with 500 job cuts.
The question is, now the industry is under investigation, will SSE’s larger peer, Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) follow suit?
Management opposition
As rumours of this investigation and the forced separation of energy companies have been swirling around the industry for some time, Centrica’s management has had plenty to say on the matter. Indeed, CEO Sam Laidlaw has repeatedly rejected calls for his company to be broken up, stating that it is essential the group remains as one, in order to compete internationally.
What’s more, Mr Laidlaw has raised the valid point that due to the size and international footprint of Centrica, the company is able to protect customers from volatile commodity prices by negotiating favourable long-term supply contracts.
Tied into contracts
The statements from Centrica’s management make a lot of sense, as the company’s annual report shows that Centrica has negotiated £60bn worth of long-term energy supply contracts with multiple major suppliers. A third of these supply contracts were negotiated during 2013 and all in all, the total financial commitment of these contracts is four times Centrica’s current market capitalisation.
It is unlikely that a smaller company would be able to commit to contracts of this size. As a result, a breakup of Centrica could lead to the breakdown of these contracts, financial penalties and volatile energy prices.
Bad for the economy
Aside from financial commitments and management opposition, it could actually be impossible to split Centrica up due to the company’s size, global integration and existing commitments.
In particular, industry analysts believe that commitments made by Centrica up to five years ago, to build new gas and nuclear power plants within the UK could fall apart due to financing issues, which would force up energy prices. In addition, industry experts and unions believe that a large bulk of 30,000 British Gas jobs would be at risk if the company is forced to split.
Great news for the City
On the other hand, a breakup could be great news for the City and Centrica’s investors. In particular, according Goldman Sachs, at present levels, Centrica’s share price does not reflect the potential of company’s international operations.
As a result, if Centrica were to split up, the newly separated international operations, free of political scrutiny would attract a higher valuation.
Foolish summary
So overall, due to the integrated nature of Centrica it does not look as if the company will be split up, although if a break-up is enforced, shareholders will benefit.
