Ukraine crisis causing turmoil in energy markets – 9 points for your company to consider

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Until last Thursday a Russian invasion of Ukraine was seen as a very low likelihood scenario.  Then the unthinkable happened, the scale of the conflict and suffering that is now unfolding is very concerning.

Crude oil has risen approximately 15% in the last week. Gas and electricity prices, however, have risen much more sharply.  UK NBP gas for April delivery has risen 71% since Wednesday’s close, the impact is being felt further out on the curve. Winter 22 gas is also up 70% and, as the price of fuel gas sets the price for electricity generation this has dragged power up to similar levels.

The key reason for energy price rises is that as Russia is a major oil and gas producer, the conflict raises questions regarding the security of Russian supply.  The difference is that the oil market is relatively well endowed with alternative sources of supply.  Without the 40% contributed by Russia, Europe would find it very difficult to balance supply and demand.

This is the reason that, thus far, sanctions, such as the restrictions to Russian utilisation of the SWIFT global payments system, have been careful not to cause interruption to gas flows.   The market is, however, concerned that Russia may respond to the damage sanctions have done to its economy, by ceasing gas supply.  There is a second scenario, where it becomes increasingly unpalatable for Europe to buy Russian gas, or ‘fund its war’ as some portray it.

The consequences of an interruption to Russian flows would be both financial and physical:

  • Without Russian flows the current c£4/therm price of gas would look very cheap, it is not inconceivable that £10/therm would be tested: that is 20 times the price of gas this time last year
  • Without sufficient gas to meet supply, and maintaining gas pressure a safety imperative, it is highly likely that there would be some interruption to supply across Europe. Industrial users and power generation would be first affected, but if necessary, commercial users would also be interrupted

 

Once interrupted, it is difficult to see gas supplies being reinstated, at any point whilst Russian troops are in Ukraine, and sanctions are in place.

The impact of high energy prices will be far reaching, affecting costs within your supply chain, and affordability for your customers. At current wholesale price levels the UK domestic energy price cap is likely to increase to well over £3000 per annum.

At 4C we recommend the following actions:

  1. Review your current hedge position and risk strategy, relying upon day ahead is starting to feel like wishful thinking, rather than a strategy
  2. Consider reducing open positions, question what £10/therm gas would mean for your business
  3. If they are not already in place, set stop loss limits, and stick to them
  4. Consider pre-emptively closing out positions before stop losses are breached
  5. Revaluate the commercials of any capex projects (efficiency or onsite generation) in the context of sustained high energy prices
  6. Understand your risk of interruption. This link describes the sequencing of interruption in the UK.  Some large users may be able to argue that restart costs make interruption prohibitive, others may argue that interruption of their supply would put life at risk.  The risk of interruption is greatest in countries that receive the most gas directly from Russia
  7. Ensure that any back up generation has been serviced, and fuel tanks are full
  8. Where feasible, accelerate production now, to minimise impact on customers, if production is impacted later
  9. Consider and mitigate the potential supply chain impact, especially where there is exposure to German, Italy or Eastern Europe, counties most directly impacted by a reduction in Russian gas flows

 

For an informal chat regarding any concerns for your business in these unprecedented times, reach out to our Head of Energy rob.morgan@4cassociates.com or Partner Allison Ford-Langstaff at Allison.ford-langstaff@4cassociates.com

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