Corporates facing up to the pressure of the energy crisis

The surge in energy prices has had a massive impact on companies across multiple sectors since 2021 when growing demand coupled with supply constraints due to the pandemic led to higher wholesale prices.

Since then, the war in Ukraine has seen oil prices escalate above $100 a barrel, driven by Western sanctions on Russia, the world’s third largest oil producer.

“There has been a big effort to alleviate the pressures in the oil market in recent weeks, which has no doubt helped, but it is the lockdowns in China that are driving the latest declines,” says Craig Erlam, senior markets analyst at Oanda. “Of course, this is just a temporary demand hit so the upside risks to the price remain but it is offering some reprieve for now.”

For many companies, understanding and managing volatile energy price risks has become a top priority – not only in terms of the higher costs they face now and, possibly, in the future, but also the impact on their wider businesses.

Treasurers with their risk mitigation skills are well placed to play a leading role in advising their companies on how best to deal with the crisis, and put in place appropriate strategies which can accommodate unexpected, future shocks.

“Treasury should be part of the discussion around the commodity risk a company is facing and oil, as well as other energies, are all commodities,” stresses Patrick Kunz, a former treasurer and now owner and consultant at Pecunia Treasury & Finance, noting that some companies do not consider commodity risks a treasury task and employ dedicated risk managers.

“Treasury should be helping in identifying a company’s exposure to each commodity,” he stresses. “Once the exposure and, therefore, the risk is known, the sensitivity can be determined alongside the risk appetite of the company.”

Some companies may be prepared to accept a certain level of commodity price volatility, and some may also take the view that price hikes can be absorbed in their current margins, Kunz adds.

However, he identifies companies operating in energy-intensive industries, such as steel manufacturing, as well as the transport sector, as the hardest hit by the recent hike in energy costs and ongoing uncertainty surrounding oil and gas prices.

However, the energy crisis has had a broad impact globally on most companies’ value chains – from production to distribution. According to research by ING, a firm’s resilience to soaring energy prices is dependent on its profit margin and ability to pass through prices hikes.

Strategies to mitigate energy price risk

This has called for companies to look for new ways of absorbing the extra costs and to consider the actions they can take to mitigate the impact of higher, more volatile, energy prices.

ING believes that energy-intensive companies should follow oil, gas and power prices more closely and pursue strategies that are in line with their own exposure, risk appetite and market situation.

The bank identifies a number strategies companies can pursue including switching to more energy-efficient production processes, which can take time; the use of price escalation clauses to pass prices increases on to customers; or directly procuring energy the moment a sale is agreed.

Another important option is to hedge against future energy price hikes by using commodity futures, which requires a detailed understanding, and monitoring, of the instruments used.

For these reasons, commodity price risks must be on treasurers’ radar, and part of their contingency planning so that appropriate strategies can be identified and pursued.

Kunz points out that treasurers are the experts when it comes to hedging against future risks such as a further hike in energy prices.

However, he also notes that “treasurers can predict and anticipate only so far forward”.

“Even if they see a steep increase in energy prices on their radars, it would be expensive to hedge all of this increase very far forward,” he says.

He points out that as most future prices are higher than spot prices, especially for hard commodities which incur storage and transportation costs, making hedging into the future very costly.

“Most companies have hedging policies that do not go further than one year – or maybe two to three years. Also, the predictability of exposures becomes more difficult the further forward they go in time,” he says.

“Now we are stuck with higher prices, and given that there are no expectations of a decline, treasurers face a dilemma: Should they hedge this risk, given that prices could rise further, or not hedge – and accept the higher prices as they are?”

While hedging offers many possibilities, it also has its limitations and, therefore, hedging programs must be constantly renewed on a rolling forward basis.

“The treasurer has to make a choice to hedge more – or less – given the high costs of it,” he says.

He adds that government intervention, like that already seen for consumers in some countries where fuel taxes have been reduced, could also stem the current energy crisis for the business sector.

“I also expect governments to intervene with subsidies or reduced taxes on some commodities,” he says.

Business impact

Given today’s energy crisis, and the possibility of even further energy price hikes, treasurers also need to consider the longer-term impact on their companies’ business as a whole and advise them accordingly.

Kunz points out that treasurers are in a good position to assess how long their companies can manage higher energy prices at current production levels and the impact these higher prices will have on profits.

“Current energy prices should be taken into account for setting future production costs and, therefore, the prices charged to customers,” he says. “Customer prices may have to rise to keep the value chain working and profitable.”

He adds that the latter could lead to demands for higher wages, and lead to spiralling inflation, which in turn, would lead to even higher commodity prices.