Surging energy costs following Russia’s invasion of Ukraine are pushing companies towards a cost of doing business crisis, with businesses of all sectors and sizes feeling the impact of soaring prices.
Companies are facing a nasty combination of spiraling inflation, especially energy costs, and weakening demand, as deteriorating economic conditions and rising interest rates prompt consumers to tighten their purse strings. The result is that many corporations around the world expect full-year profits to be below market expectations, as profit warnings in the UK reach their highest level since the 2008 financial crisis.
The economic implications underscore the urgent need for companies to start implementing energy-saving measures and reducing consumption now. This is important for curbing the effects of price hikes and to prepare for shortages over the winter if governments impose rationing. Longer term, a structural shift from fossil fuels to renewable energy will be needed.
Energy efficiency and digitalization
In the immediate term, one of the most powerful tools for lowering costs and tackling climate change is energy efficiency. There are a range of simple measures and behavioral changes that can lead to big savings and help companies reduce their carbon footprint. Preventing heating loss by topping up insulation, as well as switching off lighting and equipment when not in use, can save a business a surprising amount of money on energy bills.
Some companies are turning to digital solutions to help them assess their energy use and find opportunities to maximize savings in their facilities. The German chemicals company Henkel has installed sensors on its machines on its factory floors. These measures resource consumption in real time, enabling teams to find opportunities for energy savings.
Manufacturing companies may also consider an audit of their mechanical infrastructure and, if necessary, replacing machines – which can deliver quick energy savings and, over time, a return on investment.
Onsite power generation
To reduce energy costs and de-risk from volatile prices, are shifting to cheaper and more sustainable alternatives to fossil fuels. These include wind turbines, solar panels, and electric heat pumps, which can help companies reduce their dependence on the power grid.
The idea is to not just reduce electricity costs, but also make energy supply more resilient to climate risks. Extreme weather events have exposed weaknesses in power grids. In the US, Hurricane Ian led to widespread blackouts across Florida in September.
To keep the lights on during outages, businesses can use on-site power generation to charge up batteries that can store surplus energy for later use. The upfront cost of installation can be lessened in many countries by tax credits for investments in renewable energy, which are designed to help tackle climate change and fund the shift to clean energy.
Production cuts, offshore production
Despite a number of readily available opportunities to find energy savings, some companies may be forced by spiraling prices and weakening consumer demand to temporarily scale back production, or avoid production at times when energy prices are at their peak. The problem is that production shutdowns may cause companies in locations such as Europe, where energy prices are so high, to cede ground to opponents abroad in countries with lower energy costs.
Some firms may, therefore, consider moving some parts of the production process overseas to locations with inexpensive and more dependable energy. A number of German industrial companies, including textiles manufacturer Wuelfing and automotive parts supplier Boegra, have set out plans to move production to Portugal, Pakistan, and the Czech Republic as they face energy bills of up to 10 times more than two years ago because of Russia’s assault on Ukraine.
And one in five German engineering firms saw the risk of relocating at least some of their business overseas, a survey by German union IG Metall showed in September.
Stockpiling components, preserving margins
A drop in production would have implications further down the value chain. Companies that rely on basic materials such as chemicals and steel would find it more difficult to convert these inputs into products. The stockpiling of parts and materials is therefore advised to cope with potential shortages of components.
That is likely to increase the prices of these inputs, however. So, companies will need to consider passing on the charges to their customers by raising prices. But this could lead to lower market share thanks to weakening demand from customers who themselves are struggling with higher inflation. Therefore, businesses may need to absorb the price increase themselves, which would reduce their profit margin — unless they can find ways to save energy costs in the value chain.
Switch from fossil fuel to clean energy
Many companies see an opportunity to accelerate the green energy transition, and the plans that were put in place before the war in Ukraine. The challenge for businesses is how to balance the need for decarbonization with the need to meet energy demand today. Faced with energy shortages, some industrial companies are turning to coal and other dirty fuels to get them through the winter, potentially setting back the green transition.
Yet this is expected to be a temporary trend. One major reason is that as prices for fossil fuels continues to rise, renewables are becoming more cost competitive.
In addition, the drive for energy security is pushing many countries to embrace cleaner sources of power like wind, solar, nuclear and hydrogen. For example, the US’s Inflation Reduction Act has earmarked more than $370 billion for spending on such technologies. But the lengthy lead times for developing new green infrastructure mean renewables cannot replace fossil fuels in the short term.
However, a sustainable business transformation is about ensuring companies are ready for the future. Longer term, regulation is tightening; pushing the most polluting companies to address their carbon emissions as the planet heats up. Businesses are therefore advised to get ahead of the curve and shift to clean energy. In that sense, sustainability can be viewed through the lens of value creation, rather than just managing risks.