ZPP Newsletter
Warsaw, 8 September 2022
Position of the Union of Entrepreneurs and Employers (ZPP) on the protection of Polish industry against the increases in electricity and gas costs
The prices of electricity, gas, coal, CO2 allowances and biomass in Europe have reached record levels. The coronavirus pandemic, disrupted supply chains and, eventually, Russia’s invasion of Ukraine and embargo on Russian raw materials have contributed to the development of a gas and energy crisis. It is fuelling inflation, resulting in rising prices of products and services. This means that the economic balance of many companies has reached an alarming level. We are witnessing more and more cases of production being reduced or stopped. The Union of Entrepreneurs and Employers requests that immediate steps be taken to assess the scale of the phenomenon and that measures be implemented to offset the effects of a potential recession.
The decisions of manufacturers, including those operating in energy-intensive industries, are fundamental to the stability of the supply of numerous products. In Europe, producers of ammonia and urea have suspended or significantly reduced production, driven solely by sharp increases in the prices of energy carriers. Apart from the information on the reduction of melamine production, the official announcements of Grupa Azoty state that “Grupa Azoty Puławy constantly monitors the level of raw material prices and will adapt its production to the market situation. At the moment, the company is not in a position to precisely estimate possible negative financial effects of reduced production“. In turn, Anwil informs that “After the relaunch of the production, the price of fertilisers will reflect the current price of natural gas and market conditions“.
In 2021 in Poland, the industry was responsible for 63% of gas consumption (data from the Ministry of the Economy and Environment; total gas consumption volume in 2021 was 20.5 billion m³) and about 30% of electricity consumption, i.e. nearly 50 TWh. The values would be even higher after including “large” employers (not necessarily manufacturing companies) whose utility costs occupy a high position in the cost structure. The extreme volatility of prices on the wholesale markets puts both gas and electricity companies, as well as numerous entities attempting to pass on costs to consumers, in a difficult position. On the one hand, producers need gas to conduct chemical and technological processes, while on the other, they are struggling with high energy and CO2 prices. More and more industries are exposed to a lack of profitability, as a result of which they reduce or, in extreme cases, cease production. This applies not only to the chemical industry but also to the pharmaceutical, mineral (cement, ceramics), food, cellulose and metal industries. Restrictions on the production of raw CO2 adversely affect pharmaceutical manufacturers and the food industry, which, without access to CO2, dry ice and nitric acid, among other things, may be forced to limit or stop the production. Mines and metalworks face major problems as well. High prices of energy carriers further translate into high costs of refinery products. Due to rising inflation and decreasing demand, it is difficult to consider passing on rising operating costs to the end consumer, who will simply become incapable of affording products beyond basic needs. Sub-suppliers, including from the automotive and furniture industries, will also suffer from the economic slowdown as a result of a decline in the number of orders from Poland and abroad (e.g. Germany). Transport paralysis may take place in connection with rising prices and/or shortages of AdBlue fluid. The basic ingredient used in the production of AdBlue liquid is ammonia, which is manufactured on an industrial scale by chemical plants. In Poland, this means Grupa Azoty. Meanwhile, the limitation of metal production may disrupt supply chains in the construction and energy sectors – an issue that should cause concern, particularly in view of the challenges associated with the necessary investments in Poland’s transmission networks. Energy prices negatively affect public transport, including railways, which currently require funds for development and investment projects while transforming public transport towards a more economical and environmentally friendly direction.
Unless urgent action is undertaken to offset the effects of the drastic increase in the cost basis of manufacturing companies, development in most of the pillar industries of the national economy will be hampered. Although all solutions based on state interventionism call for careful consideration due to their economic and social impact, in this case, it may be extremely difficult for companies to maintain business continuity without state support. On many occasions, this will affect industries whose undisturbed functioning is fundamental to our health and access to products and services regarded as essential (e.g. the chemical sector, which supplies products necessary in health care and food production).
The situation calls for an immediate response and the selection, in addition to systemic solutions spread over time, of appropriate ad hoc measures that can be implemented without disturbing the existing legal order and the rules applicable in the gas and energy market. It is, therefore, necessary to develop solutions within the framework of existing and proven mechanisms to minimise the legislative and organisational effort. After all, companies need support now, not in a few months or quarters. If the mechanisms applied to date will not stabilise energy prices, it may be necessary to consider introducing new ones.
