Energy and infrastructure services companies such as Balfour Beatty plc (LSE:BBY), Babcock International PLC (LSE:BAB) and Smart Metering Systems PLC (AIM:SMS) should benefit as the UK seeks to balance energy security with cost and decarbonisation goals.
Liberum Capital highlighted the trio in its report ‘The 4S's: Support Services & Special Situations: The Energy Trilemma and how to play it,’ with construction firm Kier Group PLC (LSE:KIE) also seen as a winner.
Balfour Beatty provides services to the UK energy grid and is acting on a number of offshore wind projects. The infrastructure firm is contracted to build a substation for the 1.4 GW Hornsea 2 offshore project, which was slated in 2018 to become the largest offshore wind project in the world.
Engineering company Babcock manufactures nuclear reactor engines, due to which the UK government holds a golden share in the business that ringfences its stock and provides insulation from a possible private takeover, and construction firm Kier offers infrastructure services to renewable energy plants.
The UK government is currently in talks with EDG over the Sizewell C nuclear energy project, which will cost up to £1.7 billion, and is expected to make an investment decision this parliamentary season.
The energy trilemma is a term for the triple challenges facing the UK energy sector as it transitions away from coal and the country moves towards generating net zero carbon emissions, referring to the trade-off between decarbonisation, energy security and the cost of energy.
The World Energy Trilemma Index has the UK placed fourth in the world at meeting the energy trilemma.
With the UK currently facing high energy costs, together with the surging price of oil, the energy trilemma is now arguably more acute than ever. Energy security and pricing has recently come into the spotlight as a result of the restricted supply of oil due to sanctions on Russia following its war on Ukraine.
The upside of an economy more reliant on electric vehicles and localised renewable energy and less reliant on oil cannot be held hostage by oil supply shortages from countries such as Russia.
UK government policy aims to reduce carbon emissions to zero as part of a Net Zero Strategy by 2050. The subsequent UK Energy Strategy, released in April 2022, involves the addition of eight prospective new nuclear reactors to the country’s supply.
According to the BEIS, less than a third of UK energy supply as of October 2021 came from natural gas, with renewables being the largest source and coal being minimal, after renewables overtook fossil fuels on the grid in 2020.
The International Renewable Energy Agency said the 62% of renewable energy generation added to the grid in 2020 was cheaper than the cheapest available fossil fuels.
The shift to renewable and low-carbon energy is not risk-free, as it will involve removing baseload power sources from the grid which ensure consistent supply and operation.
There are often times when wind farms and solar panels are not producing power, and although the greater adoption of predictable power sources such as tidal power and the increased use of smart energy meters and battery storage is designed to stabilise the grid, many fear that baseload power is under threat without the wholesale adoption of large-scale power plants such as nuclear.
With battery storage also being betted on to improve baseloads, and the UK seeking to deliver 50 GW of offshore wind capacity by 2030, up from 14 GW to date, with a target of achieving 95% renewable electricity, companies such as grid-scale energy storage provider SMS could benefit.
Liberum forecasts that SMS will generate a yield of 11% but this could rise as volatility increases due to reliance on battery assets, to up to 23%. Heat pump companies are meanwhile not expected to benefit significantly in the near term as the government made no major new commitment to heat pumps, it added.
“SMS’s existing meter and battery pipeline is worth at least £135m of recurring EBITDA and will grow in perpetuity with inflation. However, the addressable market just in established products is worth almost 10 times that at £1.2bn,” Liberum said.
The broker noted that SMS has won 620MW of battery contracts to date, but that there is still room for other players to come into the growing energy-storage market.