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Wholesale energy prices begin to ease, but volatility is unlikely to be over

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Wholesale energy prices fell significantly over the last three months as Europe’s mild winter, energy-saving efforts and higher prices induced demand destruction in power-intensive industries, which kept a lid on oil and gas consumption and pushed prices lower.

In the UK wholesale energy costs have also fallen sharply, albeit at an initially slower pace compared with its European neighbours. Unique economic and geographic factors explain the UK’s more persistent energy price pressures, which include:

  • much lower gas stockpiled in the UK ahead of last winter
  • higher domestic gas demand (particularly related to heating households)
  • the UK’s relatively colder winter than historical averages
  • competition with Asian economies for liquified natural gas (LNG) supplies

European wholesale gas prices have fallen by around 50% to €65 per MWh at the start of February, as indicated by the Dutch Title Transfer Facility spot price. Europe’s lower gas consumption has helped relieve fears about gas shortages next winter, reflected in the lower gas futures curve (which indicates forward pricing expectations). Declines in European wholesale gas prices led to lower prices in the UK, offsetting the economy’s poorer preparation and higher demand. These receding headwinds have contributed to a lower path for UK CPI inflation in 2023, according to the Bank of England’s (BoE) Monetary Report.

Sources: Bank of England, Bloomberg

However, declaring victory over Europe’s energy crisis would be premature. While the outlook suggests a continued lower path for wholesale energy prices they remain at historically high levels, exerting pressure on corporate balance sheets and household budgets.

The energy industry is still adjusting to a massive upheaval in global energy supply flows, with the balance between supply and demand still extremely tight. Minor changes will continue to have a significant impact on prices throughout 2023. Last year volatile wholesale gas and electricity prices created liquidity fears among smaller energy firms, which sought to hedge energy sales in the futures market. The UK government introduced a six-month Energy Bill Relief Scheme (EBRS) last September to prevent businesses from collapsing due to high global energy prices. The BoE provided an emergency liquidity facility – the Energy Markets Financing Scheme (EMFS) – to support viable UK energy firms. In early January, the UK government reduced support to businesses for energy bills, although the existing EBRS (renamed the Energy Bills Discount Scheme) was extended by 12 months to April 2024. Further global energy price volatility cannot be ruled out, but if wholesale prices do stabilise lower it will provide some fiscal relief for the Chancellor who is committed to a capped EBDS liability of £5.5bn.

Markets are monitoring whether recent gas price drops in Europe and Asia translate back into higher consumption. Europe must compete with anticipated rising LNG demand from China, and another cold snap is expected in February that could put pressure on energy inventories and push prices back up again. The end of Beijing’s rigid ‘Covid Zero’ policy is an inflationary headwind for energy prices, although the timing and intensity of the reopening is difficult to forecast. At the same time, recessionary concerns remain for the US, Europe and the UK, while the commitment of central banks to higher for longer interest rates will influence energy supply-demand dynamics and prices.

Energy companies’ profits clash with corporates strain from higher prices

There is a stark disconnect between the sky-high annual profits of global energy firms and the financial strain on corporates and households due to historically high energy bills. Shell, Europe’s largest oil and gas company, reported a record annual profit of almost $40bn in 2022. The profit surge across the energy industry reflects higher prices in fossil fuels, due to reduced Russian supplies into global energy markets, more than offsetting rising production costs (e.g. for fossil fuels, labour, logistics and transportation). It appears to show excessive profiteering linked to Europe being forced to pivot away from Russia’s energy supplies after the Kremlin’s invasion of Ukraine. These jarring optics triggered policy interventions in the UK and Europe, capping energy prices for households and businesses and windfall taxes on energy producers’ bumper profits. However, these massive profits are far from ubiquitous throughout the energy sector.

The energy industry operates in a complex geopolitical, economic, policy and financial environment which aims to manage an overlapping set of energy priorities focused on access, affordability, security, diversification, and sustainability. The global energy industry argues that short-term windfall taxation on current profits disincentivises these vital generational commitments. 

If energy costs affect your business and you want to discuss your financial options, BTG Advisory is well placed to help. Early detection of balance sheet weakness is vital to provide options. If your company, or a company within your portfolio, would like a consultation, please do get in touch today. Our team can help you assess the resilience of your corporate balance sheet and identify the range of liquidity options at your disposal as you navigate the volatility ahead.

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