Pre-empting the energy shockwave

The inevitable long-term rise of energy prices poses a serious risk to corporate profitability. A Deloitte study, released at the World Economic Forum in Davos in 2009, showed that even modest 3.5 per cent year-over-year increases in energy and resource input costs could wipe out the profitability of a vast number of North American firms.

To put 3.5 per cent increases into perspective: The price of oil was $10 a barrel in 1999 and ran up to $147 in 2008 – that represented a 40% annual compounded increase.

Jeff Rubin, the former chief economist of CIBC World Markets, predicts oil will hit $225 a barrel in 2012. Heightened tensions with Iran, the fourth largest oil producing country worldwide, could be the catalyst for the run up in oil prices.

A risk for Canadian manufacturers is that the Canadian dollar has become a petro dollar. When the price of oil rose to $147 a barrel, the Canadian dollar hit its highest point in decades against the U.S. dollar. And that in turn hit Canadian exporters hard.

How can exporters mitigate the risk of a high Canadian dollar? One way is by becoming more energy efficient, lowering the cost of production. Another, of course, is through hedging against a rising Canadian dollar through currency swaps.

Energy efficiency is a powerful profit driver and risk mitigation strategy. Walmart is spending $500 million a year on fuel and energy efficiency projects with paybacks of four years or less. During the recession, the company’s sustainability spending didn’t decrease by once cent. Why? Because it’s about increasing profit and mitigating risk.

Walmart’s sustainability focus, which began in 2005, is now driving more than $500 million to the bottom line every year. Given that the company works on three per cent net profits, it would require $16.5 billion of top line sales to achieve the same profitability. So Walmart has become a fiscal convert to going green.

Sears Canada just completed a $4.5 million LED lighting retrofit. The project has a 13-month payback. Where, in a down market, can you get a one year payback?

Electricity prices in Ontario will be rising significantly in the near term: Simply applying the HST to electricity will drive up the price.

In North American, a staggering 23 per cent of electricity is used simply for lighting, and this consumption can be reduced by more than 85 per cent using LEDs. Lighting retrofits for companies typically have a pay back of one year.

Remember the Y2K crisis? Companies worked feverishly to re-write old mainframe software that ran their operations. But there were a limited number of COBOL programmers with the depth of knowledge required to solve the problem. Their average hourly rates spiked as demand for their specialized services rose as the year 2000 approached.

There will be a similar stampede through a very narrow opening when the price of oil spikes. Companies beginning to focus on energy and fuel efficiency once oil hits $225 a barrel will have to pay significant premiums for bona fide energy efficiency experts – or they will hire Johnny-come-lately contractors who don’t have the necessary depth of knowledge or experience to achieve the promised savings. Either way, those who are late to the game will pay for it.

Every Chief Risk Officer and CFO who is not aggressively pursuing energy and fuel efficiency is not fulfilling their mandate of increasing profit and mitigating risk.

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