Russia-Ukraine War: 6 Ways for Energy Procurement Teams to Manage Costs
- Europe faces a major energy crisis amid the Ukraine conflict and Western sanctions on Russia
- Procurement teams for the E.U. can review current contracted positions and leverage backwardation to manage uncertainties
- Other strategies can include implementing energy-efficiency measures and a renewable energy plan
The Russian invasion of Ukraine has, expectedly, rattled the European energy sector.
In the last few years, the European Union has increased its consumption of Russian energy, with Germany, Italy, Austria, and the U.K. relying on imports to meet their energy demand.
The E.U.’s bet on a stable Russia has failed and Europe is now facing its second energy crisis in two years.
On February 24, the day Russia attacked Ukraine, E.U. natural gas futures rose by over 35% and are sitting at all-time highs -- up more than 600% YoY as on March 1.
Western sanctions on Russia have ratcheted up, but concerns over a full-scale energy crisis have caused world leaders to avoid direct sanctions against Russian fossil fuel export. Russia’s aggression, however, has caused outside investors to end ties. Germany has halted the Nord Stream 2 project, while BP and Shell are pulling out from their respective partnerships with Rosneft and Gazprom.
In the U.S, the New York Mercantile Exchange (NYMEX) gas futures have been quiet for an index that had become accustomed to daily double-digit swings. NYMEX futures have moved less than 5% since February 24, as the market appears much more insulated than its E.U. counterparts.
Global electricity prices, dependent on the cost of natural gas and coal, will see increased upside pressure as global coal costs have risen 35% since the invasion and 240% YoY.
Struggling with a natural gas supply crisis since 2021, European generators had turned to coal to mitigate the rising cost of natural gas-fired electricity. In January 2022, the E.U. imported 56% more coal than a year prior, and Russia accounted for 43% of the import. With such strong dependency on Russian coal and natural gas, E.U. electricity prices may see significant upward movement as the Ukraine crisis deepens.
The U.S. will likely see some fallout from rising commodity costs, especially if there are direct sanctions against Russia’s fossil fuel industry. The upward pressure, however, will be more muted in the U.S. natural gas and electricity markets as compared to the E.U., as the U.S. imports just 5% of its coal and no natural gas from Russia.
Given the uncertainties amid the war, here are 6 strategies for procurement teams to manage the growing energy crisis:
- Review current contracted positions across electricity and gas/oil spend. Identify any contracts due in the next 6-12 months as these are most exposed to near-term risk.
- When executing sourcing events, ensure the supplier base captures all possible third-party suppliers and suppliers are properly vetted for financial and supply stability.
- Leverage backwardation. Global energy markets remain in backwardation (current price of the commodity is greater than the expected price). Executing multi-year contracts can unlock lower rates than 12-month extensions.
- For companies on index contracts, reassess value-at-risk from floating indexes. Review cost-reward options for fixing rates during the highest risk months (winter for natural gas, summer for electricity).
- With energy prices at an all-time high in many regions, find efficiency levers to reduce consumption through LEDs, VFDs, HVAC, or other facility-related upgrades – the rate of return will be higher than in previous years.
- Develop a renewable energy plan. Corporate solar PPAs have proven effective in providing savings, budget certainty and energy independence for hundreds of corporations. As commodity costs rise, renewable energy agreements will become more financially and environmentally attractive.
Learn more about how GEP can help your organization manage the energy crisis and control costs.
Author: Carter Smith-Wellman