Your energy crisis survival kit

The war with Iran is now one month old. Before I say anything else, I want to express my sympathy for all victims of war, regardless of their nationality or religion. But I must look at this through the lens of the energy expert. What this war has changed is that the non-energy experts around us now also know where the Strait of Hormuz is. I have been in this market for more than a quarter of a century, and with every conflict in the Middle East, I have cited a blockage of the Strait of Hormuz as a doomsday scenario for the energy markets. Well, now that day has come. On top of that, we’ve seen the targeting of energy production and export infrastructure in a region that produces 31% of the world’s oil, 17,9% of the world’s natural gas and 24,2% of the world’s LNG exports. In the last week, we’ve seen a bit more restraint, but there is still considerable risk of lasting damage resulting in supply interruptions for years to come.

The impact on global energy prices has been immediate and sharp: Brent prices for oil (front month) were at the end of last week 86,74% higher than 12 weeks ago, TTF for April – the benchmark for natural gas prices – increased by 95,06% and LNG for delivery to Japan and Korea (JKM) by 120,02% (in Japanese yen). Power prices in Europe are affected, German baseload for April has increased by 24,13%, peakload by 27,5%. It came with some delays, but longer-term natural gas and power prices are now also affected, with TTF Cal 27 up 70,18% from where it was 12 weeks ago. US citizens and businesses feel the impact of higher oil prices at the pump, but with domestic gas production, they are so far shielded from higher natural gas prices and its impact on power prices (this could change if the drop in Middle East natural gas supply causes demand for North American natural gas to increase). Less than 3 years after the 2022 energy price crisis, here we are again, with buyers anxiously watching reports from battlefields and the resulting daily jumps – up and down – of the wholesale energy prices that decide how much they pay for energy. In this article, I want to offer you some of my insights into what can be done and what could have been done in this situation.

What can I do if I’m fully exposed to these high prices as I’m insufficiently hedged?

As in 2022, there is only one piece of advice we can give you:

1: Limit the damage for when it gets worse,

2: Don’t panic so that you don’t create damage now for when it gets better.

You find yourself in this situation because you didn’t hedge enough. Draw the lesson from this and start hedging, do it in small incremental steps, but do something so that if it gets worse, you have reduced your exposure. Can it get worse? Yes, it can. This conflict has the potential of large scale, long-lasting destruction of oil and gas infrastructure. Don’t speculate that this will not happen.

BUT: do these incremental hedges in small steps. That way, you avoid having hedged a large volume at the peak if the worst-case scenarios don’t materialize, the war is ended, or the restraint about energy installations we’ve seen in the past week is continued, and everything returns to normal. Once again, don’t speculate on the outcome of such a conflict. We’ve now had two examples of how unpredictable geopolitics and their impact on energy markets are in less than three years. Draw your lessons and finally acknowledge that anyone making decisions in energy markets based on predictions of what will happen in the world is simply gambling.

Just as in 2022, we are setting up regular hedging tables with companies coming to us to look for a solution for excessive exposure. Most of our clients, which is those who have heeded our advice, are not in that situation. And that’s not because we knew or speculated when we advised them to hedge at low points, such as the one seen just before Christmas, that a war would break out in the Middle East and that the Strait of Hormuz would be closed or Qatari LNG installations would be bombed. It is because of our risk management approach to buying energy, which, just as in 2022, has worked very effectively in protecting clients against the energy market crisis.

If I’m insufficiently hedged, what could I have done to avoid this?

Or to put it differently, what can I learn from this to avoid being caught out again when the next crisis occurs? Here are some observations of the behaviour of large companies in the period between 2022 and the current crisis, due to which they find themselves in the same trouble again:

• Lack of strategic interest. After 2022, I thought we would never be out of the picture again as energy risk managers. During the crisis, energy prices were on top of the minds of CEOs, CFOs and Boards. But in too many companies, the executives have failed to translate their experiences during the crisis into a more continuous and consistent strategic approach to energy buying. As prices dropped, so did the C-level attention. And all too often, so did the attention of the energy buyers. An important consequence of this is the lack of timely signature of supply contracts, due to which no hedges can be made. If you only mind energy prices when they are high, then you will always take the worst of each crisis. It is not at that moment that you can do the valuable work that protects your organization against the next crisis. These two volatility events have shown that energy prices can have a knock-out effect for many businesses. That should be enough to make it a matter of continuous strategic concern. A good strategy is not about what to do when the crisis hits, it’s about avoiding it from hitting you. And in the energy markets, such avoidance is perfectly possible, but it is between the moments of crisis that you must do the arduous work.
• “2022 was a black swan event”. One way of rationalizing not preparing oneself for the next crisis is to declare the previous one to have been so exceptional that its recurrence is impossible. A black swan event. Some clients even went as far as to ask us to remove the highest prices of 2022 from reports as they were so exceptional… A good strategy isn’t one that considers only one possible outcome; it’s one that tells you what to do in all possible situations.
• “We need to adapt our strategy to the new market situation”, as clients sometimes ask us to do. What they ask is: when prices have fallen, to revise their strategy to exclude hedging (“hedging is costing us money”), when they have risen, to revise their strategy to include hedging (“not-hedging is costing us money”). What often happens is: it takes them too long to realize that markets are high and decide on the new strategy, including hedging. Consequently, they only start doing hedges at the peaks. In the reverse situation, they ditch the hedging programme exactly when the most interesting prices to hedge at occur. This is by far the worst possible energy buying strategy, one that results in prices that are structurally too high. A good strategy prepares you for any market situation, and you don’t have to revise it every time the trend in the market changes.
• Underlying most of this: trending market thinking. Most people are trending–thinking in markets. There are several psychological and social factors at work in this: cognitive biases (extrapolation via representativeness and recency), reinforced by social herding and institutional incentives. It guides the (lack of) C-level interest, it inspires people to call anything that goes against the current trend exceptional, and it inspires companies to start hedging in the bull run and stop hedging in a bear market. A good strategy combines trending and non-trending thinking. Trending thinking to recognize the bull runs when protective hedges are to be made (for example: now), non-trending thinking to recognize the trend reversals from bearish into bullish when opportunities can be grasped (for example: last December).

For those among you who have bumped their head twice, now is the moment to change your energy risk management practices and avoid the next crisis. And if you’re not familiar with E&Cs approach to risk management and wonder by now what that magic strategy I talk about in this article is all about, here are its main principles (spoiler alert: nothing magic about it, just application of good old common sense):

If you want to learn more about this strategic approach to buying energy, please request our White Paper on this topic.

What can policymakers do to protect us against this and any future energy price crisis?

Just as in 2022, there’s a call for policymakers to intervene and take measures to protect consumers, including energy-intensive business against the soaring prices. E&C’s keeping track of initiatives in this sense in many countries; subscribe to a free three-month trial of our newsflashes to stay up to date. But of course, two energy price crises in a row, and the way in which the various parts of the world are affected by them, raise fundamental questions about energy policy.

It makes sense to look at this through the lens of the clear difference in energy policy between two superpowers: the United States and China. Under Donald Trump, the US has clearly chosen the path of a fossil-fuel-fired energy economy. With growing energy independence thanks to shale gas and oil, it can afford to do this. China has chosen the path of (renewable & nuclear) electrification and – as we discovered in this crisis – stockpiling fossil fuels for crisis moments such as the current one. Without any endorsement or rejection of the underlying politics, the Chinese option appears to be wise for regions that currently depend on natural gas and oil imports, such as Europe, other Asian countries or Latin America. We’ll keep you informed about what choices are made.