Lessons From Ukraine For Centrica PLC And SSE PLC

Centrica PLC (LON:CNA) and SSE PLC (LON:SSE) might benefit from realpolitik.

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centrica / sse

The sudden escalation of geopolitical tensions over events in Ukraine is a stark reminder that we live in a dangerous and unpredictable world. Hopefully, one of the side effects will be to push the priorities of politicians towards energy security and away from populist energy company-bashing.

It would be good news for us all if the Big Six energy companies had a more favourable climate for investment, and it would be a boost for investors in the two listed entities, Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) and SSE (LSE: SSE) (NASDAQOTH: SSEZY.US).

Realpolitik

There is clearly little appetite in the UK, or most of Europe, for sanctions against Russia. That was spelled out in a document ‘accidentally’ carried in full view of the press by David Cameron’s deputy national security advisor. Either Downing Street employs security advisors with a remarkably poor concept of security, or this was the government’s way of signalling its impotence while sparing politicians the blushes of actually saying as much.

The reason for Europe’s reticence is clear: Russia is the EU’s third-largest trading partner and Europe depends on Russia for a quarter of its natural gas. Germany takes a third of its gas from the Russians.

Though we buy little directly from Russia, over half our gas is imported from Europe. And whereas on average most European nations have some two months’ of gas in storage, the UK has just two weeks’ worth. The mild winter has left storage levels relatively high, but it’s easy to see how energy bills here would rocket if things turned nasty — and that with a general election looming. It could quickly trump the cheap shots politicians have enjoyed at the expense of energy companies.

Short-sighted

Shares in Centrica and SSE have lost 20% and 10% of their value respectively since Labour leader Ed Miliband threatened to control energy prices if elected.

Centrica has pulled out of nuclear and wind farm development, and both it and SSE have refused to invest in more gas-fired generation under the prevailing economic regime. Last year Centrica dropped plans to increase gas storage capacity after Tory minister Michael Fallon ruled out subsidies, despite the country coming within six hours of running out of gas the previous winter. That could yet win an award for the most short-sighted ministerial decision.

Lib Dem minister Ed Davey whined to regulator Ofgem that the energy companies “still see their role as selling gas and electricity” rather than saving energy, and called for Centrica to be broken up.

Political risk

These attitudes have re-introduced political risk to the UK. Were it not for that risk, Centrica and SSE would still be superb companies. Vertical integration provides stability and some natural hedging of energy prices.  SSE has a strong suit in renewable energy, helped by its hydro plant. It has a great dividend track record, though it troubled some investors that increased borrowings to fund investment strained free cash flow. Now the shares are under pressure, concern will switch to the dividend and the company will probably cut back investment, thus slowing its growth and the installation of vital infrastructure.

Similarly, Centrica has developed a remarkably successful upstream operation on top of the dominant downstream business it inherited from privatisation. But continued frustration of its investment plans will likely lead it to turn its appetite more towards its growing North American business.

Watch, hope and diversify

If Ukraine gives the politicians pause for thought, it could prove to be a turning point. Investors can only watch, and hope.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

 > Tony owns shares in Centrica and SSE.

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