The UK’s political system is in some disarray – dominated by Brexit and the lack of any consensus to exit the EU, as voted for in the 2016 referendum.
Whilst the outcome of the present impasse is very difficult to predict, an early general election should not be discounted.
Of course, any sane member of the Conservative party is unlikely to welcome it, given its desperately poor opinion poll ratings at present.
Neither is the Labour party quite as confident as previously, since its poor performance in the recent local elections.
Nonetheless, any discerning investor must recognise that an early general election, for whatever reason, could take place – and its outcome is far from clear.
Indeed, a Labour-led government, perhaps supported by the SNP, is a real possibility.
For the UK utilities sector, this outcome would have major ramifications, something that fund managers are increasingly addressing.
Undoubtedly, political risks are weighing more heavily than previously on the utilities sector, for which the Labour party has some radical proposals.
Of course, some other sectors will be fearful of what an incoming Labour government might do.
RBS, the recipient of the infamous £45.5 billion tax-payer bail out over a decade ago, is certainly vulnerable, especially since the government’s stake still exceeds 60 per cent.
And the house-building sector, whose share prices have boomed partly due to the Help-to-Buy scheme, could be another Labour target, along with the few remaining UK-based railway franchise operators.
For overseas investors, there are many opportunities to avoid the complex political risks currently faced by UK utilities.
Consequently, overseas fund managers, especially in the US, will look closely at energy and water businesses based elsewhere in Europe.
Orsted and Vestas, two leading Danish renewable energy companies, are obvious examples, along with Spain’s Iberdrola, which has long championed renewable generation. Italy’s ENEL also remains very well placed.
In assessing these investor risks, it is appropriate to review what was proposed in the Labour party’s 2017 manifesto.
At a general level, there was a pledge to “…bring key utilities back into public ownership to deliver lower prices, more accountability, and a more sustainable economy”.
On the water front, the message was unambiguous: “To replace our dysfunctional water system with a network of regional, publicly-owned water companies.”
Neither did the energy sector escape. The Labour party is seeking to regain “control of energy supply networks… and transition to a publicly-owned decentralised energy system”.
Against this backdrop, the utilities sector should expect radical changes if the Labour party were to win the next general election – and to do so with a strong enough majority and political commitment to undertake a major utility renationalisation programme.
The costs would be enormous, although a combination of a future Labour government offering the lowest level of compensation that it could, and the fact that utility share prices would presumably have plummeted in the interim, would cut the overall bill quite considerably.
And in terms of shareholder compensation, there are relatively few precedents of note.
The last Labour government effectively nationalised RBS, at a massive cost to the taxpayer, to prevent it going bust.
A similar justification – accurate or not – explained the very hasty renationalisation of Railtrack in 2001. Investors eventually received just over two-thirds of the 380p float price. At their peak, Railtrack’s shares had exceeded £17.
Furthermore, on entering office in 1997 the Labour government imposed a circa £5 billion Utility Tax on companies privatised under previous Conservative governments.
No doubt, many investors were disconcerted by last week’s Sunday Times article suggesting a total cost for renationalising the water sector of under £20 billion.
This figure compares with a sector Regulated Asset Valuation (RAV) of well over £70 billion, much of which has been debt-financed.
Shadow chancellor, John McDonnell, has argued that the Labour party’s figures are based on the equity element, and not on accumulated debt that can be re-financed by public sector loans.
Indeed, such debt – given the current circa 1.2 per cent yield on ten-year gilts – could, in theory, be more cheaply financed.
Also, he has said previously that the value of any compensation – receivable probably in gilt-edged stock – will be decided by parliament and, in effect, by MPs supporting a Labour government, who may be subject to a three-line whip.
Although the Labour party’s commitment to energy sector ownership is less clear-cut, a similar methodology could be employed to renationalise the 12 distribution companies that were privatised in 1990.
Since their ownership is now very widely dispersed across leading G20 countries, it would be a desperately challenging task.
Similar comments apply to National Grid, another favourite target of the Labour party. Given that many of its assets are in the US, the legal ramification of renationalisation would be very complex.
Beyond the water and energy companies, other privatised stocks in Labour’s line of fire include British Telecom, which presumably would be compelled to undertake even higher broadband investment, and the privatised railways sector where fundamental changes to the franchise arrangements could be expected.
For an incoming Labour government to deliver such a wide-ranging renationalisation programme would be immensely challenging.
On the financial front, even allowing for far lower utility share prices, the costs would still be formidable.
After all, the UK’s net debt currently exceeds £1.8 trillion – a figure that has soared over the last decade. And interest rates may well rise sharply, thereby increasing the costs of financing this vast debt.
Clearly, a swathe of renationalisations would hardly help to reduce the UK’s burgeoning net debt.
The legal position would also be very complex and time-consuming. Both the Human Rights Act 1998 and various Bilateral Investment Treaties (BITs) could be cited to prevent the implementation of such a policy – or at least mitigating its impact.
Nonetheless, irrespective of the current political shambles, fund managers cannot ignore the fact that a Labour government could be elected – and might even seek to implement its radical utility re-nationalisation policy.
Nigel Hawkins is utilities analyst at Hardman Research.