Energy News Flash: Wholesale energy prices at 22nd August 2022 – what can businesses do to help their situation?

An update on wholesale energy prices at 22nd August 2022 by our energy economist Dominic Whittome.

Annual gas prices hit new records, now over 1,000% higher on last year’s level.

Gas Prices

Gas prices charged upwards amid concern that Russia may finally halt exports into Germany, potentially leaving much of Europe with barely six weeks of storage cover as winter approaches. However valid or not these fears are (it should be remembered that, after or before its invasion, Russia has never wilfully defaulted on a gas contract), the market is clearly anxious that the vaunted physical supply crunch will finally come. A concern reflected in the ever increasing risk premium build into gas prices along the prompt and near ends of the forward curve. This is virtually ‘hump shaped’ just now. Pushing renewal prices sharply higher, even though the forward curve reverts to a steep backwardation (i.e. with significantly reduced prices versus prompt prices today) as time extends out.

Base-Load Power Prices

Base-load power prices meanwhile have been driven by concern over French and Benelux nuclear plant availability, as aquifers and reservoirs needed for reactor-cooling run dry whilst the extreme drought in many parts of Europe continues.

For the same reason, coal generation capacity will have been threatened by depleting river levels in key European trade canals and waterways not to mention time-lags associated with fixing old or building new plants.

The resulting squeeze in the power market is feeding into gas, as traders foresee utilities urgently turning to gas-fired generation in order to redress the balance, especially with out-of-service nuclear power stations in prospect over months ahead. This has only added to the gas buying frenzy.

Year on Year Price Increases

The size of the percentage year-on-year price increases is bad enough although the timing, the stage of the year or buying cycle for some I&C buyers is perhaps equally troubling. As we are now in the final furlong of the Buying Round, barely six weeks away from the last practical dates in order to renew or extend new prevailing prices come 1st of October.

Renewing Gas Volumes and Electricity Contracts?

A worrying proportion of UK registered businesses are understood to be uncovered, needing to renew their entire forward gas volume soon. Many such firms will be renewing their electricity contracts at the same time.

The traditional ‘Electricity Year’ might not start until 1st April, 2023 but in years gone by, more and more I&C power supplies have been re-aligned to gas.

What this means is that I&C buyers – notably the smaller firms, SMEs or lesser-sophisticated larger users will be re-contracting gas and electricity at seven or eight times the I&C contract prices they secured the same volumes last time around.

Consequently we may se more I&C users averse to the idea of fixing a price now, preferring to ‘ride the market’ out perhaps. Only to discover that no Big Six or other major supplier will currently offer them a ‘tracker price’ contract or ‘buy-on-index’ product whose price will or retrospectively reflect the prompt, say OTC month-ahead, gas or electricity prices prevailing at or near the time of delivery.

Flexi Contracts

The only official or off-the-shelf option available would be the alternative ‘Flexi contract’ which, in certain cases, a supplier may offer. However Flexi contracts can prove significantly more expensive in some instances. They are also far more labour-intensive, they entail additional managerial resources and will typically involve third party intermediaries, brokers and other advisor to be commissioned as well.

In ordinary times (although these obviously aren’t normal times) Flexi contracts involve significant extra market risk, a prospect of higher prices, market or trading risk which has traditionally put buyers off them.

I&C customers that are new to Flexi deals may suddenly find themselves having to monitor the Spot, Prompt, Forward or Futures markets and make trading decisions for themselves, with Flexi contracts requiring them to periodically fix or un-fix prices and volume throughout the contract term.

But ‘trading the OTC’ which is basically what a Flexi contract involves, is and always was a ‘zero sum game’ and one which the producers, utilities, energy merchants, funds and other trading intermediaries generally end up ‘winning’. Flexi contracts were initially marketed as way of ‘giving the customer greater freedom’ and to manage risk. Both of them are still valid. However it remains very easy for an I&C customer to end up paying significantly more for its gas and electricity this way, i.e. looking retrospectively on outturn indices on the OTC.

Notwithstanding the pros and cons, Flexi contracts may simply not be practical, if even available, options for many businesses. Notably micro-businesses, SMEs, smaller commercial and industrial businesses who do not reach arbitrary consumption thresholds for a Flexi contract to apply even the Flexi contract were the preferred new purchasing strategy.

The Outlook

If, come October, new gas and electricity contracts simply prove unsustainable for buyers to remain in business, then late-payment, non-payment, insolvency and all its related credit issues could arise, possibly concertinaed into a relatively short period for financial systems to cope with, not only within banking but the energy supply industry itself.

Protection for Sector Users

Whilst domestic sector customers enjoy protection measures under the energy market regulator, Ofgem, none apply to industrial or commercial (I&C) sector users specifically. Unlike domestic customers, I&C customers have no protection by way of ‘price caps’ or other provision.

Ofgem has no legal power in respect of the I&C market, either to regulate suppliers, the bi-lateral market itself or protect customers. Such customers are not covered under Ofgem’s official remit. It has been this way since the outset of competition in the early 90s under the then truly-independent gas and power regulators Ofgas and Offer which later merged into Ofgem in the mid 1990s.

Large industrial and energy-intensive users do command more attention however. They receive various degrees of protection, especially those firms seen to operate in ‘key industries’ or in politically sensitive region. Generally on an unstructured basis, selected large industrials have had the advantage of a ‘listening ear’ in Whitehall, at least to some extent. This is increasingly evidenced of late by the granting of state loan guarantees, government loans, ad hoc support programmes, direct grants amongst and other ‘de facto’ subsidies which aim or serve to cushion the blow of higher energy prices.

The Squeezed Middle

However, this is a case of alleviating the symptom rather than addressing the cause. The help is expensive for taxpayers and it offers a transitory benefit at best to large industry. And of course it offers no benefit at all to the other industrial, commercial, SMEs and micro businesses to which such central government intervention programmes do not apply. As of now, there appears to be no policy or obvious ‘task force’ set up to help this “squeezed middle”, just six weeks before the current Gas Year ’22 Buying Round draws to a final close.

Looking Ahead

Options are limited at a time when many I&C users will be facing multiplier increases in gas prices and possibly electricity prices as well, come October. The higher energy costs may be viewed as unsustainable and the last straw by many businesses also facing a ratchet increase in Business rates as the Covid Relief taper is removed completely in Q1 2023, which is also the last quarter before the next Tax Year 2023-2024, so this autumn will be a critical time.

What can businesses do to help their situation?

As well as seek support from local MPs or Whitehall authorities directly, such businesses could engage trade associations who are directly concerned with energy. The principal association, as such, in the UK is the Major Energy Users Council, which has been lobbied for business at Westminster of late. The MEUC already held a Westminster symposium and conference this year and further delegations to Westminster may be planned. But in the weeks still left until 1st October, the focus will be on the energy supplier. I&C users may then seek the assistance of a purchasing agent, broker and/or specialist energy lawyer, certainly before asking any supplier to revisit the price in any contract, or to renegotiate terms of any deal already signed.

Further Reading

I&C users may refer to past editions of our Wholesale Energy Prices Overviews which appear on our journal page, which discuss the various industry trends foreseen the alternative purchasing options and other items relevant to affected I&C customers now.

Dominic Whittome

Dominic Whittome is an economist, and graduated with BA and MA degree qualifications from Exeter University. He has 25 years of commercial experience in oil & gas exploration, power generation, business development and supply & trading.

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

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This article is not intended to constitute legal or other professional advice and it should not be relied on in any way.