Understanding The Energy Markets
With the energy markets being particularly volatile right now, we sat down with our Head of Trading and Risk Management Colin Gordon, and Pricing Manager Chris Bennett to understand what is driving the markets, how this will be impacting businesses and what businesses should expect and prepare for when it comes to negotiating energy contracts in the current market conditions.
Head of Trading and Risk
Energy Wholesale Prices have recently hit all time highs, what has been driving the bullish markets?
Global demand for gas has been increasing year on year, most recently being driven by demand in China, whilst the global supply of gas has been struggling to keep up with the rising demand.
Russian gas flows to Europe have been lower than normal for the last 12 months while tensions with Russia increased throughout that time, leading to the recent invasion which has pushed gas prices to the record highs we have seen recently.
European gas storage levels have been well below normal levels last year due to very weak wind generation and Covid delayed maintenance projects in the North sea curbing output all putting upward pressure on prices.
For some businesses, energy makes up a small proportion of their overall cost base, will these increases really have an impact?
Since late 2014 when the oil price collapsed and gas and power prices fell significantly, UK commodity prices have traded within a range of about 3.5p/kWh – 7.5p/kWh for power and about 0.9p/kWh to 2.6p/kWh for gas.
Recently the spot gas price hit 26p with contracts for this Summer now around 10p, while power has come close to hitting 60p and prices for this Summer now at 30p. This is more than a 500% increase on average prices over the last several years.
What impact will these increased prices have on the average UK business?
Along with energy prices, other raw materials and commodities have also experienced huge rises post–Covid, leaving businesses facing unprecedented cost increases. In terms of energy, if you have been on a fixed price contract signed before early last year, you will likely be facing a significant increase in energy costs on renewal.
Those with longer term flexible strategies may have mitigated the worst of the rises but are still likely looking at increased costs both short term and beyond. Since October last year, the rising cost of energy has migrated from the business pages to front page news.
But it’s not all bad news, the fact that these increases have been well publicised means that most of your customers will be aware of the situation which will open up the chance for wiggle room to start adding energy surcharges to products or passing on cost increases.
What can a business do to mitigate the high energy prices?
In response to these high prices the number one thing businesses can do is look at energy reduction schemes. Each and every kWh not used will now have a greater impact on the bottom line.
Take a look at energy reduction projects (like installing solar panels, replacing aging equipment, installing more efficient lighting) that have been rejected because the return on investment was too long. With the increased energy prices these projects could now be more attractive as the cost mitigation offers much swifter payback.
Once you have explored all the options around reducing usage, look at how exposure to the commodity cost itself is being managed. Fixing prices for any period in such a high and volatile market can itself be risky, locking in high prices when the market could fall back significantly if the political situation improves. Instead explore a longer-term flexible purchasing strategy and integrating that with short and medium term budget requirements or goals will manage energy exposure and avoid any shocks.
How has the wider energy industry reacted to the rising wholesale market?
Throughout 2021 and into 2022, one of the most common reactions we have seen across suppliers is their tightened policies on credit. We are seeing increases in suppliers declining credit, placing restrictions, or asking for security deposits from customers who we would have previously expected to have had a straight pass. This isn’t so much down to a bad credit score but down to the customer’s credit limit – with the increased prices pushing them past their exposure limit.
There are options to navigate this, as we have had instances where a 24 month option fails credit but a 30 month option passes because the curve is lower the further out you go therefore lowering the average annual exposure limit over the term of the contract.
Suppliers are also reducing their volume tolerance brackets to limit their potential liability if a customer was to breach and over (or under) consume energy. Previously most suppliers would offer 80/120% of the contracted volume, but now we are seeing 85/105%, 90/110% and even 95/105%. If a customer breaches tolerance the supplier has to buy that additional energy at the market cost which could be much higher than when the customer agreed their contract.
The information provided for this article was correct at date of publication.
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