MANAGING ENERGY CONTRACTS DURING THE CREDIT CRUNCH
August 26th 2008

With energy prices currently double that of a year ago, inflation running at 4.4% and UK manufacturing dropping by 2%, it is evident that businesses throughout Europe are in for some tough times ahead. During the current peak summer period the market is likely to remain both volatile and unpredictable. Any surge in temperatures will increase air conditioning demand at a time when large supply capacities are offline for scheduled maintenance, whilst continuing oil market uncertainty due to geopolitical factors in Nigeria and Iran could theoretically see prices back in the ascendancy.

The energy buyer is therefore in a position where the commodity being bought is highly sensitive to natural, political, and economic drivers. Energy intensive users have an inherently larger risk premium when making purchasing decisions and can be at the mercy of the markets when securing fixed price contracts.

We are all starting to feel the pinch of the credit crunch. Financial institutions are suffering heavy losses on the back of US subprime mortgage securities and the near cataclysmic demise of US mortgage companies Fanny Mae and Freddie Mac highlight the extent to which the recessionary climate is affecting major institutions. But as the availability of loans reduces the credit checking procedures of suppliers become increasingly rigorous.

Where, historically, suppliers would be happy to quote for businesses with an average, or even below average, credit rating, now they are hesitant to quote for any business which shows a risk of non-payment. And some suppliers are now refusing to quote on current customers whose credit rating is unsatisfactory, regardless of the payment history with the client.

Mitigate your credit risk

To mitigate this risk, it is imperative that, prior to tendering, clients can issue accounts and have accurately reported the registered company address and number. Should credit problems still occur, customers may be asked for any of the following: parent company or bank guarantee; supply contract in the parent company’s name; a security deposit (usually based upon 3 winter month consumption); and company accounts. Additionally, in today’s volatile markets, suppliers look to reduce their credit exposure by offering prices with very tight deadlines. It is not unusual to be offered a price which is only valid for two or three hours to cover the suppliers against any unexpected, within day movement.

There are, of course, exceptions to this rule, however when this happens a price premium is often built into the contract price extending the length of time a contract is ‘on the table’. With pressure to accept contract prices in a relatively short timeframe, the signatory must have authority to sign and accept the offer within the set deadlines. Setting expectations and tracking the market prior to going to tender will help avoid any nasty shocks – however, be warned the unpredictability of the market can still throw a few surprises – as the fire at Rough Storage (gas storage facility) in the Winter of 2006 proved when within-day prices increased by 50%.

Renewing contracts

In difficult times companies must be prepared to avoid the full impact of the credit crisis. With energy prices unlikely to fall to levels witnessed last year, those in charge of their energy budget and who are responsible for making decisions should bear in mind these three golden rules when preparing to renew contracts:

(1) Make sure your credit rating will not become an obstacle and be aware that depending on your rating you might incur a cost premium;

(2) Monitor prices daily and set internal expectations; and

(3) Have a signatory ready to sign those contracts within time frames given – to accept the best price.

EnergyQuote is a utility consultancy with pan-European capabilities and can offer a comprehensive range of energy management solutions to mitigate risk and minimise cost in today's changing and complex market place. If you are looking for innovative products to control costs, to improve efficiency, monitor your carbon emissions or, require strategic input, EnergyQuote offers a bespoke consultancy service. www.energyquote.co.uk

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