The last few days have been a turbulent time for the UK stock market, with the FTSE-100 Index shedding around 15 per cent over the last three weeks.
In some cases, near panic has ensued; indeed, the US market was suspended for a short period on Monday.
For many, these share price falls are a much-needed correction to a long-standing “bull” market that is running out of steam; it dates back to the recovery from the credit crisis of 2008/09.
Furthermore, the decisive General Election result in December, which gave the Conservative Party an 80-seat majority, was widely seen as a positive for the market, given that the seemingly unbreakable impasse of Brexit had been resolved.
One sector that gained noticeably from the General Election result was utilities. Many had been seriously threatened by the possible election of a Labour government that was committed to widespread utility re-nationalisation.
Companies in Labour’s crosshairs included National Grid, the “big six” energy retailers and almost the entire water sector. The decisive result no doubt provided utility executives with considerable relief.
The market generally liked the political outcome – and responded positively until very recently.
How did we get here?
The stock market bloodbath of recent days should perhaps be seen in three phases.
The first phase encompassed the health aspects of coronavirus whose origins are believed to lie in Wuhan, China.
Initially, most media reports focussed on the health element of coronavirus, but financial markets started panicking when swathes of Northern Italy were identified as a major breeding ground for the virus.
As the number of its victims grew, the second area of focus were economic growth projections and specifically to what extent they would be pared back.
Clearly, the latest draconian restrictions in Italy will adversely impact its economic prospects. And, with very high public debt, there may well be a follow through impact on the Euro.
Undoubtedly, growth levels in many other leading countries will fall; several may well move into recession, including the EU’s German powerhouse.
This negative economic outlook is compounded by the fact that most EU countries, with Germany being an obvious exception, have very high public debt levels – a legacy, in part at least, of the excesses leading to the 2008/09 credit crisis.
Furthermore, with interest rates being either very low – or in some cases even negative – many countries lack monetary ammunition to provide the necessary financial support.
The third element that kicked in with a vengeance earlier this week was the plunge in oil prices, as Saudi Arabia, the lynchpin of the OPEC cartel, fell out badly with Russia.
Both are in urgent need of revenues from oil sales and are now cranking up production as the oil prices fell to c$35 per barrel. In early 2016, oil prices peaked at c$115 per barrel.
Of course, the outlook for oil prices may change. But, at present, it looks unremittingly negative – a scenario that hammered the FTSE-100 Index on Black Monday.
The Index weighting of Shell, both A and B, as well as of BP, is formidable. In Shell’s case, its shares have virtually halved in just eight months – an astonishing turn-round for so solid a business.
Importantly, too, both major oil companies are very heavy dividend payers.
Shell itself is responsible for around 13 per cent of FTSE-100 dividend payments. Millions of retired people, directly or indirectly, are heavily reliant on Shell’s quarterly dividends.
The good news is that, despite plunging oil prices, Shell’s dividend payment record is quite remarkable: there has been no cut since the end of World War 2 in 1945.
Contrast this highly reassuring dividend record with that of the struggling Centrica – its latest dividend cut last year amounted to 58 per cent.
BP’s record is less impressive, mainly because of the catastrophic Macondo blow-out in 2010, when dividends were suspended for a period as BP sought to recover from this disaster in which 11 workers were killed.
For utilities, major oil price movements are very relevant because of their impact on the gas price. Although the correlation is not as close as previously, lower gas prices still have a pronounced impact.
Whilst Centrica has moved away from electricity generation, it is still very dependent upon prevailing gas prices. Quite simply, the value of its core product has plunged, thereby further shrinking its low margins.
Add to that the undoubtedly negative impact of retail price controls – on which it has sounded off in recent months – and it is no surprise that Centrica’s share price has plummeted; it is now trading at just one-fifth of the July 2015 figure.
For one of the UK’s largest utilities, these are depressing – and perplexing – numbers.
With a chief executive, Iain Conn, now very much semi-detached, confirmation of his successor, who faces a formidable challenge, is eagerly awaited.
SSE, too, has seen its shares fall back by around 10 per cent in the last week alone.
To be sure, its rating had recovered sharply on the back of enhanced renewable generation valuations, the disposal of its retail supply business, the General Election result and a more credible dividend policy.
Impact on renewables
Two further implications of plunging oil and gas prices merit comment.
First, assuming gas prices remain low for an extended period, there may be a read-over to the renewable generation sector.
If gas generation kicks in more aggressively, renewable generation plant may become less competitive, especially in terms of subsidy-free plants, a few of which have been built. Furthermore, non-subsidy revenues may decline on the back of lower selling prices.
Secondly, in the supply market, there has been a procession of bankruptcies in recent months as new entrants fail to “cut the mustard” and secure a reasonable market share at the right price.
Coping with such price volatility is a major challenge for small utility suppliers and it seems inevitably that further casualties will result.
Arguably, true utility status is established, if a stock does not follow a pronounced change in market sentiment as has been the case recently.
National Grid, currently capitalised at c£34 billion, is an obvious example. Indeed, its latest share price is – despite all the recent market woes – around 10 per cent above its rating in early December.
Inevitably, its share price bounced after the December General Election result, although it still faces a pivotal review of its UK electricity and gas transmission businesses, which will first impact in April 2021: the electricity element alone has a Regulatory Asset Value (RAV) of £13.5 billion.
Importantly, too, National Grid’s expanding US business provides real protection against overly harsh regulatory determinations from Ofgem.
Water firms ride high
Other out-performers of a declining FTSE-100 are the two largest quoted water companies, United Utilities and Severn Trent, both of which have accepted Ofwat’s final determination.
Both have also set out new five-year dividend policies – and avoided cuts.
Last week, United Utilities held a day-long analyst meeting in London, during which it set out in detail how it would seek not only to meet Ofwat’s targets – but also to exceed them.
The complex Haweswater aqueduct scheme featured prominently, along with an unbridled commitment to improve its unimpressive leakage record.
Severn Trent’s capital markets day at Coventry dealt less with financial issues but focussed more on how – whilst meeting shareholder expectations – it could become an exemplary employer through meeting its wide-ranging environmental, social and governance (ESG) goals.
Severn Trent’s message was very different from certain financial excesses previously undertaken by some utility companies.
Falling share prices across the market has also enabled the third publicly quoted water company, Pennon, to become a FTSE-100 member. Pennon had a good periodic review, as its new status implies.
Less successful with Ofwat were three privatised water companies – Anglian, Northumbrian and Yorkshire – all of whom are appealing to the Competition and Markets Authority (CMA) regarding their final determinations.
It seems that Northumbrian is exercised about the vexed issue of the Weighted Average Cost of Capital (WACC). Anglian and Yorkshire, particularly, feel strongly about some investment programmes that Ofwat has decided not to remunerate in full.
And Bristol, a serial CMA appellant, has its own issues to contest, although its record of CMA appeals does not inspire confidence that it can bring about a major U-turn of Ofwat’s final determination.
More generally, the UK stock market is currently facing challenging times.
Some market commentators will argue that the last few days have been simply a ‘blip’ and that normality will return once coronavirus has been tamed and OPEC has reasserted its – admittedly waning – powers to fix oil prices.
Others will argue that the end of the long-running bull market is nigh. They will also point to a slew of coronavirus-related profit warnings that seem certain to emerge in coming months.
No one forecast that the combination of a near pandemic and a plunging oil price, combined with far lower economic growth, would ambush stock markets.
As recently as January, the spring of 2020 was widely expected to focus on trade deal negotiations in the aftermath of Brexit – an issue that now seems to have been relegated to the media backburner.
Nigel Hawkins is the utility analyst at Hardman and Co