Gas Prices & Supply Issues
Why have so many companies failed?
Since January 2021, the wholesale gas price has risen by over 250%, due mostly to supply chain issues. Multiple energy companies in the UK have ceased trading over the last 6 months, affecting over 2m UK homes. Various reasons like weather, politics, demand in Asia have been used as reason to why there is a sharp spike in price – and all have a part to play but could energy suppliers have done more and prevented their own downfall? And what impact does this have on other industries around the world? Could your business be affected? We are going to highlight various reasons for the current issues and ways in which Deloitte could help your business.
Supply and Demand
Recent UK prices are in part driven by high global gas prices. As countries recover from the Covid-19 pandemic and reopen their economies, the demand for global gas has increased. Coupled with a cold winter in 2021, this has resulted in a gas market with reduced capacity. Energy firms buy gas and electricity wholesale and with higher demand and limited supply, prices have shot up to record levels.
There have been gas pipeline maintenance projects delayed from 2020 to 2021 due to the pandemic, lower gas supply from Russia and less liquified natural gas (LNG) reaching Europe because of increased deliveries to Asia. All have been a factor in increases to the wholesale energy prices and an unusually low supply to the UK.
What are the solutions?
Renewable energy is by its nature very difficult to store. Without adequate storage the energy that is created is effectively lost. UK's low amount of storage capacity for renewable energy is highlighted by the chart1 below. The UK lags way behind most of Europe in having suitable power storage options.
The UK is one of Europe's largest users of natural gas - 85% of homes use gas central heating, and nat gas also generates a third of the country's electricity. Supplies of renewable energy are down as 2021 had been the least windy summer since 1961 - wind provided just 9% of power for England, Wales, and Scotland during the second week of October.
For comparison – The UK has enough gas storage to meet four to five days of winter gas demand, while neighbouring European countries typically have several weeks’ worth of gas.
Price and supply risk management
Recently the wholesale prices of gas in the UK have begun to fall and stabilise as highlighted by the chart2 below. Whilst still not near early 2021 levels, the decrease is promising in a push for cheaper power.
12 Month Natural Gas Futures Prices
The impact of high gas prices in the UK has emphasised the need to invest in more energy storage. As well as helping to balance supply and demand of energy in the physical supply chain, energy storage also provides an important calming and confidence-building influence within the energy markets. In 2005, around 25% of power was provided via nuclear sources and If no other new nuclear power stations are built, the UK's nuclear capacity in 2050 will be a third of what it is today.
The priorities now for the government, Ofgem and the ESN are to develop markets that reward further investment in a range of short- and long-term storage technologies. By encouraging zero carbon storage solutions to take over from gas, alongside developing a smarter and more flexible electricity system that can match supply and demand more effectively, a repeat of what we are seeing today should not be repeated. Nuclear or Batteries with Carbon Capture Storage methods are most likely to replace the current gas generation methods in the future.
What is the impact?
In January 2019, Ofgem introduced the energy price cap. This is a backstop protection designed to prevent consumers paying too much for their power. Ofgem calculates the cap using Spot, Forward and the Derivative markets pricing.
The price cap limits the rates a supplier can charge for their default tariffs. These include the standing charge and price for each kWh of electricity and gas.
Ofgem sets the cap level for summer and winter based on the underlying costs to supply energy. This keeps prices fair and makes sure suppliers reflect any decrease in costs in rates. Ofgem raised the cap in October to prevent further institutions going out of business. This raising of the price cap ultimately increases the price consumers will pay to their supplier.
This resulted in many smaller energy suppliers being forced into administration due to not being able to pass on rising costs. But not solely because of that, energy companies hedge their derivative positions, locking in a price that they can sell energy at in the event of price fluctuations it will limit losses. Not all companies do this as well as some others. This is an area Deloitte can play a prominent part in your organisation – our people have assisted many companies implement a strong hedging strategy.
The most noticeable impact that the supply shortage is responsible for has been the collapse3 of 28 energy suppliers.
These companies between them had nearly 4.5 million UK customers. Various issues could have caused the liquidations, but the primary source is the surging price. Using Pure Planet as an example of a supplier that has ceased trading; they had the financial backing of BP and were hedged on their future prices until spring 2022 but with prices rising, this drastically impacted their risk and margining with potentially large fiscal losses, resulting in BP withdrawing their financial support. With the energy price cap in place too this meant wholesale costs for the operators could not be passed onto the domestic user in many cases.
Power supplies have become even more constrained than usual after a blaze at the electricity interconnector at Sellindge shut down the undersea power link with France for at least another 6 months. This site was responsible for 40% of the electricity in the UK. There have also been calls for the government to focus on energy consumption rather than price. If homes were more energy efficient it would lessen the need on the supply.
This is quite a unique situation and some energy companies have been caught off guard. We can’t predict the future, but we can put measures in place to protect your assets from it.
- Operational Risk Framework – do you have robust processes, sufficient controls, and monitoring tools in place? Deloitte could assist in reviewing your current operational risk framework to mitigate design gaps and utilise the Risk experts to develop and design a bespoke governance programme specific to your needs.
- Hedging Framework and Infrastructure – do you have a robust hedging framework and infrastructure that is going to protect should markets move in an opposite direction? Deloitte’s specialists can work alongside you in designing and implementing a robust and sustainable hedging framework and infrastructure ensuring execution of hedging strategy is smooth and trouble-free.
- Software – Is your C/ETRM being used to its full potential? Could it be due an upgrade? Deloitte can advise on a wide range of solutions ranging from the tendering process through to implementation or even a bespoke system designed exclusively for you and your clients needs.
Could the failed companies have had stricter Operational and Governance frameworks? Quite possibly.
If you would like to discuss how we can help your organisation, please get in touch with either of our authors.
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