Centrica chief executive prepares to unveil turnround strategy
Centrica’s new chief executive Iain Conn is preparing a shake-up of the UK-based energy group that could pare back its struggling exploration and production arm, in an effort to restore profits growth and reverse a slide in its shares.
Mr Conn, a former BP veteran who took the top job in January, is close to concluding a strategy review that is expected to outline plans for hundreds of millions of pounds in cost savings and could lead to the sale of North Sea gasfields, where returns have dwindled after the oil price collapse.
By any measure, Centrica has been at the heart of a perfect energy storm. First came a political row over gas bills, then a competition probe. In February, the company announced the first dividend cut since its creation in 1997, as it slumped to a pre-tax loss of £1.4bn for 2014 following large asset impairments prompted by the steep falls in oil and gas prices since the summer of last year.
The owner of British Gas, Britain’s biggest domestic power supplier, is caught in a cut-throat industry. Smaller, nimbler operators have been gnawing at its customer base, squeezing profit margins. Last year, the weather added to its woes — a record mild spell in the UK meant customers used less energy than Centrica expected, while extreme cold in the US compelled the company to buy additional wholesale energy at higher prices to meet extra demand.
Meanwhile, its share price has tumbled by a third since September 2013, when the then Labour leader Ed Miliband declared that he would freeze energy prices if elected, underperforming the FTSE 100 index by about 30 per cent.
Last month’s Conservative election victory offers some relief. As the Competition and Markets Authority prepares to publish the initial findings of its probe, a break-up of the UK’s “big six” energy suppliers also looks unlikely. Yet, even after discounting political risk, Centrica’s problems remain acute.
Analysts say former Centrica chief executive Sam Laidlaw’s strategy of building a substantial exploration and production business appears to have backfired. Some investors are now urging the group to shift capital away from the struggling E&P arm and focus instead on its energy supply operations in Britain and the US.
Between 2007 and 2014, according to analysts at Jefferies, Centrica spent £9bn acquiring and investing in oil and gas assets, mainly in regions with high production costs — the North Sea and Alberta in Canada.
Centrica CEO Iain Conn
Intended as a “hedge” for the supply business, smoothing the impact of market price swings on its bigger downstream arm, these exploration and production assets were for the most part bought when oil prices were substantially higher than they are now. The proportion of Centrica’s capital spending on E&P then rose to a peak of 89 per cent in 2012, only for the recent slide in oil and gas prices to send the company’s adjusted operating profit 35 per cent lower in 2014 compared with 2013.
Peter Atherton, analyst at Jefferies, says the fall in upstream profitability, coupled with a failure of the supply business to compensate amid fierce UK competition from independent operators, suggests that Centrica’s strategy has failed.
Mr Conn has responded with a sweeping review, the conclusions of which will be unveiled with Centrica’s interim results on July 30.
His immediate priority is to maintain Centrica’s investment grade credit rating. The 30 per cent cut in the dividend was the first step, alongside a 40 per cent reduction in capital expenditure in 2015-16, much of that in the North Sea.
Analysts believe these measures should, with take-up of a scrip dividend, save about £900m a year, tackling Centrica’s shortfall in earnings and freeing up cash flow. There will also be a round of operational cost-cutting.
The bigger question is where Mr Conn will take the group. Some investors believe he should cut back Centrica’s E&P business, arguing that its meagre returns do not justify recent high levels of capital spending. The E&P arm, argues one top 20 investor, has become a burden: “Downstream is our preference as it offers higher returns and less capital intensity.”
Indeed, there are growing expectations that Mr Conn will recalibrate Centrica’s portfolio along these lines. Its current upstream production is 217,000 barrels of oil equivalent a day, but as capital spending falls, output will decline too.
Asset sales could follow, with analysts pointing to fields in the UK and Netherlands regions of the North Sea as disposal candidates.
Another large investor says: “Any legacy E&P assets are potentially for sale in domestic and overseas markets. But presumably when the price is right, not necessarily at rock bottom prices.”
A wholesale withdrawal from E&P is unlikely. Centrica’s Morecambe Bay field remains a solid contributor to earnings. Moreover, some of its larger North Sea assets are held in partnerships, which means that the group cannot unilaterally withdraw investment without renegotiating deals.
For revenue growth, Mr Conn is likely to look to the millions of customers of its core UK and US supply arms, using an 11,000-strong force of engineers to sell energy service deals to them.
The trick will be to strike the right balance between that desire for growth and Centrica’s cash needs. Verity Mitchell, analyst at HSBC, says Mr Conn needs to tread a careful line between some shareholders’ hunger for a more “asset-light” strategy and investing to benefit from an eventual commodities rebound. There will be “no silver bullet” to transform Centrica into something different, she warns.