Soaring energy prices threaten to become an economic drag and a political challenge

Soaring energy prices threaten to become an economic drag and a political challenge

The energy sector is currently undergoing one of the most volatile periods in recent memory. The knock-on impact, from suppliers and shippers through to households and industrial consumers, has the potential to significantly disrupt the wider economic recovery in the months ahead.

Tightening supplies

The cause of the current volatility is various and complex. On the supply side, lower-than-expected production of offshore wind has adjusted the UK’s electricity production mix, whilst Russia has been reducing supply of natural gas to Europe in a possible demonstration of realpolitik. On the demand side, a prolonged European winter in 2020/21 lowered reserves across the continent, whilst consumption globally has remained strong as governments continue to support their heavy industries through the COVID-19 pandemic.

The net result is that wholesale prices for natural gas continue to race upwards, hitting record highs and now trading at over five times their level of just two years ago. Outages at some fossil fuel and nuclear plants and high carbon pricing have also applied upward pressure on prices.

If Europe has another cold winter and demand jumps, energy prices could yet climb further. There is already widespread speculation that energy-intensive industries may need to think more carefully about their energy usage, placing a handbrake on the nascent and still-fragile economic recovery.

It is not only natural gas supplies which could be an issue in the months ahead. In September 2021, a fire caused disruption to one of the cross-Channel interconnectors transferring electricity to and from the Continent. This resulted in an immediate further spike in electricity prices, which may not abate following confirmation that transfer capacity is not expected to be fully restored until March 2022. This places further demands on the UK’s own electricity generating capacity, much of which is now produced via CCGT (Combined Cycle Gas Turbines) power plants or somewhat intermittent renewable sources.

Wider impacts

Although the pressure of rising wholesale prices on utility companies has produced more than its fair share of column inches, the impact of rising prices has the potential to affect a far broader range of the UK economy.

Natural gas is a critical input for the UK’s energy-intensive industries. Petrochemicals, metals and food processing are just three sectors where cost and availability of energy and associated feedstocks is critical to their ongoing operation.

For the moment, major industrial users of natural gas may be insulated from accelerating spot prices due to long-term supply contracts. In the UK, October has traditionally been an important date for supply contract renewal. However, many traders and market-makers are now avoiding trading in size in a response to a changing risk landscape caused by the volatility of prices.

For businesses already caught on the wrong side of a misjudged trade or with a significant contracting point upcoming, there may be a shock at the size of the price uplift being imposed by the suppliers. News of production line stoppages reportedly resulting from increased utility costs has already started to filter through.

Although it may be possible to pass some of these costs on to consumers, in the current economic environment there will be significant pressure to mitigate this uplift through whichever means possible.

The macroeconomic impact

On a macro level, any increase in output prices will compound growing inflationary pressures within the economy. In the B2C energy sector, for instance, many domestic customers are bracing themselves for October’s energy price cap rise of 12%, introduced by regulator Ofgem as a response to the wholesale price increase.

Volatility in commodity prices means that energy suppliers exposed to floating prices in the wholesale market but who are contracted to sell at fixed prices in the retail market (or are limited from charging more by the energy price cap) may be facing a further liquidity challenge. This is all set against the annual backdrop of the deadline for energy providers to settle their Renewable Obligation Certificates (“ROCs”) bill to Ofgem.

In recent years, this has proven to be the last straw for some of the smaller providers in the market and remains no less of a challenge to surmount. In 2021, we’ve already seen a clutch of suppliers fall into administration ahead of this upcoming cash outflow, including Hub Energy whose insolvency was managed by Managing Directors at Interpath.

High energy prices may end up being a political as well as an economic challenge in advance of the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow next month.

  • What happens if high prices cause energy-intensive businesses to curb activity?
  • Could relatively short-term supply issues impact on the ability to achieve an important long-term global environmental commitment?
  • Is it ever acceptable to curtail consumption by force at peak times, and how can that be managed effectively to avoid impacting households?
  • Should we increase supply and slow the supply stack transition by reopening coal generation capacity in Europe?
  • What does that mean for bringing the Russian-led Nord Stream 2 pipeline online? Or do current conditions serve to accelerate adoption of alternatives to gas, and potentially support the long-term aim of reaching carbon ‘net zero’ in the coming decades?

It is notoriously difficult to predict the future path of commodity prices and the impact of these on the economy. However, the current trend implies that both suppliers and retail/commercial customers will need to be agile and adaptable to successfully navigate the impact of increased prices on their liquidity and finances.

If you would like to discuss where any of the issues raised by this article are impacting your business or your clients, please contact us.