A ‘smash and grab’ renationalisation

Current political turmoil could result in a general election, and with a prospective Labour government bent on taking utilities back into public ownership, fund managers need to weigh the risks.

The UK’s political system is in disarray – dominated by Brexit and the lack of any consensus to exit the EU as voted for in the 2016 referendum.

While the outcome of the present Brexit impasse is difficult to predict, an early general election should not be discounted, even if any sane member of the Conservative party is unlikely to welcome it, given the Tories’ desperately poor opinion poll ratings at present.

Neither is the Labour party quite as confident as it once was after its poor performance in the recent local elections.

Nonetheless, any watchful investor must recognise that an early general election, for whatever reason, could take place – and it’s far from clear what its outcome would be. Indeed, a Labour-led government, perhaps supported by the SNP, is a real possibility.

For the UK utilities sector, such an outcome would have major ramifications, and that is something that fund managers are increasingly addressing. Undoubtedly, political risks are weighing more heavily on the utilities sector, for which the Labour party has some radical proposals.

Of course, some other sectors will also be fearful of what an incoming Labour government might do. RBS, for instance, as the recipient of an infamous £45.5 billion taxpayer bail out over a decade ago, is vulnerable, especially since the government’s stake still exceeds 60 per cent.

And the housebuilding sector, whose share prices have boomed partly due to the Help-to-Buy scheme, would be another Labour target, along with the few remaining UK-based railway franchise operators.

Alternative destinations

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 Labour’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”. As for the energy sector, Labour is seeking to regain “control of energy supply networks… and transition to a publicly owned decentralised energy system”.

Against this background, the utilities sector should expect radical changes if the Labour party wins power – and does so with a strong enough majority and political commitment to undertake a major utility renationalisation programme.

The costs would be huge, 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.

Furthermore, 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 £5 billion “utility tax” on companies privatised under previous Conservative governments.

No doubt investors were disconcerted by last week’s Sunday Times article suggesting a total cost for renationalising the water sector of less than £20 billion. This compares with a sector regulated asset valuation of more than £70 billion, much it debt-financed.

Shadow chancellor John McDonnell argues that Labour’s figures are based on the equity element, and not on accumulated debt that can be refinanced by public sector loans. Indeed, such debt – given the current yield on ten year gilts of around 1.2 per cent – could, in theory, be more cheaply financed.

Furthermore, he has said previously that the value of any compensation – receivable probably in gilt-edged stock – would be decided by parliament and, in effect, by MPs supporting a Labour government, who may be subject to a threeline 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 widely dispersed across leading G20 countries, it would be a desperately challenging task.

Similar comments apply to National Grid, another favourite target of Labour. Given that many of its assets are in the US, the legal ramification of renationalisation would be complex.

Beyond utilities

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 past 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 could be cited to prevent the implementation of such a policy – or at least mitigate 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 renationalisation policy.

Reaction

Water UK

A “cut-price raid on the water industry would see millions of pensioners lose out on thousands of pounds”, warned Water UK’s chief executive Michael Roberts.

“It would be an absolutely devastating blow for millions of pensioners if the water industry was subject to a smash and grab raid by a future government paying well below market value for it.

“More than five million pensioners have funds invested in the water industry – including very many public sector workers – and they would lose thousands of pounds each under these leaked plans.

“It’s becoming clearer by the day that the financial case for nationalising the water industry doesn’t stack up. As well as hurting pensioners it would land taxpayers with a multi-billion pound bill, both for the purchase of the industry and the extra £100 billion that needs to be invested in the sector
over the next decade.”

Anglian Water

Anglian Water chief executive Peter Simpson said renationalisation would be disastrous for the sector.

“Labour’s proposals would spell disaster for customers, shareholders and the environment. Many of the issues highlighted by Labour are already being tackled.

“Water company investment over the next five years totals £50 billion. If the water service was owned and run centrally, it would simply not be a priority for investment against other critical public services like the NHS, education and public pensions. This funding will specifically tackle the unique challenges faced from climate change and a growing population to ensure resilient water supplies for the future.”

Thames Water guarantee

Thames Water recently added a new clause to some of its financial bonds to ensure investors are paid back immediately if the utility company is nationalised.