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Investing in Energy

After a decade of divisive politics and no consistent energy policy, business is crying out for reliable consensus. When common sense eventually prevails – solar, wind and batteries seem likely to drive Australia’s future energy as coal diminishes significantly past 2030. Energy companies are aware of this and despite an absence of policy consensus, they’ve been acting accordingly, moving towards gas while distributors progressively utilise renewables.

Are ASX listed energy stocks somewhat neglected amid the policy log-jam? The current 10% global oversupply of liquefied natural gas (LNG) is likely to switch to an undersupply by 2020 because it’s considered the cleanest hydrocarbon for energy production. US shale production is probably unsustainable at US$50 a barrel and though electric vehicle use is rising, less than 25% of hydrocarbons in the market are used for transportation. China is the main driver of growth in global oil demand and the Middle east supplies about 43% of Chin’a oil imports but Australia provides 45% of its LNG imports.

Electric vehicles recharge themselves using electricity that comes from coal, gas, solar, wind and so on. Gas is expected to have a sustained transitional role to stabilise energy generation for many years. So over the medium term, the absolute worst case seems about 20-25% loss of demand (and more likely much lower loss of demand) where global production is falling at 10% p.a. – still a good investment outcome for gas producers. Progressive investment options for renewables are all overseas with negligible possibilities here. However, capital intensive experience with solar over the last 10 years is sobering, as progressive enterprises have not necessarily been profitable.

Larger ASX listed energy stocks fall into two categories; those that produce fossil fuel energy (Woodside, Oil Search, Santos) and; those that also distribute it (Origin, AGL, Caltex). Their profiles can be broadly summarised as tabled below:

Though Origin and AGL have some renewable energy exposure, it is not yet possible to find alternative energy stocks within the ASX 200. However, some global managed fund options are starting to emerge in the wholesale sector. Otherwise, ASX-listed conventional investment choices are discussed below:

Woodside is Australia’s premier fossil fuel operator, positioned for the energy transition ahead. It has >80% in gas, LNG, LPG, condensate with the rest in crude oil but no renewables. It’s a ‘price-taker’ but it has high quality underlying business and ample potential development in the pipeline if prices allow. The market may be undervaluing its long-term growth pipeline but shareholders take heart from its history of conservative capital management. As it trades at a significant discount to replacement cost, it can break even at low oil prices – offering value, despite perceived low growth. Of course no investment is without risk, so the question is… has the market overrated the risks?

Origin has diverse cash flow from its integrated energy exposure, largely comprising electricity generation and retailing in Australia. It controls about a third of Australia’s energy retailing with about 4m electricity, gas and LPG customers but its growth is limited to population. It also owns 37.5% of the APLNG project near Gladstone in Queensland, an improving cash flow aimed at debt reduction, limiting dividend upside (though this may also improve). Energy policy uncertainty seems to be affecting Origin’s price more than its key rival, AGL.

AGL is a large, vertically integrated Australian energy utility and electricity generator with about 3.6m customers. It is moving away from fossil fuel power generation. Its cost-cutting is progressing well and wholesale power prices are high with projected recurrent revenue. But high prices are reducing demand in a competitive retail market where regulatory risk is high. Some believe its departing CEO, Andy Vesey has become the fall guy in coal-lobby political wrangling due to his scaling back of AGL’s carbon emissions.

Santos has some of Australia’s largest and highest-quality coal seam gas reserves and possibly a positive outlook as its production rises by 15% from its east-coast coal seam to liquid natural gas and Papua New Guinea LNG projects. Since 2016, it has strengthened its capital position but in so doing has diluted earnings per share. Recent trends are encouraging though it has a long history of underperforming cost of capital.

Oil Search is a growing gas producer based in Papua New Guinea with substantial gas resources that still lack infrastructure. Its short term capital commitments are likely to continue and it has significant debt. So it’s a single country/project risk in liquid natural gas (LNG) that currently seems expensive.

The future for energy?

While renewables are the future, their cost when combined with storage for reliable power has further to fall as they compete with existing fossil-fuelled power. New gas-powered electricity generation offers transitional reliability but new coal plants are already outpriced. The relentless shift to renewables is likely to continue over many years towards affordable reliability. Future power generation plants are likely to be a package system including solar, wind, batteries and gas generation.

Home solar with batteries will be a major change – probably economic by 2020. That change will have a time-shifting effect on energy usage (remember when off-peak was at night). Meanwhile, distributors are under regulatory pressure to contain energy prices – their share prices must reflect these risks, including policy uncertainty. Are they accurately priced now for all this?

Research of complementary technology that augments renewables for reliability is still some years from peak delivery. While encouraging renewable innovation, sustained demand for cleaner fossil fuels like gas can be expected to support reliability over many years as we transition. Does this mean there is still room to profitably invest in gas producers?

Some large institutional funds have already sold out of fossil fuels but smaller investors could still expect enough market liquidity to enable them to sell before a fossil fuel tipping point is reached. That tipping point for investing in coal may be soon, perhaps expedited by belated, unprecedented climate change action and looming coal generator retirements.

Despite gas use to support power reliability, Australian electricity generation might not use fossil fuels at all after 2050. So, while taking advantage of medium-term pricing opportunities, it will be wise to exit well before the herd in the longer run. Even so, gas producers and progressive electricity utilities can provide investors with some upside while the transition unfolds. Has uncertain energy policy caused Australian energy stocks to be under-priced for now? If so, which ones suit you best?

We believe in a higher standard of financial advice, free from product bias and conflicts of interest.

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Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.