The energy crisis and investment opportunities explained

Energy prices have sky-rocketed across Europe. Here in the UK, the price of natural gas is four times what it was at the beginning of the year and, at one point this month, it was 85% higher than the last record high posted in 2008.

No fewer than seven utility companies have gone bust in the past six weeks, leaving more than a million customers looking for new suppliers and having to pay significantly higher bills.

What caused the energy crisis?

So what has caused the energy crisis? Julian Chillingworth, CIO at Rathbones, explains: “The European gas crunch has been driven by several factors. A cooler summer meant more gas was used than expected, sending stockpiles lower heading into winter. The pandemic reopening has also bolstered demand for energy, carbon credits and raw materials.

“The UK’s drive to increase competition in the retail energy market has created a plethora of fragile players in what is traditionally an oligopoly that sports just a few huge businesses. This has led to very keen pricing to attract customers.

“The government is now in talks with the industry to flesh out a plan to ride out the crisis. Reportedly, the larger players are asking for a multi-billion-pound support package from the taxpayer, and a ‘bad bank’ to take on the customers from the failed retailers. These companies will have locked in a per-unit power price with customers that is now well below what it costs to buy power in the wholesale market, so surviving retailers will be loath to take them on.

“And you can’t blame them. They would be taking on loss-making customers who will only be disgruntled and move as soon as their fixed-term price runs out and their price adjusted to a profitable level!”

Investment opportunities

Every crisis creates opportunity, and this is no exception. Investors are currently assessing which companies are likely to be the winners and losers.

The biggest utility and power companies like Centrica and E.ON - top ten holdings in Schroder Global Recovery and M&G Global Listed Infrastructure respectively - could emerge from the fallout stronger, for example.

James Yardley, senior research analyst at Chelsea Financial Services, commented: “When it comes to gas suppliers, lots of competition and heavy government regulation have made it almost impossible to make a profit in recent years and shares of these companies have performed very badly. This energy crisis is probably good news for them because it will force the sector to consolidate. A lot of weaker players are likely to collapse which should mean less competition in the future.”

Other beneficiaries could be trusts like Gresham House Energy Storage Plc, which is a holding in the VT Chelsea Managed fund range, as well as the big oil majors.

Back in August, Ian Lance, manager of RWC UK Value fund, gave a number of reasons as to why investors should be considering the energy sector and companies like BP.

He said that, not only does the energy sector have the fastest earnings growth and the most positive earnings revisions in 2021 but, in their rush to virtue signal their green credentials, many fund managers have excluded such sectors from their investable universe irrespective of how low the valuation on a company is. This is potentially creating opportunities for others to exploit.

“The irony of the energy sector being out of favour,” he said, “is that it comes at a time when the fundamentals are looking very promising. In response to falling energy prices in recent years, as well as environmental pressure, energy companies have slashed their capital expenditure. Some believe that, as Covid subsides and world economies re-open, there may be insufficient production to meet rising energy.”

And that is exactly what we are seeing today.

Thomas Moore, manager of ASI UK Income Unconstrained Equity, is also a fan of this area of the UK economy. “Resources is forecast to be 36% of UK market dividend payout for 2021,” he said. “That’s £33.6bn out of a total UK market payout of £91.4bn. 

“Resources is also the sector with the strongest earnings per share momentum and dividends per share momentum right now – so high yield, cheap and high earnings momentum – usually a great predictor of share prices!

“It has been extremely helpful for our performance and portfolio income to hold very heavy positions (i.e. 4-5%) in stocks that have continued generate huge amounts of free cash flow and pay this out in the form of elevated dividends. It is also helpful that these companies are showing far better capital discipline this cycle than last cycle.

Jonathan Waghorn, manager of Guinness Global Energy fund concluded that the current crisis is likely to be a short-term issue, but the supply and demand imbalance will be a feature of the next three decades of the global transition towards green energy.

“We need fossil fuels during the transition to satisfy and maintain balance in the energy system. Lack of investment will make crunches like this happen,” he said.

*Source: fund factsheet, 31 August 2021

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and commentators and do not constitute financial advice.

Published on 27/09/2021