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An energetic outlook

Prospects and valuations in the energy sector look good as emerging markets and scarcity continue to drive demand

Rising demand for energy from emerging markets, political risks in the Middle East, dwindling resources of oil and the environmental impact of fossil fuels are leading to fundamental changes in the energy sector. These developments create compelling investment opportunities across the whole energy value chain.

The initial growth phase for alternative energies came mainly from Europe. In the past two years, around half of all photovoltaic solar electric panel installations were made in Germany. In future, however, growth is likely to come from the US, India and China. China particularly wishes to play a pivotal role in alternative energies due to its levels of air pollu-tion, the impact of global warming and its aspirations to be a leading provider of clean energy technologies.

Global oil demand is at a new record high and the threat of an energy/oil crisis is pressing governments to secure all available energy sources. Governments have been searching for alternatives to nuclear energy for a number of years and the recent events in Japan prompted a reevaluation of energy policies. Germany closed several of its 17 nuclear power plants as a temporary measure while the approval process for new construction projects has been suspended in China, which initially announced that it had no intention of changing its nuclear policy.

Most nuclear power plants in developed countries were built 30-40 years ago and are fast approaching the end of their operational lifespan. In today’s environment, new power stations to replace the old are unlikely in many countries and alternatives will be sought. Although renewable energy will play an important role in the process, it does not have enough potential to entirely replace nuclear power in the near future. Other energy sources and measures to enhance efficiency must play a part.

Investors can benefit from themes across the entire value chain. Many energy companies have strong earnings growth and are trading at attractive valuations. Themes with potential include wind, solar, liquefied natural gas, energy efficiency and clean coal.

Demand for clean energy is becoming prevalent in emerging markets, particularly in India, China and Brazil. Coal power plants will not go away but must become cleaner. Technologies to help achieve this are already available and some will become commercial over the coming years.

Companies producing new combustion technologies, emission reduction filters and CO2 capture and storage technologies are set to benefit.

Meanwhile, natural gas is the cleanest fossil fuel, being more abundant and cheaper than oil. However, the transportation of gas in its natural state across oceans is not practical. Through liquefaction, the volume of natural gas is reduced by 600 times, enabling transpor-tation from remote places.

In the future, liquefied natural gas will play a central role in the expansion and globalisation of the gas market, not only as a substitute for nuclear energy but also as a means of reducing Europe’s dependence on gas from Russia and North Africa. Providers of installations and equipment for liquefaction, transport, storage and re-gasification of LNG have excellent potential.

The solar market is expected to grow by around 30 per cent over the next 10-15 years, with declining costs, renewable energy mandates, government subsidies and climate change goals driving demand. These drivers will also prompt demand for wind turbines. Manufacturers and industries providing materials for solar panels and wind turbines will be some of the most promising growth companies.

Other companies to watch include those improving the efficiency of energy systems. They have a wide range of energy-efficient technologies for power transmission, buildings and transport. As the landscape for energy changes, these companies will see further growth.

Roberto Cominotto is manager of the JB energy transition fund at Swiss & Global Asset Management

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