Energy utilities ready to fire

Rising energy prices and new export opportunities are boosting the prospects for power utilities.

Summary: Origin and AGL are key beneficiaries of rising energy prices, with each having access to energy resources and distribution networks including export channels.
Key take-out: There are good buys and bargains to be found among energy utilities, which have become synonymous with reliable earnings and steady dividends.
Key beneficiaries: General investors. Category: Growth.

There is never any such thing as a sure bet, either at the race track or the stockmarket.

When it comes to utilities – those once government-owned monopolies that deliver essential services –the belief for decades was that you couldn’t go wrong, that they were sure-fire money spinners.

Even before Enron, some of the world’s biggest and best-known power utilities had their fingers burned in Jeff Kennett’s great Victorian power industry sell-off. Financially, it was a terrific deal for the state of Victoria. But it was a disaster for the buyers.

The game changer was that all the foreign buyers banked on the assumption that every state would quickly follow Victoria and that they would operate in a national privatised market, where cheap Victorian coal-fired electricity would power the nation. But the other states, principally NSW, refused to sell its power assets.

In the past 12 months, as investors have zeroed in on yield stocks, utilities once again have become synonymous with reliable earnings and steady dividend payments. As a sector, utilities have enjoyed a solid run for most of the past year.

But several new game changers have entered the equation for investors looking for solid returns – the introduction of the carbon price and, more significantly, the imminent ramp-up of the Australian LNG industry and the massive energy exports that will entail.

For almost 40 years, Australian gas prices were relatively stable. New supplies matched new demand. But the industry now is going through a period of unprecedented change. Gas prices have almost trebled from $2.50 a GJ to $6. And, as the LNG export ramp up continues apace, they are expected to rise further.

Already an angry alliance of manufacturers and heavy power users such as Xstrata are complaining that gas supplies beyond 2014 are difficult to negotiate, and are demanding government action.

It is worth noting that Australia is the only country in the world that allows foreign energy corporations to exploit and export natural gas without prioritising domestic users. But even in Western Australia, where the state government has imposed such a policy, gas prices have still trebled.

Were all the utilities on an equal footing, this would not have too much impact as most utilities would merely pass on the higher costs to consumers.

But Origin in particular, and AGL to a lesser degree, both have exposure to this new source of income while being able to source gas at a cheaper rate than the pure utilities. AGL, in addition, now has the Loy Yang A power station, a dirty brown coal-fired operation that nevertheless will benefit hugely from any major upswing in gas prices.

In addition, Infigen Energy, a wind farm operator, also is expected to receive a boost from any major realignment in the gas price, given it already is a beneficiary of the Renewable Energy Targets policy and the introduction of carbon pricing. A recent report by Bloomberg New Energy Finance claimed wind energy operations were cheaper to build than both gas and coal-fired power stations as the cost of turbines dropped.

The predicted effects of the gas price surge are complex. But as prices rise, more fields will become economic. That primarily will benefit Origin, which has enormous as yet undeveloped reserves.

Origin already is profiting from rising east coast prices. Having sold down its stake in the APLNG venture to 37.5%, it has agreed to supply gas to other ventures and now is uniquely placed as a supplier and consumer to benefit from the upswing.

Origin has underperformed the ASX 200 since December 2011. In the past few months that has begun to swing and the gap has begun to narrow.

Unlike other utilities that are mere middlemen in the market, Origin can source 40% of its gas requirements from its own operations. It also has the capacity to switch between fuel sources, with coal-fired electricity generation at Eraring, cheap coal under contract with the NSW government and gas-fired generation from the Darling Downs.

Macquarie maintains an outperform rating on the company with a price target of $15.50, well up from its current levels of under $12.

As principally an agent of gas, AGL has less scope to directly benefit from the substantial upswing in prices. While its gas supplies are far less than Origin’s, it has enormous storage facilities and should be able to better trade seasonal peaks.

Most of AGL’s benefit should be derived from its coal-fired operations, principally Loy Yang A, but also through its hydro and wind operations. Macquarie believes rising energy prices could benefit AGL to the tune of $80 million to $120 million a year.

The smaller operations all hold appeal although many already have gone for strong runs. Credit Suisse recently slapped an “underperform” on APA, purely because of its strong performance in recent months.

SP Ausnet has also risen strongly in recent months, although it has been constrained by the ominous  threat of a class action following the Victorian bushfires at Kilmore where 119 people lost their lives and 1,000 homes were destroyed. A March 22 deadline has been set for all those wishing to join the action.

Duet, a pure utility, controls the Dampier-Bunbury gas pipeline along with 60% of United Energy, a Melbourne electricity distributor and a gas distribution network in east and south-east Melbourne.

There are good buys and bargains to be found among the utilities. But they should not all be lumped into the same basket. And the constant change in energy industry dynamics are bound to continually affect prospects.

Power Surge

Company FY12

EBITDA ($ mil)

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Source: Bloomberg

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