Are Energy Firms Stealing Your Profits?

Thanks for reading my monthly series where I share behind-the-scenes practical hints, advice, and insights I use with my clients to help fight spiralling?inflation and protect margins.

Are Energy Firms Stealing Your Profits?

As the tragic ramifications of the Russian invasion of Ukraine are realised, we are also seeing impacts closer to home with the costs of good and services spiralling and margins shrinking.

The International Monetary Fund has said that the UK economy will be hit harder than most, with growth slowing as price pressures lead households to cut spending, whilst growing interest rates are expected to "cool investment".

Russia are the second-biggest exporter of crude oil, and the world's largest natural gas exporter, their invasion has led to even more price volatility in the energy market.

Energy prices come from a number of long-term trends and current events, including shifts in sentiment among customers and investors, carbon pricing, the post-COVID-19 surge in global demand, and, most recently, the conflict in Ukraine.

In energy-intensive industries, these extraordinary increases are having a profound impact on production costs.

Business leaders are worried about how they respond to the emerging risks they face.

These risks are new, and require a different response.

Whilst most businesses have expertise in managing their direct spend, they can't replicate that level of expertise and insight across all their spend, which becomes particularly important at times of volatility and uncertainty.

This month’s newsletter is based upon the insights and expertise of one of ERAs experts, Richard Clayton who leads our energy team. He has been busy supporting clients to navigate the significant financial pressures from the energy market.

Let me share some of those insights...... ?

Western economies have taken steps to reduce reliance on Russian energy imports but they have stopped short of embargoing Russian gas.

Within Europe, Germany is showing the greatest resistance to pushing forward with gas sanctions due to its heavy (+50%) dependence on Russian supply.

Russia insisted EU member states pay for gas imports in roubles, which the G7 nations and the EU refused.

So far we have seen very little change in supply, as Russian gas continues to flow. However energy prices have reached all time highs.

Governments and large organisations have distanced themselves from the Russian gas supplier Gazprom, with the UK Government considering what steps to take next, with a significant number of public sector bodies getting their energy from this supplier.

The chart from statista shows the main gas exporting countries in billion cubic meters. Russia is a significant supplier and currently supplies 40 percent of the natural gas imported by the EU. Qatar is the closest alternative to Europe, the Qatari government has been tight-lipped about stepping in as a gas supplier for the EU.

Whilst the UK has a relatively limited exposure to Russian imports accounting for just 4% of gas and 8% of total oil demand, the impact of worldwide supply constraints?are felt directly across UK energy costs.

March saw day-ahead gas prices reach a record high of 580p/th, whilst year-ahead costs closed at 273.22p/th; a year-on-year increase of 507%.

Electricity prices were similarly affected with year-ahead costs closing at ￡243.50/MWh; a year-on-year increase of 350%.

Unlike the domestic energy market, there is no price cap for businesses.

At the end of your fixed rate energy contract your energy costs are likely to increase by 3 to 5 times your current price, depending on when you fixed and whether its electricity or gas.

How will you pay for that pressure?

What about the future?

As the appalling war in Ukraine drags on, it’s very difficult to see an end to the current market conditions. Commentators are anticipating a long period with the prevailing high prices.

With the winter behind us this is the period when gas is traditionally injected into storage to replenish depleted stocks; if Russia starts to make its supplies available to China and Asia the crisis will deepen as competition increases for gas supplies.

According to calculations by the Economic Institute of Kiel, a complete end of natural gas sales to the West (with no alternative buyers) would constitute a painful event for the Russian economy, cutting out almost 3% from the country’s GDP.

With so much uncertainty, this is reflected in the energy price volatility we are seeing.

The steps you should be taking now to reduce the financial pressure

Understand your current situation for your gas and electricity supply:

• Hunt out your agreements.
• Check when your energy contract end dates are.
• If you have a Broker, what support and advice have they given you around market conditions and forecasting of the financial pressure?
• Review the prices you are currently paying and how that compares to market rates.
• Forecast the impact the increase will have on your budget / margins? (How will you fund this?)
• Consider your risk appetite and how you wish to respond. (Fix for a longer period to mitigate against further risks or fix for a short term in the hope the price falls.)
• What's your approach to your energy procurement?

Energy futures for the next 3 years are 2-3 times 2021 rates. A lot needs to happen in the geopolitical landscape before we will see the price of energy fall.

If you are out of contract, then you will be paying out of contract rates, we would advise against staying on these.

Short term contracts for one, three and six months are available at better prices than standard out of contract rates.

One of my clients was unaware of the impact they would see on their bottom line, our energy expert reviewed their current agreements as their fixed term was ending shortly.

We estimated their increased electricity cost at ￡180k (3.2 times current cost) which wiped out already tight margin.

They had not built the increased costs into their forecasts, its fair to say the CFO was shocked at the level of pressure with no internal options to mitigate.

So how did we help?

We provided insight into the market and presented a range of options. My client was keen to ensure certainty in their costs, whist taking all steps to mitigate the pressure.

The ERA energy team went to the market to seek the best rates using our knowledge and relationships for 6 month and 1 year contracts to provide the client a comparison of the unit rates which was important to the CFO to support decision making and discussion at the Board.

The supplier market is currently very difficult, Scottish Power recently withdrew from the industrial and commercial market. Suppliers are also increasingly cautious when considering credit risk.

To further support the CFOs conversation at the Board, we deployed our energy management team to review energy utilisation across their building and provide costed options and payback periods to reduce overall consumption.

The ERA team support the capital investment by project managing the acquisition, implementation and on going monitoring of the solutions to ensure the project deliver as promised.

With unit energy prices so high, payback periods for capital investment to reduce energy consumption are more favourable?than ever.

To offset the ￡180k energy pressure and to generate cash to support capital investment the CFO asked us to help them reduce their costs.

The aim is a ￡250,000 annual reduction across fuel, merchant cards, water, waste and insurance. The ERA model is based upon using industry specialists to deliver savings and process improvements, they know where to look for savings and how to deliver them at speed.

Our client has taken steps to mitigate the position they found themselves in, getting external support ensured as much risk as possible was mitigated.

This was not a situation the CFO wanted to find himself in, but as a result of the steps taken the overall cost of the business will fall, they will be more cost conscious and they will be further along on their sustainability journey.

Are you clear on the impact of energy costs on your business and the steps you will take to mitigate the impact on your margins?

Is it time to reduce your energy consumption?

After you fix the price for your energy, your next focus should be reducing energy consumption.

This is also important as part of your approach to sustainability.

High energy prices have transformed the business case for energy efficiency.

With such large increases in the unit price of energy, payback periods are smaller than ever for capital investments to reduce energy.

Savings can be considerable and immediate, for example, installing LED lighting can bring a 50% - 70% energy saving immediately, as well as savings in maintenance and downtime.

Larger investments may include solar thermal water heating, photovoltaic electricity generation or even wind turbines.

Changing behaviors can account for up to 60% of reducing energy usage. Investing in smart technology can support this as can clear objectives across the organisation to reduce energy.

The best way to start the journey to use less energy is an energy audit, the outcome of which should be costed investment options with payback periods for how you can reduce your energy consumption.

Tip: ensure the energy survey is independent of any proposed solutions.

Capital investment to support energy reduction should be high on your list of priorities.

What should you do next?

• Check your contract end dates and review your financial forecasts.
• Take steps to mitigate your risk.

If you would like to learn more about options for your energy contracts, how to reduce energy consumption or reduce your costs, then send me a message ([email protected]), give me a call (07801 550 403) or click here to book some time in my diary.?