Last week it was revealed that the German government is leaning towards allowing the “fracking” of rocks for gas production to recommence in just a year’s time. Tan (pictured) says that this is part of a wider trend towards the exploration of unconventional fossil fuel sources which the £27m New City Energy Trust is set up to exploit.
“At the beginning of 2014, the Board of New City Energy (NCE) revealed plans to focus on shale Oil & Gas opportunities and to move away from conventional exploration and production,” he said.
“In our view, the shift gives investors access to an emerging, rapidly growing segment of the industry and makes NCE a unique proposition in the closed-ended fund universe.”
“News that the German government was leaning toward lifting its longstanding ban on fracking as early as 2015 reaffirms the global trend toward increased unconventional energy exploration and production and has positive implications for the shale support services industry (to which NCE has significant investment exposure),” he added
“In North America, where the sector is the most developed, shale has become the dominant means of natural gas production and is supporting economic growth by providing industry with a cheap, plentiful source of energy and hydrocarbons.”
“Furthermore, we believe there is significant potential from the exports of hydrocarbons, as well as technology, to Europe and Asia, where there is significant demand and large, untapped reserves.”
Tan says that geopolitics is likely to influence greater exploitation of shale oil and gas, as suggested by the recent crisis in Eastern Europe.
“The Ukraine crisis is a reminder that we shouldn’t be as reliant on volatile energy superpowers like Russia as we are currently,” he said.
“If you have those resources in your own back yard it might cause some problems like flaming tap water if you believe the YouTube videos but there are ways of making it up to those affected.”
“In the longer term if you have the resources in your back yard you don’t have to ship natural gas across the earth.”
The £20m New City Energy trust has now refashioned itself to focus exclusively on shale resources, and invests heavily in the support service companies which provide the technology required for extraction.
“These guys have the know-how that allow you to produce the oil and gas in your own back yard,” said Tan.
“It’s about exporting the technology and benefitting from this change in attitudes.”
Data from FE Analytics suggests the new strategy has had a successful start. The trust is up 13.14 per cent in 2014, as the average commodity and resource-facing trust has lost two per cent.
Performance of trust vs sector and index in 2014
Source: FE Analytics
However, this has been a good period for the oil and gas sector as a whole, with the FTSE World Oil & Gas sector up 8.44 per cent. In NAV terms the trust is up 9.1 per cent with the remainder being a reduction of the discount.
The only commodities and resources trust to beat it this year is the City Natural Resources High Yield Trust, also run by Will Smith, which has returned 13.3 per cent.
This represents a significant improvement in performance after a rough period for the sector which saw it lost 50 per cent of its value in three years.
Performance of trust vs sector and index over 3yrs
Source: FE Analytics
However, Tan says that the prospects for commodities are better in the coming years, as improving economic activity looks to support demand.
Sterling strength has also worked against the sector, which largely reports in dollars.
The nature of the shale oil and gas industry means that New City Energy is focused on the US and Canada.
Tan points out that fracking has gone on for decades in this part of the world, but only became possible in its current extent and commercial opportunity more recently.
Largest holding Vermilion Energy is a Canada-based oil and gas producer which produces conventional and shale oil and gas. It makes up 9.2 per cent of the fund.
PHX Energy Services, 7.7 per cent of the fund, is also Canadian and provides drilling services and equipment for shale exploration.
New City Energy has 16 per cent in the bonds of companies connected to the oil and gas industry but is eliminating this position by allowing bonds to mature and not replacing them.
These help contribute to the yield of 5.33 per cent on the trust. The managers are confident they will be able to maintain a yield at this level thanks to the dividends on offer in the sector. PHX Energy yields 5.07 per cent, for example.
The trust is trading on a discount of 13.7 per cent, tighter than its one year average of 15.8 per cent but much wider than the low of 4.9 per cent.
Price and NAV of trust over 1yr
Source: FE Analytics
It has ongoing charges of 3.35 per cent thanks in part to a performance fee, which may put off some investors.
