As winter settles in, Gerben Hieminga, Senior Economist, ING, suggests how European companies can navigate the energy crisis.
Companies are focused on forecasting and budgeting their energy costs for the year ahead. But in these markets of high uncertainty, a different approach incorporating scenario risk analysis is better suited to assessing the impact of energy prices on financials. Risk analysis will help companies secure their costs for a period ahead so they can start planning in a more stable environment.
Scenario risk analysis allows companies to measure what risk they can take and what type of volatility they can support before it damages the company. Companies should be aware of these calculations and act accordingly – for example, to what extent is halting production a risk to avoid?
We would also warn companies that scenario planning should include the risk of gas prices rising and returning to €300 per megawatt hour (MWH) in the winter months.
In December 2021, the gas price peaked at €140 MWH. It subsided, but in February 2022 we had another peak of €200 MWH. Summer 2022 it peaked again at almost €350 MWH. Prices ahead will depend on how severe the winter is and how much gas Europe has managed to store. We believe that if it is a mild winter, prices will stay below €200 MWH, but if it’s a severe winter prices could reach €300 MWH. At this price, manufacturers like aluminium or glass makers may be forced to save energy and stop production.
Energy intensive industries like chemicals, plastics, base metals, steel and cement will feel a direct impact. The impact will then filter down to food and beverage groups, and agriculture. These businesses will see their costs increase although it will depend on the type of energy contracts they have. In a second order of impact, high prices will trickle down to the real economy to travel agencies, hospitality and construction. This is where the full economy and every supply chain will start to feel the impact.
Corporate treasury is in a better position than consumers and households to weather the impact because the pricing power for companies is quite high. We hear from energy companies that a lot of contracts will expire by the end of the year as contracts are signed from year to year. It could be that the full impact is felt when companies need to start negotiating their energy contracts. In this way the energy crisis for corporations is like a peat fire, burning underground and not visible from the surface. Renegotiating contracts could mean the energy crisis suddenly becomes a full forest fire.
Positively, companies are in better shape now than after the global financial crisis. Many have cash on their balance sheet because interest rates have been low for so long. In the past, energy has only been a small portion of typical costs and companies outsourced their procurement strategy to energy service providers. Because costs have increased, many companies now want a one-on-one relationship with their energy provider. Procurement departments are working much more closely with their energy provider to secure energy for the year ahead and energy procurement strategies have become more interactive and time consuming as a result.