Energy market under pressure
It is not only in Europe that gas and electricity prices are reaching record levels. What impact does this have on the financial markets and are there still interesting investment opportunities within the energy sector?
Rising energy prices = rising inflation?
The recent increase in energy prices will inevitably lead to a further rise in inflation. However, central banks around the world are taking a relaxed approach to the situation. They argue that the current spikes in inflation rates are only temporary. “For monetary policy, overcoming the slump in employment and economic activity as a result of the coronavirus pandemic is currently more important than the level of inflation,” says Dr Volker Schmidt, Senior Portfolio Manager at Ethenea. “Therefore, for the time being, high energy costs should have little impact on central banks’ interest rate decisions.” Inflation and the development of central bank interest rates are also only one factor among many for the development of long-term bond yields, he adds. An increase in long-term interest rates, e.g. for 10-year US Treasuries or German Bunds, is currently still limited thanks to the central banks’ asset purchase programmes.
Country-specific differences in dealing with high energy prices
“Generally speaking, both consumers and companies whose production relies heavily on the use of energy, have at least temporary protection against the rise in energy prices, because they have entered into longer-term contracts or hedging transactions,” explains Dr Schmidt. “The decisive factor for them will be the duration of the high-tariff energy costs, because at some point even the longest-lasting contract will expire.”
However, he adds, there are clear country-specific differences. “In Italy, Greece, and France, consumers already receive government support,” the expert elaborates. “Spain has fixed the energy prices of nationally-generated hydroelectric and nuclear power, suspended energy taxes, and thereby curtailed the rise in energy prices through government regulation. The current situation in the UK is particularly dramatic. Fertiliser manufacturer CF Industries has shut down its plants in the UK as a result of the energy crisis.” However, as one by-product of fertiliser production is CO2, which is essential for food preservation, the government stepped in and persuaded CF to resume production, he said.
How can investors benefit?
“At the moment it is difficult to keep track of which companies are benefiting from the developments and which are struggling,” says Dr Schmidt. For energy suppliers in particular, the situation is tricky. “On the one hand, utilities want to offer their customers the lowest possible competitive prices, which argues in favour of short-term contracts between utilities and electricity producers when prices are low,” the Portfolio Manager explains. “On the other hand, long-term contracts with producers are important for utilities to calculate reliably. But if a utility has hedged at too high a price level for too long, it will be overtaken by competitors who have taken short-term hedges in the event of a price drop.”
The example of the British energy supplier Green shows why it is important to thoroughly analyse individual companies when investing. “Green has capitulated due to the current regulations, which stipulate that customer contracts cannot be adjusted to current market situations. The cost of buying gas is well above the price the company is allowed to charge its end customers.” Even though Green is not represented on the capital market with either shares or bonds, this is a powerful illustration of the fact that a fundamental case-by-case analysis, as well as an understanding of the most important pricing mechanisms, is particularly important when it comes to smaller companies. At least six other energy suppliers in the UK have gone out of business in September alone because the suppliers are not also the producers of the energy.
Consequences for the portfolio
“In summary, at present, bonds issued by companies in the energy sector rarely represent an attractive investment,” says Dr Schmidt. “The owners of electricity or gas grids, for example, are not currently paying attractive risk premiums. Investors rightly consider them low-risk because their business model is scarcely dependent on changes in energy prices and they are also usually still partly state-owned.” The main risk is the potential loss of one or more customers. “The clear winners of the current energy crisis are the gas and oil exploration companies as well as the pure electricity producers, including the producers of coal-fired electricity, which are rightly criticised for sustainability reasons if they have their own coal deposits. In Germany, this only applies to producers of lignite-based electricity; hard coal has not been mined for some time, but is instead imported. At the moment, the priority of consumers and energy-consuming companies is definitely more security of supply and less about sustainability.” This is also shown by the fact that coal-fired electricity in Germany replaced renewable energies as the most important energy source during the first half of 2021.
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