In AGF’s 2022 Outlook Report, Dillon Culhane describes how inflation affects energy, utilities and electricity stocks in different ways. Depending on the type of business, opportunities should be available to identify investors in a variety of disciplines.
According to Culhane, the general beneficiaries are oil and gas producers who benefit from rising energy prices because higher revenues are usually more than offset by rising inflation in labor, material and fuel costs. Producers in better positions are usually more cost-effective, as lower output reductions lead to reduced reinvestment.
Because of productive capital discipline and the reserve capacity of equipment such as drilling rigs, which limit their pricing power, energy service companies are comparatively less profitable and pass on the higher costs to their customers. If inflation continues, service companies with high barriers to entry, fierce competition, limited replacement equipment and consistent pricing power will prove to be the most attractive.
Regulated utilities stocks should rise, Kulchen said, passing higher costs to customers through rate hikes, while benefiting from the longer-term potential for higher regulated return rates. The impact could be more pronounced on non-regulated power producers and renewable energy developers, Culhan wrote in the AGF report. Smaller companies are more vulnerable, with lower scale, higher financing costs, and less bargaining power with suppliers and longer-term customers, while most large developers are not significantly affected by inflation so far.
These are all under the assumption that inflation continues to rise while economic growth remains strong. However, if growth slows and stagnation becomes a threat, it will result in a drop in energy demand and a drop in energy prices. Nevertheless, this may not be a pressing matter as inelastic (power, heat, petrochemicals) energy demands take a higher part.
