William John Market Report 23-09-21
William John Market Report 23-09-21Category: Reports
Following on from the Market Report last week on 17/09, the situation surrounding gas prices has deteriorated rapidly. According to the Financial Times, five UK energy suppliers (with a total of 570,000 domestic customers) have already gone out of business since the start of August due to insufficient hedging or weak balance sheets.
Hedging, a type of investment of which the intention is to reduce the risk of adverse price movements in an asset, is a crucial part of protecting suppliers of natural resources from price fluctuations. There are two principal reasons for this. First, to protect the consumer from fluctuating retail price changes and second, to safeguard suppliers from large scale wholesale price changes. The main component of natural resource supply hedging involved locking in their wholesale prices for resources over a long-term futures or forward contracts.
Clearly, these contracts will eventually expire, and a combination of not enough hedging coverage across the market and the surge in gas prices increasing over what has been the entire summer, is going to leave the remaining suppliers that haven’t already gone bankrupt in a very difficult position. In fact, at the time of writing, two further firms Avro Energy and Green have gone bankrupt constituting a further 830,000 customers between them that will need switching to a new supplier.
Ofgem, the Office for Gas and Electricity Markets, is ultimately responsible for handling customers through this crisis. They have come out in recent days suggesting that more companies would fold, and the recent gas price surge was “something not seen before” according to BBC news. They have even gone as far to ask UK energy providers to open their books to the regulator to show their hedging strategies to understand exactly how exposed individual companies are to the surge in wholesale prices.
Having already explained the reasons for gas prices being at the price they currently are and why the UK is so exposed in Market Report 17/09, the rest of this Report will focus on the implications of the unfolding gas crisis and what lies ahead.
Global gas prices have been at their highest since June 2008. What is deeply concerning is that the UK is hardly through Autumn and the Winter months are usually when wholesale gas has the most demand to heat homes. With Gazprom (the Russian state-backed gas provider that plays a huge part in the European gas markets) recently announcing it was not planning to increase its European gas exports in October, it is expected that wholesale gas prices have no reason to stop growing as quickly as they are. Without dramatic intervention from the government, the UK energy suppliers are watching a historic crisis unfold before their eyes.
UK energy is not the only sector being affected by the current wholesale gas price crisis. Soaring natural gas prices have forced closures of fertiliser plants – the UK’s main source of carbon dioxide used to make fizzy drinks, stun animals for slaughter and to cool nuclear power plants. This could have many knock-on effects ranging from a mass cull of animals that cannot be stunned for slaughter in time to the UK government stepping in to find alternative sources of nuclear reactor coolant.
What is the UK governments position on both crises? The Secretary for Business, Kwasi Kwarteng, has offered sensible solutions for each with varying levels of desperation. Regarding the UK energy crisis, the secretary has reassured the public that current circumstances will not result in a throwback to the 1970’s, where similar coal-dependant energy shortages resulted in a “three day” week with power cuts.
Even though a vast proportion of energy suppliers are not expected to remain standing by Christmas, the government’s position is that they will not reward failed companies with bad business models by bailing them out. Instead, the view is that the government will offer state-backed loans to larger more robust providers to take on stranded customers who have lost their providers and ask Ofgem to facilitate the process.
Regarding the carbon dioxide crisis, the government has met this week with major UK suppliers offering them financial support (although it hasn’t been specifically clarified what this entails). One particular supplier, CF industries, has closed two fertiliser plants in Teesside and Cheshire. Both plants supply roughly 40% of the UK fertiliser market, which in turn has a huge knock-on effect for the carbon dioxide market – demonstrating the severity of crisis.
The government really has no choice but to fiscally intervene in both markets to keep critical carbon dioxide and natural gas supplies flowing down the supply chain which will upholster key national infrastructure and markets. Given how bad conditions are, refusing to reward businesses that have not been able to cope under the current market stress tests sets a good standard for future UK energy companies.
However, there is a deeper issue at play here. Europe is heavily reliant on Russian and Scandinavian gas. No matter how a company hedges its prices, if the gas isn’t being extracted, sold, and transited, eventually the market will come under strain now and in the future for countries heavily dependent on it.
Europe must reduce its exposure to gas and accelerate its transition to other renewable energy sources to build a “state-wide” hedge against reliance on natural gas. Alternatively, countries must collaborate with Russia and Scandinavia to build better pipelines and better infrastructure to transit the gas. This opens another can of worms entirely, as collaborating with Russia is not the easiest diplomatic effort for the UK or the European Union and choosing where to build critical infrastructure or utilise new pipelines runs into its own diplomatic problems – highlighting the recent rebuttal by Gazprom to export gas through Ukraine.
Which path the UK and European bureaucrats decide to take over the coming days, weeks, months and years will ultimately decide the future of net-zero economies on the continent and how they produce their energy.
Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.