Rising natural gas and electricity prices are creating an unexpected problem for businesses this winter, and another worry for the Bank of England. The expected opening of several new import facilities had prompted hopes that gas prices would fall. But high oil prices and delays to some important projects have pushed up prices for natural gas, and hence electricity because of the use of natural gas for power generation. A year ago, wholesale energy prices rose in the run-up to Christmas, and then fell back sharply in January and February. The same may well happen again this winter. If it does not, then it is very likely that retail gas and electricity prices will rise. Centrica, the owner of British Gas and a price leader, dropped a heavy hint of that on Friday when it said: “The high wholesale prices will, if sustained, create a more difficult environment for retail energy suppliers in the UK going into 2008. We will continue to monitor this with regard to future pricing policy.” The worry for businesses, especially in energy-intensive industries, is that the balance of supply and demand is tighter than they had hoped. If we have an unusually cold winter, or there are supply disruptions, then the gas shortages and soaring prices of winter 2005-06 could be repeated. The immediate cause of the rising price of natural gas is the high oil price, which last week climbed back close to $95 (£47) a barrel. Natural gas prices in continental Europe are generally set on contracts linked to the price of oil products such as heating and fuel oil, so they follow oil prices, typically with a three to six-month lag.

Alexander Medvedev, the deputy chief executive of Gazprom, recently predicted European gas prices would rise by up to 17 per cent next year, simply as a result of the rise in the oil price.

That has meant higher prices for Britain, too. David Cox of Poyry, an energy consultancy, said continental gas prices tend to set a floor for UK prices, with a premium on top for weather risk. In addition, some of the hoped-for extra sources of gas supply into Britain have been disappointing. The two new terminals for importing liquefied natural gas at Milford Haven in Wales, South Hook and Dragon, are not expected to come on stream until well into next year.

The LNG terminal at the Isle of Grain has been used only intermittently, prompting Ofgem, the energy regulator, to ask companies whether they think there is a problem. Production from Ormen Lange, a Norwegian gas field that came on stream in October and is connected to Britain by the Langeled pipeline, has been growing more slowly than expected, as Norway’s national oil company StatoilHydro admitted this month.

The combined effect has been to push month-ahead gas and electricity prices to their highest level since the first half of 2006, adding to upward pressure on inflation. The Bank of England reckoned in last month’s inflation report that it was “more likely that retail energy prices will rise over time, rather than fall”. It warned that energy prices were one of the factors likely to keep inflation above target in the short term.

For energy-using businesses, higher costs are squeezing profits, but the effects are mitigated by the nature of energy price rises. British companies and their foreign competitors are all facing higher costs, and in many cases are able to pass on increases to customers. The real problems for business will come if British energy costs get out of line with those elsewhere, as they did in winter 2005-06.

Jeremy Nicholson, of the Energy Intensive Users’ Group, said: “We are not there yet, and fingers crossed we won’t be there. But the risk is significantly higher than we had been led to expect a few months ago.”

The vulnerability of British companies could be greater because more businesses have shifted to buying gas and electricity at spot or short-term prices.

Companies that might want to sign longer-term contracts are also put off by high futures market prices.

Jim Hempseed, UK-based energy director of Air Products, the industrial gases company that is a heavy user of energy, says: “My concern is next summer, where the forward price is about £49 per megawatt hour, compared to spot prices that averaged about £20 to £25 last summer. So we are faced by prices double what they were this year.”
Energies spent managing risk

Malcolm Lee of Sheffield Forgemasters International, a manufacturer of heavy engineering components, says he is not just managing energy, he is managing the company’s production costs, writes Ed Crooks.

As energy and commercial manager, he is responsible for buying the energy that accounts for about 20 per cent of the company’s production costs. But his greatest concern is that his ability to manage that risk in the market is disappearing.

For Forgemasters, a strong order book means higher costs can be passed on to customers. “We have a strong, buoyant market, and we are a very robust company, and there is an ability to pass that extra cost on. If you are a marginal company in a commodity business, though, you can’t pass it on,” he says.

However, profits are stillsqueezed by the delay in passing on higher costs, because contracts are typically signed for six to nine months ahead. “The energy price is not disastrous for us, but it does impact the bottom line all the time.”

His attempts to manage that risk have been hampered by a lack of liquidity in the forward market. “As prices started to rise in September and October, we started a damage limitation exercise, buying ahead,” he says. “But when we tried to do it a bit further forward, into January, February and March, it became very difficult.”

Very few sellers have been trading either gas or power in the wholesale market, he said.

“It has noticeably got worse since we came to the end of the summer,” Mr Lee said. “There seems to have been a bit of a sea change in how the market operates. If you try to fix forward, you can’t get a price.”
Keep costs down and homes warm

Beryl Barrett reprimands her five children when they neglect to turn the lights off or they keep the hot water running in her four-bedroom Croydon home, writes Ellen Kelleher.

The rising cost of electricity and gas is a burden and Ms Barrett, 40, struggles to find ways to keep gas and electric bills to £80 a month.

“I do everything I possibly can to save money,” she said. “When I was growing up, I had this habit of brushing my teeth and leaving the hot water running, which made my mother mad. Now I understand why.” Ms Barrett has pared back the cost of running her home by taking part in Warm Front, the government’s fuel poverty scheme. Her boiler was replaced last year with a more efficient one, resulting in yearly savings of at least £100. Since then, Ms Barrett has spread the word about the programme to friends.

She said: “I ask people I come in contact with on income support whether they’ve heard of Warm Front and they tend to say: ‘Oh yes, I received a leaflet about that’. I tell them to sign up for it. My house is a lot warmer now that they’ve taken out the old boiler.”

RSS feed for comments on this post. TrackBack URI

You must be logged in to post a comment.