UK businesses need a solution to exorbitant energy costs

UK businesses are in the middle of a slow-motion car crash. New, expensive energy supply contracts are kicking in, just when government support has been scaled back. This makes energy unaffordable for some smaller companies and is likely to hit the troubled retail and hospitality sectors the hardest.

Of course, this was all terribly predictable. The commercial and industrial sectors collectively consume about two-thirds of the UK’s roughly 300TWh of electricity demand. Smaller enterprises are by and large, on fixed-price contracts, many of which roll over in October or April. These reflect the expectations of future energy costs when the contract is renegotiated, as well as a plethora of network and policy-related levies. 

A number of smaller firms — the Federation of Small Businesses reckons 13 per cent of them, or 90 000 companies — renegotiated their contracts when the market was at its peak last year. They are now stuck with unaffordable bills.

By way of a worst-case example, a company renegotiating an April 2023 — March 2024 electricity contract at the peak of the market in August last year would have been looking at forward electricity prices above £600/MWh, according to Cornwall Insights, a consultancy. Adding in network and other charges would raise the bill to almost £700/MWh.

In this scenario, a small business consuming 20MWh of electricity a year would be hit with a £14,000 bill. In 2019, it would have been more like £2,600.

At the same time, under the government’s new discount programme, support has been drastically cut.

Businesses are, unsurprisingly, very unhappy. High energy costs will make it uneconomic for some to operate. Indeed, energy debt bankruptcies this year are reportedly on course for a record. That is a worrying sign for the UK economy. Ofgem, the regulator, has launched an investigation into poor behaviour in non-domestic energy supply.

Contracts at high fixed prices also feel unfair, given how rapidly energy costs have subsequently fallen. By March, expectations of future electricity prices had fallen by almost 70 per cent.

That helps explain calls for suppliers to lend a helping hand. However, companies such as EDF, Eon and Drax cannot easily unpick one contract and sign another. They generally hedge fixed-price contracts, buying — in this case high-priced — energy on the forward market and locking in a margin. 

These have historically been wafer thin. Centrica’s ebit on non-domestic electricity supply in 2022 was 1.7 per cent of revenues. “Non-domestic supply has been very tough for utilities,” said Mark Freshney from Credit Suisse, “which have made returns below their cost of capital.” 

There are signs energy companies may be tiring of this suboptimal state of affairs. Eon is reportedly looking to sell the business-facing arm of its subsidiary Npower. Centrica and Scottish Power have been scaling down their presence in the market. Leaning on suppliers to take more pain might encourage more action of this sort. 

There should be some room for mutually beneficial renegotiation. The FSB has proposed a “blend and extend” programme. The basic idea is that companies would extend 12-month contracts to, say, 24 months, and pay an average rate. British Gas and EDF are offering some version of this.

Averaging down would help, to some extent. Forward price curves for the year from April 2024 are, at the moment, around £110/MWh. By this reckoning, the average wholesale cost for a two-year contract would fall from some £600/MWh to £360/MWh. Suppliers would probably charge for postponing some revenue though, and for taking longer-dated credit risk on customers. 

But while blend and extend would smooth out the pain, the burden on smaller companies is still significant. Calls for further government support are likely before this crisis blows over. Ideas have ranged from outright subsidies to credit risk insurance, which would enable suppliers to offer longer-dated contracts at cheaper prices.

Meanwhile, the UK would do well to think about how to resolve this problem structurally. Lowering wholesale energy costs should be a priority. A review of how the electricity market operates, launched last year, is a welcome step. Reducing energy consumption should also be part of the answer. Current scalding hot prices certainly encourage users to think about that.