Buying energy better: strategies for controlling cost risks in electricity contracting

07 Dec 2012Archived News Climate Change Matters

To buy energy better and manage costs, many successful organisations learn to treat risks in energy contracting as they do any other risk. They first identify, understand and assess the risk, and then develop strategies to avoid and reduce the risk.

The risk management process

For each contracting situation, successful risk management requires identifying, understanding and assessing:

  1. your business’ current usage, load profile and forecast
  2. the underlying energy market
  3. contract opportunities and internal management processes

The sharper the picture of load and forecast, the more accurate the offer from an energy retailer

Understanding load profile and forecasted usage requires accurate data. Such insight helps with any assessment of cost or benefit. It also means that you can present the load to the prospective retailer in a way that minimises the need for risk premium to be built into pricing.

Within the load profile you should examine the actual charge components for energy, carbon, network, environmentals, market and metering. Considering each component will provide understanding of those items that are able to be influenced in retailer negotiation, and there are strategies for each that will ensure you are buying better.

Firstly, you should review the current contract and note any special conditions that have been included, and work out which of these should be retained. Where standard clauses may impact overall costs, such as penalties for load variation or methods for pass through of carbon pricing, an assessment of how these were practically implemented in your current term, can help you develop a cost effective position for your new contract.

For energy usage, reliable data on the split of peak and off-peak consumption is vital. This will not only be pivotal to assessing any offers from energy retailers, but you may be able to shift the electricity load to different times to make your business even more attractive to retailers and potentially reduce your costs.

For carbon make sure that you not only read the current clause in your electricity contract, but given that a federal election is likely to be held within your next contract term, model the costs of the potential carbon price outcomes under different governments.  For example what is the cost impact of carbon if the current pricing values and structure survive, versus carbon pricing being repealed or reduced? This may help with deciding whether to accept carbon inclusive or carbon exclusive clauses in a supply contract.

While not negotiable within a retailer contract, network costs may offer a real opportunity for saving.  To understand what is possible, an assessment should be made against the available tariffs in your network area. This is simply done by looking up published alternate rates on your network operator’s website and where beneficial, you can change network tariffs through a retailer request.

For market charges, whilst typically regulated and less than 1 %of overall costs, it is possible to review with the retailer how these are defined in case any overheads have been applied.

For metering charges it may be beneficial to explore a direct contract with a meter data agent or metering provider rather than simply accepting an operator suggested by your retailer. Importantly, where charges appear to be more than $2.50 per day there may be a contract already in existence. If so, it is worthwhile checking the benefits versus the cost e.g. are people actually using any paid reporting features or alarms?

Base risk and investment decisions on a good understanding of the energy market.

The two markets that heavily impact contracted pricing are the electricity ‘spot’ and ‘futures’ markets.

The spot market is influenced by short term demand and displays pricing paid to generators every half an hour as electricity is produced. The market has a capped price of $12,500 per megawatt hour when demand is at its greatest.

Whilst the spot market has some influence on contract prices, the electricity futures market may be a better guide to possible prices in contract offers. The futures market is a secondary market developed to mitigate the risk of short term fluctuations in spot market prices. It predicts spot prices for a given period in the future.

The futures market can be very useful for both timing when to make a market approach and assessing exactly ‘what is a good price?’ Where an electricity futures market is trending down in pricing or is low relative to previous days or months, it may be a good time to test available contract pricing. Once pricing is received in a retailer offer, it may be good to compare it to the futures market pricing for the same state and time period.

Understand the short and long term drivers of market pricing

Weather, water availability, economic and regulatory climate, generation fuel prices and generation mix all can contribute to fluctuations in market pricing. Many of these directly or indirectly affect demand which ultimately drive futures and spot pricing. Understanding the drivers will greatly assist buying decisions.

Explore contracting opportunities and evaluate internal management capabilities

Traditionally most organisations will enter into a fixed-priced fixed term contract as it provides budget certainty and is easy to agree and manage. This kind of contract usually allows a + /- 10% load variation without penalty.

Some companies however have negotiated permission to progressively purchase portions of their overall load over the term of their contract.  They do this to potentially avoid the market risk of contracting on any one day and to try to take advantage of any downswings in market pricing. Typically a margin for the retailer is agreed and electricity is bought on the wholesale market when favourable pricing is available and in advance of supply needs.

This kind of contracting offers potential rewards when wholesale market pricing is better than available contract pricing, and when the market is trending down. However it also exposes the organisation to market risk if the market trends up. Naturally this approach requires more resource time to negotiate and manage, and ultimately provides less certainty.

For companies that are able to curtail their electricity load at short notice, progressive purchasing of part of the load is balanced with exposure to the spot market. On days where the spot market becomes expensive they curtail their load and potentially are rewarded by the network operator. They can also take advantage of low spot pricing days to reduce costs as well. Again this type of contracting takes even more resource time to manage and offers even less budget certainty, however the rewards under this model can also be substantial.

In assessing these types of contracting opportunity it is prudent to investigate your organisation’s:

  • requirement for budget certainty
  • appetite for risk
  • capability to negotiate this type of contract
  • capability for ongoing management of purchasing and/or curtailment of electricity usage.

Whether looking at a traditional contract, progressive purchasing or load curtailment options, each organisation has different needs and capabilities, so it pays to take the time and do a thorough analysis.  Energetics is happy to provide advice or assist with assessment of the best contract for your organisation.

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