Can your portfolio benefit from lower energy demand?

Once again, the Australian Energy Market Operator (AEMO) has downgraded its forecast energy demand for the next decade.

Many Australians labour under the misapprehension that energy demand is growing, because their power bills are growing. In fact, the increase in your power bill is driven by overinvestment in power infrastructure, which is in large part a result of the historic tendency for AEMO to overestimate power demand. The truth is that wholesale power prices have been on a downtrend since 2010, as a result of overinvestment in centralised power generation.

Finally, AEMO has wised up to the fact that it can’t rely on vested interests to provide forecasts for energy demand, and is now accounting for the impact of energy efficiency and rooftop solar. It’s worth noting that rooftop solar is counted as “negative demand,” not supply, so if you’re a shareholder of Origin Energy (ASX: ORG) look no further than your neighbour’s rooftop panels to see what you’re betting against.

Amongst the big retailers, Origin seems particularly perturbed by the proliferation of solar panels and wind farms. This is less to do with its concern for consumers and more to do with its power generation assets. All the big retailers invest in polluting assets, but it’s clear that they take different positions. For example, AGL Energy (ASX: AGK) has been quietly supportive of the renewable energy target and is heavily invested in wind power (as well as fossil fuels).

In contrast, Origin has invested heavily in both baseload and peaking gas plants. Peaking plants rely on price “peaks” to make their return on capital. Peaks usually occur on hot summer days, when air conditioners are turned on and solar panels are producing the most electricity. Despite announcing a forecast downgrade in February, Origin’s share price has proved resilient, presumably on the back of optimism about its plans to export liquefied natural gas.

However, its domestic power generation strategy might not be so successful; the peaks in demand have been flattening in the last few years. This is due to the high penetration of rooftop solar, and the increasing popularity of energy efficiency solutions, such as those provided by Energy Action (ASX: EAX). These trends are sure to impact the returns generated by newly built gas generators.

Indeed, Europe’s largest utility, E.ON SE (Xetra: EOAN), has recently closed a gas-fired power plant after just three years of operation. That closure, as with others, is attributed to the falling cost of coal, and higher penetration of solar generation, which UBS has described as a “revolution.” Macquarie Group says that even with subsidy cuts “solar installations could continue at a torrid pace.”

According to Bloomberg New Energy Finance newly build wind farms are cheaper than new coal or gas-fired plants under the current Australian policy settings. Up until last week, investors may have believed strongly that the current policy settings would be unwound by a Coalition government. With the latest political hijinks putting King Kevin back on the throne, many will be questioning the validity of this assumption.

Furthermore, politicians are slowly waking up to the fact that the reason retail power bills are soaring is because we are spending too much on the networks. It is therefore quite possible that network owners such as Spark Infrastructure (ASX: SKI) and SP Ausnet (ASX: SPN) may find it harder to argue for increased capital expenditure (on which their increasing earnings are largely dependent) when they are negotiating capex in the next regulatory period.

Foolish takeaway

Dominant incumbents are rarely offered at a discount and often poorly understood by retail investors. Investors should consider each company’s long-term strategy and consider how they are responding to long-term trends. The incumbent generators, retailers and network owners have considerable political sway, and will be profitable for many years to come, but profit growth is not guaranteed.

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Motley Fool contributor Claude Walker has an indirect interest in Energy Action through a managed fund.

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