The lack of industry support may result in a wave of bankruptcies
An aspect that comes to the fore in terms of necessary initiatives to be taken is an attempt to relieve the burden placed on energy and gas consumers, for whom the current record high prices prevailing on the wholesale market are associated with an inability to cover present and future liabilities. These companies are at risk of losing liquidity, which can very quickly lead to a deterioration in their financial situation.
Metal producers can serve as an example. On the one hand, the share of energy costs in the overall costs of their operations has significantly increased, while on the other, metal prices are currently decreasing after a period of growth. In this situation, the possibility of generating profit from their business activities is limited by the general market price trend, which means that passing on higher operating costs to end users will not be possible in such cases. The consequences of such a state of affairs can already be seen in many European countries, where zinc works, alumina plants or facilities dealing with aluminium hydrolysis are being shut down. This example includes a number of industries and puts a strain on all subcontracting and supply chains.
The level of energy prices needs to be anaysed
An issue that requires deeper analysis is the scale of the increase in electricity prices in the wholesale and power markets in recent months.
The process of concluding contracts for the sale of electricity to be executed in year “n” usually takes place during year “n-1”. The contracting strategy is developed and implemented based on the projected price of fuel and CO2 emission allowances for year “n”. The gas market works very similarly in this respect, and this year’s record increase in the price of fuel gas has put gas companies in a difficult position.
Based on the observations of the current situation in the energy and gas markets, the only possible way to achieve the expected margin is, on the one hand, to calculate it at a “safe level” for future contracts (traded today), and on the other, to sell energy on the SPOT market (characterised by high daily dynamics). The latter applies only to the spare capacity of a given generator, not involved in the execution of “n-1” contracts for the sale of energy or gas. Such a situation causes the power and gas generators to calculate many of the risks they currently observe on the wholesale market in their futures contract valuations for subsequent periods. Charging end users for risks that may have been overestimated forces companies to reduce their energy and gas consumption – not through investment and efficiency-related actions, but by limiting their activities (e.g. limiting production or reducing the network of connections in the case of railways).
This issue certainly needs to be examined more extensively. Recently, it has been addressed by the European Commission, while the topic of the next meeting of the Transport, Telecommunications and Energy Council (TTE), scheduled to take place on 9 September, will be high gas and electricity prices and their potential short-term solutions.
Therefore, it appears that given the current market situation, it is necessary to mitigate the negative effects of this phenomenon by either their partial reduction or ensuring that consumers receive compensation, which will allow them to maintain their profitability, for example, by supporting measures undertaken at the EU level aimed at changing the organisation of the wholesale electricity market to reduce electricity costs incurred by end consumers. This includes a review of the marginal (merit-order) pricing scheme. In addition, it is worth considering the idea of “market splitting” in order to separate the price of electricity generated from RES and fossil fuel-based units.
A solution to the current price impasse should be analysed taking into account two perspectives – short and medium-term (discussed in the following part).
There is an urgent need for a direct line of government support for companies launched on an ad hoc basis. Additional support could be financed from the budget of the compensation scheme and be included in the existing model, as defined in the Act on compensation for energy-intensive sectors and subsectors.
A fund for the payment of compensation representing the price difference between the rate charged to the entrepreneur for the electricity consumed and the benchmark indicated in the legislation but referring to, for instance, 90% of the existing energy/gas demand, might be the solution. The market benchmark could be directly used by trading companies in their settlements with customers and the payment of compensation could take place between Zarządca Rozliczeń S.A. and the trading company. This scheme appears to be efficient and faster from the perspective of the trader (who would receive reduced settlements immediately and would not have to wait for the payment of compensation, which, due to the scale of the problem, could take a long time and could undermine the financial liquidity of companies). On the other hand, the entire burden of handling such a solution would then be taken over by trading companies and at this point, it seems reasonable, assuming that the solution is adopted, to establish the level of costs of preparation and operation of the whole process on the part of the trading companies implementing it.
The verification of entities entitled to compensation should be possible to carry out in a short period of time. At the same time, it is necessary to emphasise the need for a tool that will motivate entrepreneurs to increase energy efficiency.
