The human tragedy unfolding in Ukraine is having dramatic ramifications across the world, not least in the energy market.

The US has banned the import of Russian oil, LNG (liquefied natural gas) and coal. Europe is not able to turn the taps off overnight as it is more reliant on Russia to meet its energy needs. However, the direction of travel is clear – the West is committed to weaning itself off Russian hydrocarbons.

This will be a painful process for individuals, businesses and governments and is likely to require significant investment in everything from renewables and nuclear energy to traditional oil and gas. In the short term, LNG imports and even coal could play a part in making up the shortfall and keeping the lights on across Europe.

There are several different industries and businesses which could be an important part of the transition and this article will explore some of those which are exposed and ways to invest.

THE OLD REGIME

Until 24 February 2022 and its invasion of Ukraine, Russia had a central role in the global energy mix.

According to the International Energy Agency, Russia is the world’s third largest oil producer behind the US and Saudi Arabia and was the world’s largest exporter of oil to global markets.

It accounts for nearly 20% of global natural gas production, second only to the US, and continues to be a significant exporter of gas, particularly to Europe.

Around 40% of Europe’s gas and 25% of its oil comes from Russia. This compares with 4% of the UK’s gas and 8% of its oil. The US doesn’t import any Russian gas and Russian oil represented less than 2% of total US supply and 8% of all its imported oil.

The UK gets a big chunk of its oil and gas from domestic production with the remainder made up by imports, principally from Norway but also LNG shipments from countries such as Qatar and the US.

However, both the UK and the US are affected by the surging energy prices resulting from such a significant chunk of supply effectively coming out of the market.

The UK has said it will phase out Russian imports of oil by the end of 2022 and noted it is not dependent on Russian natural gas. At the time of writing (11 March) a new energy strategy for the UK was believed to be imminent.

EU PLAN OUTLINED

The EU has published the outline of its own plan for what it describes as ‘affordable, secure and sustainable energy’ to make itself independent from Russian fossil fuels ‘well before’ 2030. As well as moving towards other energy sources, this plan includes room for windfall taxes and imposed limits on household energy costs.

The problem is that boosting the contribution from other forms of energy is not something which can be done overnight.

Germany has signed a contract to build its first LNG import terminal, but it is not expected to be operational until 2024 while the typical build-time on a nuclear power plant is at least five years. Russia’s position as a big player in the world’s metal markets means the cost of all this infrastructure is elevated too as metal prices have soared in recent weeks due to sanctions disrupting supplies.

However, the gravity of Russia’s actions against Ukraine means the West’s will to prioritise energy security is not something which is likely to evaporate in the short or even medium term.

SHORT-TERM SOLUTIONS

Short-term fixes may involve leaning more on polluting sources of energy like coal. Australia, for example, is looking for coal developments to be expedited to boost exports to Europe. Another solution is to use less energy in absolute terms by making buildings better insulated or upgrading energy networks.

For those countries with substantial reserves of oil and gas there may well be efforts to incentivise new investment. Below we discuss in more detail the levers countries can pull and some relevant investment ideas.

RENEWABLES AND ALTERNATIVE ENERGY

Investment bank Berenberg notes that as part of the EU’s new power strategy: ‘Member states should swiftly map, assess and ensure suitable land and sea areas that are available for renewable energy projects.’ Both in the UK and Europe accelerating a shift into renewables is likely to involve speeding up the permitting process for this type of project.

There also needs to be investment in battery storage to help mitigate for the unpredictable nature of wind and solar power generation.

Companies with direct exposure to renewables include London-listed utility SSE (SSE), which builds and operates large onshore and offshore wind farms, as well as the likes of RWE and Orsted in mainland Europe.

Clean energy companies, centred around the use of hydrogen as an alternative fuel, have soared on the stock market in the wake of Russia’s decision to invade Ukraine. However, the likes of Ceres Power (CWR:AIM) and ITM Power (ITM:AIM) are still broadly flat year-to-date despite the recent surge in their share prices thanks to previous weakness on the market.

Both businesses are still some way off achieving profitability, though they have a decent amount of cash in the bank as they look to commercialise their technologies.

