In the latest Double Take, we examine the investment implications of the continuing energy crisis enveloping the UK.
Is the UK about to embark on a winter of discontent amid soaring heat and electricity costs? Double Take spoke to business groups and former regulators to understand the opportunities and perils for investors in this budding crisis, and what it means for the energy transition.
Arjan Geveke of the UK Energy Intensive Users Group, which represents manufacturers of steel, chemicals, fertilisers, paper, glass and other heavy energy users, said members are scrambling to understand what government price caps and exceptionally high spot prices could mean for them. Some manufacturers are hedged and have locked in prices, but that is hardly consolation amid the current uncertainty.
At one point, the hedge that they’ve negotiated will expire. And the increase between what they’ve hedged and the current gas and electricity spiral is so huge that there will come an existential threat. And lately, I’ve started to see noises from my membership, which have started looking further ahead, and they started to raise that issue.Arjan Geveke, Director of the Energy Intensive Users Group
Ironically, manufacturers might have to pause investments in capital improvements designed to boost the energy efficiency of their equipment, said Geveke, a former assistant director at the UK Department of Business, Energy and Industrial Strategy.
From what I hear from my members, they are still trying to balance the book internally. So they’re cutting back on some other outlays… A rotator, for example. They can be big and heavy and definitely use a lot of electricity. In the analysis I’ve seen, if you upgrade them, it often can be more energy efficient. But again, the question is now, do you have the budget if you have to spend your budget on energy cost?Arjan Geveke
Less energy-intensive manufacturers are also feeling pressure. Verity Davidge of Make UK, which represents approximately 20,000 small and mid-sized UK manufacturers, reported roughly 60% of recently surveyed companies have adjusted their business practices to reduce energy consumption.
Ironically, I was speaking to a company earlier this morning, who told me that they were looking to put solar panels on their factories… there is so much demand for the solar panels at the moment, that they actually were given a six-month lead-in time before they could get them on their factories. So, it does demonstrate that companies are looking to reduce energy consumption themselves.Verity Davidge, Director of Policy at Make UK
Davidge said her inbox is filling up as members raise their concerns about having to make job cuts.
Twelve percent are making job cuts already – 12% – and actually moving into more drastic action. They are taking decisions not to invest, not to expand, because the cost of doing so, isn’t going to benefit them in any way, shape or form. We aren’t at a point now where we can simply pass it onto the customer … that’s often an assumption, but for a lot of companies, they are in a, long-term, fixed-price contract with their customer. They can’t simply increase the prices. They’re absorbing it within themselves. I think that’s where we are really at risk.Verity Davidge
Manufacturers large and small are anxiously awaiting more detail on the specifics of how the UK government’s new energy cap plan could help support the winter ahead. Renewable energy generators are awaiting detail on the price they could fetch for the upcoming season.
Martin Young, former director of investor relations at Ofgem, the UK’s energy market regulator, believes a key determinant will be if renewable plants are swayed to shift from ‘renewables obligation’ schemes, in which they’re compensated at market prices, to ‘contract for difference’ schemes, which involve strike prices. In this arrangement, if the wholesale price of, for example, wind energy, rises above the agreed-upon strike price, generators pay back the difference into the system, with savings passed to the consumer.
Deciding those strike prices will be a complex exercise, Young said.
I would say there are three different types of plants that are material in this respect. Two of them are renewable. That’s wind and biomass… but then you have an issue that biomass actually has a high marginal cost to its generation. So what might work for biomass would probably work for wind. But if you spun it on its head and said, what might work for wind, it is possible that that would not be sufficient to cover the needs of a biomass plant. So the first question would be: is the government going to try and seek a simple, one-size-fits-all price for moving from the wholesale price exposure over to the contract for difference, or will it go down a technology-specific route?Martin Young, Senior Analyst for Energy Utilities, Renewables and Waste Equity Research at Investec
As for the supply equation, Young is not sure further North Sea gas exploration, which the government has signaled support for, would ultimately temper UK energy bills.
(You) are exposed to wholesale prices and not necessarily the contractual price of gas. So even if you could persuade someone to explore and produce in the North Sea and give them the opportunity to do so, you then have the question of why would they want to sell it to their home market at a discount to international markets? Where that contract sits relative to a wholesale price quote could vary quite significantly.Martin Young
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