Investing in Energy Sector

Typically, in bull markets, a few sectors fuel that rally. Earlier rallies were led by pharma, FMCG, banking, infotech, and telecom. Energy and power companies are leading since the Sensex crossed 17,000 the frenzy for these stocks is reminiscent of the infotech bubble in 2001. Energy and power companies are, of course, not new, but investors have taken to them lately. To differentiate between energy and power, the energy sector includes wind, solar, hydel, nuclear, and conventional energy through power generation via gas or coal based plants. Hence, the energy sector is vast, and the power sector is an important and integral part of it.

A host of factors is responsible for the poor performance of the energy and power sector India – capacity shortages, old equipment, bankrupt state electricity boards transmission and distribution losses, political and bureaucratic hurdles and so on India’s power deficit is around 12.5% and per capita consumption of power is 606kwh (kilo watt hours) far below the global average. The government has planned “power for all” by 2012. It has set an optimistic target of 100,000 MW by the end of the 11th plan, costing an estimated Rs 9 trillion. It announced ultra mega power projects of 4000 MW each. It has also allocated funds to reduce transmission and distribution losses from the current 40% plus to the international average of 10-15%

Good times are ahead for power companies in all segments, from generation and transmission, to the manufacture of equipment and cables. Companies with strong balance sheets, the latest technology and project execution capabilities stand to gain the most. Global players are eyeing the power sector as well.

The energy sector, which includes oil and gas, is set for a compounded growth rate of 9% over the next few years. With crude around $90 a barrel, oil exploration in India is more viable. Demand for oil and gas has been subdued due to supply constraints, but that’s set to change due to supply constraints. Demand for petro-products is set to grow from 164.7 million metric tons, now, to 209.2 million by 2011.The government has started a new exploration licensing policy to promote hydrocarbon exploration.

With companies like Reliance Industries and ONGC discovering large reserves of oil and gas, the energy sector’s outlook is good. Companies in oil exploration, production and logistics, and industrial users, are all expected to benefit. For example, ONGC will spend an estimated Rs 1.65 lakh crore on pipeline infrastructure transmission network gas distribution and exploration between 2007 and 2012.

The Indian mutual fund industry has its eye on the sector. Currently, there are only two funds in energy and power. Due to their different mandates, it’s difficult to compare their portfolio and performance. New funds with similar themes are on the way, with Sundaram BNP Energy Opportunities Fund recently closing its new fund offer. The first utility based fund, launched in 1999 was UTI Petro Fund. It aimed to invest only in petroleum stocks like oil and gas exploration, drilling, refining, and constructing and managing pipelines. It was recently repositioned as the UTI Energy Fund. With a corpus of Rs 880 crore, it now invests in power generation, energy storage, energy equipment manufacture. The Reliance Diversified power Fund, launched in 2004, is star performer. Its corpus has ballooned from Rs 376 crore in May 2004 to Rs 4,937 crore in November 2007.It has delivered 121% returns over the past year, and multiplied investors’ money approximately eight times since its launch.

The energy sector will benefit greatly from India’s economic growth in the next decade. A clear regulatory and policy framework would attract more participation. The government has set ambitious targets, and is focused on the downside risk of probable delay in capacity additions remains. Fuel supply concerns due to shortage, and the near monopoly of the state in coal and gas supply, may slow growth. Also, valuations of most energy and power companies are at dizzying levels, and may not sustain in the long run. If one wishes to invest in energy and power sector, it would be wise to take only a small bet. As in any other sector, there is a big chance of markets losing their fancy for this sector over time.