Centrica (LON:CNA)

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Alexander Haring

Waseem Alim

Centrica is the largest gas and electricity utility company in the United Kingdom in terms of revenue. In 2008, the company generated revenues of £21.3 billion (US$35 billion), 69% of which came from the UK where they have 15.6 million customers.^[1] Outside of the UK, Centrica has a strong presence in North America, which contributed 27% of Centrica's revenue in 2008. ^[2]

Centrica's strength lies in its residential British Gas business because of its large customer base and established retail price leadership position. British Gas is the largest residential and commercial supplier of gas and electricity in the UK with 4.6GW of generation capacity (5,345 mmth of gas and 23,880 GWh of electricity supplied in 2008). In addition, British Gas operates a service business of installation and maintenance of heating and gas appliances and energy efficient technologies.^[3]

Natural gas price fluctuations pose the greatest risk to cost of delivering energy to Centrica's customers, as more than 80% of energy generated by Centrica is natural gas based.^[4] The company has focused on diversifying into nuclear energy and acquiring gas production facilities in order to mitigate this risk. In November, 2009 Centrica was cleared by the European Commission to purchase a 20% stake in British Energy -- which operates 8 nuclear power plants in the UK and produces 8,683 MWh of elctricity.^[5] In addition, the stake in British Energy has improved Centrica's gas price hedge by roughly 25%. This has lowered the gas price risk as Centrica can now cover more of its gas requirement from through its own production.

Corporate Overview

Centrica posted strong revenue gains and a small increase in profit between 2008-2009. Revenue in H1 2009 was £11.66 billion (US$18.83 billion), a 20% increase compared to the H2 of the previous year. EBIT (Earnings Before Interest and Tax) for H1 2009 was £936m (US$1.51 billion), a 5% increase compared to H2 of the previous year. However, from the full year 2007 to 2008, profit declined 20%. This shows that oil and gas prices in UK are effecting Centrica's costs. ^{[6] [7]}

Centrica plans to exit its business in Europe and focus on strengthening its operations in the UK. In its 2008 Annual Report Centrica outlines its plans to dispose of its businesses in continental Europe starting with the sale of its 51% stake in Belgian company SPE. Centrica also plans to sell its subsidiaries in Spain and Germany. ^[9]

In order to strengthen supply to the UK, Centrica took over Venture Production, a North Sea oil and gas company, for £1.3 billion (US$2.1 billion) in 2009. Through this it acquires oil reserves of 240 million barrels and extraction capacity of 52,000 barrels of oil a day. ^[10] In November, 2009 Centrica purchased a 20% stake in British Energy; a deal that was proposed in August. British Energy has a nuclear output of 8,683 MWh with 8 nuclear plants in the UK. The aquisition of shares in British Energy has improved Centrica's energy hedge adding approximately 25% to its total gas equity. ^[11]

Geography

Centrica operates in 9 countries: the UK, Canada, USA, Norway, Germany, Spain, The Netherlands, Belgium, Nigeria. It also owns licenses for gas exploration in Trinidad and Egypt and have outsourced operations in South Africa and India. Its businesses in Spain, The Netherlands and Belgium are planned on being sold. The UK is the hub of Centrica's business with 35 locations (offices and plants) with 4 main activities of energy sourcing, supply, home services and gas storage. There are 6 locations in continental Europe sourcing and supplying energy. Egypt, Nigeria, and Trinidad and Tobago have 1 location each sourcing energy. In North America, Direct Energy has 11 locations supplying energy and home services. Centrica has over 20 million customers worldwide. ^[13]

Business Segments

^[14]

United Kingdom (69% of revenue)

Centrica operates under the names British Gas, Scottish Gas, and Nwy Prydain in Wales. Centrica has 4.6GW of UK electricity generation capacity, 1,500bcfe of gas and liquid reserves and 120bcf of gas storage capacity. In the UK it operates 9 power stations and 7 wind farms with over 32,000 employees. It is making a strong effort to integrate its business by producing more of the energy it sells. In the UK, it supplies 29% of its gas requirements from its own gas fields and 58% of its peak electricity demand from its own generation facilities. Wholesale markets are volatile and represent a potential hazard due to variations in Oil and gas prices. As a result Centrica has made it a priority in acquiring power generation assets. In August 2008, Centrica purchased a 20% stake in British Energy. 2009.^[16]

