the times | Tuesday July 28 2020 1GM 37

CommentBusiness

BP once made its green move too

early. Now it can’t afford to be late

O

f all the ways to measure

the precarious state of

the government’s

balance sheet, the one

that gets the least

attention is the whole of government

accounts (WGA). Which is odd,

because it subjects the government

to the same standards as a private

company.

The WGA is by no means a

perfect measure. Future public

sector pension liabilities are

capitalised because they are a

contractual obligation but spiralling

NHS costs are not, because the

promise of healthcare is only

implicit, for example. But it is more

complete than the monthly public

finances, with their restricted

definition of borrowing and debt.

The gaping hole in the monthly

data is the cost of those public sector

pensions. Every WGA release is a

reminder of how expensive they are,

how the young are having to

mortgage their futures to pay for

benefits most will never enjoy, and

how reform is vital.

The latest update, for 2018-19, has

some startling revelations. For the

first time, the payroll cost of the 5.3

million public sector workers is the

largest single government expense.

At £256 billion it is bigger than the

£230 billion social security bill for

state pensions and welfare. Two

fifths of that, £96 billion, is the cost

of servicing the 5.3 million pensions.

The accounts also include an

estimate of the net public sector

pension liability for 2019-20. An

increase of £350 billion to

£2.25 trillion is expected, taking it

far above the national debt that year

and even above forecasts for this

year after the coronavirus bailout.

There is no pot of money to cover

the cost; taxpayers will simply have

to pick up the bill. What makes the

schemes so expensive is that they tie

pensions to salaries. Such generous

defined-benefit guarantees have

vanished from the private sector,

where staff have to save up to buy an

annuity or property for their

retirement income. In a world of

tiny returns, this is storing up

pension inequality. An employer

may pay 10 per cent of an employee’s

salary towards their pension but, the

WGA reveals, the promises to public

sector workers are equivalent to 40

per cent of their wage. For a worker

on £30,000, that’s an extra £9,000 a

year. An unrecognised wage top-up

for the public sector worker. All

covered by future taxpayers.

The government tried to grapple

with the spiralling costs of public

sector pensions in 2015 by aligning

the retirement age with the state

pension, increasing employee

contributions and switching from

final salary to career average

benefits. Some of the savings were

wiped out after a court ruled this

month that the reforms

discriminated against younger

public sector workers. The Treasury

says the cost will be £17 billion. The

WGA says it is £31.8 billion.

Even so, the government’s 2015

efforts were blown away by falling

market interest rates, which drive

up long-term pension costs. The

“discount rate” used to calculate the

pension liability for 2019-20 will be

-0.5 per cent, the first time it has

been negative. Far from shrinking

since the 2015 reforms, the pension

sector pension liability has risen

50 per cent.

A rise in market rates would fill

some of the hole but the public

sector wage top-up would still be a

multiple of any private scheme and

the risk to future taxpayers would

remain. To control those costs,

something else is needed.

John Ralfe, an independent

pensions expert, has proposed a

hybrid system, with an initial wage

earning defined-benefit perks and,

above that threshold, contributions

made into a savings pot like private

schemes. Universities already do

this. Only the first £60,000 accrues

defined-benefit entitlements. The

public sector would still have better

pensions than the private sector but

costs would be lowered for future

taxpayers. Is the government brave

enough to take on the public sector?

Philip Aldrick

In business it is not

enough to have the

right strategy. You

need to get the

timing right too.

Twenty years ago last week BP was

rebranded as Beyond Petroleum as

John Browne (now Lord Browne of

Madingley) sought to turn the oil

giant into a leader in the transition to

a low-carbon future. It was the right

strategy. But he was too early. His

efforts to build a big business in

alternative energy fizzled out and

most of it was sold off or closed down

by his successor.

BP eventually stepped up

investment in renewables again and

its new boss, Bernard Looney, is

facing calls to sell some of the assets

once more. This would be a different

kind of sell-off, one designed to help

the business to grow, not shrink. The

idea would be to demerge the

alternatives business into a separate

company and float a minority stake

on the stock market.

Such a rejig should deliver a quick

boost for BP’s long-suffering

investors, who have watched the

share price sink to levels not seen

since 1996. “You would see a massive

change in the valuation of the two

businesses,” says Charles Donovan,

director of the Centre for Climate

Finance and Investment at Imperial

College Business School.

