Three Questions Bankers Should Ask Companies Doing Business in Germany Now

What are German companies doing to prepare for a possible energy shock after last year’s surprisingly mild winter? Are they positioned for the long term?

After Russia cut off Europe’s gas supply last August and Germany halted Russian oil imports at the start of this year, there were fears of a bleak winter in Germany. But unexpectedly mild weather and the diversification of energy sources helped keep prices lower than anticipated and staved off a national energy crisis. It is likely that winter 2023-24 temperatures will return to normal, however, and the German companies that were lulled into a false sense of security may find themselves unprepared for energy shortages and price hikes, even as their very survival is under threat.

Complicating matters for business leaders are mixed economic signals coming out of Germany. While government ministers have pronounced the energy problem solved,¹ some prominent members of the business community disagree.² Meanwhile, corporate insolvencies in Germany saw an increase of more than 15 percent in the first half of 2023, with high energy and material costs cited as the primary reasons.³ Inflation, too, continues to be an issue.⁴

This murky economic outlook is creating a complex situation for bankers, who now must take a more nuanced approach to calculating lending risk on behalf of their clients. While last year it was sufficient to ask company managers about how they planned to deal with an anticipated winter energy crisis, it’s not so simple looking ahead. Bankers must look more closely at balance sheets to identify how companies are planning to deal with a potential energy shortage not only this year, but well into the future.

Here are the three questions bankers should be asking their clients to determine if they’re prepared for the long term:

Can You Segment Your Energy Usage?

While all companies should ideally have a long- or medium-term energy dependence strategy, such an exercise is often impractical for all but the largest firms. More realistically, companies should determine what portion of their future energy usage will be for production and what portion will be used for the heating and cooling of plants or machinery.

Determining future process-related energy usage is critical for planning purposes because, unlike the energy used to heat or cool a facility, there’s little room for ongoing adjustments when it comes to powering a piece of heavy machinery. In contrast, energy usage for heating and cooling purposes can be adjusted simply by moving a thermostat a few degrees in either direction.

Similarly, German companies should be familiar with the energy segmentation of their vendors and equipment providers, especially in energy-intensive industries (such as manufacturing) that are dependent on complex supply chains. It’s also a good practice for companies to know about the energy usage and needs of the firms that supply to their suppliers.

How Are Your Financial Fundamentals and Outlook?

Established companies typically have few day-to-day cash management issues. That said, repeat year-over-year losses may often be a sign of bad things to come. Are there cost structure issues? Are unpredictable energy costs eating into profits? Or is something else causing erosion?

If the issue is related to runaway energy costs, companies should consider renegotiating prices with customers — even when there are fixed, long-term contracts in place. For example, a mechanical engineering firm that typically charges €100,000 for a machine may incur an additional €4,000 in costs when energy prices soar. In these situations, many German firms are hesitant to approach their customers about adjusting the machine’s final price tag to cover the additional energy costs. Bankers should be asking why not. And while it’s unlikely a customer would be willing to make up the entire difference for the higher costs, a 50 percent outcome isn’t unreasonable.

What Are the Financial Effects and How Are Countermeasures Taken?

Unpredictable energy prices mean many organisations with operations based in Germany are considering retooling their production processes to optimise efficiency and trim costs. One way to realise these gains is by swapping out older machines for new, more efficient models that meet higher energy standards. Another common change is outsourcing a specific aspect of the production process. In both approaches, quality and cost controls, as well as the time needed for overhauls, are the primary concerns: Will the new machine or vendor produce the same high-quality components as the older model on time and on budget?

Ongoing decarbonisation efforts are another reason why Germany-based companies may be considering changes to their production processes. In 2019, the German government enacted an ambitious new environmental law that mandates the reduction of greenhouse gas emissions by 65 percent from 1990 levels by 2030, and an 88 percent reduction ten years later. The law specifies net greenhouse gas neutrality by 2045 and negative greenhouse gas emissions by 2050.⁵ All Germany-based companies are required to meet these targets.

Thus, bankers should ask companies what they’re doing to prepare for the deadlines and if they have ESG measures in place for direct energy usage (Scope 1), indirect energy usage (Scope 2), and upstream and downstream value chain energy usage (Scope 3).⁶ One way companies are already meeting their carbon reduction targets is by purchasing offsets through the European Union’s Emissions Trading System, a market-based “cap and trade” approach.⁷

The topic of energy efficiency/CO2 footprints is not new for German mechanical and plant engineering companies. The “Blue Competence” initiative of the industry association VDMA has been around for years.⁸ The aim is to help customer industries, especially energy-intensive sectors, make their own production more energy efficient and cost-effective. For machine builders who take this into account, an energy crisis can also mean an opportunity.

Footnotes:

1: “Germany’s energy crisis is ‘more or less solved’ and its economy is safe, Bundesbank’s Nagel says.” CNBC. April 13, 2023.

2: “German energy prices are so high they’re driving companies to relocate, industry body says.” CNBC. June 21, 2023.

3: “Energy crisis and inflation push more German firms into insolvency, study says.” Reuters. June 29, 2023.

4: “German inflation surges more than expected to 6.8%.” Financial Times. June 29, 2023.

5: “Germany’s Climate Action law.” Clean Energy Wire. June 19, 2023.

6: “Guidelines on Reporting Climate-related Information.” European Commission.

7: “Understanding the European Union’s Emissions Trading Systems (EU ETS).” Clean Energy Wire. Jan. 26, 2023.

8: “Blue Competence.” VDMA.