• British Gas (Revenue £6.2 billion, Operating Income £364 million)

British Gas supplies gas and electricity to UK residential and business customers, provides central heating and gas appliance installation and maintenance and low-carbon and energy efficient products and services. They are the largest energy supplier in Britain's domestic market with 15.6 million customers in 2008. They are also Britain's largest operator in the installation and maintenance of domestic central heating and gas appliances with 8.1 million customers. In 2007, they launched British Gas New Energy to supply low-carbon and energy efficient products and services. They supply and install a range of microgeneration technologies including solar thermal, wind turbines and ground source heat pumps. ^[17]

• Dyno Group (Revenue £688 million, Operating Income £112 million)

Dyno is the UK’s leading drain cleaning service, also offering plumbing and lock fitting. Dyno-Rod specializes in emergency drainage and plumbing. Dyno Locks & Alarms specialises in home and property security. This segment posted an operating profit CAGR of 15% growth over the past 5 years. ^[18]

• Centrica Storage (Revenue £124 million, Operating Income £73 million)

Centrica Storage specializes in gas storage. The "Rough" facility, bought in 2002, stores gas under the North Sea on behalf of a number of companies, including other Centrica businesses, to meet seasonal peak demands. The facility is the largest in the UK, able to meet approximately 10% of the UK's current peak day demand and representing over 70% of UK storage capacity. In 2006 Centrica began operating a facility nearby storing Norwegian gas. In 2010 they are constructing two new storage facilities in the UK. Profits of this segment are driven by UK gas summer-winter price differentials because storage capacity is sold to third parties for winter withdrawal of summer produced gas. Winter-summer differentials are tightening leading to a decline in profit. ^[19]

• Centrica Energy (Revenue £1.9 billion, Operating Income £332 million)

Centrica Energy sources gas and electricity to its customers in the UK and Europe. It owns a portfolio of producing gas and oil fields in the UK and Norwegian North Sea. It operates the North and South Morecambe fields which are valuable assets in terms of reserves being two of the largest in the UK. Centrica also holds exploration licenses in Egypt and Trinidad & Tobago as well as a potential liquid natural gas production and liquefaction project in Nigeria.^[20]

Europe (4% of revenue)

Centrica has assets in Belgium, the Netherlands, Germany, Spain, and Norway which are part of the Centrica Energy segment (Revenue £1.9 billion, Operating Income £332 million).

Centrica first entered the European market in Belgium in 2001 with a joint venture with GdF controlling Belgian generation and supply company SPE which s the second largest player in the country. It produces electricity at 21 plants with an installed generation capacity of 1,900 MW and has over 1.5 million gas and electricity customers. In 2009 Centrica sold its stake in SPE.

Its subsidiary, Oxxio is the fourth largest supplier in the Dutch market and has 800,000 customers for electricity and natural gas. Oxxio has struggled to compete due to highly volatile commodity prices and vertically integrated competitors. ^[21]

Since 2002 Centrica has had an interest in the Statfjord oil and gas field which straddles the UK and Norwegian sectors. This gas exploration there is meant to provide supply to Centrica's UK customers.^[22]

Centrica's subsidiaries in Spain and Germany have industrial customers and accounts total a few hundred -- the segment does not contribute significantly to Centrica's revenue or profits.^[23]

North America (27% of revenue)

• Direct Energy (Revenue £3.4 billion, Operating Income £66 million)

Centrica's subsidiary Direct Energy was aquired in 2000 and is the third largest commercial supplier of energy in North America supplying over 200,000 meter points. Geographically, North America is where Centrica is focusing its expansion. ^[25]

Direct Energy operates in 20 states in the United States and 10 provinces in Canada with 5 million total customers. It operates 3,000 natural gas wells in Alberta, while in Texas has three gas-fired power plants and power purchase agreements totalling 813MW of wind power. Its principal business lines are sales of natural gas and electricity to residential and small commercial customers, sales to medium and large-sized businesses, government, and public institutions, wholesale energy, and home and business service including household ventilation and air conditioning, plumbing, water heater and electrical appliance services along with facility maintenance and energy management consulting services for commercial customers. Revenue in 2008 was $11 billion with a profit of $400 million. ^[26]

Key Trends and Forces

Centrica buys stake in British Energy

In November, 2009 Centrica was cleared by the European Commission to purchase a 20% stake in British Energy for £3.1 billion (US$5.0 billion); a deal that was proposed in August. British Energy is owned by Electricité de France (EDF), the largest utility company in the world with €64.28 billion in revenues 2008.