The catalogue of companies that could be entitled to compensation should be extended beyond the group of energy-intensive enterprises, which are naturally identified first as beneficiaries of such a support scheme. The necessity to broaden the potential compensation scheme to more economic sectors stems from the fact that in some industries, the share of electricity and/or gas costs is comparable to that of energy-intensive industries. Today, it is essential to maintain the continuity of production in all industries that have actually suffered from the drastic increase in the price of energy raw materials. An initial catalogue, taking into account final costing, has been published by the European Commission in Annex 1 to the Guidelines on State Aid for Climate, Environmental Protection and Energy 2022. However, it would be necessary to verify by means of consultation with companies whether this catalogue exhausts the list of industries eligible for state aid. For instance, the only reason why the cement industry does not comply with the process of qualifying for subsidies for energy-intensive industries is the intensity of trade, which is peculiar to this particular industry and, at the same time, remains an indifferent criterion in the process of assessing the extent of the financial burden on cement producers associated with the increase in the price of energy raw materials. Another example includes railways, which, as an environmentally friendly mode of transport, without subsidies will be forced to reduce the number of operated routes. This will translate into an increase in the demand for hydrocarbons used in car transport.
Projects aiming to remove the exchange obligation need to be re-examined
Simultaneously, it should be emphasised that ideas assuming the abolition of the exchange obligation appear to be too far-reaching an interference in the market and the legal status. The only exception to this rule is the possibility of limiting or suspending the gas obligation provided for in the recent amendment to the Act – Energy Law and understood as a temporary, interventionist response to a supply crisis.
It is essential to make every effort to support well-established market solutions, especially under conditions of inhibited competition among trading companies (significant price dynamics, lower liquidity of contracts, lower volumes traded). The price crisis is not caused by wholesale energy or gas trading – it results from external geopolitical factors. And even in a time of crisis, the existing market mechanisms guarantee transparency in trade and its clear rules.
The only issue relating to the functioning of the wholesale market, which in the opinion of ZPP requires immediate adjustment to the current price dynamics, is further support for market participants in securing guarantees for deposits placed on the exchange.
With regard to participants of Towarowa Giełda Energii (TGE, Polish Power Exchange) – purchasers of electricity in futures contracts who provide security to Izba Rozliczeniowa Giełd Towarowych S.A.
(IRGiT, Clearing House), it is worth considering the following postulates:
– expansion of the group of entities capable of providing security in the form of submission to enforcement so that it can be done by entities that do not have a rating, but own assets and concluded sales contracts (a purchase position on the TGE is not a speculative position),
– the abandonment of the need to provide security in cash (currently, at least 10% of deposits must be provided in cash), while given the current wholesale prices, some trading companies do not have sufficient funds for security,
– the application of an extraordinary ratio reducing the variation margin on the TGE (in the event of a decrease in prices on the TGE, the variation margin required from the purchaser would not be calculated directly from the difference between the purchase price and the market price, but rather multiplied by a reducing ratio of 0.5).
To sum up, there is a need for solutions related to the management of deposits on the TGE to ensure that there is no need for the intervention closure of positions among entities which, due to hyperbolic price increases, do not have the capital to cover their liabilities. What is needed is an intervention mechanism for securing the guarantees required by trading companies to manage their purchasing portfolio, so that they are not pushed out of the market. Today, it is particularly important to maintain liquidity in the wholesale market and support smaller players who may be at risk of being “forced out” of the market due to high unpredictability and price volatility. At the same time, it should be noted that it is necessary to balance the interests of both trading companies and the TGE (and IRGiT), which must have the means to settle transactions.
Recognising the difficult situation of some sellers, the legislator has recently introduced solutions, such as those included in the Act of 26 January 2022 on special solutions for the protection of consumers of gaseous fuels in connection with the situation on the gas market or the Act on compensation for energy-intensive sectors and subsectors, specifying the procedure for granting public aid for transferring the costs of purchasing emission allowances into the price of electricity consumed in the production of products. Support for district heating companies is also guaranteed by Bank Gospodarstwa Krajowego (BGK), which provides liquidity and investment guarantees through ten banks. The guarantee takes the form of security of the repayment of a loan intended for the day-to-day financing of business activities or the financing of investment expenditure from the Crisis Guarantee Fund to improve the liquidity of the borrower. A similar solution could temporarily include trading participants in the wholesale energy and gas market.
