Further electricity price shocks are on the way.

Hard on the heels of a doubling of electricity prices, the head of Australia’s largest listed energy utility, Origin Energy, has warned of a heavy new round of capital spending that might place further pressure on power prices.

After the steep rise in power prices over the past five years due to heavy network investment, Origin managing director Grant King said a new round of spending would be necessary to achieve the federal government’s renewable energy target (RET).

This will come as the government is seeking to rein in power prices, hoping that electricity will decline under a ”CPI minus X” pricing regime.

But according to Origin’s estimates, about 2200 megawatts of additional wind generation capacity will be needed annually between 2017 and 2020, ”which will require an enormous increase in activity to 2020” in terms of new investment, Mr King said.

Even though wind power is inexpensive to build, it is difficult to obtain the permits and approvals, and it also needs gas-fired power stations to generate electricity when the wind is not blowing.

This would drive a significant new round of capital spending that would put pressure on power prices at a time when renewable energy was already a big burden on households and smaller companies, he said.

The Climate Change Authority has recommended leaving unchanged the existing target of 45 terawatt hours of electricity sourced from renewable energy by 2020. But declining electricity output will push the proportion sourced from renewables to 27 per cent of the total by then, more than the 20 per cent initially planned.

”We don’t yet know what the RET scheme is costing us and we should have known more about that as a result of the [authority's] review, but we don’t,” Mr King said.

”At the moment, these are marginal fuels, free-riding on the system. Once that free ride is over, they will have to pay their way, and that will result in increased costs.”

It was likely the proportion of environmental programs such as the carbon tax would exceed that of the wholesale cost of generation for many small and medium businesses unable to access compensation under present arrangements, Mr King said.

Programs to spur the take-up of solar photovoltaics had cost about $4 billion, or as much as $600 a tonne of carbon abated, he said.

Read more: http://www.theage.com.au/business/more-pain-to-come-on-power-prices-20130318-2gb4c.html#ixzz2NvxQzSK1

In the wake of an AGM season where the only thing that came out of a mining services’ executive’s mouth indicated a “profit downgrade”, investors should be aware that these stocks are poised to surprise in the coming year, especially with $100 billion or so in projects either going ahead or forecast to go ahead.

The list of mining contractors that have issued downgrades recently is long, and it’s been at the big and the small end. It includes companies involved in the construction end, and also the operational. Basically, they’re all being hit.

The driller Macmahon was possibly first off the ranks in the AGM season at least, but others in recent months include Coffey International, Imdex, Boart Longyear, Orica, ALS (previously called Campbell Bros), Cardno, Matrix C&E, Emeco, NRW, Lycopodium and Ausdrill. We could go on.

Following big falls, many of these companies a trading on PE multiples of four times for the current year, compared to the market average of about 13 times. Even if their earnings halved, they’d still be on single digit PEs!

Issam Eid runs a small cap fund for Sigma Funds Management. He says the market assumption that the work-in-hand for mining contractors is drying up is far from correct.

“It’s not like it’s all stopped, but that’s what’s being priced in. The danger for investors is missing the recovery, which will be driven by these big projects.”

It seems obvious that the big operators like BHP Billiton, Rio Tinto, and Fortescue are inflating costs and blaming labour to (among other things) screw the profit margins of the mining contractors they employ, in order to increase their own profits.

But once these big projects start rolling, that won’t be possible. The ball will move back into the contractors’ court.

Big projects coming on stream

Sydney based Eid is just back from Western Australia where he met extensively with mining contractors, and says “nine out of 10” believe Gina Rinehart’s $10 billion Roy Hill iron ore project “will almost certainly go ahead”.

Another positive sign for the sector and the resource industry as a whole was the official data out China last weekend. It showed that after seven quarters of slowing growth, China’s economy is set to rebound after a strong improvement in factory output and new orders, shown by a government survey of manufacturing.

Having grown its economy at double-digits rates for the past decade, incoming premier Li Keqiang has said that this government would target more moderate growth over the next one. But there is no doubt its authorities are ramping up infrastructure approvals, particularly for rail projects.

And with the rebound in the iron ore price, there is an increasing likelihood that Fortescue will expand its “Kings” iron ore project. Other massive developments include the $25 billion Wheatstone and Ichthys liquid natural gas projects, plus there is still $4 billion or so Rio Tinto still has to spend on its projects in the coming year. Then there is the $40 billion worth of Gladstone coal seam gas projects.

It probably won’t be a case of every mining services outfit shooting the lights out like it was in the past two years (before they crashed) but it will be a case of watching for the well positioned ones.

What to look for

Another fund manager, Chris Prunty, of Ausbil Dexia, says that investors need to look out for more stories like the contract miner MACA, which digs dirt out of the ground and runs fleets of yellow trucks. Its shares have rebounded about 12 per cent in the past six weeks, being assisted by an (wait for it) earnings upgrade at its AGM.

He says MACA “defied the trend because it has contracted revenues, and it has aligned itself to miners that are expanding”.

Radar would add that having a strong balance sheet, meaning lots of cash, is also pretty important.

Seeing trends is easy in hindsight, but predicting them is much harder. Investors should be wary that while the current year’s earnings for contractors might not impress, it’s all about fiscal 2014.

Click here to access the fortnightly newsletter Under the Radar Report: Small Caps  edited by Richard Hemming.