Commercial awareness: think like a professional about... British Gas profit drop

Our banker, lawyer, accountant and consultant take a look at the challenges currently facing the energy industry

British Gas has reported a 30 per cent fall in operating profits since winter 2010. The UK's largest gas supplier made £522 million in 2011, compared to a figure of £742 million for the previous year. The company has blamed the drop in revenues on the fact that the UK's weather in 2011 was milder overall than that in 2010, leading to a fall in UK energy consumption. Improved energy efficiency has also been cited as a reason for lower usage.

British Gas's parent company Centrica, which has owned British Gas since its 1997 demerger from the international exploratory arm now known as BG Group, fared better, reporting a 1 per cent rise in profits for 2011.

However, Centrica's profits are lower than many in the market were expecting. The fact that the rise in profits isn't bigger has been attributed to the costs of changes Centrica is making to its business, and particularly expenses associated with 2,300 redundancies it recently announced. However, these steps should make the company stronger in the medium to long term. The shedding of excess employees is part of a cost-saving initiative that the company hopes will save it £500 million, while structural changes being made to the business mean that Centrica now has a more "resilient model", according to Sam Laidlaw, the company's chief executive.

These changes include the extension of the upstream side of Centrica's operations to offset its less profitable downstream business, of which British Gas is a significant part. To this end, Centrica has increased its oil and gas field holdings by 45 per cent since last year. At the end of 2011, Centrica announced a £1 billion deal with Norwegian national oil and gas company Statoil to purchase its stakes in North Sea oil and gas fields. At the same time, Centrica also entered into a £13 billion supply contract with the Norwegian company. More recently, just before announcing its annual results, Centrica revealed that it had struck a deal with French energy company Total to acquire seven North Sea oil and gas fields, this time for £246 million. The change in focus seems wise: profits in Centrica's upstream business have risen by 33 per cent since the end of 2010.


  • The whole story: Wholesale gas prices are a huge ongoing issue for energy companies, and will have had an impact on British Gas' and Centrica's profits. Energy businesses have to deal with continuous price fluctuations on the commodity markets, where they buy much of the energy that they supply to consumers. Many large energy companies employ teams of analysts and traders to monitor the markets and to buy and sell energy and energy-related derivatives on behalf of the company. They aim to ensure that the company always has the energy it needs to supply its customers at the lowest possible cost. Energy companies might also employ the services of commodities traders at investment banks.
  • Grow your own: Centrica's strategy of striking deals to build its up its own holdings of oil and gas fields to sidestep commodity market fluctuations is a good one. However, I'd question how valuable an asset North Sea oil and gas fields are - although there's plenty left to extract for now, output has fallen significantly since the fields reached peak production in 1999. Nevertheless, the market seems to think these deals are good news for the business - the price of Centrica's shares rose in a falling market following the announcement of the Statoil agreement last November.


  • Bolt for the blue: One of the big shocks for the UK's energy industry last year was Chancellor George Osborne's decision to raise an extra £2 billion by increasing the tax on the North Sea oil and gas industry by 12 per cent, from 20 per cent to 32 per cent. The tax was reported to have led to Centrica's shutting of one of the UK's largest gas fields - the South Morecambe field - for two months over the summer.
  • Nuclear options: Like many businesses, Centrica has tough decisions to make about where to put its money to ensure it continues to prosper in the future. So what is the company doing with its cash? Sam Laidlaw, the company's chief executive, recently stated that Centrica is investing less than it would like to in Britain because of continued uncertainty over government energy policy, particularly the extent to which nuclear energy will be part of the UK's future.


  • Regulation, regulation, regulation: UK energy companies have been in legal hot water with industry policeman Ofgem for some time. British Gas and the other five members of the UK's "big six" energy companies have been accused by the regulator of dominating the country's energy market in a way which violates the principles of EU and UK competition law. Ofgem recently announced plans to force these energy companies to sell up to 25 per cent of their energy in public auctions in order to allow more suppliers to participate in the market.
  • Regulation, regulation, regulation #2: The big six energy companies are also engaged in an ongoing spat with the industry regulator over the way in which they bill their customers. Ofgem has accused these companies of using complex pricing structures as a way to charge their customers excessively high sums. British Gas has countered that Ofgem has failed to take discounts and other benefits offered by energy companies into account when calculating the cost of their tariffs to consumers. Ofgem, however, continues to claim that British customers want easy to understand energy bills to make comparing suppliers easier, and is pressing for new rules on the issue.


  • Three-second memory: Centrica's current restructuring is just the latest phase of a much longer reorganisation process, which has seen the business morph from a state-owned utility company into its current incarnation as a large plc. British Gas plc, the descendant of the formerly publicly-owned entity, demerged in 1997 into Centrica and BG Group which, broadly speaking, took over the domestic and international branches of the business respectively. Centrica initially tried to diversify out of the energy business through assets such as the Goldfish credit card business and telecoms operator OneTel before settling on its current strategy of focusing on the energy sector.
  • Lofty ideals: British Gas has attracted some good publicity recently through a clever initiative. They're offering £50 to anyone who gives them details of an elderly person or a family on benefits needing to have their home insulated. They'll then carry it out for free and give the beneficiary £50 too. It sounds very noble - but it's actually a good strategic move for the business. Energy companies are coming under severe pressure from the government to meet insulation targets as part of the government's commitment to halve carbon emissions by 2025, and it would cost companies like British Gas much more than £100 to locate appropriate households themselves.