The reasoning goes that the value

of BP’s biofuels, wind and solar assets

(which green investors would love to

own) is hidden within the oil and gas

group (which many investors would

not buy at any price). The spun-out

renewables arm would command a

much higher price relative to its

earnings and the implied value of the

retained stake would be reflected in

BP’s own share price.

This is a time-honoured manoeuvre

for mature companies that want to

highlight a fast-growing new business

while hanging on to most of the

upside. Readers with long memories

will recall Racal’s partial flotation of

its Vodafone mobile business in 1988

and Dixons’ spin-off of its Freeserve

internet start-up at the height of the

dotcom bubble in 1999.

Some observers see equally bubbly

valuations these days among

companies that investors bet will be

winners in the new low-carbon

economy. Tesla, the electric carmaker

now worth more than triple the big

three US auto giants combined, is

only the most extreme example. Even

long-established renewables

businesses in wind and solar are being

bid up by investors and some of BP’s

European oil rivals are said to be

contemplating demergers to take

advantage of this enthusiasm.

This month Aker Solutions, a

Norwegian energy engineering group,

announced plans to demerge its

offshore wind and carbon capture

arms into a separately listed company.

Its shares are up more than 50 per

cent on the news. Oyvind Eriksen, its

chairman, explained that “renewables

and green technologies have entirely

different value chains, customers,

investor bases and sources of

funding” from its oil services business.

Although there is not an exact

parallel between energy services and

energy production businesses, many

observers, including Lord Browne

himself, think a similar demerger

would probably be the right move for

BP. But once again it is a question of

timing. “There may well come a time.

But I don’t think the time is now,”

says Lord Browne, who is chairman of

L1 Energy and (until September)

Huawei UK. He believes the business

is too small and incoherent and fears

that a spin-out could be interpreted as

a first move towards a complete exit.

Bruce Duguid, head of stewardship

at Federated Hermes, which has been

leading investor pressure on BP over

climate change, says a demerger

could be good for shareholders in the

short term. But for now there would

be a long-term benefit from keeping

full ownership of what is still a

relatively small business, accounting

for less than 5 per cent of BP’s

investment, and making use of the

expertise of the oil and gas business.

A spin-out would still be able to tap

the skills on the oil and gas side

according to Jason Gammel, an

energy analyst at Jefferies, but he

agrees it is too soon to demerge what

is still “a very immature business”. He

points out that BP has yet to

“articulate their strategy for the low-

carbon businesses”, which may come

at a presentation in September.

According to proponents of a

demerger, one of the benefits would

be that the spun-out business would

enjoy a lower cost of capital which

would justify investing in some

renewable schemes that would not be

viable for the BP group.

Sam Arie, head of European

utilities research at UBS, is sceptical

about demerging new renewables

companies simply to reduce their cost

of capital. Project finance and green

bonds already give the oil majors

access to very low-cost debt for clean

energy projects, he says.

For him, the crucial question is

whether shareholders can exert

enough pressure to accelerate the

shift in capital allocation from fossil

fuel projects to clean energy.

Mr Donovan argues that this will

only happen at BP if the renewables

business is spun out. And he speaks

with some authority as he was a

senior executive in BP’s alternative

energy arm when a previous plan to

demerge the business was derailed by

the global financial crisis.

Citing the famous failure of Kodak

to capitalise on its lead in digital

photography, he says that time and

again mature companies have

struggled to develop upstarts that are

“inevitably about the decline” of the

original business.

Supporters of a demerger say it

would deliver transparency about BP’s

alternatives ventures and counter

accusations that they are just a

“greenwashing” PR campaign.

There is pressure on Mr Looney to

pull something out of the hat and Mr

Donovan predicts that BP will

announce a spin-off by the end of the

year. Otherwise it will surely not be

long before one of its European rivals

gets in there first.

Having turned up

to the party too

early 20 years ago, it

would be a shame if

this time BP is late.

‘‘

’’

David Wighton, a former business

editor of The Times, is a columnist

for Financial News

Patrick Hosking is away

Philip Aldrick is Economics Editor of

The Times

Wanted: brave minister

to deal with runaway

public sector pensions

BP could attract investors by floating

its clean energy arm as a new entity

Discount rate trend

2.5

2.0

1.5

1.0

0.5

0

2,000

1,500

1,000

500

0

%

£bn

*for four largest schemes Source: HM Treasury

2012-13 14-15 16-17 2018-19

Public sector pensions

liability, £bn

Discount rate

net of CPI

(pa)*, %

David Wighton