Manufacturers have seen gas and electricity prices soar over the past year and everything indicates they’ll stay high for the foreseeable future and could even increase.
As a result, more and more large energy users are adopting or refining a flexible procurement strategy in order to reduce long-term risk while increasing agility in the short-term.
To learn more, The Manufacturer spoke with David Oliver, an energy expert from business utility specialists, Inenco.
What are the current micro and macro-trends affecting the energy market and how are they impacting pricing?
David Oliver: The UK and Europe energy market started 2018 in pretty good shape, but February’s ‘Beast from the East’ had a very significant impact on local gas prices. It was widely acknowledged that the UK had a lack of gas reserve prior to that cold wave hitting, and despite the market rebalancing itself in the weeks that followed, a sense of nervousness remained.
Political events, such as the US placing sanctions on Iran, have pushed up global oil prices and that has had a knock-on effect with gas prices, which are very closely linked. Most of our power stations are gas-powered, so increased oil prices raise the price of gas which in turn raise the price of electricity.
The other factor affecting electricity prices is that when gas prices are high, the economics of using coal suddenly become far better. Europe has a lot of coal-fired power stations and we’ve seen almost all of them running and ramping up activity even in the height of summer, which is highly unusual.
During that peak summer period, the UK actually had more than 1,000 hours without coal, but the extra activity in Europe meant businesses were having to use their carbon allowances – which are part of the EU Emission Trading Scheme (ETS).
When you generate a lot of power from coal, you have to offset that by buying what is effectively a ‘carbon credit’. These credits were around €5 a tonne in 2016/17 but rose to €20 a tonne this year; that’s a massive increase, which also affected UK power stations.
All these factors, alongside the UK’s domestic Carbon Price Support which is fixed at £18 a tonne, add to the cost per megawatt of both coal and gas-fired power generation.
How will the Budget affect your business energy costs?
The Chancellor’s speech may have made little mention of anything energy-related, but the government documents that were subsequently released offer some insights into the UK’s energy future.
The Manufacturer sat down with Inenco’s David Oliver to discuss how the Budget will affect industrial businesses energy costs and commitments.
What factors makes the UK energy market unique?
I wouldn’t say the UK is entirely unique; Europe, for example, has similar issues around fluctuating gas and electricity prices. The UK buys gas through the interconnectors with Europe, so our gas and electricity markets are very closely aligned. Everything seems to suggest that that will continue, irrespective of whether we have a ‘hard’ or ‘soft’ Brexit.
The UK is at the end of the pipeline, so we do suffer slightly more from volatility; and Europe is far better at managing its reserves – the UK’s only significant gas storage field closed more than 12 months ago.
We do have some liquified natural gas (LNG) terminals, so we compete for global LNG cargoes. Though when it gets very cold, our European neighbours are all competing for those same cargoes which obviously pushes the price up.
Overall, we don’t have the luxury of the reserves that some of our neighbours do, but equally the UK doesn’t tend to face the extremes of weather that they do – at least, not historically.
Given current volatility, how can energy-intensive manufacturers limit their exposure in a rising market and expose volume in a falling market?
It’s a great question. You need to step back and look at how your business buys energy. If, for example, you just buy 12 months in advance and then the following year you buy another 12 months in advance, you end up paying whatever the price is at the time you’re buying. That greatly increases your chances of hitting the market at the wrong time, i.e. when cost is very high.
A far more effective strategy, particularly for large energy consumers, is to adopt a ‘flexible procurement’ approach, i.e. buying electricity or gas at different times of the year depending on market activity.
‘Flexible procurement’ is much more of a commodity trading proposal because it allows a business to buy energy when prices are low and, sometimes, when the price goes very high sell it back and rebuy it once the price has dropped.
UK gas prices this winter are going to be around 65p a therm, but the businesses who utilised flexible procurement to import gas last year are paying around half that. They bought when the markets were low and that’s completely insulated them from the high prices we’re seeing currently.
More and more large industrial energy users are adopting ‘flexible procurement’, and some businesses are even buying gas five years ahead. It allows you to take a more long-term view while at the same time providing businesses with the flexibility to react in the short-term.
Some manufacturers will hedge up to 100% of their volume, while others will limit it in order to protect themselves; but having that flexibility gives you time to look at the market, consider what’s happening and if you see that prices are very cheap, you can buy, and if prices are very high, you have the time to sit that rise out.
Winter Outlook: Manufacturers’ energy cost forecast for 2018 and beyond
Faced with record-high costs and ongoing uncertainty, it pays for manufacturers to reassess their energy risk management strategies to consider how the cost of energy will impact their organisation.
A FREE new report provides a forecast of energy costs over the coming months and compares three manufacturers with and without Energy Intensive Industries exemption and Climate Change Agreements.