British Energy poised to profit from next generation game

BRITISH Energy pulled off the unlikely trick last week of announcing a barnstorming 145% rise in profits and ending up the biggest loser in the FTSE 100.

Britain's biggest nuclear generator said on Wednesday it might miss its output target for the year - the third year in a row that BE has cut its output goal - and the City was not at all happy about it. Shares closed down more than 4.5% on the day and investors' concerns about the money BE is losing in lost electricity production will be ringing in the ears of group chief executive, Bill Coley, for some time.

Analysts praised the Livingston-based group's financial performance, with pre-tax profits jumping seven-fold to £210m, but one said the results raised "concerns about BE's long run operational performance" while another said it raised questions about the credibility of management.

Lakis Athanasiou, analyst at Collins Stewart, said: "The results were fine. Power prices have risen, so revenues have risen. The main problem was the high level of unplanned losses. Coley and his team are spending a lot more than the old management [on reducing the losses]. We thought we had seen the back of large unplanned losses."

Coley, who joined BE last year from US energy giant Duke Power, said: "I am pleased with our financial results benefiting from strong electricity prices. However, I am not pleased with the level of unplanned losses."

The American is trying to shake off BE's reputation as a "basket-case" after the group shocked the market in 2002 with a warning that it was facing insolvency. At the time, the former FTSE 100 company blamed a combination of high fixed costs at its stations and low power prices, as well as a high level of unscheduled outages for its predicament. Faced with the prospect of one of the country's most strategically important businesses falling into administration, the government stepped in with a £5bn rescue package. A controversial £1bn debt-for-equity swap was arranged - resulting in millions of pounds of shareholders' funds being wiped out - and BE re-listed on the stock market in January 2005.

Coley has focused on ensuring the smooth-running of BE's eight nuclear power stations, including two in Scotland - Torness in East Lothian and Hunterston B in Ayrshire - and one coal-fired plant at Eggborough in Yorkshire.

His efforts have benefited from the sharp increase in electricity prices, which has driven up the amount BE can charge customers. In the three months to July 2, the company was earning £35.9 per megawatt hour (MWh) for the power it sold, up £11.2 per MWh from a year earlier. BE has also sold 76% of the planned output for the current financial year at an average price of about £44 per MWh.

But the price you can charge for your products means little when you are having trouble making them.

Coley said last week that its output target of 63 terawatt hours for the year to end-March 2007 looked "challenging" and that a lower target of somewhere between 61 TWh and 63 TWh would probably be easier to reach, especially when "human performance improvement remains a specific area of focus".

Nuclear power accounts for almost a fifth of the UK's electricity but this is likely to drop to just 6% by 2020 as plants gradually go out of service. With energy usage expected to rise, the government is faced with tough choices about how to meet growing demand and at the same time appease public opinion, much of which remains to be convinced about the safety of nuclear generation.

The government's energy review concluded last month that nuclear would have a major part to play meeting the country's future energy needs. Last month Trade and Industry Secretary, Alistair Darling, said: "Our analysis suggests that, alongside other low carbon generating options, a new generation of nuclear power stations could make a contribution to reducing carbon emissions and reducing our reliance on imported energy."

Part of this process involves extending the life of existing plants and BE is investing heavily to slow the process of decommissioning and said last week it would invest £250m to £300m this year.

BE, which generates one-fifth of the UK's electricity, is also expected to have a major role to play in the process of building the next generation of nuclear stations - assuming management can demonstrate that they are up to the task.

Edmund Reid, analyst at Cazenove, said: "The new management team has consistently missed its output targets over the last three years and there is probably an issue of credibility. It may be slightly unfair to judge them on output this year, given there is still quite a lot of ongoing work on the plant."

Analysts believe BE would have few problems raising finances to pay for the next generation of nuclear plants if, as is likely, it is involved. Coley told Scotland on Sunday in December that institutions are waiting until after the outcome of the government's review of the nuclear industry before deciding whether to pump billions into building the next generation of nuclear reactors.

The government's decision to give the green light to new build nuclear is likely to lead to increased interest in Britain's nuclear energy market from BE's rivals, including France's EDF and Germany's E.On.

Athanasiou said: "The Germans and French are very keen on new build in this country. I have no doubts that behind closed doors, there's a lot of discussion going on between EDF, E.On, British Energy and the government. BE has a big advantage in it has the sites and the connections."

One legacy of the government's bail-out of BE is a complicated financing system, which results in 65% of BE's earnings above a certain level being paid to the Nuclear Decommissioning Fund.

Gordon Brown, the Chancellor, said in March the government was prepared to sell part of its stake in BE and a decision would be made after the six-month-long energy review. The sale could raise anything between £2bn and £6bn and is expected to take place next month or in October.

BE said it would review its dividend policy when the government confirms a buyer for its stake.