Businesses almost everywhere in the world are facing increased costs. Among those costs, rising energy prices are having a critical impact.
In the summer we spoke to finance professionals in large and small businesses across the UK, Europe, and the US about the impact of energy bills. For many, these have increased by 300% already this year even before winter has arrived. Some UK businesses have reported energy bills increasing by as much as 700%, and reports about businesses in Europe indicate bills rising by up to 900%.
Impact of war in Ukraine
In the UK and Europe energy costs surged from around September 2021 and have been exacerbated by the Russian military invasion and war in Ukraine. Earlier this year the World Bank warned that the war in Ukraine would mean higher energy prices for at least the next three years.
In the two weeks following Russia's invasion, the European Central Bank estimated that the cost of oil, coal, and gas rose 40%, 130%, and 180%, respectively. Since then, energy prices have continued to rise, especially with the recent closure of the Nord Stream 1 gas pipeline from Russia to Europe — in the first day of trading after the closure of the pipeline, European natural gas prices increased by 28%. The CEO of German gas giant Uniper, Klaus-Dieter Maubach, said that wholesale market gas prices had increased 20-fold in two years and that worse is still to come.
These price increases are having an impact on consumers and businesses alike. While in some countries consumer prices are capped, often energy prices for businesses are not, and they pay wholesale rates. In the UK there has been a warning that energy costs could close 50,000 businesses — and some businesses have already taken the decision to close premises or scale back on new sites.
Some European companies, such as in Germany, are already halting production to cope with rising energy prices. Some of our members have already told us that they are changing their hours of operation to reduce costs.
Rising energy costs are clearly impacting businesses, but how can finance teams help support their organisations as they prepare for the winter and beyond? Here are six actions and responses to the increases you should be considering.
Understand available government support
Before considering other responses, companies should review what government support is available.
In the UK and EU this support for business is being discussed. In the UK via the Energy Bill Relief Scheme energy prices have been capped for businesses for six months at least from the start of October 2022.
This has effectively created a maximum price for gas and electricity of £211 per megawatt hour (MWh) for electricity and £75 per MWh for gas for those on fixed-price contracts. Businesses on other contracts including variable contracts will receive support up to a "Maximum Discount" to be confirmed but currently estimated at £405/MWh for electricity and £115/MWh for gas.
Companies may be able to use that window of support to lock in energy prices before future price increases occur. Before doing so, however, it is key to understand what these energy price freeze policies actually mean for your business's energy costs.
One way business can try to get some certainty in the medium to longer term on energy prices and other key commodities is by hedging with either forward contracts or options. Contracts must be exercised, regardless of whether the strike price is favourable or not, whereas options allow the contract to expire if the strike price is unfavourable. Companies that are able to successfully hedge can ensure they have some certainty over price volatility.
While energy prices are high currently, they could get higher as disruption to energy supplies continues.
Forward options and contracts are accounted for and reported as financial derivatives and can have unforeseen impacts on a business's profit and loss account and balance sheet, depending on your business's regulatory jurisdiction. It is advisable to consult with your auditor or finance expert about the potential impact of hedges on your financial statements before going ahead and to incorporate the impacts into your management information for maximum visibility and to avoid surprises at year end.
Before considering hedging, it is crucial that you understand how different price scenarios could affect your business. One member described to us how they delayed locking in a price they were hedging until after maintenance work on a key gas pipeline — once that was concluded, the price went down, and they locked in at that price.
Hedging is not about beating the market but providing certainty on costs to your business.
Think about fixed-price contracts and supplies
Fixed pricing helps hedge against rising energy prices and can be used not only for your own direct energy costs but also to ensure you have price certainty with other supplied goods and services. Businesses in your supply chain will be hit by rising energy costs, too, and may have to raise prices due to that.
To help, for key goods and services, you may be able to lock in fixed-price contracts that will allow you to plan finances better over the medium and longer term and experience fewer price shocks.
Undertaking this could also mean that as prices rise over the months ahead as forecast, you could be saving your business money in the long run.
Talk to your suppliers, clients, and customers
Another key action for finance teams is to ensure they have regular dialogue with their customers and key suppliers.
This allows you to:
- Fully understand and anticipate cost pressures they are facing.
- See where difficulties may come in the production and supply of goods and services due to price increases.
- Understand what level of price increases customers would potentially be able to absorb if you had to increase your prices.
- Consider how contracts and obligations could be delivered in different ways to mitigate and offset the costs of rising energy prices.
Look at production and work schedules
Another way finance teams can support their businesses in mitigating against rising energy costs is by looking at the optimal and most cost-effective hours of work and production.
This is not a solution for all businesses, but for some in manufacturing and other production industries — energy-intensive sectors — it may be. In some countries, such as the UK, times of high energy usage are charged at a higher rate.
We heard from one finance team in a manufacturing business that is already looking at energy costs at different times. They are using this information to advise the heads of operations on timings to take advantage of cheaper energy prices for maximum efficiency.
In Europe, it has been reported that some ceramic factories have changed their operating hours in response to energy cost increases.
Prepare for energy shortages
Finally, finance teams should be preparing for energy disruptions such as supply being limited to certain hours. Both in the UK and wider Europe, it is possible that due to the energy supply shortage, particularly in gas, there could be blackouts or energy rationing.
In August, the UK government's "reasonable worst-case scenario" on energy suggested possible blackouts. Also, Reuters reported that some of Europe's biggest banks are already preparing for energy rationing by buying backup generators.
Finance teams should be preparing their businesses for this possibility and reviewing mitigations they can put in place if this were to happen.
To help in their scenario planning, finance teams should:
- Understand government resilience plans and advice around energy shortages and rationing — and what these would mean for the business.
- Look at what lessons can be learned when this occurred in the past and from other countries where it may already be taking place.
- Create a plan to mitigate against this if rationing or blackouts occur. This plan could include changes to work patterns, looking at backup energy generation, shifting work to other locations, or reviewing what work is most needed.
Key questions that finance teams should be asking themselves are "What if" questions — "What if energy prices rise to a particular level?", "What if our suppliers fail due to rising energy costs?", "What if customer demand falls due to rising energy costs?", "What if there is energy rationing and blackouts?".
By seeking answers to these questions — and others — around energy price increases, finance can ensure businesses are well placed to manage energy price shocks and disruptions.
— Ross Archer is director–Public Policy at the Association of International Certified Professional Accountants, representing AICPA & CIMA, and based in the UK. To comment on this article or to suggest an idea for another article, contact Oliver Rowe at Oliver.Rowe@aicpa-cima.com.