The Future Is Gas

Published in Investing on 31 July 2012

Two FTSE 100 gas giants.

"It's really a gas and wind world today." So Jeff Immelt told the Financial Times while visiting London for the Olympics. He should know, he's CEO of General Electric, a company that manufactures plant across the whole spectrum of the energy sector. And he made clear that, in most countries, gas and wind power -- with some solar thrown in -- is seen as the way forward.

It's a trend that is playing out in quite different ways for two FTSE 100 (UKX) companies, Centrica (LSE: CNA) and BG Group (LSE: BG).

As if to underline Mr Immelt's comments, last week the UK Government announced measures to support the role of both gas and wind in the UK's energy supply. It will give tax relief for shallow water gasfield development in the North Sea, and it will cut the generous subsidies for onshore wind power by just 10% rather than the 25% lobbied for by Chancellor George Osborne.

North Sea

The North Sea tax measure had an immediate impact, with Centrica saying that it would go ahead with a £1.4bn investment in the Cygnus gasfield.

That fits with Centrica's strategy of matching its retail gas and electricity supply business with upstream production. Its strategy is to hedge fluctuations in retail margins against fluctuations in wholesale margins, which tend to move in opposite directions.

It's a strategy that seems to be paying off. In the first half of the year, adjusted operating profits were up 15% on revenues of just 4%, with the upstream UK business delivering a 28% increase and the UK retail business rising 9%.

It's a very different story for BG, which saw its first-half operating profit down 25%, after a $1.3bn non-cash write-down on its gas reserves. The reason: BG has invested heavily in the shale gas sector in the US, where a glut of supply and the economic downturn has pushed gas prices down to a quarter of their European equivalent.

Shale gas

The shale gas revolution has transformed the US energy sector. By combining technologies of horizontal drilling and hydraulic fracturing, or fracking, it has become commercially viable to extract natural gas trapped in shale rock, one of the most abundant rocks on earth. It's estimated that the US's reserves could last for 100 years.

Fracking is controversial. It involves pumping a mixture of water and sand into sedimentary rocks to force natural gas, or oil, to the surface. If it goes wrong, it has the potential to contaminate water supplies, and even cause earthquakes.

But the benefits of a cheap resource and energy security mean its future looks secure. The US aside, Mexico, Argentina, South Africa, China, Australia, Canada, Brazil and Libya all have massive reserves as well. There are prospects in Europe, too, including the UK.

The Motley Fool's latest report, "How to Unearth Great Oil and Gas Shares", tells you how to go about prospecting for value in oil and gas stocks. And it reveals the name of a small UK company that is taking part in the shale gas revolution. It's your chance to get in at the start. You can download the report here, for free, straight to your inbox.

LNG

BG's asset write-down was explicit recognition that US gas prices have been permanently reduced. But the company has an ace up its sleeve. As a vertically integrated gas company, it can ship liquefied natural gas (LNG) around the world. Its long-term strategy is to sell cheap US gas in higher price markets, exploiting the fact that, unlike oil, the price of gas varies region by region.

It's also cutting back production of US shale gas, a strategy being followed by others in the sector, such as Royal Dutch Shell (LSE: RDSB). That's likely to help stabilise prices.

BG is at a turning point. The experienced management team has enjoyed great exploration success, especially in Brazil, and is now in the process of turning discoveries into production. That requires massive capital expenditure. The long-term growth profile is attractive, but the execution risk is considerable, too, and the shares have dropped over 10% in the past year.

 Share pricePE (ttm)Dividend yield%
BG1,282p191.2%
Centrica322p184.9%

Centrica is the more defensive stock, with a juicy 5% yield.

Oils, Pharmaceuticals, Banks, Telecoms -- just where should you invest today? "Top Sectors Of 2012" is the Motley Fool's latest guide to help Britain invest. Better. The report is free.

Further investment opportunities:


Tony has shares in BG Group and Royal Dutch Shell but no other stocks mentioned in this article.

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