Fitch: SSE Price Freeze, Market Probe Underline UK Utility Risks

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March 28 (Reuters) - (The following statement was released by the rating agency)

SSE (LSE: SSE.L - news) 's decision to freeze prices and regulator Ofgem's proposal for an investigation of the UK energy market underline the political risks facing energy suppliers, Fitch Ratings says. The investigation also increases the potential for break-ups in the long term, particularly for market leaders Centrica (LSE: CNA.L - news) and SSE. These risks are credit negative for both companies. The investigation would be carried out by the Competition and Markets Authority and would probably conclude around November 2015. But political risk may remain high even while it is ongoing, because public trust in energy suppliers is likely to be a focus of the general election in May 2015. SSE's decision to freeze prices until 2016 effectively mirrors Labour's price freeze proposal made last September, and other energy companies may face pressure to match SSE's commitment. Ofgem's case for proposing an investigation was based largely on surveys showing that 43% of consumers do not trust energy companies, up from 39% a year earlier, despite reforms intended to improve market transparency.

Ofgem suggests vertical integration between generation and supply is a barrier to entry, as new entrants need to post significant collateral to trade on wholesale markets. This is truer of electricity, where the big six own 70% of generation capacity, than gas. The case that vertical integration reduces competition to the extent that it requires companies to be broken up is far from proven. Nevertheless, in a bid to restore public trust SSE has also announced plans for a legal separation of supply from generation. Centrica too faces increasing shareholder pressure to consider a potential break-up because of UK political risk affecting valuation.

For Centrica, a break-up of UK generation and supply would increase earnings volatility and raise the cost of capital, particularly in terms of credit support for financial commitments for gas supply contracts. SSE's price freeze will be partly funded by lower gas costs and cuts to opex, capex and asset disposals. But if its freeze raises pressure on the others to follow suit industry supply margins could drop from 4%-5% to 2%-3%. This is a further potential negative for Centrica, despite its recent acquisition of Bord Gais, which brought some risk diversification.