Last week our editor Richard Hemming wrote on the energy sector for my column in The Australian. Here is his article. Join Under the Radar Report today and invest confidently in Small Caps.
What is happening in the energy sector?
The time to buy is not when everything is going hunky dory, but when current difficulties obscure future profit growth. This is what’s happening in the energy sector, where many of the companies are mired in current difficulties obscuring the future profit growth from higher spot gas prices.
Liquefied natural gas prices collapsed early in 2020 due to the COVID-19 pandemic, but factors such as an Asian cold snap, northern hemisphere winter demand, shipping constraints, China recovery post COVID-19, and higher Korean demand due to nuclear generation outages led to severe supply tightness resulting in a surge in the LNG netback price from historical lows of around A$2.30/gigajoule in mid 2020 to as high as A$19. While the price has settled back to around A$10, gas producing ASX listed companies stand to benefit, though this is being obscured by current difficulties, some COVID-19 related and some not.
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Three Small Cap energy stocks
A classic example at the small end of town is Cooper Energy (COE), which will benefit from the severe shortage in gas Eastern Australia is on to experience from 2026 due the vast LNG exports from Gladstone through the likes of Origin Energy (ORG) and Santos (STO).
Cooper is in the box seat to be a key supplier to South East Australia where it believes the market opportunity is 70 petajoules a year by 2023 and over 100PJ by 2024. 1 petajoule is the equivalent of powering about 19,000 homes for a year. Utility customers include AGL Energy, Energy Australia and Alinta Energy.
Cooper is now at the beginning of contracted gas sales, which is no mean feat considering the major problems management has had to deal with. These centre around the APA owned and operated Orbost Processing plant for Cooper’s flagship offshore Sole gas field in the Gippsland Basin, Victoria.
What's happening with Blue Chip energy stocks?
At the big end of town our Blue Chip Value model likes Origin Energy, which has the ability to ramp up LNG production to take advantage of higher prices with gas production techniques supported by artificial intelligence.
This is through its 37.5% interest in Asia Pacific LNG. In November 2020 it achieved record operated asset production of 1,614 terajoules/day, but the company is experiencing pressure on earnings, an announcement this week highlighting that its retail business is generating lower profits, driving a 13% downgrade in FY21 earnings (EBITDA) guidance.
The LNG prices Origin receives are linked to the oil price. Over time we believe that higher LNG prices will boost its bottom line, as will continuing production increases. On the retail side, Origin is also on track to deliver cost reductions, some of which through its disruptive distribution platform Kraken, owned by Octopus Energy (Origin has a 20% stake in this company).
Then there is the energy contractor Worley (WOR) whose stock was hit hard recently in the wake of a profit downgrade due to ongoing COVID-19 related project deferrals. The company expects these projects to return as global economic conditions improve. There have been negligible project cancellations, but the announcement underlines how volatile the contractors’ earnings are and also how there are opportunities for investors who appreciate value.
Worley has broadened out its offering to beyond oil and gas says it is seeing profit potential accelerate across all its sectors.
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Watch this stock if you're looking to reduce risk
Last, if you’re looking to reduce your portfolio risk, arguably you can’t go past the pipeline owner/operator APA Group (APA). The company has a strong defensive asset base and balance sheet, which gives it the ability to fund more infrastructure investment.
Late last year the company announced it will invest up to $460m to construct a 580km pipeline in WA connecting the emerging gas fields in the Perth Basin to the resource rich Goldfields region, forming an interconnected WA Gas Grid, expected to be operational mid-CY2022.
APA has growth potential and offers a dividend yield of over 5%. With all this uncertainty, here’s a stock with a monopolistic position to consider, in part because it allows you to take more risk in the smaller end of the market, which I would argue is more fun and more lucrative.