Profit from another 'dash to gas'

Sector Focus

Much has been made of the amount the UK will need to invest in its energy infrastructure in the coming decades just to keep the lights on. The transition from carbon intensive power generation to more diversified, flexible and environmentally friendly ways of producing electricity will cost hundreds of billions of pounds, and will create some significant investment opportunities.

But the renewable energy industry is still in its infancy and struggling to convince the powers that be that huge upfront costs represent value for money in an age of austerity. Even the argument for new nuclear is beginning to fray around the edges. Coal-fired power is being phased out until carbon capture and storage can be proven, leaveing gas as the clear winner in the UK's energy mix for the coming decades.

Gas-fired power already accounts for 44 per cent of the UK's energy generation and, as coal and the existing nuclear fleet are phased out, this contribution is only likely to grow. The Department for Energy & Climate Change (DECC) recently confirmed that emissions limits on power plants will be held at 450 grams of carbon per kilowatt hour. Gas power plans already meet this requirement, so the ruling effectively enshrines gas as the baseload fuel of choice for the next three decades.

Source: DECC

Gas guzzling

But the UK is currently a net importer of gas and, as such, can find itself beholden to the vagaries of the international markets and the whims of major exporters, such as Russia. This places increasing emphasis on the UK's ability to produce its own gas from offshore fields in the North Sea, where the likes of Enquest , Nautical Petroleum and Faroe Petroleum are active gas producers, or from the growing potential of onshore gas production, be it from conventional gas or coal bed methane. IGas Energy , Alkane Energy and Egdon Resources are small-scale onshore gas producers and Infrastrata is a gas storage business that could experience an uplift in demand as the UK's fuel mix moves further towards natural gas. Europa Oil & Gas has interests in potential shale gas and in gasifying stranded coal reserves, which would feed into the natural gas supply.

Onshore gas production in the UK is relatively small scale and has actually fallen sharply in volume since peaking around the turn of the century. But this could change if the UK is able to exploit its shale gas reserves in the way that the US has - it has transformed the extraction industry there. Just recently, the Department for Energy a& Climate Change indicated its willingness to back onshore hydraulic fracturing, or fracking, which is the process used to release shale gas from underground reserves. Fracking in Lancashire has been on hold since last year when two small-scale earthquakes were recorded close to Cuadrilla Resources ' operations. While the fracking is believed to have caused the tremors, DECC believes that with enhanced safety measures fracking should be allowed to resume.

Cuadrilla estimates that its fields in Lancashire alone could hold 200 trillion cubic feet of shale gas and there are several other regions of the country where onshore shale reserves are believed to be substantial. And, looking further into the future, offshore UK could hold significantly more shale gas. A report by the British Geological Survey published earlier this month suggested that the UK could be sitting on offshore shale gas reserves of more than 1,000 trillion cubic feet, a figure that would allow the UK to become self-sufficient in gas once again.

Quoted companies with exposure to UK shale are few and far between at present, so one way of playing the expected boost in gas extraction both onshore and offshore in the UK would be through investment in oil and gas services companies such as Hunting and KBC Advanced Technologies . The beauty of services companies is that their valuations are simply reliant on the level of investment going into the industry, rather than being tied to exploration success.

Cleaning up

But what of the UK's other, cleaner sources of energy, in the form of nuclear and renewables? The new nuclear programme is purely the domain of multi-national utilities with pockets deep enough to fund the huge investment required. And, even here, some are cooling on the idea, with the German consortium of RWE and E.ON recently pulling their plans to build new nuclear capacity in Anglesey and Centrica also expressing some doubt about its commitment to new nuclear unless there is more certainty on pricing.

The renewables and clean energy sector is in a state of flux, too. Large-scale projects, such as the huge offshore wind arrays growing around the coast of the UK, are the domain of major utility players such as Scottish & Southern . Government support for offshore wind remains reasonably strong, with tweaks to the subsidy regime last year offering some reassurance to developers. But the onshore market is facing a less certain future as subsidy support has already been reduced amid cooling support from DECC.

Beyond wind, the government has already nailed its colours to the mast as far as solar is concerned by slashing subsidies for both large- and small-scale solar power after its initial feed-in tariffs proved to be hugely popular. Many other forms of distributed generation remain effectively in the laboratory and investors in clean energy companies have suffered a torrid time in a sector described by Peel Hunt analyst Andrew Shepherd Barron as "a graveyard for investors". Macro headwinds, shrinking government support and competition from low-cost rivals have hammered performance and shredded sentiment.

A prime example is Ceres Power , which has spent tens of millions of shareholders' funds and still remains years away from commercial development of its fuel-cell-driven wall-hung combined heat and power units. Others such as PV Crystalox Solar have suffered from falling demand, oversupply and low-cost competition; a triple whammy that has obliterated its margins.

But there could still be value to be had in the clean energy sector for the brave. Investors need to be more realistic, though, and to look for companies that are already established, enjoy some barriers to entry and are less reliant on government support. Areas such as energy efficiency have potential and LED lighting specialist Dialight has been a strong performer. And consultancy and services groups also remain well-placed, hence the recent share price rebound at RPS Group .

IC VIEW:

True, renewable energy targets remain in place and in some cases are enshrined in law. If such targets are achieved, we could see one-fifth of UK electricity provided by renewables during the third decade of the millennium. But supporting renewables is costly, and the government is strapped for cash, which puts the onus on the private sector. Gas appears to be the fuel of choice for the current government and this is where the most reliable opportunities lie.

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