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The Times: Energy winners are tough to call

Saturday February 17, 2007

Graham Searjeant, Personal Investor

Energy is the most confusing sector on the stock market. Oil prices are still fluctuating wildly. Gas prices spiked last year and now Centrica’s British Gas is cutting prices by 17 per cent to stem the loss of customers. It is benefiting from new supplies from Norway. As pipeline networks spread, however, even UK prices will depend on Russia, just as the price of North Sea oil depends on Saudi Arabia.

Oil shares, top dogs in the previous two years, fell away last year. BP, for years the one to follow, started panting like an exhausted hare while Royal Dutch Shell, having updated its financial structure, is edging back to its accustomed role as the reliable tortoise.

The counterpart to these oil and gas price movements has been British Energy, operator of the UK’s second and third-generation atomic power stations. Four years ago, when oil and gas prices were low, it had to be rescued. The Government took a right to most of its cashflow and the banks nearly all the shares. It relaunched two years ago with a value of £1.4 billion, which trebled to £4.3 billion last summer, only to fall back to £2.3 billion.

These fluctuations seem mere comedy interludes in the great global energy drama to be played out over the coming decade. Energy demand is projected to surge by 50 per cent in 25 years, making China and India the biggest power users, mainly by burning more coal. Yet the global political priority, exemplified by the Stern report, is to cut emissions of carbon dioxide from electricity generation and transport through taxes, subsidies, regulation and carbon markets.

Expansion offers investment potential. Restructuring energy markets is bound to inject more risk. These forces will conflict but both require massive capital spending. The International Energy Agency suggests that £12,000 billion will be needed over 25 years, half to expand output and half to replace existing energy sources.

How will this be met? The more uncertainty lingers over regulation and prices, the less likely investors or companies are to make massive commitments. Will gas, the dominant UK power source, retain government approval, as in the 2003 White Paper, or be damned in the next one?

Most European electricity generators are backing wind power but on a small scale relative to existing operations. British Energy may need to replace all but one of its plants in a decade to keep its market share. That looks impossible because ministers have only just come round to keeping this noncarbon power. The group cannot finance replacements by itself and partners will want atomic power to have a guaranteed place, like wind power, in the next Energy White Paper.

This week British Energy rather desperately invited interest from private equity houses. Electricité de France looks better placed but state holdings overhang the market.

No wonder Lehman Brothers favours nonenergy businesses that adapt faster and better to new conditions and steal a march on competitors. If being ahead of the game were the only test, however, tobacco shares would not have enjoyed their recent success.

Barclays Capital argues, conversely, that there needs to be a boom in energy profits to finance all this spending. The longer that investment is delayed by uncertainty, the worse the shortage, the higher the prices and the bigger the boom must be. In the 1970s, an era of oil shortage, oil and gas was one of only three UK equity sectors to make significant real returns, the only bigger winner being banks.

Given the uncertainties of pricing and policy affecting UK utilities, however, big oil looks the safest bet to hedge against shortage and new fuels. That is hardly green.

The prospect of huge capital spending is often a sell signal. The biggest returns to investors are in discovering oil or gold, not extracting it. If there is to be a boom, it is more likely to be among high-risk innovators quoted on the Alternative Investment Market (AIM). There have been plenty of big winners recently, not just in exploration. The American companies Clipper Windpower and Renova Energy (which is in ethanol) have multiplied their opening AIM prices. So has a Chinese solar power venture.

Others, often at the bright idea end of the market, have been big losers. Significantly, Ensus, which tried in November to become “the first UK-based bioethanol-producing company to list on AIM”, has yet to raise the necessary equity capital from institutions. Perhaps it should have asked private investors.

Benefiting from this boom will not be straightforward. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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