Plans in the Pipeline
The need to find cheaper and renewable sources of energy is creating some interesting investment opportunities according to Edward Russell-Walling
High oil prices today, and what will almost certainly be even higher prices tomorrow, will have a significant effect on the world economy. Many of the results will be unwelcome, but a changing energy outlook will actually also throw up new opportunities for thoughtful investors.
Some blame speculators for forcing up the recent price of oil, but their influence has been overstated. The main culprit is demand, which is outweighing the long-term supply. More worryingly, from an oil user's point of view, the gap between the two is going to get even wider, not narrower. Unlike the situation in the 1970s, when the last dramatic oil price spikes occurred, discoveries of new oil reserves can no longer keep up with consumption. Many now believe it not merely possible, but probable, that a barrel of oil will cost $200 by the end of the decade. What's more, the cost of transporting oil is going up too.
This will not be a passing phase - given the dwindling ratio of reserves to production, it is likely to be a permanent shift. Oil economists have much to say about that process but, for investors, there are broad implications, including the fact that alternative energy sources, along with the energy suppliers, will become increasingly important.
The Way Forward
Alternative energy is already being encouraged by governments, who want to cut carbon emissions and increase the proportion of energy produced from renewable resources. A growing desire for energy security and protection from the increasing cost and scarcity of oil will reinforce their determination. That will be important to the immediate future of energy alternatives, which are not yet viable without some form of subsidy. Subsidies drive mass production, which in turn drives the costs down.
Solar energy is considered one of the most promising alternatives. Here, sunshine is used to heat water or produce electricity, using photovoltaic (PV) cells. While PV electricity is uneconomical right now, there is plenty of scope for the costs to fall in the future. Solar energy systems can be installed anywhere, and future applications could include powering desalination plants, charging electric vehicles, and - importantly - making hydrogen from water.
In essence, there are two competing PV technologies: silicon wafer-based cells and thin film. Silicon cells generate more power per square metre, so are better suited to small spaces. Silicon prices are high at the moment, however, making thin film systems cheaper per watt generated. Thin film also works better in cloudier, high temperature areas and are easier to incorporate in buildings - they can cover windows, for example.
Rather than choose between these technologies, Baillie Gifford has invested in leading firms with solid balance sheets and low non-silicon costs. "Our portfolios include Germany's Q-Cells, the largest independent cell manufacturer, and First Solar of the US, the largest and lowest cost maker of thin film modules," says Tamas Bakacs, who is head of Baillie Gifford's energy sector group.
Wind power is already becoming more competitive with traditional energy sources, particularly as oil prices rise. Its longer-term fortunes may depend partly on the progress made by other sources, such as solar and nuclear. However, Texas oilman T Boone Pickens - who is currently building the world's largest wind farm - recently told US senators that the USA could generate at least 20 per cent of its electricity from wind turbines. Baillie Gifford, meanwhile, has been buying shares in Denmark's Vestas, the world's largest manufacturer of wind turbines.
Biofuels are taking a buffeting today, as the food-or-fuel debate continues, but they clearly do have
a future, particularly once the second generation technologies are viably able to produce fuel from non-edible feedstocks - like jatropha, switchgrass and, eventually, timber. Alongside firms at the forefront of promising technologies, second-generation feedstock producers could also be a promising avenue for exposure to this alternative energy sector.
The energy/ecology theme should add value to certain non-energy stocks too, such as makers of hybrid cars. Carbon sequestration could prove to be an important investment opportunity. The technology involves capturing carbon from fossil fuels and storing it underground before it can be released into the atmosphere. It is at an early stage and is potentially very costly, but it seems likely that US emissions legislation may help it take off, in which case a whole new infrastructure would have to be built. Beneficiaries of this would include a variety of companies involved in extraction systems, pipelines and reservoir injection systems.
Seizing the Opportunities
So, for forward-thinking investors, there is some hope in a world without oil and carbon emissions. But - and it's a big but - alternative energy is not going to displace fossil fuels any time soon. In mid-2007, solar energy accounted for just 0.04 per cent of world electricity generation. Even in the US, it could grow at 30 per cent for 20 years and still only have a 2.4 per cent share, according to Bank of America. We haven't even begun to see the end of fossil fuels in general, and of oil in particular - and this is where another potential implication for investors comes in.
In an era of rising oil prices, inflation may take its toll on many sectors, as central banks seem to be reluctant to raise interest rates because of concerns about the effect of higher rates on individuals, on governments and companies.
So, in the years ahead, oil and gas could remain the best haven for investors, since companies with reserves will have even more value than they do now. The most attractive are those located in parts of the world with ample reserves as well as the opportunity to grow them. As far as Baillie Gifford is concerned, that means Brazil and Russia.
"Brazil's Petrobras has discovered more oil in the country's off shore deep water region, and has a
tremendous opportunity to increase the value of its reserves," explains Bakacs. He believes Russia's Gazprom shows promise too. Not only does it provide more than a quarter of Europe's natural gas, but it also owns the biggest gas transportation system in the world (i.e. the pipelines that deliver it). "Gazprom is a national champion and its ex-chairman is the president of Russia - this makes it
rather attractive during an era of growing resource nationalism."
Fossil fuels offer opportunities to diversify too. More expensive oil spurs production in awkward and
costly places, such as deep oceans - and oil services companies, such as oil rig suppliers, are the obvious beneficiaries of that. "If the majority of an energy portfolio is invested in integrated oil companies, oil services companies with a demonstrable competitive advantage are a useful diversifier," Bakacs concludes.
The value of shares and any income from those shares is not guaranteed and could go down as well as up.
Edward Russell-Walling is a finance and business writer and editor. He contributes to The Banker and Director and is author of 50 Management Ideas You Really Need to Know.
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