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The Rising Cost Of Energy And Its Effect On Business

Apr 27, 2023 Red Flag Alert Updated On: January 24, 2024
The Rising Cost Of Energy And Its Effect On Business

The previous three years have seen businesses faced with an unprecedented series of challenges; from a global pandemic through to soaring inflation. However, it is the rising cost of energy that has become the biggest threat, admittedly amongst many others, to the survival of many companies.

The UK government had shielded businesses somewhat against these price increases with its Energy Bills Relief Scheme, which saw business energy bills discounted, but as of 1st April 2023 the significantly less generous Energy Bills Discount Scheme was implemented. This will see many small businesses effectively receiving no support and the rising energy costs will be much more keenly felt.

In this article we will look at why energy prices rose in 2022, what the effect of this has been and what might happen in 2023.

A snapshot of the current situation

Business energy bills have increased by over 400% since early 2021

The government’s new  Energy Bills Discount Scheme will see small businesses receiving as little as £50 relief per year

Wholesale prices of natural gas rose significantly due to numerous factors including: War in Ukraine, global demand, depleted gas reserves, a poor UK energy market, low UK government support and the UK’s overreliance on gas

Business energy costs contributed to 2022 having 22,109 insolvencies; which is the highest number since 2009

Whilst wholesale energy costs have gone down, it is unlikely that bills will drop soon

Insolvencies in 2023 are predicted to be significantly higher than in 2022, in part due to energy bill shock

Why did energy prices rise In 2022?

It is often put forward that the sole reason for the price rise is Russia’s invasion of Ukraine and the subsequent shut down of Nord Stream 1. Whilst it is undeniable that this played an important role, there where many other issues and events that also contributed.

These factors can be divided into international and domestic.

International Factors

  • Russia’s invasion of Ukraine – As previous mentioned, a significant factor in the rising costs of energy is Russia’s invasion of Ukraine, or rather the ensuing political fallout. On 24th February 2022 Russia launched their invasion of Ukraine and this was followed by a raft of sanctions against Russia and prominent Russian figures. As global political tensions increased, Russia responded by limiting and then stopping its supply of natural gas to Europe, via the Nord Stream 1 pipeline. The recently completed £11 billion Nord Stream 2 pipeline, which would increase the amount of natural gas that Russia can import to Europe, has also yet to be turned on due to Russian hostilities.
  • Post COVID demand increase – Even before the Nord Stream 1 shutdown gas prices were already high. A significant factor in this was demand increasing as countries around the world, especially Asia, left lockdown and industry ramped back up.
  • Freeport LNG’s Texas plant fire – Global gas supply has been further limited due to a fire at a Texas production plant. This has further limited the supply of gas into Europe.
  • Depleted gas reserves – Following a prolonged and cold winter in 2020-21 European gas reserves were depleted and could not be used to subsidise

UK Factors

  • Low renewable energy production – The UK energy market has been hit by low production of renewable energy. Low winds and nuclear power outages have been cited as contributing factors to this.
  • Low UK gas reserve capacity – Whilst the entirety of Europe saw depleted gas reserves after a long and harsh winter, the UK also suffered from the fact we have an unusually low storage capacity for natural gas. Continental European countries have storage capacities of between 25% - 37% of annual demand the UK is able to store just 2% of annual demand.
  • National Grid Kent site fire – A 2021 fire at a National Grid site in Kent damaged a cable used to import energy from France. This increased the need for domestic energy output and subsequently increased the demand and price for fuels.
  • The poor UK energy market – The UK energy market had numerous smaller ‘providers’ supplying domestic energy at competitive prices. In reality these companies worked more like energy brokers, buying wholesale power from producers. When the wholesale price rose above what could be charged by the price cap 29 of these companies collapsed. Even before the rising cost of wholesale energy this was still a system that saw relatively high levels of failure, since 2016 there have been 65 energy suppliers go out of business.
  • When a supplier goes out of business its customers are transferred to a healthy company (known as a ‘supplier of last resort’), who then need to quickly buy more wholesale energy; the cost of this travels through the supply chain until the customer eventually foots the bill. The estimated cost to UK energy bill payers for these collapses is around £2.4 billion.

This does not include the cost of Bulb collapsing. Bulb had 1.5 million customers and when it collapsed the government decided to place it in special administration as opposed to following the usual supplier of last resort system. Whilst initially expected by the government to cost £2-2.5 billion, experts estimate it will actually cost in excess of £6 billion, which would be enough to add £200 onto domestic energy bills.

  • An overreliance on gas – The UK relies on gas to supply around 40% of its power, as compared to an average of less than 20% in the EU bloc. This means that just producing the energy in the UK is extremely expensive and this cost is ultimately paid for by the consumer.
  • Low government support – Whilst the UK government has contributed funds to business and domestic energy bills to help with the price rise it falls well short of other countries.; and of 1 April 2023 businesses support in the UK has been slashed.

To apply some context, France has limited energy price rises to 4%, Spain has lowered VAT on energy bills form 21% to 10% and taxes on electricity from 7% to 0.5% and the Netherlands has lowered VAT on energy from 21% to 9%.

How have businesses been affected so far?

