Why the future is nuclear

"Energy security is fundamental to our existence as an independent, democratic, free state," said Business Secretary John Hutton in The Daily Telegraph last week. It's a shame, then, that we haven't got much of it. Instead, Britain is heavily dependent on external energy sources. Since 2004 Britain has been a net importer of energy in 2006, more than a fifth of our energy needs came from abroad. That's the highest level since 1978. However, it's in the gas market that things look worst: this year the UK is set to import a massive 40% of the gas it uses.

Only last year, says Centrica, that number was a mere 27%. Worse, that figure is still rising, with 75% of our supplies expected to come from overseas by 2015. Given that we make 40% of our electricity from gas, that's a big deal (another 30% comes from coal and 20% from nuclear). But what makes it a particular worry right now is that a large percentage of our imported gas is derived from Russia. And Russia is not in a co-operative mood when it comes to energy supplies.

The empire strikes back

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For evidence of Russia's attitude, look no further than the recent displays of Russian might around the Baku to Tbilisi oil pipeline one of the most strategically important pieces of kit in the West's efforts to reduce its energy dependence on Moscow. The pipeline accounts for 1% of global supplies and, just like a proposed gas counterpart, bypasses Russia, shipping oil directly from Azerbaijan on the Caspian Sea through Georgia, on to Turkey, and then into the West. And this is probably the reason why the Russians took the opportunity last month to drop at least 50 bombs within metres of the pipeline.

Infuriated by Nato's shift Eastwards, not to mention the Westernisation of former satellite states, such as Georgia and most of Ukraine, the Russian state looks keen to maintain a high level of control over the region's energy supplies. Already, Azerbaijan is considering diverting its pipeline through Russia in order to keep the country's ex-Moscow masters sweet. The Azeri State energy firm Socar is planning to reroute part of an as yet uncompleted section of the pipeline, sending 6,066 barrels per day (bpd) to 8,087 bpd of oil through Russia this year. Similar plans are also being proposed in Kazakhstan. This semi-capitulation suggests that the future of the proposed gas pipeline 'Nabucco', which was supposed to bypass Russia via the Caspian, is beginning to look in doubt. Following the events in Georgia, it remains vulnerable to Russian pressure for a rerouting.

The result of all this is that more and more British and EU energy supplies are ending up under Russian control or at least under Russian influence. Gordon Brown might not see everything clearly these days, but even he has spotted this. If we aren't vigilant, he says, we "risk sleepwalking into an energy dependence on less stable or reliable partners".

Not that Brown or the West should be surprised by any of this, of course: as Hutton points out, Moscow has been using energy as a political weapon in its old back yard for quite a while now. In 2006, Moscow cut off the taps to Lithuania, when the latter sold a refinery to a Polish firm rather than to a Russian bidder.

And just two months ago, irritated by Prague signing up to play a part in the creation of the American Missile defence shield, Moscow went ahead and cut crude supplies to the Czech Republic by 50%.

Indeed, according to The Swedish Defence Research Agency, "since 1991, the energy lever has been used for putting political or economic pressure on Estonia, Latvia, Lithuania, Ukraine, Belarus, Moldova and Georgia, which in turn has affected most of Europe. The number of incidents, ie cut-offs, take-overs, coercive price policy, blackmail or threats, is over fifty in total."

We don't need Russia for ever

The good news is that energy independence or energy independence from Russia, at least is possible. To see how this could come about, just glance across the channel, where the French are well on the way. They've got two things right that we have got wrong. The first is gas storage. In the early 1990s, during the great North Sea gas boom, Britain was wallowing in gas but we didn't take the opportunity offered to build the necessary infrastructure to stockpile gas. As a result, Britain now has enough storage capacity to stock gas for only 13 days. The French have 99 days' worth of gas stored up. This means that short-term squeezes hurt us more than them. It also means that we have to export short-term surplus domestic production to foreign storage facilities and then buy it back later from the French and the Germans at a higher price.

