Britain’s medicines sector is facing unprecedented challenges as soaring energy costs and inflation threaten the supply of drugs.

In the coming months, the U.K. is likely to see gaps in supplies as raw materials, manufacturing and freight costs spiral, exacerbated by a weaker pound.

Locked into rigid drug pricing systems, some manufacturers are considering exiting the market — hitting the National Health Service with further costs as it too struggles with a tighter budget and growing demand for its services.

Generic drugmakers have seen their profit margins squeezed over the past year as these economic factors have eaten into their bottom line. Many companies are bound by long-term payment deals with the government, while others are tied into years-long contracts with hospitals.

Those that are not tied into contracts, however, are passing on these added costs to the NHS by increasing prices for their drugs. Other companies, meanwhile, have opted not to launch new products in the U.K.

“In the last 30 years of my working career, I can't remember a sector under this level of pressure,” said Mark Samuels, chief executive officer of the British Generic Medicines Association (BGMA).

The cost of raw materials for the sector has tripled over the past year, shipping rates have increased six-fold and air freight costs have more than tripled. Even before the most recent increase in energy prices, the sector had seen a 230 percent increase in energy costs, Samuels told POLITICO in an interview.

Meanwhile, with the U.K. having some of the cheapest generic medicines in Europe, it’s little surprise they account for four in five drugs used in the health service.

From profit to loss

The nail in the coffin for some companies will be the rebate tax rate the Liz Truss government sets for next year.

Branded generics that are tied to the government payment scheme must pay back a percentage of their sales at the end of each calendar year. Last year it was 5.1 percent, this year it is 15 percent.

This payback scheme, added to existing cost pressures, means that some products will become loss-making and companies will consider withdrawing them, Samuels said.

Branded medicines, which fall under the remit of the scheme, make up about 30 percent of all prescription medicines in England. Of those about a third are branded generics and biosimilars — cheaper, copycat versions of biological drugs, such as IV cancer drugs or injectable arthritis treatments, that save the NHS billions of pounds once patents expire.

“As the [rebate] rate goes up, we'll see fewer launches of new biosimilars and branded generics in the U.K., because companies won't be able to supply those products and avoid making a loss,” he said. “I know several of our members have already made decisions not to launch biosimilars next year.”

The rebate rate is designed to limit NHS spending on medicines. Any spending above a growth threshold must be paid back. While the rate for the new year has not yet been set, the BGMA forecasts that it could be as high as 30 percent.

The impact of a higher rebate will be withdrawn drugs, less competition further driving up prices, and limited choice of supply. As a result, the risk of drug shortages is increasing.

POLITICO asked the Department of Health and Social Care about its rebate plans and the economic impact on the generics sector, but the department declined to comment. In her speech to the Conservative Party conference on Tuesday, Health Secretary Thérèse Coffey said the government had responded to the biggest concern among people, and health and care leaders — energy bills. "The prime minister and the chancellor listened. They acted. They have delivered," she said, referring to a cap on energy prices that the new government has set.

For the NHS, affordable drugs are essential. Inflation is anticipated to cause a minimum budget shortfall of around £4 billion, according to NHS Confederation.

This “yawning gap” leaves the NHS in a "perilous position,” said federation chief Matthew Taylor, since health bosses will either have to cut back patient care or accept that waiting times will continue to lengthen.

The federation has called for an immediate top-up in funding and for the government to set out how they can manage their own surging energy costs.

Meanwhile, in the research-intensive biotech sector, which is developing the medicines of tomorrow, some are looking for ways to cut costs.

“We're seeing discussions amongst our members around things like temperatures in which you operate fridges,” said Steve Bates, chief executive of the BioIndustry Association. “It’s those types of things at the margin that may be able to save them energy and help with the general challenge.”

Innovative medicines

The branded pharmaceutical sector is better protected.

With its higher profit margins and market monopolies while patents are valid, the sector has greater protection against economic headwinds. Many big pharmas also trade in dollars, protecting them from the weaker sterling.

Nonetheless, the government’s medicines contract doesn’t allow for any wiggle room.

“Given that the prices paid by the NHS for new medicines change very rarely, pharmaceutical companies continue to absorb these additional costs, adding to the pressures they are under in the U.K.,” said Richard Torbett, chief executive of the Association of the British Pharmaceutical Industry (ABPI).

The greatest impact is on “supply chain, distribution and manufacturing,” he added.

For those that do manufacture in the U.K., raw material imports will be most affected, although many companies will have longer-term contracts. Freight and logistics costs are also adding to the pressure, now accounting for between 5 to 10 percent of the costs of producing generics, up from around 3 to 4 percent before energy prices surged.

Today, only around 25 percent of NHS generic medicines are manufactured in the U.K.; around the same amount are manufactured in continental Europe; and about a third of generics are made in India.

After Chancellor Kwasi Kwarteng announced a suite of tax cuts funded by extra borrowing, the pound fell to a record low against the dollar of $1.03. It’s since lifted to the pre-mini-budget level, sitting at around $1.13 on Wednesday afternoon.

Incredible need

A key reason is that other markets are outcompeting the U.K. by offering more attractive terms to manufacture medicines. Ireland, Singapore, Germany and the U.S. have been winning medicines-manufacturing investments.

The U.K. also needs to attract talent to feed its rich biotech sector.

There’s an “incredible need for great scientists and great people,” said Bates, at the BIA. “Making sure that we've got the flow of skilled people to support the companies that are continuing to grow and thrive in the U.K. is the other challenge.”

But it’s also exacerbated by the economic climate.

“If you're working in pharma … you're trying to attract talent that at the moment is very, very hard to find,” said David Leal Ayala, co-author of the U.K. Innovation Report, from Cambridge University’s Institute of Manufacturing. “The question is, why would they come here to live, if from the outside, you look at the U.K. and you see all these problems, particularly in terms of quality of life and the cost of living?"

The U.K. government has announced a £500 million adult social care discharge fund, but has scrapped the National Insurance tax rise to support health and social care. In addition, Kwarteng announced a £500 million fund to boost biotech investment.

The biotech sector is more upbeat on the outlook. It’s seen significant investment growth in recent years, culminating in a host of clinical trials that should deliver results fairly soon.

“We're off the back of a couple of excellent years of financing," Bates said. "People have gone away and got going with their science and I think what we'll see in the coming period is some of those results coming out, some of those cards being turned."