Is utilities sector the place to go for income and safety?

Rising debt and other costs plus government interference have made this year tougher for the usually reliable utilities sector. But our City writer finds reason to be cheerful. 

An unusually volatile year for power firms National Grid (LSE:NG.) and SSE (LSE:SSE) looks to be ending favourably after new price controls were viewed as being on the generous side.

The shares have risen since yesterday’s determination for electricity distribution networks saw Ofgem increase the allowed return on capital to 3.9% from 3.3% at the draft stage.

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That compares with consensus estimates for 3.6%, although analysts at Deutsche Bank noted that the better-than-expected result needed to be set against the recent rise in costs.

The settlement covers 14 electricity distribution networks, including the four owned by National Grid and SSE’s in the north of Scotland and in central southern England.

Owners of the networks are remunerated according to a framework set by Ofgem, which determines an annual allowed level of required capital expenditure and operating costs in order to meet the required network outputs.

The regulator told the six companies involved, which also include Scottish Power owner Iberdrola SA (XMAD:IBE), that the plan covering 2023 to 2028 is “critically focused” on a drive to move away from importing fossil fuels and reliance on expensive gas.

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Ofgem said the investment would be delivered without any increase in network charges on bills, which will remain at an average of £100 per year per bill payer.

The allowed capital expenditure of £22 billion is 5% higher than in the draft documents, but 12% lower than companies requested in their business plans. However, UBS points out that the figure is still 17% higher than the last price control period on a like for like basis.

The City bank said National Grid’s allowed expenditure rose by 7.1% versus the draft and return on equity was higher than requested in the business plan. SSE’s allowed spend rose by 9.2% against the draft but the allowed return was lower than requested.

The companies are now examining whether to challenge the determination, but UBS notes their initial responses contrast to previous statements which have been stronger in tone.

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Deutsche Bank described the proposals as better than expected, noting Ofgem’s willingness to adjust its methodology to take into account the sharp change in market conditions.

Firms have been buffeted by rising debt and other costs this year, as well as the threat of interventions from governments looking to claw back windfall power gains.

Chancellor Jeremy Hunt revealed a 45% levy on renewables, biomass and nuclear generators in last month’s Autumn Statement, but the move to raise a potential £14 billion between 2023 and 2028 was seen as being less onerous than many feared in the City.

SSE shares have risen by around 6% to 1,749p in the two weeks since Hunt’s statement, with sentiment further helped by signs that the current wave of interest rate rises should end in the first quarter of next year.

In a sector favoured by investors for its dividend income and predictable returns, SSE’s shares have traded in a broad range between 1,900p in May to just above 1,400p in October.

They are now back in positive territory for the year, having risen after bosses said the £1.5 billion sale of a 25% stake in Scottish Hydro Electric Transmission would unlock further growth as part of a drive to become a “clean energy champion”.

Deutsche Bank recently highlighted a target price of 1,900p for SSE as one of the integrated energy players whose earnings projections are still higher than before the energy crisis.