Clamping down on energy cash costs

THE ANNOUNCEMENT in July by the UK government that the average domestic fuel bill will rise to £1,000 – or just above 4% of UK average earnings – led to nearly 400 press articles and a good deal of political debate. A less reported story was the increasing cost to business of the UK’s sustainable energy policy, which the government admits will lead to energy price rises of up to 10% per year.

One of the main issues driving the escalating costs is the increasing dependency of the UK economy on imported energy sources. To address this issue, the forthcoming Energy Reform Act will stimulate more UK energy being produced from local renewable sources, including nuclear energy.

However, it will be a long time before such renewable energy sources come online, which will leave UK businesses facing unpredictable energy costs for the foreseeable future. UK finance professionals will need to factor the unpredictability into their cost projections or, better still, establish processes to mitigate the impact of this unpredictability.

Finance directors need a strategy to help their organisations cope with four major energy issues that are rapidly approaching: a lack of mid-term pricing certainty, rapidly increasing energy costs, higher costs from more stringent compliance reporting, and – on the upside – renewable investment cost-saving opportunities.

1: Lack of mid-term pricing certainty

The UK’s mix of energy sources leaves UK business increasingly dependent on non-UK providers and therefore very susceptible to the whims of the global energy market. Not only is there a diminishing supply of fossil fuels, there are also increasing demands on what is left, due to the high growth in energy consumption in the BRIC countries.

This is amplified by recent political events, such as the so-called Arab Spring, and economic events, such as fluctuations in the US dollar exchange rate. Purchasing forward energy contracts when prices are volatile is risky. Such unpredictability can make FDs over-cautious and funds that might have been used for investment are set aside to insure against further rises in energy prices.

2: Increasing costs and cashflow

According to the Department of Energy and Climate Change, the new energy bill “has three principal objectives: tackling barriers to investment in energy efficiency; enhancing energy security; and enabling investment in low carbon energy supplies.” This is all good, but at a cost our foreign competitors do not have to suffer. There is no consideration about keeping UK industry competitive globally.

An export-led strategy could bring us out of our current economic stagnation. However, an increasingly larger chunk of operational expense will be siphoned off and so reduce our profitability as energy costs rise 9-10% per annum (well ahead of both our competitors and UK inflation at 5%). This gives a huge advantage to our overseas competitors whose governments are not forcing the cost of increased energy diversification onto their local businesses.

3: Compliance and reporting costs

In April 2012, the financial impacts of the Carbon Reduction Commitment (CRC) will hit home for the first time. The purchase of CRC allowances is likely to add a further 6% to the average energy-related costs to 4,000 of the larger UK organisations, another cost our overseas competitors need not worry about.

However, there is some good news. The CRC is a consistent, clear, objective and public benchmark. Globally, there are few consistently applied sustainability reporting standards, and the Carbon Disclosure Project (CDP) is a notable exception. This means that foreign companies’ green credentials often lack credibility, despite the commendable efforts of some organisations, such as Puma’s recently announced environmental profit and loss account. But UK finance executives will have a very clear idea of the cost of sustainability reporting thanks to the CRC. They will begin to benefit by benchmarking their energy consumption against their peers based on a consistent methodology.

4: Renewable energy investment

One area in which government could give more clarity to FDs is how UK companies will be supported with their long-term renewable investment strategy. While UK consumers are enjoying both government encouragement and reduced energy bills thanks to feed-in tariffs, and are busy installing photovoltaic cells on their roofs, transforming them from consumers to small-scale energy suppliers, UK businesses find themselves in limbo.

The details of the Green Deal will not be released until the second half of 2012, effectively putting many UK companies’ investment decisions on hold. But rather than sitting back and bracing yourself for the inevitable impact of rocketing energy prices on your business, there is another way: proactivity.

Our enterprise sustainability software uses social media techniques, familiar from Facebook and Twitter, to highlight areas of saving and encourage employees to become involved with the energy-saving initiatives UK business must adopt in the light of energy cost increases.

We have offered our thoughts to the government’s Green Investment Bank in an open letter to its chairman, calling for a focus on the demand side of energy sustainability. We also advocate the so-called nudge strategy of frontline persuasion, which is taking root in government policy and elsewhere. This ensures your sustainability strategies are both practical and relevant to your employees.

Forward-thinking FDs must deliver a strategy to prevent energy costs consuming increasing amounts of cashflow. Saving energy and changing employee behaviour delivers benefits in the short and, even more valuably, the longer term. The good news is that managing rising energy costs could give us an opportunity to out-compete our gas-guzzling competitors if we have the right processes and software to drive change.

Simon Corley is chief financial officer of CloudApps