This sounds insane and it is. It is also one reason why Britain is facing yet another round of inflation-busting gas-price hikes this winter. Scottish and Southern Energy (SSE) and E.ON are increasing rates by as much as 29% this year, with Tariq Aqvar, a Senior Analyst for energy at Datamonitor forecasting high price increases in the future. EDF is increasing prices by 20% in Britain. But in France, the same firm is increasing its prices by a mere 5%.

So France stores more gas than we do. However, the other key to the equation is that France needs less gas than us. In the UK, around 80%of our total electricity needs come from fossil fuels. But in France, that number is only 10%. The majority of the rest comes from nuclear power a reasonably clean source of energy (depending on how you account for waste disposal).

But more importantly, for security purposes at least, it's one source that is free from Russian domination: the world's biggest uranium mines are in the more friendly nations of Canada, America and Australia. France generates so much of the stuff, that it even exports the surplus.

Back in the oil crisis of the 1970s, France decided to begin weaning itself off foreign oil suppliers. The result was a nuclear boom that has seen nuclear's share of electricity production increase tenfold since 1974.

So why isn't Britain following suit? Because of Government paralysis. For some years now the state has rested its hopes on the appearance of a magical kind of alternative energy that might help it out of its energy hole. The EU has given Britain a target of meeting 15% of our energy needs from renewables, such as wind power and solar energy, by 2020, and there has been a general pretence that this might be possible.

If it were, it would, of course, be no bad thing. According to the Department for Business, Enterprise & Regulatory Reform, if the UK achieved the 15% target, gas imports would be reduced by 12% 16 % by 2020.

But given that we only sourced 5% of our electricity needs from renewables this year, up from 4% in 2007, that 15% target looks a long way off. That means we have to focus on old-fashioned energy sources for now if we want to keep the lights on (as most of us do), something the Government has only recently accepted. And that in turn suggests that we might now get the new coal-fired power stations we so badly need (many of the existing plants are soon to be phased out),and we might get to join the rest of the world in going nuclear.

There are currently 435 operating reactors around the world and another 35 in the process of being built (China has embraced nuclear pretty whole-heartedly and has 11 reactors already pouring out power). Yet no nuclear station has been built in Britain since a pressurised water reactor at Sizewell was finished in 1995. And only in January this year did John Hutton, encouraged perhaps by a shift in the green lobby towards nuclear acceptance, finally tell parliament that nuclear power, "should have a role to play in this country's future energy mix alongside other low-carbon sources".

The next move is to actually take some action. When French energy giant EDF, which operates 59 nuclear reactors in France, agreed in principle to buy British Energy earlier this year, the Government was thrilled. The UK's nuclear power stations (eight out of ten of which are operated by British Energy)are mostly coming to the end of their operating lives and are often turned off for safety reasons. This means that at times they are powering not 20% of our grid, as they are supposed to, but as little as 15%.

This deal was supposed to kick start the building of a new generation of nuclear power stations with the first batch coming online in 2017. But it fell through in August as big British Energy shareholders pulled their backing for the deal (over a disagreement on both the structure and the price). This clearly puts the 2017 date in some jeopardy, but it is unlikely to derail Britain's nuclear renaissance completely. If we don't want to spend the next 50 years in semi-darkness, we don't have much choice but to get building whatever the cost and the Government knows it. Our existing nuclear power stations have to be decommissioned and new ones need to go up sharpish.

This might not be great news for taxpayers or for energy bills the money is going to have to come from somewhere and the average reactor costs £845m to put up. But on the plus side, it should be good news for the companies involved in doing the work and for investors in those firms. The nuclear boom around the world should also mean that investors in market leaders, such as Areva (EPA:CEI) and EDF (EPA:EDF), will do well.

