Monday, August 15, 2011

How to ease the pain of rising energy prices

The last few years have been very unkind financially to anyone with savings in building societies or bank deposits. With rates slashed to the 2-3% mark (before tax) the value of these savings has steadily declined as inflation has risen. This mix of rock bottom returns and high inflation is set to continue for years.

Worse for many people who rely on these savings has been the rising cost of energy - petrol prices and domestic fuel bills have risen much faster than inflation. What to do?

Ever helpful the big 6 energy suppliers have been offering fixed price deals which fix your tariffs for up to two years. A bit rich when they have just raised them 20% - "we're putting up your bills and would you like to lock into paying these rates for two years?". You would rue this if there is a recession and energy prices fall again even if just temporarily (and they have been falling recently).

A better option might be to buy shares in a couple of energy companies. An example would be Royal Dutch Shell B shares (RDSB:LSE). The share price has fallen recently below £20 (it has been as low as £17.68) at which levels the dividend yield is nearly 6% which could be received tax free if you open a self-select ISA. That yield is likely to grow in the coming years as Shell benefits from rising prices for oil and natural gas (which makes up half its output) and a growth program of investment in such areas as unconventional oil extraction and liquefied natural gas projects. The company's most recent set of results show profits up 74% with strong enough cashflow to support the dividend, finance the investment program and leave a very strong balance sheet with little debt.

Double the returns of a deposit account with potential for inflation-beating growth sounds too good to be true. But what of the risk to capital? Protecting the value of the original investment is the deposit account saver's key priority. No one can deny the risk of share price falls. We have just seen some recent market mayhem (though Shell recovered very quickly) and Shell may fall again in the coming months as the oil price softens. Also who can forget the BP oil leak which halved the share price practically overnight (Shell is dealing with a North Sea oil spill as we speak although thankfully on a much smaller scale).

All true but I would argue that the deposit account capital is not as safe as it looks. In fact savings there are suffering rapid erosion is real term and likely to continue to do so as interest rates are held below inflation for several years. At least by buying Shell or similar shares with a proportion of their capital the investor has benefiting in some way from rising energy prices. The risks can be reduced in two ways - buying up shares in stages so that the buying prices are averaged out and diversifying (buying a mixture of shares) through a energy fund or energy ETF, though watch out for charges.

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