The UK energy sector, with its mountains of debt and inflation-linked income, has benefited from two peculiarities of the global response to the economic crisis: record low borrowing costs and above average inflation. These factors are unlikely to change any time soon, and this will underpin returns from the sector. But investors need to beware of complacency given the prospect of major regulatory upheaval in the year ahead.
Shares in the UK energy sector have become a haven for investors attracted by their inflation-linked dividends. National Grid (NG.), in particular, has caught the eye. The shares have risen almost 30 per cent in the last two years, but still retain a chunky yield. However, there is increasing uncertainty around the company's dividend following the publication of the energy regulator Ofgem's final proposals, which will set revenues for two-thirds of National Grid's business for the next eight years.
The regulator has come down hard on the returns National Grid can make from its network and this, in turn, will limit future dividend growth. Some analysts fear outright cuts are a possibility. The energy giant is expected to respond to the proposals by the end of February or early March and a referral to the Competition Commission is still a possibility. The board's final decision on the dividend policy and a possible rights issue will be made at the time of the final results announcement in May.
The government's UK energy bill was published late and lacked some important detail, but it was clear on one factor: gas would fulfil a major part of our power needs. This is good news for Centrica (CNA) which has invested heavily in securing North Sea gas supplies. The group is due to make an important decision in the coming months on its joint nuclear project with EDF. If it pulls out then this could free funds for share buybacks, and we retain our positive stance.
The introduction of the carbon price floor in April will make power generated from coal increasingly expensive. But, until new generation capacity is built, coal will remain a key part of the UK's energy security as it provides around 45 per cent of the nation's electricity. Drax (DRX) has also secured the funding necessary to convert to biomass-based generation and the company's shares have recovered well following a dip last summer caused by fears over its biomass future.
| COMPANY NAME | LATEST PRICE (P) | MARKET VALUE (£M) | PE RATIO | DIVIDEND YIELD (%) | PERCENTAGE CHANGE IN 2012 | LAST IC VIEW |
| CENTRICA | 341 | 17,717 | 12.4 | 4.6 | 15.3 | Buy, 338p, 13 December 2012 |
| DRAX | 555 | 2,227 | 10.5 | 4.7 | -0.1 | Hold, 472p, 31 July 2012 |
| NATIONAL GRID | 707 | 25,703 | 11.2 | 5.6 | 12.5 | Hold, 704p, 21 December 2012 |
| SSE | 1,439 | 13,791 | 12.8 | 5.7 | 9.8 | Hold, 1,388p, 14 November 2012 |
