The UK energy market has been experiencing unprecedented volatility in gas and electricity prices, which is likely to persist through the rest of 2024 and into 2025.
Businesses across the country are grappling with the challenges of managing operational costs amid the uncertainty, and many are asking what the future holds. In this article, we will examine the key drivers of energy price volatility, how this could affect businesses, and the strategies companies can adopt to mitigate the risks.
Factors driving gas and electricity price volatility
The UK’s energy market has been under strain for a number of reasons, with both domestic and international factors playing a role. Here are the primary drivers behind the current volatility:
Geopolitical tensions
The war in Ukraine has had a significant impact on global energy markets. Russia’s position as one of the world's largest suppliers of natural gas means that sanctions and disruptions to its exports have created shortages, pushing up prices across Europe, including the UK. Although the UK is less directly reliant on Russian gas, it is still affected by the broader European market dynamics.
Transition to renewable energy
The UK is actively transitioning away from fossil fuels and investing heavily in renewable energy sources such as wind, solar, and nuclear. However, this transition has its own set of challenges. While renewable energy is essential for long-term sustainability, the intermittency of wind and solar power means that gas-fired power stations still play a crucial role in balancing the grid. This dependency on gas during periods of low renewable output keeps the market vulnerable to fluctuations in gas prices.
Infrastructure and supply chain issues
Maintenance of energy infrastructure and disruptions in the supply chain have also contributed to energy price volatility. Planned and unplanned outages in power plants, delays in building new energy projects, and supply chain bottlenecks for critical components like wind turbines and gas pipelines all add to the instability.
Regulatory changes
Energy price caps, subsidies, and changes in government policy have played a role in shaping the market. For example, Ofgem, the UK’s energy regulator, adjusts the energy price cap every three months, based on wholesale prices. These adjustments can result in sudden changes in the cost of electricity and gas for businesses, making it harder to plan ahead.
Inflation
The broader macroeconomic environment, with rising inflation and a fluctuating pound sterling, has contributed to the cost of importing gas and electricity. A weaker pound can make energy imports more expensive, adding further upward pressure on prices.
Impacts on businesses
The ripple effect of energy price volatility is being felt across every sector. Businesses of all sizes, from SMEs to large corporations, are grappling with how to absorb these costs while staying competitive. Below are some of the key ways that volatility will impact UK businesses throughout 2024 and 2025:
Rising operational costs
For energy-intensive industries such as manufacturing, logistics, and agriculture, the impact of rising gas and electricity prices is significant. These businesses have seen their energy bills skyrocket over the past two years, and this trend is set to continue. Companies that rely heavily on energy for production may find it difficult to pass these additional costs onto customers without losing market share, particularly in competitive or price-sensitive markets.
Reduced profit margins
As energy prices rise, businesses may struggle to maintain profitability. Companies that cannot increase prices due to competitive pressures will face shrinking margins, putting financial strain on their operations. This is particularly concerning for smaller businesses that have less financial resilience to absorb cost shocks. In 2024 and 2025, we can expect some businesses to downsize or halt operations entirely if they are unable to manage the rising costs.
Investment delays
Energy price volatility can deter businesses from making long-term investments in growth and infrastructure. High and unpredictable energy costs make it harder for businesses to accurately forecast their financial position, leading to delays or cancellations of investment plans. For example, manufacturers may hold off on expanding production facilities, and service industries may delay the implementation of energy-efficient upgrades.
Increased focus on energy efficiency
On a more positive note, businesses are likely to double down on energy efficiency measures as a way to mitigate the impact of price volatility. Investments in energy-saving technologies, such as LED lighting, energy-efficient machinery, and building insulation, are expected to increase. Additionally, more businesses are likely to explore on-site renewable energy generation, such as solar panels or small-scale wind turbines, to reduce their dependence on the grid.
Supplier renegotiations and Power Purchase Agreements (PPAs)
Many businesses are now looking to renegotiate contracts with their energy suppliers in an attempt to secure more stable pricing. Power Purchase Agreements (PPAs) with renewable energy suppliers have gained popularity as they allow businesses to lock in energy prices over the long term, reducing exposure to market volatility. Expect to see more businesses exploring these types of contracts in the coming years.
Impacts on consumer spending
The knock-on effect of higher energy prices for consumers could also impact businesses. With households facing higher energy bills, discretionary spending is likely to fall, affecting sectors such as retail, hospitality, and leisure. Businesses in these industries may experience reduced demand for their products and services, which, when combined with higher operational costs, will create a challenging business environment.
Looking ahead: How to prepare for 2025
Given the volatility in the energy market, businesses need to adopt proactive strategies to mitigate the impact of fluctuating gas and electricity prices. Here are a few key approaches to consider:
Energy audits
Conducting an energy audit can help businesses identify where they are using the most energy and where they can make efficiencies. This could include upgrading equipment, improving insulation, or changing operational practices to reduce energy consumption.
Diversifying energy sources
Businesses should explore diversifying their energy sources, including investments in on-site renewable energy or securing long-term contracts with renewable energy suppliers. These measures can help reduce exposure to volatile gas prices.
Flexible pricing models
Where possible, businesses should negotiate flexible energy contracts that allow them to take advantage of lower prices during off-peak times or periods of lower demand. This can help spread the risk of price spikes.
Budget forecasting
It is important for businesses to build contingencies into their budget forecasts for energy costs. Given the unpredictability of the market, businesses should prepare for a range of scenarios and have contingency plans in place for worst-case outcomes.
Government support and grants
Keep an eye on government schemes and grants that can help businesses manage energy costs. For example, the UK government may offer subsidies or support packages to help businesses during periods of extreme price volatility, particularly for SMEs.
The volatility in gas and electricity prices is not going away anytime soon, and UK businesses need to be prepared for what lies ahead. While the road may be challenging, proactive measures such as energy efficiency improvements, renegotiating supplier contracts, and exploring renewable energy options can help businesses weather the storm. The rest of 2024 and 2025 will be a critical period for companies to adapt, innovate, and navigate the complex energy landscape to ensure long-term sustainability and profitability.
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