Radiant outlook for energy sector

The year of the dragon has begun on an auspicious note with the S&P 500 having its best start since 1987, after a disappointing performance in 2011.

The outlook for energy appears particularly radiant, especially compared to last year when the single worst-performing share in the S&P was First Solar, a maker of solar panels. A short on the shares was the most profitable position for some hedge funds such as Greenlight for 2011.

Energy has always been the subject of hype – a perennial wild card for economies, financial markets and shares, as First Solar’s dismal share price drop underscores.

On the macro front, both instability in the wake of the Arab spring (which threatens to turn into an Arab winter) and the US efforts to encourage other nations to boycott Iranian oil have led some to fear a spike in oil prices. Any rise would lead to renewed inflationary pressures and discourage consumer spending at a time when global growth remains weak or non-existent.

Many future deals will focus on traditional energy. But many others will also involve bets tied to the new technologies around gas generally – and shale in particular – in part because of such uncertainty.

Meanwhile, the first US initial public offering of the year is an energy group, Renewable Energy, which priced on Thursday in New York. The company originally planned to list in 2008 and has been waiting nearly four years to make its debut.

Moreover, so far this year, oil and gas is the most active sector for equity capital markets globally, according to data from Dealogic.

In addition, much of the merger activity expected this year both into the US and outward bound from the US is likely to be energy deals, bankers say. Mergers and acquisitions in the upstream oil and gas industry in the US set records last year both in terms of the value and number of deals.

Asian investors are all rushing to the US to gain exposure to new technologies and sources of energy, and companies that can bridge the two. For example, last year Temasek and RRJ Capital, controlled by investor Richard Ong, partnered to acquire 70 per cent of Frac Tech Holdings from Chesapeake Energy Corp for $3.5bn, making it one of the 10 largest Asian deals. And last month, China National Petroleum announced that it was working with Shell and ExxonMobil on projects in its home market.

Nothing shows the transformation more dramatically than the way the focus has shifted at private equity groups such as Kohlberg Kravis Roberts from deals involving traditional energy to investments focusing on gas. In 2007, KKR teamed up with TPG to take over Texas utility TXU Energy in a record buy-out deal. For that deal to work out, natural gas prices could not drop too much. Today gas prices are less than half what they were then and KKR is valuing the investment at 10 cents on the dollar. Meanwhile, two of KKR’s investments in shale gas ventures returned three to five times the money invested. At the end of last year, Japanese trading firm Itochu joined KKR in a $7bn investment in Samson, an Oklahoma energy firm while its great rival Marubeni is taking a big stake in a Texas oil and gas venture, according to Japanese press reports this month.

The US is already exporting more energy than Opec member Ecuador, while the price of natural gas has sunk to levels that were inconceivable just five years ago. That trend has all kinds of second-order effects.

Today, KKR is not only investing in capital intensive shale gas ventures, it is considering investments in the infrastructure to handle changing forms of energy and patterns of trade. KKR executives note that major petrochemical companies are building new complexes in the US for the first time in years as the economics of energy change in favour of the US.

And, of course, they are also pondering who the victims of these changes are. Asset prices have already risen dramatically, leading some to believe that assets are already inflated and that there could be a correction.

So perhaps the surest bet for 2012 is a bet on volatility?

henny.sender@ft.com