How to profit from rising energy prices
By
Simon Wilson Oct 31, 2005
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Your utilities bills may have shot up, but energy price hikes are good news for UK utilities, says Simon Wilson.
The era of cheap power, it seems, is well and truly over. Already reeling from the effects of soaring petrol prices, British households came back from their summer holidays to a new round of painful hikes in domestic fuel bills. Two weeks ago, British Gas announced that it was raising domestic electricity bills by 12.4% and gas bills by 9.4%, due to take effect this week. Since then, nPower and Powergen have announced similar inflation-busting price rises, with other suppliers sure to be following close behind.
For many gas and electricity users, this will be the second price hike this year, following rises of between 5% and 15% in the spring, and the effect on household finances will be significant. In 2003, a family of four was paying on average £356 for gas and £243 for electricity each year, notes Allan Asher, chief executive of industry watchdog Energywatch. But according to some estimates, following the latest price rises, that same family will pay around £900 a year - a startling 50% extra.The industry puts the blame for the price hikes squarely on rising wholesale energy prices. There is undoubtedly some truth in this. Gas prices have risen this year in line with the oil price, with forward gas prices currently up 50% on last year. And because about 40% of UK electricity is generated by gas-fired power stations, this has inevitably raised the amount paid for electricity.
But business and consumer watchdogs are sceptical that rising wholesale gas prices are solely to blame. In particular, they want to know why Britain, which is still more or less self-sufficient in gas and oil, has up to 30% higher electricity prices than continental Europe, says Jeremy Nicholson of the Energy Intensive Users Group. Industry-watchers worry that a handful of big gas producers are abusing their position to control prices and muddy the waters of an already murky market. Ofgem, the industry regulator, is conducting an investigation into last year’s price rises, looking for evidence of collusion or uncompetitive activity, and is due to report soon. But whatever Ofgem concludes, there is little doubt that higher UK energy prices are here to stay as the UK moves from being a net exporter of gas and oil to becoming a net importer. For much of the past 30 years, Britain has in effect been ringfenced from global-energy shocks because of our North Sea gas reserves. But as demand rises from 110 billion cubic metres now to an estimated 150 cubic metres in 2015, domestic production is set to slump to less than 40 billion. The huge shortfall means that Britain will be much more vulnerable to oil-price shocks in the future.
The economic havoc that could be wreaked by the soaraway oil price of recent weeks is just the latest in a long line of reasons to invest in the UK’s utility companies, according to The Independent. “Their wares - water and electricity - are the very staples of modern life, and demand does not ebb and flow with the economic tide.”
But what are the companies that are best-placed to benefit from higher energy costs? The utilities sector has always been popular for its defensive qualities. Stocks enjoy strong, predictable cash flows and generally trade on attractive yields. The UK utilities sector trends on an average yield of 5%.
Centrica, parent company of British Gas, is the pick of the utilities. Following the sale of the AA and its Goldfish banking division, it has enough cash to pay for new power-generation assets as well as to fund generous returns to shareholders. On the other hand, the shares are up 40% in the past six months, so now might be the time to take a bit of profit. National Grid Transco (NGT), the gas and electricity networks business, recently impressed the markets with the £5.8bn disposal of four local gas-distribution networks. It plans to return £2bn of this windfall to shareholders and will use a further £2.3bn to pay down debt, which should underpin the current valuation of the business, reckons Lex in the FT. The expectation is that it will use the remaining £1.5bn to buy assets in the US. This is a risky strategy, but NGT has a good track record with acquisitions and if it gets it right, the shares will do well. Meanwhile, the company is well placed to profit from the switch to imported gas. It is building a huge liquid natural gas storage facility on the Isle of Grain in Kent that is due to open in 2005, which should give it a headstart on its rivals. The Fleet Street Letter rates NGT a solid, cash-generating company paying a big and fast-growing dividend.
Scottish and Southern Electricity is about to become the second-largest energy distribution company in the UK following the acquisition of two of the local distribution firms put up for sale by National Grid Transco. It is also one of the leading investors in wind power in the UK. It is widely tipped for the security of its dividend. United Utilities, which owns both water and electricity distribution networks in the north of England, is worth holding for its huge yield and a balance sheet strengthened by a £1bn rights issue. Scottish Power is reckoned to have good growth prospects in the US. International Power has just been on a buying spree of power stations around the world. It has promised to pay a dividend, but only a modest one. The Independent rates it “an unappealing beast”, although Merrill Lynch thinks it’s a “strong buy”.
Those looking for a more imaginative way to play higher-energy prices should consider SIG, the UK’s leading insulation product distributor, says Philip Aldrick in The Daily Telegraph. Since the end of 2001, the company’s stock is up from 150p to 420p, and last week’s half-year results show why: pre-tax profits are up 30% to £28.3m on sales 6% higher at £649m.
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