There's political pressure in the pipeline for the utilities sector. For the regulated water stocks, the coming year will be dominated by wrangling over the five-year regulatory review spanning 2010-15. And for Centrica , the coming months will determine whether regulatory approval will be granted for its planned 25 per cent stake in EDF's acquisition of British Energy .
The biggest worry for water stocks is the that regulator Ofwat will make in November 2009, when it determines the level of return the big water companies are permitted to make for the next five-year period (2010-15). The cost of capital is an estimate of the long-term cost of the debt and equity used to finance an investment.
For 2005-10, a post-tax cost of capital of 5.1 per cent was assumed, but for part of the period, cheap debt was available that undercut this assumption. The fear is that Ofwat will come down hard at the next review, with broker Dresdner Kleinwort bearishly forecasting a drop to 4 per cent.
This being so, water companies will need to tap the debt markets to make up any shortfall if they are required to make a higher level of investment in infrastructure, which could dilute future profits and even involve raising fresh equity. Share price volatility in the sector is expected as negotiations continue throughout 2009, and fears over the impact of water metering on volumes and rising bad debt won't help.
THE GAS PIPELINE
Until Christmas, life was a gas for Centrica. Having successfully raised £2.2bn in to fund its proposed stake in British Energy, it seemed like its problematic imbalance between production and supply could be solved through gaining exposure to nuclear power.
Now that EDF's takeover of British Energy has become unconditional, it is expected to take another two to three months before Centrica can acquire its mooted 25 per cent stake, eventually unlocking the generation capacity it so badly needs. However, if the acquisition is blocked by the regulator, Centrica could spend the cash on other transformational deals, perhaps teaming up with gas-rich foreign oil companies.
The impact of the Russian-Ukraine gas dispute on wholesale gas prices remains to be seen. At the time of writing, forward gas prices were holding steady. This compares to the last time such a dispute occurred in 2006, when forward gas prices shot up 50 per cent. The dispute could reduce pressure on Centrica to cut customer bills, in light of the fall in wholesale gas prices since last summer, but it also highlights the low levels of gas storage in the UK, and emphasises the group's exposure to fluctuating wholesale prices.
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