It did not take long for the elephant in the room that was the asset bubble of the Noughties to charge into the local china shop, but now there are a number of energy experts who believe not enough is being done to prevent a coming electricity shortage in the UK.
The government made clear in its 2006 Energy Review that its two main energy challenges were climate change and energy security. This summer, industry body Oil & Gas UK warned that, while most of the government’s attention and effort had been focused on the former problem, not enough was being done about the latter issue.
In its 2009 Economic Report, the organisation argued that power generation was the biggest concern since there are so many coal-fired and nuclear power stations scheduled for closure during the next 15 years that the replacement of generating capacity, using the same type of equipment (ie coal, gas and nuclear) would require some £30bn of investment by the mid-2020s. Moreover, when the government’s target for renewable energy generation – required to comply with the European Union's 2020 emissions targets – is taken into account, the actual investment needed will be something like £100bn.
Oil & Gas UK says this implies an investment during the next decade at a rate of approximately twice that achieved by the UK’s energy industry during the past three years. Malcolm Webb, the organisation's chief executive, put the situation in stark terms when he said: "We have had the credit crunch. Next we will have the energy crunch."
Webb is not alone. Several other energy experts have been warning for years that the UK faces an energy gap. In 2005, a report from the UK Energy Research Centre said that, by 2015, the country may be generating only 80 per cent of the electricity it needs. It also pointed out that there would be little alternative to fossil fuels as the dominant energy source in the UK until 2050, while it was inevitable that nuclear energy would have a key role in a future clean energy mix.
Professor Ian Fells, who estimates the UK will lose one-third of its electricity generating capacity over the next decade as old coal and nuclear power stations are retired, told a conference in June this year that "there could well be blackouts in the UK by 2014/15, or even earlier if the economy picks up".
And Prof Fells, of energy consultancy Fells Associates, does not think the government's plan to develop 30 gigawatts of new offshore wind farms by 2020 is a viable solution to the UK's looming energy crisis. Even if this amount of wind capacity can be built in time (a tall order in itself), wind power is intermittent so it will have to be backed up by more reliable sources of electricity (ie coal and nuclear plants).
The solution, according to Prof Fells, is for the UK to quickly build more gas-fired stations but the country should also be concentrating on coal, "with or without carbon capture", and nuclear plants.
The problem with getting a new generation of nuclear plants up and running is the bureaucracy involved during the planning process. Although they will take only about four years to actually build, regulatory hurdles mean that nuclear energy companies EDF and Areva reckon the earliest they could complete the construction of a new Evolutionary Power Reactor in the UK would be 2017 (assuming everything runs smoothly).
So while the government and industry is slow to wake up to the energy issue, we think investors should prepare for the coming crisis. Here, we offer a few ideas of the kinds and sectors and companies that might feature in an 'energy crunch' portfolio.
COAL
Coal is, of course, a dirty fuel. Not only does burning it release carbon dioxide into the atmosphere, but waste products hazardous to health – like mercury and other heavy metals – are also released and acid rain can result from burning high-sulphur coal.
But coal is also a readily combustible, high-energy density fuel that is the world's largest source of energy for the generation of electricity. And, unlike nuclear plants, coal-fired power stations can be constructed very quickly (a few years instead of a decade).
Most of the UK's coal-fired power stations were built back in the 60s and 70s, and many of these are expected to reach the end of their life soon unless they install emissions control technologies that enable them to comply with the EU's Large Combustion Plant Directive. Whether the rules end up being bent to allow these plants to continue operating, or the government and the UK’s energy industry decides to back the building of a new generation of coal-fired power stations, the use of coal seems a compelling solution to the forthcoming energy crisis.
Notwithstanding energy utility E.ON's recent volte face, when it announced that a dramatic fall in energy demand due to the recession had led it to put its controversial 1.6GW Kingsnorth Power Station on hold, "clean" coal solutions are likely to be high on any future government's priority list once the blackouts start no matter what the environmental movement thinks.
In fact, E.ON has not entirely given up on Kingsnorth. The company has merely deferred its investment decision for the site for two to three years, which means the plant could still come on line within six years.
E.ON claims the 'supercritical' technology that would be used by the plant would make it around 20 per cent more efficient than the existing power station on the site. But more important is the fact that it would produce enough electricity to supply around 1.5 million homes.
Firms that are likely to benefit from renewed interest in coal as a source of electricity include: FTSE Small Cap coal miner UK Coal and FTSE 250 coal power station operator Drax.
£200m-market cap UK Coal operates four deep mines in the UK, as well as four surface mines and it has planning approval for a further three surface mines. In total, the business has coal reserves and resources of more than 155 million tonnes.
UK Coal's shares suffered during the late autumn after the firm reported a fatal accident at its Kellingley site, which slowed production there. The company also revised down its estimate for deep mine production, from 6.2m tonnes to 5.8m tonnes after a more general slowing of production at each of its deep mines during November.
Consequently, the firm's share price hit 71p in late November after having been as high as 140p during the summer. However, as every value investor knows, a fall in the share price of a fundamentally sound business due to adverse events can often be a good time to pick up shares.
UK Coal may be currently loss-making, but one suspects the shares will not be languishing around 70p in a few years time, especially if we are in the middle of an energy crunch. Buy.
Drax runs Yorkshire's Drax Power Station, which supplies enough power to meet 7 per cent of the UK's electricity needs.
Built in two stages, in the 70s and 80s, Drax is currently the UK's newest and most efficient coal-fired power station. Its six generators produce 4GW of electricity, making it almost twice as big as the next largest coal-fired power station in the UK.