British Energy has a nuclear output of 8,683 MWh with 8 nuclear plants in the UK. The operational performance of the British Energy nuclear fleet has improved in the first three quarters of 2009, with 42.5TWh of power generated, 42% above the level in the same period of 2008. The aquisition of shares in British Energy has improved Centrica's energy hedge adding approximately 25% to its total gas equity. This lowers oil and gas price risk with a higher percentage of the gas needed covered by Centrica's own production. On top of this, it has reduced its need to provide cash collateral for some of its energy purchases reducing its trading volatility and increasing its access to low-cost, low-carbon generation.

This new partnership formed with EDF enables Centrica to be a part of the focus on expanding nuclear energy in the UK with an 80/20 joint venture with EDF to build four nuclear reactors, the first planned for operation in 2017. EDF will also provide Centrica with an additional 18TWh of power at market prices for five years from 2011. The final term of the transaction is that EDF will acquire Centrica’s 51 percent stake in Belgian generation and supply business SPE for £1.2 billion (US$1.9 billion). This deal shows commitment to Centrica's strategy of focusing its business within the UK and reducing its exposure in Europe by selling off its power assets there. ^[27]

Alternatives for the Future: Nuclear Energy

^[28]

The European Union is imposing strict limits on CO2 emissions and stretching targets for the use of renewable energy. The European Renewables Directive, for example, will bind the UK to a 15% renewables target by 2020. The UK Government suggested that this is likely to mean up to 30–35% of electricity could come from renewable sources compared with less than 5% currently. Centrica believes that renewable energy alone is not enough to meet its supply and is investing in nuclear plants for energy security in the new low-carbon world. It plans for new nuclear construction in the UK immediately due to build time and its aging nuclear fleet. Centrica's partnership with EDF Energy is a step towards its future goals.

Centrica plans to build a major wind farm

Centrica plans to construct a £725m offshore wind farm to be completed by the end of 2012. Its plans includes 75 turbines generating 270 megawatts of energy. They already have approval for the site off the eastern coast of the UK. According to Sarjit Sambi, Centrica's managing director of power generation, offshore wind farms are more expensive but helps the country to meet its carbon reduction target. The wind farm would increase the total output of Centrica's Renewable Energy projects to 650MW. When other projects currently in development are completed, the company's wind capacity would jump to 1.25GW. Centrica is matching competitors investment in wind farms and improving its energy hedge, however wind generation capacity is still small producing an estimated 25 million therms of Centrica's 3,487 million therms in 2009. In the future wind could rise to an estimated 180 million therms over the next 5 years, yet this number is still a small percentage of the total. ^[29]

Gas Price Risk

Gas prices pose the greatest risk to the company's performance as they directly affect the cost of sales for the company. 80% of Centrica's electricity is based in natural gas. Their British Gas Residential Business which constituted 25% of profit in 2009 depends on low gas prices in the UK to maintain its profitability.

Historically there has been parity in oil and gas prices in the UK. However, UK wholesale gas prices have been resilient in 2009 in the face of falling oil prices. The spot UK gas price since the summer of 2008 is only down 40% while oil prices are down 70%. In 2008 and 2009 Centrica benefitted from lower cost of oil, which fell from its peak of $147 per barrel in July 2008 to $70 in December 2009. Because oil prices have fallen, should gas prices normalize to historical oil parity levels then Centrica will benefit and its profit margin will increase. Because of the recent volatility in oil and gas price parity, this trend should be monitored closely.

