The UK's offshore oil and gas output has been gradually declining as production from North Sea fields slides. What's more, Oil & Gas UK, which represents the offshore industry, has said rising costs, higher taxes and weak commodity prices could accelerate de-commissioning of older fields. It's no surprise then that the country is importing a greater amount of natural gas in order to fulfil the UK's growing energy capacity needs.
Centrica (CNA) has agreed to buy a greater volume of gas from Russian state-controlled energy group Gazprom and Norwegian energy giant Statoil ASA (STL). The British Gas owner has extended its 2012 gas supply contract with Gazprom Marketing and Trading, a UK-based subsidiary. Centrica originally signed a three-year supply deal with Gazprom in September 2012 for 2.4bn cubic metres (BCM) a year to be delivered from October 2014. Under the new and previous agreements combined, Gazprom will supply Centrica with a total 29.1 bcm of gas or 4.16 bcm on average per year between 2015 and 2021.
The group has also upped the volume of gas it will purchase from Norwegian state-backed energy business Statoil, which has shares listed in both Oslo (N:STL) and New York (US:STO).In 2011 Centrica signed a 10-year agreement with our recent tip, Statoil, purchasing five billion bcm of gas annually to be delivered from October this year. However this has now been increased by 2.3 bcm to 7.3bcm per year or 73 bcm over 10 years.
Centrica said the UK now imports half of the 70 bcm of natural gas a year it needs to heat homes and businesses and generate electricity. Its agreements with Gazprom and Statoil will meet the gas needs of nine million UK homes annually and takes the total amount the group has committed in securing gas and electricity from suppliers to over £50bn.
Its deal with Gazprom does mean Centrica is more exposed to potential EU sanctions against Russia. However it is important to remember that, unlike many mainland European energy providers, Centrica is not buying gas directly from Russia but a UK trading arm of Gazprom.
Angelos Anastasiou, utilities analyst at broker Whitman Howard, says Centrica's extension of its supply deals "are sensible moves, and the value and scale of the contracts is indicative of the importance of Centrica's position as a key, integrated UK energy supplier". Management's assertion that it has committed to "a range of suppliers" could be therefore helpful in the context of the Competition and Markets Authority review into energy supply, according to Mr Anastasiou.
Shares in Centrica have rebounded recently, rising by a fifth to 281p since the beginning of March. It received a further boost following the majority Conservative election win earlier this month. Shares in the group rose 8.1 per cent the day the result was announced. Mr Anastasiou says much of the negative news surrounding Centrica has already been priced in by the market. With the starting point that the oil price will recover in the medium term, and assuming Centrica's downstream business performs as expected, he said the group is in a relatively good position and rates the shares as a buy.
However, the energy group has suffered as a result of milder-than-expected weather and weak commodity prices have lowered profitability for its upstream gas business. As a result of this, Centrica cut its final dividend for 2014 by 30 per cent and management plans to cut the first-half dividend by the same amount. Management is carrying out a strategic review on areas including its operating efficiency and sources of growth to boost the company's bottom line.
