National Grid / Ofgem and Royal Dutch Shell

“Further weakness in oil prices has served to weigh on shares in the oil sector and by default pull down the FTSE 100. Any movement in Royal Dutch Shell and BP have a direct influence on the direction of the blue chip index because they are among its largest constituents. “The FTSE 100 dropped 0.7% to 6,727 in early trading, also dragged down by weakness in mining, utility and tobacco stocks. Markets in Asia and Europe were also weak,” says Russ Mould, Investment Director at AJ Bell.

National Grid / Ofgem

“Plans by energy regulator Ofgem to cut the cost of capital for networks as part of a shake-up of the energy system is negative for investors who own shares in certain parts of the utility sector.

“Energy distribution group National Grid, loved by many investors for its dividends, is particularly affected by the announcement. “Power generation is a free market in most parts of the world, yet regulated utilities’ earnings are usually decoupled from demand, in theory substantially reducing risk.

“Someone like a gas pipe owner would effectively receive back their capital investment over the lifetime of the asset through a tariff set by the regulatory formula, plus receive a rate of return set by the regulator and adjusted over time to take into account movements in interest rates.

“Returns are usually inflation-linked in that most regulation is carried out on a real rather than nominal basis.

“Ofgem says its new proposals will lower returns for investors and generate more savings for consumers. National Grid is not happy, saying the proposed finance package doesn’t reflect the level of risk borne by transmission networks.

“The consensus analyst forecast is for National Grid to pay 48.9p per share in dividends for the financial year to March 2020, implying a 6.1% yield. One could expect dividends beyond 2021 to potentially be less generous should Ofgem’s proposals be finalised without any amendments.

“It shows that even the most defensive companies are still at risk from regulatory changes.”

Royal Dutch Shell

“Market speculation of an $8bn bid for US-based oil company Endeavor Energy by Royal Dutch Shell offers several useful insights into both the wider sector and Shell itself.

“Since buying BG for the best part of $50bn in a 2016 deal, Shell has been selling off assets and if the reports prove correct the acquisition of Endeavor would represent the most material acquisition since BG and a potential gear shift from consolidation to growth.

“The mooted price tag is also interesting. It is a long way short of the $15bn that was apparently expected from a sale of Endeavor when the privately-held firm put itself up for sale earlier this year.

“This reflects the impact the recent crash in the oil price might have had on confidence in the sector. It might also be a reason this prospective transaction doesn’t happen and why anyone hoping for more widespread industry M&A could end up being disappointed.

“Agreeing a fair price for an oil and gas takeover is tricky when commodity prices are volatile as the selling party will be very wary of being cheated by a short-term slump and looking silly if prices recover. The exception is when the seller’s hand is forced by a stretched financial position.”

These articles are for information purposes only and are not a personal recommendation or advice.