Competition

Within the UK, Centrica competes with:

• E.ON AG (EON) - A major European public utility company headquartered in Germany with other assets in Russia and the United States. They owns 50% of the London Array project, which is the largest wind farm ever built with 1GW of capacity.^[32]
• RWE AG (RWE-FF) - Another major European player based in Germany with subsidiaries across Europe serving 20 million electricity and 10 million gas customers.^[33]
• Scottish & Southern Energy - The UK's second largest electricity producer behind Centrica and the largest renewable energy producer. It is developing the UK 500MW Greater Gabbard offshore wind farm in partnership with RWE nPower.^[34]
• Scottish Power - The company is a subsidiary of the Spanish utility company Iberdrola. It operates in the central and southern Scotland and the Merseyside and North Wales regions.^[35]
• Electricité de France (EDF) - The worlds largest utility company and the leader in electricity supply in Europe with revenues of €64.28 billion in 2008. The company has generation capacity of 127GW of across Europe, Latin America, Asia, the Middle-East and Africa. It operates in the UK through its subsidiary EDF Energy. ^[36]

All data is from 2009 from UK business operations.

Market Share

British Gas Residential has a market share of 43.5% in gas and 22.2% in electricity. This makes British Gas the largest supplier of gas and electricity to residents in the UK. This is a result of the decline of wholesale prices and a strengthening of the residential market share. As a result, the company can now be more price stringent in this segment without risk of losing market share. Centrica's focus on preserving its strong market share in the UK makes it less venerable to attacks on its customer base by competitors. ^[62]

In the figures notice Centrica's large power and gas supply market share but smaller generation capacity market share.

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References

1. ↑ Centrica 2008 Annual Report
2. ↑ Centrica: Our Businesses
3. ↑ Centrica 2008 Annual Report
4. ↑ Centrica About Us
5. ↑ Centrica to complete on British Energy investment
6. ↑ Centrica: 2008 Financial Statement
7. ↑ Centrica: At a Glance
8. ↑ Centrica 2008 Annual Report
9. ↑ Centrica 2008 Annual Report
10. ↑ Venture takeover a coup for gas-hungry Centrica
11. ↑ Centrica to complete on British Energy investment
12. ↑ Worldwide Operations
13. ↑ Where We Operate
14. ↑ Centrica 2008 Annual Report
15. ↑ Centrica 2008 Annual Report
16. ↑ British Gas
17. ↑ British Gas
18. ↑ Dyno
19. ↑ Centrica Storage
20. ↑ Centrica Energy
21. ↑ Oxxio
22. ↑ Norway
23. ↑ Centrica Energie
24. ↑ Direct Energy Corporate Profile
25. ↑ Direct Energy
26. ↑ Direct Energy
27. ↑ Centrica to complete on British Energy investment
28. ↑ Centrica About Us
29. ↑ Centrica powers up £725 million (US$1.17 billion) wind farm venture
30. ↑ Fleet Street Invest
31. ↑ Centrica 2008 Annual Report
32. ↑ E.ON Annual Report
33. ↑ RWE Investor Relations
34. ↑ Scottish and Southern Energy
35. ↑ Scottish Power
36. ↑ EDF Key Figures
37. ↑ EDF 2009 Annual Report
38. ↑ EDF Energy Generation
39. ↑ EDF Energy Generation
40. ↑ EDF 2009 Annual Report
41. ↑ Centrica 2009 Annual Report
42. ↑ Centrica: At a Glance
43. ↑ Centrica: At a Glance
44. ↑ Centrica 2009 Annual Report
45. ↑ E.ON Annual Report 2009
46. ↑ E.ON Annual Report 2009
47. ↑ E.ON Statistics: Portfolio
48. ↑ E.ON Annual Report 2009
49. ↑ SSE Annual Report 2009
50. ↑ S & S Power Generation
51. ↑ S & S Generation Portfolio
52. ↑ SSE Annual Report 2009
53. ↑ RWE 2009 Annual Report
54. ↑ RWE Power Generation
55. ↑ RWE Sites UK
56. ↑ RWE 2009 Annual Report
57. ↑ Scottish Power 2009 Report
58. ↑ Scottish Power 2008 Report
59. ↑ Scottish Power Sites
60. ↑ Scottish Power Wind Locations
61. ↑ Scottish Power 2009 Report
62. ↑ Centrica 2008 Annual Report
63. ↑ Centrica 2008 Annual Report