For energy-intensive firms, the heat is on

11 March 2022

  • Many firms renew their energy contracts in April and October, making them crunch months for energy-intensive industries
  • Companies need to protect themselves against customers failing due to higher energy prices
  • Trade credit insurance not only reduces risk, but helps firms grow, despite current high levels of uncertainty

April and October are set to be crunch times for some energy-intensive businesses. It is when many energy contracts come up for renewal, and firms that use a lot of energy will be the first to feel the pain from higher prices.

"I think it's probably fair to say that this is an existential threat, particularly for lots of small businesses that are already quite fragile and have already been hit hard by COVID-19 restrictions,” says Shannon Murphy, who covers energy-intensive businesses such as metals, vehicles and engineering as Assistant Head of Risk Underwriting at Euler Hermes UK & Ireland.

"When current contracts are renewed, there’s a fear that prices are not just going to double, but triple, or quadruple," Shannon said.

Energy consumption in the UK

The UK has limited imports of Russian gas, but is vulnerable to rising international energy prices caused by the conflict in Ukraine. Regulator, Ofgem, has raised the “price cap” from April 2022 by 54% to nearly £2,000 a year on average, which means a significant rise in energy costs for UK consumers.

The UK is tied to international markets, so it has to pay more when there is strong demand or concerns over tightening supply. For businesses, we have seen UK gas prices hit a fresh record 800p per therm at one point in very volatile trading, before falling back. In 2021, UK gas prices were trading at 40p per therm. 

The UK has a relatively diversified energy supply, with a significant amount of wind and solar energy, along with fossil fuels and nuclear power. However, wind and solar have the disadvantage of being variable, which means they aren't always available.

While the UK has pledged to phase out coal-fired power stations by 2024, it is still heavily dependent on coal when wind and solar power falls.
About 16% of the UK's electricity is currently supplied by nuclear power, but existing fleet reactors are nearing the end of their operating lives. A new nuclear power plant - Hinkley Point C – is under construction in Somerset and aims to provide 7% of the country's current electricity needs.

Elsewhere, the government is pushing forward with a strategy to drive replacement of fossil fuel use across industries with ‘green hydrogen’ made from renewable energy and water. The government aims to produce 5GW of green hydrogen by 2030, the equivalent of replacing natural gas in 3 million homes.

Dwindling options for SMEs

But the immediate problem for many energy-intensive industries that face an increased cost of power, is that their energy bills are big enough to threaten their business, but not big enough to benefit from the hedging facilities available to the largest users, such as steel mills and car factories.

This leaves small- and mid-sized firms with high energy bills - ranging from specialist materials manufacturers to industrial bakeries - with few options when prices rise.

The best solution is to recoup the higher energy costs from customers. Unfortunately, for many companies, a rise in prices means some customers may leave.

Shannon says that firms' ability to raise prices depends on their place in the industry's value chain. Do they provide unique goods or processes? Is it a bespoke product that is not easily obtained from other suppliers? Or can customers easily turn elsewhere?

"SMEs, simply because they are smaller companies, often don't have this pricing power," he notes. "They don't have power in the supply chain."

There is also a risk of production disruption if some firms in the supply chain reduce output as a result of higher energy costs, creating a further knock-on effect.

Indeed, they may be suffering a double squeeze, as the price of the goods they buy with a high embedded energy cost will be rising.

In the short term, there have been some winners. For example, Shannon says that wholesalers with a warehouse full of products with high embedded energy costs, such as steel stockholders/processors, have seen high profitability as they could sell that stock at good prices, especially where there is also a shortage of supply.

Increasing insolvency risk

UK business insolvencies are rising, and Shannon says increased energy costs will help push defaults yet higher. For many smaller businesses, the challenge will be to try to secure more affordable energy deals.

Even before the price rises and the disruptions of Covid-19, UK firms were at a competitive disadvantage in energy. According to House of Commons research, although the UK’s largest industrial energy users pay marginally less for gas than the rest of Europe, they pay double the EU average price for electricity.

With margins tight, banks can get nervous about lending. "Quite often, you see how tough it is for the SME segment to get bank support," Shannon says, "The directors may have to give personal guarantees or offer the house as collateral to the bank."

He adds that this poses a challenge for companies wanting to protect themselves against customers failing, part of the insolvency domino effect. Working out whether a customer will be hard-hit by energy price rises and whether they have the pricing power to offset, is a difficult task for any company credit controller.

This is doubly so for companies that trade with a wide range of customers, such as transport and logistics firms, and don't have specialist insights into their customers.

The role of trade credit insurance

In this environment, he says, trade credit insurance has two roles. Firstly protection - if a customer cannot pay invoices due to high energy bills, then trade credit insurance will step in accordance with the policy.

But a second vital role is to enable firms to grow in such an uncertain environment. This is part of the case for trade credit as a strategic investment, allowing firms to seize opportunities by trading extensively with new, creditworthy customers, without slowly building a credit history.

He also notes credit insurers have access to non-public information that helps firms manage risk amid uncertainty.

For a free credit insurance consultation call our UK team, 09:00-17:00 Mon-Fri.