Centrica Building a North American Retail Power Relationship Future

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Researched by Industrialinfo.com (Industrial Information Resources, Incorporated; Houston, Texas). Deregulation is not just another word in the burble of a circular dialogue between government authorities and the power production industry. It is a force precipitating the arrival of the results of a fairly visible hand moving the generation and transmission markets.

If you generate power you must distribute/transmit it. If you transmit power you must have large wholesale clients and drop off terminals/nodes. If you are a power wholesaler, provider, or both, you must have the means to retail/market the power to the end user. Spared the intervention of middlemen spinners and round trippers this is not rocket science. The story below of the Centrica-ATCO deal has some interesting pointers on how deals will shape the market, and the company players involved.

The speed with which customers can be switched from regulated gas and electricity supply contracts, where energy is supplied at break even, to profitable fixed price unregulated contracts retained over the long term, is a key driver behind a $82.5 million deal in which Centrica plc (LSE:CAN) (Windsor, United Kingdom) will acquire the retail gas and electricity supply business of the ATCO Group (TSX:ACO) (Calgary, Alberta). The price of the deal is equivalent to around $83 per customer for ATCO's 988,000 strong user list.

The government of Alberta is committed to choice for consumers and is expected to foster an environment that is favorable to competition. Centrica noted in its interim results in September that although many states and provinces in North America remain committed to effective energy deregulation the pace has generally slackened and this has resulted in a slower rate of organic growth in customer relationship numbers. Centrica aims to grow a substantial North American business both organically and through acquisitions, focusing, as always, on value creation.

In Canada, Centrica's Direct Energy business will become the largest supplier of energy and services to homes and small businesses with almost 4 million customer relationships. Centrica has been expanding in Canada since acquiring Direct Energy this year. The company supplies natural gas to more than 1.3 million households in Ontario and Manitoba. But the company now faces several years of Ontario government-imposed price caps on electricity, making it more attractive to expand outside of Canada's most populous province.

The Acquisition of the ATCO business will boost Direct Energy's customer base in Canada to 2.8 million households, making it the biggest provider of retail services in the country. Following the completion of the ATCO deal, which is expected to close in mid 2003 after regulatory approval, Direct Energy will become the largest supplier of energy and services to homes and small businesses in Canada, with almost 4 million customer relationships. With the purchase of 860,000 AEP customers in Texas, expected to be completed by the end of 2002, Centrica will have almost 5.5 million customer relationships in North America.

Centrica's 10 year exclusive agreement with ATCO's I-Tek subsidiary includes the provision for customer care functions, including call center, billing, credit and collections services. The contract includes a five-year break clause under which Centrica has an option to exit the contract at a cost of $30 million. This cost reduces over time after the first five years. There are also opportunities to realign pricing of the contract in line with market rates. I-Tek was developed by ATCO to provide customer care and billing for ATCO's regulated customers. I-Tek will not be allowed to provide billing or care services to any of Direct Energy's competitors in Alberta.

ATCO says the sale will allow the company to focus on power production and their gas wholesale business. With the onset of deregulation ATCO analyzed core strengths to create a focus on opportunities to add value for shareholders in the new marketplace. The result was that their core confidence was that they were good at building power plants, very good at building and maintaining transmission lines and pipelines and that the company was good at industrial infrastructure. With these positive core recognitions came the realization that they did not have any retail skills in-house. In addition ATCO's shareholders enjoy the stability that comes from 60% of earnings being derived from regulated operations and do not appear to have the appetite for the risk that is inherent with energy retailing.

ATCO, which is the main regulated gas supplier in Alberta, supplies natural gas to approximately 80% of Alberta's consumers (About 821 000 regulated consumers) and electricity to around 14% of the market (167 000 regulated consumers).

The announcement in November by the Ontario government that it would cap electricity retail prices until 2006, at a time when projected electricity shortages were expected to drive up spot prices, was an obstacle for energy wholesalers but a windfall for energy retailers who are entitled to rebates from the government.

Centrica is a provider of energy and other essential home services. In the United Kingdom it offers gas and electricity supply and related products under the British Gas brand, roadside and financial services from the AA (Automobile Association, a customer service related entity if ever there was one), telecom products, and financial services. The company turned over more than $19 billion in 2001.

ATCO is engaged in power generation, logistics and energy services, utilities and industrials. In 2001 it had revenues of around $2.4 billion.