Energy price rises – what’s going on and how might investors respond

What's going on in the gas market?

George Trefgarne

In early September, serious stresses and strains emerged in the UK’s energy market as recovering demand exceeded low-cost supply. Things got so bad that an old coal power station – which are supposed to be phased-out in order to comply with the Paris Agreement on climate change – had to be switched back on at the request of National Grid.

The causes of this crunch were threefold. For several days there was almost no wind, holding back production from wind farms. This came amid a global surge in demand for natural gas as countries switch to it as a ‘transition fuel’ in the move towards net zero emissions by 2050. Investors and corporates are cautious about ramping up natural gas production, especially in the US.

Natural gas has 50% lower emissions than coal when used in electricity generation. No wonder national power companies are attracted to it as they withdraw coal powered stations from use and turn to lower carbon sources.

The surge in natural gas demand is a long-term trend, much of it originating from Asia. For example, South Korea expects to increase the capacity of its liquid natural gas plants by 43% by 2034, compared to 2020 levels. There are similar trends in other major Asian economies like Japan and China.

This has driven the demand for Liquefied Natural Gas (LNG), much of which is exported by ship from the Gulf, Australia and the US. It’s estimated that 95% of the new demand for LNG is coming from Asia.

Why this time is different

During past price rises, US shale gas producers, who use so-called ‘fracking’ techniques to extract natural gas from rock and sand formations, have met increased demand with increased production. But they have been slow to do so this time so far. That’s partly because investor appetite for investing in oil and gas has been dimmed by the impact of climate change and regulation. But also because companies are taking a more disciplined approach to their finances.

The US Energy Information Administration expect production of dry natural gas to remain relatively flat for the rest of 2021.

Meanwhile, in Europe, where markets are more reliant on gas coming via pipeline from Russia as opposed to LNG, there has also been a lack of supply. Russia’s stocking up its storage for domestic use after depleting it during last year’s cold winter.

Demand for natural gas is also strong in Britain. Natural gas contributed 41.9% of our primary inland energy consumption in 2020, up from 24% in 1990.

Put all this together and we are seeing record wholesale prices for electricity in Europe and the UK. The day ahead price for British wholesale electricity on the N2EX exchange reached £277.30 on 8 September, more than twice the level of the previous day. The situation is especially critical here because we are relying on interconnectors from Europe at peak times and shortages or high prices in France or Ireland feed through into our own market.

As far as consumers are concerned, domestic electricity and gas prices are already rising. Ofgem, the regulator, will raise the price cap on standard duel fuel tariffs from 1 October by £139, or 12%, to £1,277 per year. However, this only applies until April, when it could well rise again.

George Trefgarne is CEO of Boscobel & Partners, a political consultancy. Hargreaves Lansdown may not share the views of the author.

How might investors respond?

Nicholas Hyett, Equity Analyst

It’s not always clear how investors might respond to these kinds of big macro trends. However, when it comes to the turmoil in the energy market investors actually have quite a range of options.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest.

Investing in gas – more than hot air

The structural shortage in gas markets is unlikely to change quickly, not least because developing major new gas projects is an expensive and time-consuming process. Royal Dutch Shell spent well over $10bn on its huge Prelude liquid natural gas (LNG) facility off the coast of Australia. The project took eight years to move from final investment decision to first LNG.

That bodes well for companies that already produce significant quantities of natural gas. In the first half of 2021, ‘Integrated Gas’ accounted for 34.5% of total underlying profits at Shell and 46.8% of all profits from oil & gas production. Because higher prices have minimal effect on production costs, higher gas prices should feed straight through to profits.

Shell's underlying profits by operating segment

Source: Royal Dutch Shell Half Year Results 2021.

Over time, and as the economy de-carbonises, there’s a risk that oil & gas giants are left with ‘stranded assets’ (oil & gas fields that cannot be profitably developed). That means there’s serious corporate restructuring to do over the medium term, and major asset sales always create some risk.

An added attraction of Shell, and perhaps even more so rival BP, is their increased investment in low carbon energy. Shell is devoting 35-40% of capital spending to service stations, renewable energy and hydrogen from 2025. If gas proves a vital transition fuel as we move toward a lower carbon energy mix, then oil majors are in a position to capitalise on that short-term gain and future green investment at the same time.

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Copper – electrifying

There is an alternative to going for gas directly.

Spiking gas demand reflects declining appetite for coal power, but also the ever-increasing demand for electricity – whether that’s from increased access to technology and power in the emerging world or the switch to electric cars in more developed markets. All that extra electricity requires vast quantities of wiring, and for wiring you need copper.

Unsurprisingly the extra demand, together with strike action at some important Chilean mines and disruption in Canada, has sent prices soaring over the last year or so.

Copper Price ($/lb)

Past performance isn’t a guide to the future. Source: Nasdaq, 15/09/2021.

The UK stock market is well placed when it comes to large copper miners, whether that’s through diversified giants like Rio Tinto and Anglo American, or smaller specialists like Antofagasta.

As with oil producers, higher market prices for what miners produce should drop almost directly through to profits – meaning the current price rises are something of a windfall. Given what are likely to be long-term tailwinds for global copper prices, that might tempt investors to opt for smaller dedicated copper miners.

However, investors should bear in mind that smaller miners, by their very nature operate in fewer countries. And that increases their exposure to specific geopolitical risks. Mining is an environmentally messy and socially contentious business, and as a result is frequently the target of government or industrial action.

Antofagasta for example, operates solely in Chile. It has historically enjoyed good relations with the government and workforce, but the world’s largest copper mine, BHP and Rio Tinto-owned Escondida also in Chile, has struggled against industrial action in the past. On the plus side though, investors in specialist miners like Antofagasta don’t have to contend with shifts in the iron ore market – which is a key industry for larger miners.

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Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio. Investments will rise and fall in value, so you could get back less than you invest.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.