On 10 February, Berenberg issued research on the clean energy sector whereby it had a ‘buy’ rating on Ceres Power and a ‘sell’ on ITM. It likes Ceres for its blue-chip partners and leading solid-oxide technology. The bank dislikes ITM because of scale-up, technological and competition risks.

Exposure to a diversified portfolio of renewables infrastructure is possible through The Renewables Infrastructure Group (TRIG). Even though the trust trades at a 17.3% premium to net asset value, it pays an attractive yield of 5% and will be a beneficiary of elevated power prices.

Increased investment in renewables should also increase the value of its assets and create further opportunities for the trust.

Investec, which has a ‘buy’ recommendation on the shares, comments: ‘TRIG remains well placed against the current macro-economic and geopolitical backdrop through its ability to enter into fixes/hedges at elevated forward pricing and/or through capturing materially higher spot prices where revenues remain unhedged.’

NUCLEAR POWER

There are obstacles to more widespread adoption of nuclear power. Green parties across Europe are increasingly powerful and are broadly opposed to any expansion in nuclear, and Russia currently produces a large proportion of the world’s enriched uranium for nuclear reactors.

Germany has already expressed scepticism over any plans to expand or extend its nuclear sector and there was no mention of this form of energy in the EU’s recently published plan. New nuclear developments also have long lead times.

However, given nuclear is a low-emission option capable of providing substantial and predictable baseload energy, it could well form part of the solution.

Regulators in the UK are currently looking at designs from Rolls-Royce (RR.) for small modular reactors which could largely be built in a factory, reducing development time and costs. The UK Government has put up £210 million of funding to help back the technology, although the first plants aren’t expected to be operational until the 2030s.

One way to get to exposure to any revival in nuclear power is through Geiger Counter (GCL) which invests in companies involved in producing uranium for the nuclear power sector. As of 30 September 2021, the trust had no holdings in Russia with more than 80% of its assets based in Canada and Australia. Shares in the trust trade at a modest 1.45% premium to NAV although the ongoing charge is relatively high at 2.67%.

Another relevant share to the nuclear theme is Yellow Cake (YCA:AIM) which invests in physical uranium.

OIL & GAS (AND COAL)

One controversial move could be to lean on coal-fired power stations. Shares in coal producer Thungela Resources (TGA) have already increased by 109% year to date amid a surge in coal prices, showing there is still plenty of life in the coal sector.

Another move is for countries like the UK which have material domestic reserves of oil and gas to ramp up investment in exploiting those resources.

There is speculation the UK might reverse a ban on fracking for shale gas, while separate reports suggest a new round of North Sea exploration licences could be in the offing for the first time since 2019.

New licences tend to take decades to move into production but increased spending on existing fields could help boost output.

Any support for the North Sea oil and gas industry is likely to be accompanied by requirements for operators to reduce their emissions.

A good way to play a potential renaissance in the UK North Sea is to buy shares in Serica Energy (SQZ:AIM). Based on consensus 2022 forecasts, the shares trade on a price to earnings ratio of 3.3 times and, unusually for an AIM-quoted oil company, they also pay dividends with the shares yielding a modest 1.3%.

The company is the largest listed independent producer in the North Sea – with 85% of its production accounted for by gas. The main risk it faces is the introduction of a windfall tax by the UK Government to help cushion the impact of soaring energy bills on consumers.

On a broader basis, increased investment in offshore oil exploration could benefit oil service companies. It’s interesting to see how the market has recently bid up shares in services giant Baker Hughes, mostly likely because the Russian/Ukraine war has raised awareness that the West needs to take more action to secure future  energy supplies.

ENERGY EFFICIENCY

On the basis that the cleanest form of energy is that which you don’t use, energy efficiency is likely to form an important part of the West’s future energy strategy. One way to play the theme is SDCL Energy Efficiency Investment Trust (SEIT).

The trust has nearly £1 billion of assets, ranging from roof-top solar installations and on-site power generation to energy reduction through more efficient heating, cooling and lighting.

It earns a contracted return on these projects based on the efficient supply and reduction in demand for energy.

More than 52% of its assets are in the US and 23% in Europe and the shares trade at a 12.8% premium to NAV. The trust yields 4.8%.

Read more on other energy efficiency investments in this article. 

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