But Drax is not just a coal-focused company. The Drax Power Station itself has been set a target to produce 12.5 per cent of its output from renewable sources by mid-2010 through the co-firing of biomass fuels. Meanwhile, the company plans to reduce its carbon footprint further by developing three dedicated biomass-fired renewable energy plants via a partnership with Siemens. Drax says the plants, together with the renewable output from the co-firing capacity of the Drax Power Station, will make the company responsible for around 15 per cent of the UK’s renewable electricity output (equivalent to 2,000 wind turbines).
Drax's shares are well down on the start of 2009 – a year that has seen a glut of natural gas drive energy prices lower and falling demand from industrial customers for electricity due to the recession, both of which have had the knock-on effect of reducing the company’s profits significantly. Meanwhile, a downgrading of the company's debt rating by Standard & Poor's earlier in the year meant it had to take steps to strengthen its capital structure, so a £107m share placing was completed in June.
However, lower electricity demand and prices are temporary issues. The fact remains that Drax's power station, and planned biomass-fired plants, will be important assets during the forthcoming energy gap. Electricity utility Centrica recently extended its agreement with the company to receive hundreds of millions of megawatts of baseload power for a five-year period that starts in October 2010. Good value.
ENERGY EFFICIENCY
As well as focusing on building wind farms and new nuclear plants in order to reduce carbon emissions and improve energy security, the UK government also recognises energy efficiency as playing a vital role. One of the best ways to cut energy use in the home is, of course, better loft insulation, which reduces the amount of energy needed to heat the home, and the government has already begun initiatives to improve insulation.
However, the Department of Energy and Climate Change is also keen on smart meters. These perform the traditional meter function of measuring energy consumption but they also offer a range of advanced features, such as allowing energy suppliers to communicate directly with their customers, removing the need for meter readings and ensuring accurate billing.
The government plans to mandate smart meters for all households in the UK by 2020, and this should be good news for companies like Alternative Investment Market-quoted Bglobal.
The company is rapidly increasing the number of meters it installs and this year it should carry out almost 50,000 installations – approximately the number it needs to reach to break even. Bglobal has an agreement with Superdrug to roll out its smart meters at all the retailer's stores in the UK. Meanwhile, it has a contract with Gazprom, which is establishing a presence in the UK electricity market, and has just signed a deal to supply npower, which is embarking on a trial of smart meters.
Bglobal has enjoyed a very strong rise in its share price during the past year, after it removed uncertainty about how it would finance its installations thanks to arrangements made with Barclays and Macquarie Bank. But the company's shares look like they can still provide good long term value.
Another play on the drive for energy efficiency, and one with a connection to smart meters, is to back companies that manufacture devices for voltage optimisation. This involves reducing the amount of voltage (and thus power) entering a building in order to reduce wasted electricity.
Because electrical products across the EU are designed to work at voltages of 220V and below, the typical UK voltage of 245V brings too much power into households and offices. Just by fitting a voltage optimisation device to a fuse box, you can save about 10 per cent of your energy costs.
Two AIM-quoted companies – Cinpart and VPhase – supply voltage optimisation devices, but although these firms' products have passed regulatory tests, and are now being sold, they are still at an early stage so the shares must be regarded by investors as a speculative buy.
NUCLEAR
Engineering services group Babcock sees its nuclear business, which currently accounts for more than 5 per cent of its total revenues, as a "major engine of further growth". Meanwhile, fellow engineering firm Balfour Beatty is setting up training camps to make sure that enough engineers and technicians with nuclear skills are available so that its partner, French nuclear plant builder Areva, is able to construct several new Evolutionary Power Reactors in the UK.
Of course, new nuclear power plants are seen as a solution to energy security and lower carbon emissions not just in the UK, but in far bigger economies like the US and China. So, investing in uranium mining is likely to prove to be a good long-term investment.
Hundreds of uranium miners exist around the world, with plenty quoted on stock markets like AIM and the Toronto Stock Exchange. However, a more passive approach is probably the most sensible way of playing demand uranium over the long term.
Geiger Counter, a closed-ended investment company incorporated in Jersey, offers investors just such an option. The fund invests in a wide range of companies involved in the uranium industry and its shares are quoted in London.
RENEWABLES
Whether or not you agree with the view that wind power can become a reliable large-scale source of electricity, there are still going to be a lot of wind farms built in the UK between now and 2020.
Of course, the large electricity utilities have their own wind programmes and investors in such companies will have some exposure to the growth of wind power. But to enjoy the full effect of the wind dividend during the next few years, it could be worth buying into wind turbine manufacturers.
UK stock markets do not host the biggest turbine makers, such as Denmark's Vestas Wind Systems (the largest turbine maker in the world), but there are still AIM's Clipper Wind Power and the LSE main list's Hansen Transmissions – a Belgian manufacturer of gearboxes for wind turbines. However, Clipper's revenues are somewhat dependent on growth in the US wind market, while Hansen is looking to China for its future growth.
Still another approach might be to invest in stealthier wind farm operators, like AIM-quoted Renewable Energy Generation. It recently disposed of its Canadian subsidiary in order to focus on the UK wind power market, where it sees significant growth opportunities during the next few years. Good value.
Renewable power is, of course, not just about wind. As mentioned above, coal power station operator Drax is planning to use biomass as a way of ‘greening’ itself, but for a pure-play investment in biomass power it could be worth backing AIM-quoted Helius Energy, which has a number of biomass power projects dotted around the UK. Currently loss-making, Helius is making progress building the projects and alliances it needs to stand it in good stead. Speculative buy.
