The government's strategy is good news for Centrica (LSE: CNA)...
George Osborne announced the government's new Gas Generation Strategy last week. Overshadowed by his own Autumn Statement, it attracted most media attention for the tax and regulatory support it gave to fracking.
But it was also supportive of the conventional gas sector; enough so for the government's environmental critics, at least, to dub it a second ‘Dash for Gas'.
That was good news for Centrica (LSE: CNA), which coincidentally last week announced the start of construction of the £1.4bn Cygnus gasfield in the North Sea. The company had given the final go-ahead to the development in the summer after Mr Osborne announced tax reliefs for North Sea gasfield development.
Centrica, the owner of British Gas, is usually thought of as a utility. But it has a strategy of investing upstream to balance its downstream gas and electricity business. Wholesale margins tend to move in the opposite direction from retail margins.
Upstream gas production contributed a third of its operating profits in the first half of this year, not much less than the UK downstream business.
So the government's confirmation of its commitment to the gas sector is positive support for a share that is in many equity income portfolios. Indeed, the stated objective of the government's strategy is to reduce the uncertainty around gas generation for investors. It plans to:
- Balance the support it gives for low-carbon technologies by capping the levy charged on conventional energy firms out to 2020;
- Fund the development of Carbon Capture and Storage technology, which could turn both gas and coal into low-carbon fuels;
- Look at improving the operation of the wholesale gas market;
- Consider whether there is a case for measures to encourage gas storage.
The measures should ensure that "adequate gas generating capacity is available... [there are] opportunities for investors in gas generation plant... and the necessary gas supply infrastructure is in place to support the role of gas in generation".
Centrica is the largest investor in the Cygnus gasfield project, with a 49% interest. Operator GDF Suez has 39% and Bayerngas 12%. The field is the largest discovery in the southern North Sea for 25 years, with the first gas due to be delivered in 2015.
Further downstream, Centrica's ageing gas-fired power generation fleet has been a drag on performance. It has closed one power station and is reviewing the future of two others, and has said that the business will be loss-making from next year when the regime for carbon credits ends.
But again the government's Gas Generation Strategy is encouraging, recognising the need for significant new investment in gas-generating plants over the next 20 years.
Centrica is also benefiting from the government's nuclear policy. It's a 20% shareholder in EDF Energy's Hinkley Point B and Hunterston B nuclear power plants, which have just had their operating life extended by seven years from 2016 to 2023. Also, with EDF Energy, it has just won the first licence for a new UK nuclear power station in 25 years.
Centrica's increasingly diversified business model is in stark contrast to that of BG Group (LSE: BG). Originally both part of state-owned British Gas, BG took the upstream operations when Centrica was spun off as the downstream business. Just as Centrica grew a new upstream business, BG acquired downstream transmission and distribution businesses.
But in recent years it has been rowing back, selling its downstream businesses to fund investment in massive projects in Brazil and Australia. When it announced further delays in development of its Brazilian operations at the end of October, its shares lost a fifth of their value.
That shows the dangers of concentration, but also the upside: BG's shares are much more likely to add 20% than Centrica's are. With its massive utility business, Centrica is a relatively safe play that gets some benefit from its upstream activities. BG is a big bet on its ability to turn its discoveries into income-producing assets.
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> Tony owns shares in BG Group but no other shares mentioned in this article.