Energy facing change

Centrica, the owner of British Gas, has raised its prices by 7 per cent rise in gas and electricity and Scottish & Southern has hiked them 9.4 per cent. The rises have even led Ofgem to launch an investigation into sector profitability, after the regulator's analysis showed that retail margins have increased from £65 to £90 per customer on standard dual fuel tariffs.

Suppliers blame the volatile price of gas in the wholesale markets, as these costs make up 44 per cent of the average fuel bill. But even worse for consumers, the chiefs say that the extra costs aren't part of the industry's goals of investing and renewing UK infrastructure. Ofgem reckons that £200bn needs to be invested in the next 10 years to secure sustainable supplies at affordable prices for consumers, which equates to a 14-25 per cent rise in bills by 2020. That's above those increases already announced.

Although this uncertainty around energy capital expenditure and regulation is not attractive for investors, the dividend yields on offer certainly are and shareholders can take heart in the fact that large investment plans have been managed and achieved in the past. Having announced a £3.2bn rights issue back in May, National Grid has now pledged to spend £22bn over the next five years upgrading the network, which includes ensuring that renewable energy sources can connect. The industry push towards renewable energy will continue to be high on the agenda in 2011, with the government aiming for 15 per cent of the UK's total energy demand to come from green sources by 2020.

To help facilitate this change, Ofgem revamped its price control process back in August, labelling it RIIO - Revenue equals Incentives plus Innovation and Outputs. The crux of the changes is that those companies in the sector that invest efficiently and spend on facilitating renewable energy sources will be rewarded, while Ofgem also said it would expand the Low Carbon Networks fund.

This added flexibility is likely to be encouraging for investors, who will reap the benefits from those companies that excel. Also positive for investors is the fact that many analysts predict a return to merger and acquisition activity in the sector after a quiet period during the recession. Last year's major deals were EDF's sale of its UK electricity networks to Cheung Kong Infrastructure and GDF Suez's reverse takeover of International Power. The UK government is one of few in Europe that is comfortable with foreign ownership of utilities, so analysts see Centrica, Drax and Scottish & Southern Energy as potential targets in 2011.