Both Areva and EDF are currently offering their engineering expertise to emerging economies, such as India and China. Uranium, which has fallen dramatically from its highs over the last year, is also worth a look for long-term investors. So too are clean coal companies of various sorts (we are going to need to keep using coal for many decades to come, however fast we build new nuclear reactors). See the boxbelow for more details.

A selection of firms to power your portfolio

There are two sectors for nuclear investors to focus on: those who will be building and operating the new reactors, and those who will decommission the existing ones. But with the first new reactor not coming online until 2017 at the earliest, it's best that investors first focus on the latter. The clean-up industry is expected to make about £100bn over the next 75 years, doing everything from tearing down old reactors to treating the spent waste from old nuclear warheads. That puts nuclear service firms such as Costain (LSE:COST) into pole position. Civil engineering projects account for 80% of its order book, meaning it is relatively immune from the headaches affecting other companies in the building sector. A major contractor to Sellafield, in the first six months of the year it also secured £900m worth of new work, including a seven-year contract with Severn Water and work on Farringdon station in London. The shares currently trade at £26, giving a forward p/e of 9.46 times, which seems too cheap.

Redhall Group (AIM:RHL) is a purer play on decommissioning. It has just two main divisions-nuclear services and engineering services. The firm took in over £40m in revenue in the first half of the year, and recorded a 116% jump in profits in the six months to June. With its engineering business largely focused on the growing nuclear industry, in July it won a £22m contract to manufacture and supply specialist equipment to Sellafield's Thorp nuclear reprocessing plant. Redhall has a marketcap of £64m and trades on a forward p/e of 21.

Amec (LSE:AMEC) is the biggest player in the UKmarket, having, along with America's URS Corporation and French nuclear giant Areva, just won the £5bn-plus contract to clean up Sellafield. The deal is for an initial five years, but could run as long as seventeen, making it one of the UK's biggest public procurement deals. Amec recorded a 38% jump in pre-tax profits for the first half of the year of £92.3m, up from £66.9m a year earlier. It employs 1,300 nuclear engineers in the UK alone, and is currently building a division in North America, aimed at getting two stalled nuclear plants in Canada working again. The shares trade on a p/e of around 20 times, but given its rate of growth and market position it may well be worth it.

The next place for energy security-conscious investors to put their money is in the renewable sector, where, if we, or most other western countries, are to have a hope of meeting the various targets being bandied about, much work needs to be done. The wind-power sector is of particular interest note that it accounted for 35% of the electricity-generation capacity added inAmerica last year. But most of the operators in this sector are already grossly overvalued, so investors would probably be better advised to head for firms making the electronic parts that go into them. Zoltek (NASDAQ:ZOL), a carbon fibre manufacturer, is the pick of the bunch. It sells its materials to wind-power generators, such as Denmark-based Vestas and Spanish-based Gamesa, and saw a 25.4% increase in sales in the first nine months of this year on the first nine in 2007. On a forward p/e of 26, it's not cheap. Better, on a forward p/e of 11.5 times, might be MEMC Electronic Materials (NYSE:WFR), which makes silicon wafers for solar panels, a market forecast to be worth more than $16bn by 2012.

Lyxor launched its New Energy ETF (LSE:LNEW) in March, investing in 20 stocks involved in alternative energy and has risen 23% since launch. Its total expense ratio is 0.60%. PowerShares Global Clean Energy fund (LSE:PSBW) is based on the WilderHill New energy global innovation index, which has returned 28% over three years. It's composed of firms that focus on renewable sources of energy. In the US the PowerShares Global Wind Energy Portfolio (NASDAQ:PWND) is based on the NASDAQ OMX Clean Edge Global Wind Energy Index. It's up 10% over one year.

And Market Vectors Nuclear Energy ETF (NYSE:NLR) tracks the DAXglobal Nuclear index, which is 42.2% uranium mining, 25.6% plant infrastructure, 24.0% nuclear, 4.6% uranium storage, 2.3% uranium enrichment, and 1.3% nuclear fuel transport and is down about 30% since launch in June 2007.