Energy price spikes are not a new phenomenon. Like all commodities, when supply and demand fall out of balance prices will rise, or fall sharply. In Autumn 2008, the UK saw high prices, due to unplanned outages affecting the majority of the nuclear generation fleet. More recently in spring 2018, the so called ‘Beast from the East’ sent gas prices soaring. This time last year, Storm Uri in Texas forced the regulator to cap prices at $9000/MWh.
The high prices we are seeing at the moment are, however, different. In each of the examples above the high prices were, largely, caused by one short term fundamental driver, once generation returned from outage or the weather warmed up, prices returned to historic average levels.
This time there are multiple drivers, each has the potential to influence energy prices into the medium to long term.
- Globalisation of gas supply and increasing Asian demand. Asia is now the worlds top buyer of LNG. If Europe needs scarce LNG to balance supply and demand it must outbid Asia.
- Net Zero, which has the dual impact of reducing the appetite of investors, in new fossil fuel production, and increasing demand for, and intermittency of, power production.
- The West’s plan to wean itself off of Russian fossil fuels, will reduce global supply of fossil fuels, particularly gas.
Persistently high and volatile energy prices have wide ranging ramifications, not least in the UK’s public sector.
First, the good news. The majority of the public sector buys its energy requirements through one of several public sector buying consortia, so called Public Sector Buying Organisations (PSBO’s). PSBO’s typically utilise prudent flexible risk managed buying strategies, purchasing energy in incremental layers over 2 or more years leading up to delivery.
This means that a typical PSBO customer will have an advance hedge in place protecting against the initial price rise during winter 2021/22, and will have at least a partial hedge for Winter 2022/23.
Having said that, prices for Winter 2022/23 are at such a level that even a organisation with a 80% hedge bought before prices began rising will see a 33% increase in the delivered cost of their electricity.
Beyond next winter, exposure to high prices will be much greater, leading to tough decisions, whether to buy at elevated prices, to protect against further rises.
At 4C we recommend the following actions for any public sector organisation concerned about the impact of energy prices:
1. Understand your current energy hedge position; what proportion is hedged, what proportion is open, and what is the total cost implied by current market pricing.
2. Ensure that your budget reflects expected energy costs.
3. Some PSBO’s will have more than one hedging strategy, consider whether the current strategy best suits your needs and objectives in the current market.
4. Some PSBO’s will allow member organisations to make additional hedges, diverging from the consortium average.
5. In the private sector it is quite common for flexible hedging strategies to include ‘sellback’. This is where a previously bought hedge is sold, if prices begin falling, in anticipation that it could be bought again, later, at a lower price. Sell back is very rare in the public sector, however, unusual times call for unusual measures!
6. Revisit any previously rejected energy capex (energy efficiency or renewables) projects. The likelihood of high and volatile energy prices in the future adds to project rationale, and certainly won’t do project payback’s any harm.
7. If your organisation hasn’t previously considered on site generation, or has only previously deployed small scale projects now is the time to look at more significant projects.
8. Consider the budget certainty, and potential cost benefits of a long-term Power Purchase Agreement (PPA) direct with a renewable generator. As a rule of thumb, new build renewable projects offer significantly lower pricing that already operational generators; but you will have to wait 2 or more years for construction, before power deliveries can commence.
9. The risk of interruption to energy supplies is currently relatively low in the UK, when compared to some parts of mainland Europe, however, it is important to ensure that backup generation is serviced, and fuel tanks are full.
If you are concerned regarding the impact of high energy prices on your organisation contact Rob Morgan to discuss how 4C can help.