The Federation of Small Businesses reports that the average rise in energy costs amongst its members has been 424% since early 2021. Following the various challenges and crises since the start of 2020 the huge increase in energy costs has proven to be the final straw for many businesses, even with the more generous Energy Relief Scheme.

There were 22,109 insolvencies in 2022, which is the highest number since 2009. This number was driven by Company Voluntary Liquidations (CVLs), which made up 85% of all insolvent businesses in 2022 and represents the largest amount of CVLs since records began in 1960.

Whilst there were other contributing factors to this, such as bounce back loans coming due, inflation, supply issues etc, the role energy costs has played is well stated. The Director General of the British Chamber of Commerce reported that over 33% of businesses were reporting problems paying their bills and the Chief Executive of the British Beer & Pub Association has stated that the price of energy is the biggest threat to that industry.

It is small businesses that suffered most as they are least able to absorb sudden costs and after years of razor thin margins, initially started by COVID, record numbers of directors threw in the towel as the cost of energy finally made their businesses unviable.

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Will energy costs fall in 2023?

The wholesale cost of energy has already fallen to below pre-Ukraine invasion prices though this has not yet been passed on to customers.

This has a lot to do with how energy providers purchase energy. An energy provider pre-purchases energy from the generators based on projected demand; this means that energy used in any given day was purchased by the energy provider in advance. This leads to a lag in wholesale price changes reaching the end user. The fact that wholesale prices are down does not necessarily mean that bill payers will see reduced costs as energy providers are slow to reduce prices and given the incredible volatility of the global wholesale energy markets in recent years, they are likely not to gamble that the downwards trend will continue and decrease bills in any short order.

The Chief Executive of Centrica, the parent company of British Gas, has stated that bills are not likely to decrease in 2023 and maybe even early 2024.

To summarise, that whilst wholesale energy costs have fallen recently it is almost impossible to predict how geo-political events and global demand might influence costs in the near future.

What will the effects of energy prices be on business in 2023?

 The first blow to businesses relating to energy will be felt in their first power bill following 1st April. This will be the first bill under the government’s new Energy Bill Discount Scheme. This is far less generous than the previous iteration and will see a small discount on the wholesale price of energy should it exceed a certain threshold.

This may not provide much practical support, especially in a time where the wholesale price is below the threshold, but bills remain high. The Federation of Small Businesses estimates that the average small business will see between £50 - £200 off their bills annually against bills that have more than quadrupled.

The immediate effect of support for business effectively being removed is likely to be a large surge in insolvencies in the first half of the year at least and if prices do not fall in an immediate way then this is likely to continue for the rest of the year. Red Flag Alert is projecting that there is likely to be 28,000 insolvencies in 2023 but that this could rise to exceed 30,000.

Cornwall Insight, which works with energy companies and provides industry analysis and insights, stated that there was concern in the energy industry about bad debt after the Energy Bills Relief Scheme gave way to the Energy Bills Discount Scheme.

The Chair of the British Institute of Energy Economics Council said, ‘it is clear that without energy cost reduction, small business will not be able to survive’.

Despite the vocal criticism of the UK government’s current business energy support scheme, they seems to be gambling on a significant reduction in energy cost in the rest of 2023. Chancellor Jeremy Hunt advised that the old scheme was ‘unsustainable’ and was only meant to be a temporary measure.

The cost of the Energy Bills Discount Scheme is projected to be £5 billion, which is an 85% reduction as compared to the previous scheme. This reduction is undoubtedly a response to strain on the public coffers and may be the best the UK government is currently able to do.

Whilst many companies are expected to go insolvent, the cost of energy will also have a negative effect on those that do not as well. Margins will be much reduced and leave them operating in a state that is vulnerable to any sort of shock.

Another effect will be that solvent companies will have significantly less funds to reinvest into themselves. This should be of concern to a government that has set having the strongest growth in the G7 as one of its five aims and has a general election on the horizon. Especially considering France’s strong business support scheme and America’s low energy prices and President Biden’s aggressive subsidies designed to attract tech startups.

This puts UK business and our economy at a significant disadvantage for global competition and, given that energy bills are not projected to drop soon, it is likely the government will need to introduce additional measures of support if their lofty economic goals are to be achieved.

How Red Flag Alert can protect your business:

As government support has now been significantly scaled back it is likely that the UK will see an increase in insolvencies. Each insolvency causes a ripple effect as creditors have to absorb the loss caused by bad debt and themselves become one step closer to insolvency. In fact, a company that experiences a bad debt is three times more likely to go insolvent itself.

Companies also need to ensure that they are doing business with financially solid suppliers. Should a supplier go insolvent, then not only will a new supplier need to be found in a hurry, often leading to unfavourable payment terms, but given global supply chain issues, business critical resources may not be able to be supplied in the short term. Business that weather 2023 will need to demonstrate excellent supply chain management in addition to credit risk management.

Red Flag Alert grew from the UK’s largest insolvency practitioner and is the industry leader at spotting the early warning signs of insolvency.

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Start a free trial of Red Flag Alert and begin protecting your business today. 

Published by Red Flag Alert April 27, 2023

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