With fears of a global recession and continued turbulence in financial markets, 2008 has not been a particularly rewarding year so far for investors. In such difficult times, it can pay to explore investments that are well positioned for a longer-term favourable theme rather than those dependent on a highly unpredictable economic cycle. One theme such theme with this positive outlook is global power.
The world's electricity supply is undergoing a major transformation and it is important to understand that there are a number of drivers behind it.
In the developing countries, rapid rates of industrialisation and urbanisation have led to a massive surge in electricity demand, and power generation needs to be upgraded to keep up. Recent estimates predict a shortfall of 1,000 Gigawatts (GW) in the developing world by 2015, which is more than 10 times the UK's current electricity capacity. It will take an estimated $22,000bn (£11,000bn) to be spent on new supplies to meet the demand over the next 25 years.
Western governments, however, face a different problem. Ageing power stations need to be replaced and there is a desire to reduce the instability that comes from reliance on oil and gas. There is also increased environmental legislation to be met, such as the EU's commitment to supply 20 per cent of all generation from renewable sources by 2020.
Nuclear power is being widely coveted as the solution and was high up the agenda in meetings this week between Gordon Brown and French President, Nicolas Sarkozy.
The problem, though, is the long lead times on nuclear development. In addition, the spiralling demand for nuclear infrastructure globally has heightened the development costs for the UK market, a factor also playing out in the non-nuclear power sector where the rising world cost of materials such as steel has ensured a dramatic rise in the cost of new build for power stations.
This rising cost of new supply will necessitate a rise in the electricity price to justify further investment. In addition, with the depletion of cheap gas reserves from the North Sea and a significant rise in the oil price caused by emerging market demand, it seems likely that UK consumers are facing higher energy prices for some time, a factor that will continue to irk government. Nevertheless, concern that supply is struggling to match demand has led to increased growth opportunities for UK listed power companies.
One such company is FTSE 100-listed Scottish & Southern Electricity (SSE). It has been active in developing increased capacity from renewable sources in line with more demanding environmental legislation and recently bought Airtricity, a group with substantial interests in wind power.
Furthermore, given that SSE is a vertically integrated power group with interests in both electricity supply and generation it retains a superior business model if electricity prices remain stronger for longer. Power groups without generation assets are more exposed to a rise in wholesale prices given they struggle to pass on fully the cost in a competitive supply market and control no upstream generation assets which can provide a very useful hedge in a rising price environment. This outlook perhaps goes some way to explaining the recently rumoured interest of Centrica in buying the Yorkshire based power generator, Drax.
Another stock to consider is International Power. It keeps the lights on in 20 countries worldwide and should be a key beneficiary of the trend towards an increase in the electricity price emanating from the supply and demand in-balance. Of additional interest, it operates desalination plants in the Middle East, which utilise its electricity assets to convert salt water into drinkable water. With a growing threat over longer-term water supplies, particularly in emerging nations, this part of the business may have significant investment potential for some considerable time.
Aggreko is another stock with good opportunities for growth. It provides temporary power solutions to the international market via mobile power generation units, up to the size of a small power station. The group is a key beneficiary of any trend towards power shortages given the flexibility of its operating plant.
BG Group is a company associated with the outlook for power. Essentially, BG supply liquefied natural gas (LNG) to international markets, a product that can be distributed internationally due to its high portability. Given the level of global demand for clean fossil fuels such as LNG that are not tied to pipelines, the price has been rising on international markets, a factor which benefits BG Group significantly and which has been another feature in inflating domestic and global electricity prices.
Issues such as power generation are longer term in nature and should be likely to benefit companies that respond well for some time. With uncertainties emanating from the global credit crunch, power generation is certainly a visible and viable theme to invest in.
Andrew Moffat is the manager of the Co-operative Insurance Society's (CIS) Income With Growth Trust. Sean O'Grady is awayReuse content