Energy Inflation: How to Manage Increased Costs

For a decade, energy costs have been decreasing and consistently low. But due to lingering effects of the COVID-19 pandemic, subsequent global supply chain issues and ongoing geopolitical issues, prices for wholesale natural gas and electric, crude oil, gasoline and even renewable energy have reached multi-year highs. These increases bring additional energy procurement challenges for every organization — impacting their budgets, operating costs, margins, and supply contracts.

While prices are likely to drop back down eventually, there are adjustments to both strategy and expectations that can be made now in order to address the immediate and long-term energy needs of your organization.

Causes and Impact of Energy Increases

Energy inflation pressures are being felt across the board, driven by different issues for different energy sources, including:

• For natural gas, storage deficits are the primary driver for U.S. and European price hikes — with U.S. storage about 12% below the 5-year average and European storage about 65% full. Despite the increased prices, producers are not increasing output due to increased dividends, strict drilling budgets, material and labor shortages, and pipeline capacity constraints.
• For crude oil, the post-pandemic demand recovered more quickly than the supply output. Both OPEC and U.S. producers are increasing output, but still not enough to meet demand. Refinery capacity is stretched thin, especially with countries shifting away from Russian imports and Russia itself reducing its supply.
• For electricity, power generation costs are driven by soaring fuel costs. Grid reliability concerns — especially given the predictions for a hot U.S. summer and the ongoing drought in much of the western U.S. limiting hydropower potential — means potential power shortfalls, being unable to meet demand.

These energy-specific issues are in addition to overall global inflationary pressures around material costs, labor costs, and shareholder expectations. With so many factors in play, it is difficult to determine when prices will begin to go down. Until then, there are steps organizations can take to address the current need and better position themselves for the future.

Reducing Energy Costs, Reducing Risk

The first step in addressing increased energy costs is to address energy use. Take the time to implement technological and behavioral changes that reduce energy consumption and increase efficiency, which will not only reduce your near-term costs but will set you up for future success as well. This often means looking at how your facilities are currently running, how efficiently equipment is operating, and if there are any obvious ways energy is being wasted. Budgets may not allow for bigger projects — replacing or upgrading equipment, implementing drastically different procedures — but incremental changes will make a difference, including training employees about behavioral changes they can make in their day-to-day efforts.

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When it comes to energy procurement generally, previous strategies have assumed year-over-year savings without having to worry about making adjustments throughout the year. But even once current prices return to historic lows, maintaining that same strategy will bring the same risks when market volatility returns. Short-term, if you’re currently fully invested in one specific energy source, you may not be able to switch completely to a less expensive option, but you can make shifts to diversify — even incrementally. This also sets you up for success in the long term, as having that balance of energy sources allows you to be more agile and react to future fluctuations in the market. If budgets allow, you can also begin making those long-term investments into renewables — establishing the framework you need to handle future volatility.

The Benefits of Implementing Changes

There are obstacles to addressing energy inflation, of course. There is always a risk to implementing changes — whether those be changes to procurement strategy, facility operations, or employee behavior. And there can be multiple stakeholders required in order to implement any changes, big or small.

But if organizations want to be able to weather the current energy cost volatility and also set themselves up for success in the future, it’s essential to take action now. A comprehensive review of your energy procurement strategy will help address short-term and long-term opportunities for your organization.