December 19, 2010 8:18 pm

Centrica’s model smoothes volatility

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments

In April this year one of Britain’s largest energy companies drilled its first well in Norway. It was an auspicious first strike – the well found gas – but the operator of the field was not an oil and gas company but Centrica, often better known as the owner of British Gas, the UK’s biggest household energy supplier.

The Norwegian gas discovery is one of nine the company has made this year, from 14 wells drilled. Its gas and electricity customers might not know it but Centrica is the sixth-largest producer in the UK continental shelf, is the third-largest owner of acreage and is on the hunt for more.

The transformation from plain-vanilla gas supplier to integrated energy company has taken less than four years. Driven by Sam Laidlaw, Centrica’s chief executive, who came from the world of oil and gas, the purpose has been to reduce the company’s exposure to the volatility of the wholesale energy markets which previously led to sharp swings in profitability at British Gas.

It has worked. When Mr Laidlaw joined in July 2006, the company was buying 80 per cent of the energy it sold off commodity markets. Today, that has fallen to roughly 40 per cent.

Two deals last year are behind the change: the purchase of a 20 per cent stake for £2.3bn in British Energy, the nuclear power generator owned by EDF of France, and that of Venture Production, the North Sea oil and gas explorer for £1.3bn. The two acquisitions, plus some smaller ones, mean Centrica now has the potential to grow and no longer relies on the Morecambe Bay gas field.

The acquisitions are taking Centrica back to its roots. The company was formed in 1997 when it was demerged from British Gas plc. The production assets, excluding Morecambe Bay, stayed with what became BG plc, now BG Group.

Mark Hanafin, managing director of Centrica Energy, which includes its power generation and upstream businesses, says when he joined in 2008, the field was its only operated asset.

“If you do nothing, you slowly go out of business. There is a natural decline rate of 15-20 per cent in gasfields,” he says.

Acquisitions were key and with many of the world’s oil majors increasingly looking to exit the North Sea, Centrica spied its opportunity. Since joining, Mr Hanafin has invested £5bn, notably on Venture Production and its stake in British Energy.

The integration has paid off financially. Mark Freshney, utilities analyst at Credit Suisse, says: “In the UK, Centrica makes among the best margins in gas supply. In my opinion this is partly because they operate their own gas assets which are flexible. They also have economies of scale. They have the ability to flex their own production to help hedge themselves against the volatility in the wholesale gas price.”

But if Centrica’s shareholders are benefiting, what about its customers? With Britain gripped by yet another big freeze, sending demand for electricity and gas soaring, the spotlight has already turned on the big six utilities – most of which, including Centrica, have raised prices for households and businesses this winter citing high wholesale gas prices. Ofgem, the energy regulator, recently launched an investigation into the price rises although it has in the past never found any evidence of price fixing.

So is Centrica profiteering? Should its own sources of supply not enable it to protect its consumers from price rises? The company’s counter-argument is that it is not that simple: consumers might still be facing price rises when wholesale prices rise but they are being protected from the wilder swings in the open market.

Being vertically integrated means “we can absorb spikes in price,” says Mr Hanafin. “We also have greater flexibility to delay changes in the price.”

And none of this would be possible without investment, he adds. Over the next three years Centrica Energy’s upstream division plans to maintain production at about 50m barrels of oil equivalent a year while drilling at least 45 wells, with investments of £2.2bn over that time.

Centrica Thumbnail

Centrica Thumbnail

So how far can Centrica push the model? Mr Hanafin is clear that “to have a company that goes from drill bit to burner tip in people’s homes is pretty rare”. He is keen to expand the upstream business and sees it as a business that can deliver in its own right.

The company is also investing in trying to reduce customers’ energy consumption by installing in homes smart meters that provide information on how much electricity and gas people are using.

Mr Laidlaw has declared the old utility business model dead and wants to build an integrated supplier that can deliver secure and sustainable energy. As the government looks to reform Britain’s electricity markets to enable it to meet tough climate change targets and keep the lights on, companies such as Centrica will need to invest hundreds of millions of pounds over the coming years.

The lesson for consumers from all this is that energy is not getting any cheaper.

Copyright The Financial Times Limited 2015. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments

NEWS BY EMAIL

Sign up for email briefings to stay up to date on topics you are interested in

SHARE THIS QUOTE