Energy crisis: The cost of doing business

We are living in a time of daily headline-grabbing forecasts for cost increases on just about everything we consume. Although some of the numbers talked about are eye-watering, the reality of them is very real for many consumers and businesses alike.

Only a few days ago Loungers’ chairman Alex Reilley called out today’s “obscene” energy prices. The business, which hedged its energy last May, until 2024, said entering a hedge today would have cost it an extra £17m.

But it’s not just a question of being able to a negotiate a fixed deal, operators have to weigh up whether to fix for a year, for example, and risk the situation being even worse in a year’s time, or fixing for several years and tying themselves to higher costs for a longer period of time.

Heart with Smart Group (HWS), which operates the Pizza Hut Restaurants and Itsu franchises, is one of those facing huge year-on-year energy cost increases. Its energy is only hedged until next Wednesday (31 August) as its current contract is due to expire at the end of September and its 12-month extension will not be signed until the end of this month, Steven Packer, chief infrastructure and sustainability officer, HWS, tells MCA.

“As such, we cannot purchase beyond the end of September 2022 and have largely been buying a day or a month ahead over the last 11 months due to the volatility in the market. We have not yet purchased for September 2022,” he says.

The group’s 2022 expenditure is forecast to be £12.5m for electricity, and £2.3m for gas. This compares to expenditure last year (based on same store count) of £6.3m and £0.8m, respectively.

Using live prices, as at 22 August, its forecast 2023 expenditure would be £19.1m for electricity and £3.9m for gas. This represents a 98% increase in electricity in 2022 (188% increase for gas) and a further 53% increase in electricity for 2023 (70% increase for gas), Packer explains.

These are not small numbers for any scale of business to absorb.

Investment will be restricted

Packer says the business is very concerned about what will happen when its contract comes to an end, as higher energy costs “severely restricts our ability to invest”. Given the other inflationary pressures as well, he says it will “inevitably lead at some stage to a dilution in the value for money we can provide our customers – at a time when they are suffering”.

Despite the higher price forecasts it is facing, Packer says HWS has been fortunate in that it has been able to secure a new supply contract. Others have not been so lucky. The market is severely restricted from a supply perspective with few energy firms willing to take on new business, and contract renewals coming with ever tighter payment terms.

“If we had not done so, then we would have moved on to ‘out of contract’ rates. We do not know how much these would have been but likely to have been at least double again what we expect to pay in 2023,” he adds.

While the situation at HWS is far from a standalone example, Jim Pickworth, CFO, New World Trading Company (NWTC), believes the industry may be at risk of sleepwalking into another crisis. “I think it’s a bit of a silent killer, in that I don’t really hear people talking about it,” he says.

“Businesses may have fixes in place that are not expiring just yet, but it might not be much help to be hedged until next summer, for example, if the Ukraine war shows no signs of abating, and China comes out of its succession of lockdowns and puts more pressure on the demand side.”

Highlighting the scale of the rises, Pickworth referenced a quote from the CEO of Octopus, which noted that “if beer had risen at the same pace as gas, a pint would now be £25”.

“If these increases persist for another year or so, it will be another existential threat. We are doing all the sensible stuff about reducing unnecessary usage, but it’s not really going to touch the sides.”

Pickworth says NWTC has a range of fixes between three months and three years, across electricity and gas, with the estate reasonably well-hedged in that respect. But the on-cost for sites coming off their hedges this autumn/winter is looking to be around 200% up on the rates that were fixed in 2019.

’2023 is not looking as healthy as planned’

McMullen & Sons has already seen the rates for its gas and electricity increase this year. Its gas supplier (one of the largest) liquidated the subsidiary arm with whom it had a contract for supply, joint MD Heydon Mizon explains. It is therefore expecting to be hit with an increase of £2m in its utility costs in 2023, compared to 2019.

The business is solid, almost entirely freehold, and has been increasingly profitable over the last 10 years, even during Covid, and with shareholders that have allowed it to invest. “Without this level of performance and support, we would be feeling far less confident about the next three years,” Mizon says.

“Even in the fortunate position we find ourselves, the forecast for 2023 is not looking anywhere near as healthy as we had planned, and the cost of utilities is the primary issue.”

Some operators are in a more comfortable position. Various Eateries is hedged for the next three years in general terms, chief executive, Yishay Malkov says.

If he had to calculate what the business would be paying now if those hedges weren’t in place, “I don’t think I can count that high”, he jokes.

Joking aside, Malkov says the business still has to be very careful with its ongoing usage as its hedging is volume-based and Various Eateries is a growing business.

Oakman Group is another operator in the more favourable position of having oversight of its prices in the medium-term. Chief executive Dermot King said the business had “a little bit of luck” in that it renegotiated its contacts earlier this year and has a cap in place until June 2025.

King says the group’s year-on-year increase will be around +8-9%, but some of that is the full-year impact of businesses that it opened last year.

“I think we are lucky that we got ahead of the game before the crisis really hit hard,” he says. But while the business is in a better position that most, King believes it is also reaping the rewards of its three-point strategy around energy usage. This encompasses energy hedging, developing strategies to reduce energy consumption and investment in efficiencies.

While there is “still a hell of a lot of work” to do on energy reduction, he said small things, like realising that it was not efficient for its ice makers – which produce hot air – to be located in a cellar, designed to keep things cool, can make a difference.

’The energy markets are broken’

King is not confident that the situation with regards to volatile energy prices will sort itself out any time soon.

“The energy markets are broken. The fact renewable energy pricing is based on gas pricing, and that the UK procures most of its gas from the North Sea and not on the open market, means that both consumers and businesses are paying more than we should for energy.

Government intervention is needed now, he says. “We shouldn’t be allowing the market to dictate things.” But “in the long-run, we need to wean ourselves off carbon fuel.”

With some businesses seeing increases of 300% – and smaller operators unable to negotiate like larger organisations can – the cost of energy is almost certain to have a material impact on the viability of others in the sector, Packer adds.

“Hospitality businesses run on wafer-thin margins, even in normal circumstances. The hyper-inflation we are seeing on energy also flows through as material inflation on food and drink purchases and, coupled with likely falling consumer confidence, this perfect storm means businesses will have limited financial options at their disposal which is likely to lead to increased corporate debt and business failures,” he says.

“Many businesses, especially the small ones, that rely on the current market price, will go to the wall,” Malkov adds. “Breaking even for them in what used to pass for normal times was tough at best. Now it’s going to be impossible.”

Pickworth adds: “Government needs to recognise that the energy crisis is not just a consumer problem. A sector like ours, which is relatively high usage […] may wall need some intervention if prices don’t come down soon.”