Dynamic development of RES is a burning issue
In the medium term, dynamic development of RES generation sources is necessary to stabilise the prices in Poland and Europe. On the national level, it is necessary to remove all legislative barriers and to make it easier for individual investors to implement projects appropriately scaled to the demand of a given consumer. Among the demands that have been made repeatedly is first and foremost the liberalisation of the 10H rule and the introduction of solutions such as “cable pooling”, direct lines and the possibility to upgrade older wind farms under the so-called repowering into law. These are solutions that are feasible without putting additional strain on the electricity grid, and therefore do not require the time necessary to adapt the grid infrastructure. Generally, the ideal scenario would be if the individual investor, when calculating the profitability of RES investments, could take the wider economic and social context into account and, as far as possible, also supply energy to regional, smaller consumers. However, as this involves the development of the entire distribution infrastructure and cannot be realised in the short term, it would be necessary to look at the issue in two stages.
And although Poland’s installed RES capacity is already around 20 GW (1/3 of the total installed capacity), legislative and infrastructural (network) barriers still limit the dynamic growth of generation sources. In many European countries, in addition to provisional solutions to support local producers and the economy in the face of the gas and energy crisis, efforts to increase CO2-free sources are now clearly intensifying. In Germany, the development of RES has become an “overriding public interest”, with the aim of providing 80% of electricity from these sources by 2030. France has allowed RES generators to sell energy directly on the market (at current prices), bypassing the conditions obtained in earlier auctions. Belgium, Denmark, Germany and the Netherlands have stepped up investment in offshore wind energy. Because of its “existing” energy mix, Poland should be at the forefront of similar initiatives, while coal-fired power generation should be modernised to provide a stable base for rapidly growing distributed sources of green energy. Only such a scenario will guarantee a sustainable reduction in energy costs.
Consumption restrictions preceded by consultation with business.
Another absolutely key topic is to ensure business continuity in the face of possible restrictions on energy and gas consumption or limits on coal availability. Maintaining fluidity of the supply of products and services is essential for the uninterrupted functioning of the state. Regardless of the likelihood of black-outs, which may be avoided this winter. The possible introduction of restrictions on electricity and/or gas consumption, based solely on the applicable regulations (and based on the data om consumption for the preceding year – i.e. 2021) may lead to chaos and great financial losses. In that context, entrepreneurs are asking to extend the timeframe for the reduction of the power or natural gas consumption, so that the reduction of energy and gas consumption in enterprises could be carried out more smoothly. Moreover, today, there is no clear mode for companies to appeal against the restrictions related to the consumption of energy imposed on them.
The issue of Poland’s food security should be considered particularly important. The current regulations on the availability of electricity and gas in situations of higher power levels do not correspond to the actual demand of food industry plants for the minimum power necessary to maintain continuity of production, due to incorrect algorithms that do not take into account seasonality in power consumption. It is necessary to introduce new ways of calculating minimum capacity to guarantee the continuity of food production in a possible crisis situation. Failure to secure access to energy carriers and coal in the food production and processing chain will have disastrous consequences for the entire society, both in terms of reduced access to food and environmental security (e.g. on-site sewage treatment plants may come to a standstill), irreversible loss of agricultural raw materials and finished products or animal welfare.
Securing coal for industry and agriculture is also important. For that purpose, approximately 1 million tonnes of coal per year is required, and the lack of continuity in coal supplies to some enterprises may have particularly negative effects not only for those companies but also for their supply chains and the entire economy. Gas, the continuity of supply of which is critical for the safety of installations and the manufacturing process, also plays a significant role in the technological processes of many industries. This problem is highlighted by the European Commission. The ”Save Gas for a Safe Winter ” plan, adopted on 20 July 2022, sets out the tools that Europe already has at its disposal for coordinated demand reduction and what still needs to be done for the EU to be ready for disruptions in gas supply. And although the situation of individual Member States is different, and Poland seems to be largely protected here, considering the upcoming heating season, we should still have realistic scenarios of action in the event of disturbances in the functioning of the system.
In that context, it is also worth paying attention to the proportionality of the taken measures related to the introduction of power supply levels and restrictions on the operation of the network – in relation to the efforts that would have to be made to implement the restriction plan. For example, some domestic consumers, including representatives of energy-intensive industries, use nitrogen‑rich gas. Possible denitrification of gas to channel it into the standard distribution network would be a huge technical undertaking, significantly exceeding the capacity of the few denitrification facilities. The benefits of the introduction of such a measure would be rather negligible, with significant complications for customers whose installations are adapted to the parameters of nitrogen‑rich gas.
