Centrica heats up

The bill still lacks details, but the overall message is crystal clear. The UK has an energy problem with up to 20 per cent of generating capacity set to be mothballed by 2020. The department for energy and climate change thinks this could lead to electricity shortages and blackouts by as early as 2015. The government has decided that the quickest and cheapest solution is to build gas-fired generators.

The 'dash to gas' plays straight into Centrica's hands. Centrica has just completed a £1.2bn project to secure gas supplies in the North Sea. Production from these and other reserves increased by 20 per cent this year and is expected to grow another 12 to 15 per cent next year. The so-called 'upstream' gas production division contributed 47 per cent of operating profits in the first half of 2012 and, as long as gas prices stay high, its profits will be secure.

While gas is heating up, Britain's nuclear future is going cold. The stumbling block is deciding who should pick up the bill for projects that cost billions now and only benefit future generations. In the wake of Japan's Fukushima nuclear disaster, costs for new-build are spiralling out of control and safety fears have led to massive design reviews - for example, the cost of the first nuclear project in France for 15 years has more than doubled to €8.5bn (£7bn). And Centrica is due to make a decision on its 20 per cent stake in a joint nuclear project with French energy giant EDF at Hinkley Point.

Analysts at investment bank Citigroup think that, if Centrica walks away from the project, it could free up £500m of cash flow next year, and Centrica's bosses are understood to be considering a share buy-back as an option for that cash. A decision on the Hinkley project is expected before the full-year results due at the end of February, and such a buy-back would give a nice boost to shareholders' returns.

Another feature of the government's energy plan is something called the carbon price floor, which will make it increasingly expensive to generate power from coal and older gas plants from next April. This will steadily increase the price of production from these sources and this, combined with mothballing older plants, will squeeze electricity supply and should support higher electricity prices. True, there is a temporary glut of energy supply in the market, meaning generating profit margins - or spark spreads - are at multi-year lows. Spark spreads have to rise to persuade companies to build new gas-fired power stations and any rise will boost returns for Centrica.

Naturally, Centrica comes with some risks. As energy prices rise consumers use less gas and the weak economy is causing a slump in business demand. This is hurting the downstream gas supply division, which is responsible for 38 per cent of operating profits. And, although price increases were pushed through in November, analysts at Deutsche Bank think that political risks remain, if excess profits are generated. They warn that every percentage point cut in the long-run retail margin of 6 per cent would feed through to a hit to earnings of approaching 8 per cent.