Tonight:
5°c
People still have not really grasped how the shortage of capital has changed the world. If they engage with the subject at all, they seem to think it is a problem for the banks, and to a lesser extent the other players in the financial sector.
But the fact is that all economic activity needs capital to some extent. If it becomes scarce and costs significantly more - as it has - it affects the pricing and cost structures of every business, every product and every service throughout the economy. If the shortage and the repricing persists - as it may well do - it will force a change in the relationship of supply and demand in every area of economic activity. In some cases, the effects will be dramatic.
This poses a threat to businesses as far away from banking as it is possible to imagine - like, for example, the water industry. Now whatever customers think about their water supply - its taste, its security, the level of customer service or the cost - what they are most likely to be completely oblivious of is that it is an industry which lives on debt.
It was privatised 20 years ago, because the investment it needed was so massive that government simply did not know where it could find the money. The newly privatised companies rose to the challenge, became some of the biggest UK borrowers in the capital markets and - in the past two decades - have taken on literally billions of pounds of debt.
The point here is that the water companies have been able to finance the necessary investment, pay dividends to their shareholders and deliver relatively low bills to their customers only because debt has been cheap and plentiful. There is not enough money from other sources.
The challenge for them going forward is that they will have to continue to invest - in a world where capital may be neither cheap nor plentiful - to continue modernisation, combat leakages and enhance security of supply, even before they start to cope with the challenge of climate change and flooding. If the cost of capital soars, something is going to have to give. Extra money will have to come from somewhere, but will this mean raising consumer prices, cutting dividends or scaling back levels of investment?
These are the huge issues which lie behind some seriously arcane documents - such as the paper this week from Severn Trent on its "weighted average cost of capital", a key benchmark for the industry regulator in setting the allowed return on water companies' regulated capital value.
In plainer terms, this means that if the regulator agrees - when he does the sums later this year - that companies have to pay more for their capital, they will be allowed to charge more to the customers. Not much risk of deflation here, then.
Reasons to cheer the Premier deal
Recessions go through phases. Once companies realise they are in trouble and their banks are not in a position to help them or are unwilling to do so because they feel the company has already borrowed enough, we have the season of the rescue rights issue.
This is the ritual whereby financially embarrassed companies go to their shareholders to ask for more capital, and the shareholders choose between those businesses they are prepared to rescue, and those they think best left to their fate.
This is the phase we have been in for some months, and may be for some months more. But it is worth noting that it is not quite so rational as lovers of efficient markets would have us believe. The theory is shareholders will put more money into businesses they think will have a prosperous future once they are properly financed.
Unfortunately, however, evidence suggests many of the firms thus rescued continue to underperform. Academics who have studied the subject would have us believe that in a lot of cases shareholders would be much better off putting their money somewhere else.
Be that as it may, rescue rights issues give way in time to capital raisings, where the money is needed to finance expansion, or more commonly to acquire a distressed competitor. This signals a moving-on of the recession from rescue towards recovery.
We had an example yesterday when Premier Oil raised several hundred million pounds to buy at a bargain price the North Sea assets of a bankrupt rival. In doing so, it demonstrated three truths that tend to be forgotten in times like these.
First, there usually is money somewhere to back the right deal. Second, even if companies fail, their best assets often get recycled. Third, hard times throw up unrivalled opportunities for good companies. That's three reasons why Premier's deal gives us all something to be cheerful about.