We are asking the state administration and operators to engage in dialogue with large energy and gas consumers – to make the restrictions imposed on energy and gas consumption real. The purpose of such arrangements would be to match the emergency power plans in companies and the state’s needs related to the temporary reduction in energy and/or gas consumption. On the one hand, possible restrictions on consumption should not affect the safety of people and facilities in companies, which should be understood as a direct or indirect threat to the company’s personnel and infrastructure (e.g. interruption of production due to the shortage of supply of products and services related to the maintenance of safety of people and property). On the other hand, the efficiency of enterprises in the planned reduction of gas and energy consumption, following the optimisation of their processes and infrastructure, should be rewarded.
Voluntary reductions in energy and gas consumption and resignations
It also seems rational to introduce a state mechanism for rewarding entities who are willing to declare a voluntary reduction in energy and gas consumption, or are willing to resign from the consumption due to the suspension of the use of one or both utilities. A solution similar to the DSR mechanism in place in the power market could relieve the burden on the system in a smoother way and according to the actual needs of consumers. Especially in periods when an urgent response is necessary – the search for pragmatic solutions turns out to be the most effective. If companies were entitled to a certain bonus for the voluntary reduction in their energy/gas consumption or resignation – they would be able to calculate the cost-effectiveness of such an action and declare possibilities of periodic reduction in consumption. Often, those would be levels above the thresholds defined within the power supply levels, and if not mandatory, they would be much easier to implement immediately by the companies. In turn, the obtained bonuses could be used by the companies to maintain their level of employment during the production standstill, which would certainly be appreciated by both employers and employees.
The minimum target – maintaining the status quo in relations with the EU
The national perspective of organising ad hoc (short-term) state aid and a medium-term plan to support entrepreneurs in the development of their own renewable energy sources must not overshadow the priorities in negotiations with the European Union administration. Today, Poland should strive to maintain the existing set of free allowances as long as possible, or even temporarily suspend the performance of obligations arising from the EU ETS. Pursuant to Art. 1 of the ETS Directive, the EU Emissions Trading Scheme was to support the reduction of greenhouse gas emissions in a cost-effective and economically efficient manner. Without the reform in the EU ETS market, which has been implemented by the Brussels administration for many months, the CO2 emission allowance market is prone to speculation and constitutes an additional burden for the economies of the Member States, thus failing to meet its initial assumptions. Until emissions trading becomes again a motivating mechanism for the energy transformation, leaving producers the funds necessary to invest in that transformation at the same time, the system will only be prolonging the deadlock in which entrepreneurs have found themselves.
Exporting companies also point out that while the EU’s fight against the ”escape” of CO2 emissions outside the Community is important, the issue of indirect emissions remains controversial. The inclusion of indirect emissions in the scope of CBAM entails the risk of destabilising the market for the EU producers. Taking into account today’s market conditions, the introduction of the planned CBAM tax may turn out to be a dangerous experiment, as possible retaliatory measures introduced by non-EU economies could place an additional burden on European producers. Therefore, further analysis of the potential impact of CBAM on the European and global markets is crucial, to be able to exclude the risk of potential abuse (e.g. redirection of more carbon-intensive products in their manufacturing process to other markets). It seems a more sensible idea today, to look for solutions to grant export rebates to the EU producers, which would allow them to remain competitive compared to the manufacturers less affected by the burden of emissions and energy charges.
Postulates
- At the time of the gas and energy crisis in Europe, dialogue and cooperation between the administration and business should be intensified
- Without ad hoc state aid, redundancy, limitation of activity and even termination of operation of enterprises due to the hyperbolic increase in prices of energy, gas and other costs are possible in some sectors
- It is necessary to analyse the possibility of changing the method of calculating the minimum capacity set out in the regulations governing the implementation of restrictions on electricity supply and natural gas consumption, to ensure the continuation of the types of production that are of key importance for society and the functioning of the state (e.g. food).
- The solutions proposed by the government administration should be applicable in the short term
- In parallel to the short-term solutions, today, all efforts should be focused on managing the situation on the gas market, developing renewable energy sources and effectively defending Polish postulates within the EU.
- Despite the specific market situation, the introduced support mechanisms must not restrict free competition and liquidity in the energy and gas trading market or burden its participants unequally.
