Spiralling gas prices have made headlines in recent months, with manufacturers calling for government intervention as rising costs forcing several to temporarily reduce production or even lay off staff.
However, this has been a crisis at least 18 months in the making, and companies could have avoided the worst effects of it by having a more robust strategy in place. Cast your minds back to April 2020 and the start of the first lockdown. As demand for energy fell through the floor, prices hit a record low; from there, though, they have risen past previous levels and show no sign of stopping.
To understand why this has happened, first we need to understand how the UK – and wider European – energy market works. We are heavily reliant on gas imports, most of which comes from pipelines from Norway and Russia, or via LNG deliveries. During the summer, we import excess gas and store it for the winter. This stored gas is important as it balances the system in the winter, so when things are cold and we need more gas, the stored supply helps avoid massive price rises because there’s always enough stored supply to cope.
Last winter, storage levels dropped significantly, as usual, but there were signs that there may be a difficulty in securing gas in the summer to bolster storage. LNG deliveries coming to the UK and Europe were greatly reduced, instead going to Southeast Asia, where they were willing to pay high prices to land it. As a result, prices kept rising. As we went through the year, though, it got worse. We had expected to see Russian gas flows come on-stream through the Nordstream 2 pipeline, but for various reasons it never came. It’s been quite politicised from both sides, but the point remains: storage levels are very low for this time of year, which means we’re heading into winter without the cushion we’d normally have.
For energy users, the result is a volatile and unpredictable market, with massive swings in prices happening without warning during a 24-hour period – often driven by nothing more than rumour and speculation. In early 2020, gas was available for as little as 30-35 pence per therm, whereas now that is as high as 180 or more. Not only is this very high, but it’s shot up from an all-time low, which is causing a lot of strife.
While it may be of little comfort to those struggling with prices now, the events of the last 18 months have demonstrated the importance of having a proper energy strategy in place. Companies can either buy energy forward, or buy it as they use it, close to the point of use. There has long been a school of thought that says it’s cheapest to go down the latter route.
The energy market works in cycles of around five years, so taking the pay-as-you-go approach means you stand to benefit once in five years. By contrast, those who planned ahead, listened to advice and understood the market and took out a three-to-five-year contract early last year are now not just well insulated against the high prices at the moment, but also paying a record low. Most contracts renew on 1 October, meaning they’ve been putting off the decisions until the last minute, praying for a miracle that never came and have just signed a contract at a record high. Anyone on this tariff will have just received their first bill on this rate and, at that point, they’ll realise the impact of the problem. There will definitely be some distressed end users out there.
Of course, this is all happening at a time when suppliers’ flexibility to such problems is at its lowest – they’re exposed to record high balancing costs, so where in the past they could have been flexible on payment terms and the like, they are constrained by what’s happening in the market, so we’re seeing companies forced to hold clients to strict payment terms and so on.
Easier times to come?
I’d love to be the bearer of good news and say that, while this winter will be tough, we can expect to see things return to normal soon. Unfortunately, that isn’t going to be the case. For a selection of manufacturers, it’s going to be a very tough winter, and there’s no sign it’s going to get better any time soon. As previously discussed, the problem is a lack of stored gas, and those supplies don’t get filled in the winter – especially not when stocks are running as low as they are.
The earliest opportunity to start to regain any ground will be in early 2022, and that all depends on how bad a winter we have, whether Russia comes back online and all manner of other factors. We already know that we won’t come out of winter with high stock levels, meaning the problems we have seen this year stand a good chance of happening again in 2022. As an indication of the scale of the problem, the way the market forecasts are heading, we are expecting this to be an issue until at least the end of next year.
Be ready to act
One thing we at Inenco are saying to clients – whether they are struggling or not – is that now is the time to take stock and learn from the current situation. Our hope is that it will encourage end users to have a more rounded approach to purchasing. At the very least, it should kill off the idea that the pay-as-you-go model isn’t the right one to take, as it’s volatile and leaves you exposed.
Companies need a robust hedging strategy and buy forward. Lots do that already, and there is a proportion who don’t who can pass costs down the chain – hitting the consumer. But there is a large proportion who can’t pass costs on, or are competing against companies that have bought forward and can’t include the increase or they’ll lose competitiveness.
There’s also a conversation to be had around usage. With sustainability so prominent in the media, companies are thinking more and more about the energy they use and looking to reduce their consumption. The current energy prices should be enough incentive for companies to look at how much energy they use – even if there’s an investment to be made in new machinery, for example. A holistic energy strategy will look not just at how much you’re paying, but also how you’re using it. That links to the growing requirement for organisations to recognise their sustainability credentials. In short, the current market will cause a lot of companies to take a look at what they’re doing and encourage those without a proper strategy to consider one.
I’m not going to say that there’s something coming that will make things easier – there isn’t. The message we are giving is that companies need to be ready to act. There will be short windows for purchasing, and you need to be ready for those.
To examine UK manufacturing’s attitudes to the rising price of energy, Manufacturing Management and Inenco are conducting a survey. Anyone completing it is in with a chance of winning £100 of Amazon vouchers, and all answers will help with a major body of work in the new year. To complete the survey, visit https://bit.ly/3wFOzm3