Chris Bowden, MD, Squeaky
11 minute read
How to protect your business against rising energy costs
Soaring wholesale energy costs have triggered a national crisis both in the UK and Europe.
Not only are these unprecedented energy costs likely to undermine the green revolution if prices don’t return to more affordable levels…
But the energy costs we see today pose a very real threat to businesses.
In fact, we have calculated the impact of the increase in wholesale energy costs on UK industry.
And the bill is eye-wateringly high.
In this blog, you will learn how hard organisations may be hit and how you can protect your business against the soaring cost of gas and electricity.
Plus, we’ll give you clarity on some of the most important questions.
Let’s get started.
Will UK energy prices stay high in 2022?
The weight of evidence would suggest that energy prices will remain at - or near - all-time highs in 2022.
First, the surge in post-pandemic demand for energy was greater than many forecasters predicted.
Second, the surge in demand hit a very tight market that was supply constrained after years of under investment in new oil and gas fields and storage.
Third, the crisis in Ukraine significantly accentuated this supply demand imbalance.
Without a doubt, geopolitical tensions bring a tricky dimension to the energy industry (more on this to come).
It is a confluence of factors that has led to today's unprecedented cost of wholesale energy.
Indeed, as I write this (15/03/22) the 2022 baseload power price is at £268/MWh.
This is 665.7% higher than the cost of power in 2020.
And the gas price is trading at 275 pence per therm.
This is 953.2% more than the cost of gas in 2020.
What will the energy cost be for UK industry in 2022?
The reality is: the UK manufacturing industry is facing a bill of billions of pounds due to the soaring cost of energy.
In fact, earlier this year we analysed data from the Digest of United Kingdom Energy Statistics (DUKES) to calculate the impact of the rise in whole energy costs on industry in the UK.
Here’s what we found:
One, the UK manufacturing industry is set to swallow a bill of £22.4bn in 2022.
Two, this is £8.7bn more than the energy bill for the UK manufacturing industry in 2021.
And it is £18.7bn more than the cost in 2020.
Plus, it’s worth noting that these costs exclude the additional costs paid to the national grid and the network companies and policy costs to support renewables and the grid.
Why will businesses only start to see these costs now?
Whereas consumers have been hit by soaring energy prices for some months already, the price pain for businesses has been delayed.
To date, British businesses have been largely unexposed to oil and gas price spikes.
That’s because many adopt a rolling hedging program and buy energy supplies 12-to-24 months in advance.
Energy bought forward that delivers later this year and next year will have been negotiated at wholesale prices that could be as much as five times higher than they were in 2020.
The above numbers will of course be damped by previous forward hedging, but as the price rise has been sustained it becomes impossible to avoid the increase.
How hard will individual businesses be hit?
Many companies will be hit hard by their energy bill when it does arrive.
And if the increase in energy costs filters through into the direct costs of the business, the result could be catastrophic.
So exactly how will unaccounted for high energy costs impact businesses?
Here’s an example:
Let’s say a company has a price-earnings ratio of 20.
And that company is facing a £10 million increase in energy costs.
The consequence is that the increase should - all things being equal - knock £200 million off that company’s market cap.
Without a doubt, the energy crisis is a ticking time bomb for organisations in the UK.
Will energy prices stay high because of the crisis in Ukraine?
The short answer is, yes. Energy prices will stay high as a consequence of the crisis in Ukraine.
As a matter of fact, the Financial Times has reported that UK households face a £38bn hit to their budgets from an expected doubling in electricity and gas bills following Russia’s invasion of Ukraine.
Here’s the thing: The energy security of European nations, including the UK, is especially vulnerable to geopolitical crises.
That’s because, as a nation, we are still reliant on imported fossil fuels and we’re interconnected with the European gas grid.
And we will continue to experience instability for as long as there is conflict in Ukraine.
But it’s not just the cost of energy that will suffer.
Undoubtedly, the Ukraine crisis will hamper efforts around net zero too.
This is because we are now in a situation where gas - the transition fuel for renewables - is largely controlled by countries which are governed by unstable regimes.
As a result, we may need to rethink the whole energy system.
For instance, we will need to look towards more indigenous energy, more renewables, better storage, and network integration with other markets.
It is a monumental shift that will need to happen against the backdrop of - what was already - a very expensive transition.
Plus, energy security will always trump carbon neutrality.
The one advantage of the soaring energy costs is that the economics of renewables will improve.
Will the energy crisis end?
It’s the big question on everyone’s lips…
Will, or when will, the energy crisis end?
Without a doubt, the future of energy prices is uncertain.
What we are seeing is the old economic theory of supply and demand taking its revenge.
The fundamental composition of the oil market highlights significant dislocations.
In fact: there is a two million barrel per day deficit of supply to demand and inventories are at a five-year low.
The truth is, it’s not clear whether new oil and gas exploration will deliver the required returns given the global push to stem climate change by decarbonising the economy.
As such, many oil and gas companies are being run to generate free cash more than growth…
And this dwindling supply is colliding with the rising demand to push up prices to, in the case of gas, historic highs.
Ultimately, the next two years could require nearly all of the world’s spare oil and gas production capacity as demand rises above pre-pandemic levels.
How can businesses protect themselves against soaring energy costs?
The reality is: there is no changing the situation.
But you can protect your business against the continuing price volatility by mitigating the risk.
And you can do that by entering into a Corporate Power Purchase Agreement (CPPA).
Here are the three basics of a a CPPA:
First, a CPPA is a long-term contract between an energy buyer and an energy generator.
Second, the two parties agree to buy and sell an amount of energy which is, or will be, generated by a renewable asset.
Third, a CPPA is usually agreed over a period of 10-15 years, although we are starting to see shorter terms.
Essentially, a CPPA enables businesses to lock-in a long-term supply of clean energy and importantly, the prices for new to earth projects are significantly below the wholesale market price as solar and wind costs aren’t linked to fossil fuels.
With such uncertain energy prices, a CPPA is a tangible way for your company to gain some certainty, whilst also demonstrating your environmental commitment.
Our step-by-step CPPA guide tells you everything you need to know.
In fact, we’ve been helping organisations manage their exposure to volatile energy prices for over 20 years.
And our team was behind Europe’s first CPPA back in 2008.
So, if our guide doesn’t have the answer to your question, our team will.
Manage the energy costs your business is facing
Across the UK, businesses are facing gigantic energy bills.
And there is no doubt that high energy costs will put huge pressure on those already operating under tight margins.
Actually, rocketing energy prices have already hit some sectors hard.
Like the food and beverage industry, where the energy crisis is an existential crisis for some businesses.
Don’t delay in protecting yourself from volatility.