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Brexit deal defeat raises prospects of nationalization for UK utilities

Regulated utilities in the U.K. including National Grid PLC and SSE PLC could be increasingly at risk of being nationalized under a Labour government after Prime Minister Theresa May suffered a historic defeat in Parliament over her proposed plan for leaving the EU.

Lawmakers rejected a deal hammered out between negotiators in Downing Street and Brussels by a large margin in a so-called meaningful vote Jan. 15, adding more uncertainty to the process for the country's exit from the bloc by an end-of-March deadline. May's Conservative government now has only several days to return to parliament with an alternative plan.

Meanwhile, Labour leader Jeremy Corbyn has tabled a vote of no confidence in the government, which will be held at 7 p.m. U.K. time on Jan. 16. The opposition leader has so far resisted backing a second referendum on Brexit, which some in his party favor, and is instead trying to force a general election. This remains a possible outcome of the vote, although May is seen as likely to win the contest by a slim margin, with full backing from her Conservative colleagues and members of the Democratic Unionists, the Northern Irish party that supports the prime minister on key votes, the Financial Times reported.

Nevertheless, the specter of new polls could spook some investors after John McDonnell, the Shadow Chancellor of the Exchequer, reaffirmed only months ago that Labour would renationalize energy and water networks if it was swept back into power. "We are extending economic democracy even further by bringing water, energy, Royal Mail and rail into public ownership," McDonnell told a Labour party conference in September 2018.

That possibility led equity analysts at UBS to downgrade SSE from 'Buy' to 'Neutral' Jan. 16 after Parliament struck down May's Brexit deal. Although other factors, such as a recently failed plan to demerge its retail unit, also played a part, the analysts indicated they lowered their rating of the utility in large part because of the downside posed by a Labour administration.

"We suspect the street takes nationalization risk too lightly, and we believe this risk may weigh on the shares until the next U.K. general election, or beyond," the analysts wrote in a note to clients on Jan. 16. SSE operates power transmission and distribution networks in parts of England and Scotland and owns a third of the country's second-largest gas distribution network company.

If a general election is called, UBS expects a potential impact of up to £1.70 per share from their lowered target price of £11.90 for the company. Surveys carried out by BMG and Survation this month showed that voters in the U.K. were either equally likely to vote for the Conservatives and Labour or favored the Conservatives by only 3 percentage points in case of a snap election.

National Grid's larger power and gas network is also at risk, while water companies Severn Trent PLC, United Utilities Group PLC and Pennon Group PLC were also flagged by UBS analysts as carrying downside potential due to Labour's plans.

Analysts at S&P Global Ratings estimated in a report published in December that carrying out the nationalization of utilities would roughly cost between £140 billion and £160 billion, corresponding to the regulated asset value of the companies.

But the rating agency cautioned that "there are significant uncertainties about the upfront costs associated with the policy, the source of financing those costs, the timing of the policy's implementation, the nature of the regulatory framework, and how the utilities would be managed post nationalization."

Water companies represent the biggest chunk of a potential nationalization bill, at £70 billion, followed by £55 billion for gas and electricity distribution and £20 billion for transmission companies. But high premiums of up to 50% above the regulated asset value that have been achieved in recent sales of regulated utilities in the U.K. could push the upfront costs significantly higher for the country, S&P Global Ratings said.

Lawyers at London law firm Clifford Chance have said the technical and political hurdles standing in the way of a law for nationalizing the companies would be immense, however. In addition, investors would be highly likely to sue in order to ensure adequate compensation.

"Any nationalization that does not provide full market value compensation, or is otherwise perceived as unfair, will almost certainly be challenged," the lawyers wrote in a briefing published in March.

If Theresa May survives the no-confidence vote, a general election could also become more likely if no alternative deal is reached or the government is forced to delay its exit past March 31, although some investors think the defeat in parliament will lead to a softer Brexit, with a higher possibility of the U.K. remaining in a customs union or a second referendum overturning the decision to leave altogether.

An orderly exit is seen as vastly more preferable for the economy and a split without a transition deal could have specific negative consequences for the energy sector, from hindering electricity trading to impeding funding for infrastructure and clean energy projects, despite contingency planning by the government for such a scenario.

The government's defeat means that "a no deal Brexit remains a real possibility," Bronwen Maddox, director of the Institute for Government think tank, said in a statement after Tuesday's meaningful vote. "Our work shows that the government is woefully underprepared for such an outcome."

S&P Global Market Intelligence and S&P Global Ratings are owned by S&P Global Inc.