Strength and volatility have returned to commodity markets and non-commodity energy bill elements continue to rise. How can businesses navigate an increasingly complex environment? The Energyst asked energy experts.
The tail end of 2018 saw several smaller energy suppliers going bust and the Capacity Market suspended. It underlined “how quickly things can change in the energy market”, according to Ben Spry, head of risk management at Npower’s Energy HQ.
“The market is changing at pace. We have seen strength and volatility return to the wholesale market and that brings risk management and timely market intelligence back into focus,” says Spry.
A strong year for all kinds of fuel as well as carbon prices have seen wholesale prices “rocket compared to 18 months ago”, he adds, bringing price management “firmly back into focus”.
Cheaper wholesale prices had masked increases in non-commodity costs. “I’m not saying people had become complacent, but [softer prices] had perhaps reduced the focus on following the markets intently to keeping a watching brief,” Spry suggests. “But markets are cyclical and we have seen a real reverse.”
But Spry says the volatile and unpredictable nature of the current market is an opportunity as well as a challenge.
“Short term, the challenge is to navigate through winter. Longer term it is to understand price drivers, the impact of structural changes in setting the price of power,” says Spry, with increasing volumes of wind and solar likely to significantly increase price variability.
“Wind generation is forecast to be around 35GW by 2030. That could cause negative prices when it is windy, but then quickly drop off, leading to very high prices, potentially hundreds of pounds per megawatt hour,” Spry suggests. “We are already starting to see the impact [of higher volumes of intermittent generation] this winter. But that should really benefit those that have the ability to react quickly to market price signals.”
Many businesses have been used to cutting their power bills by reducing consumption during peak network charging periods, both transmission (Triad periods) and distribution (DUoS red bands). Spry thinks there is now greater opportunity for those that can react at any time, rather than planned evening peak reductions.
For businesses with less agility, Spry says it is important to minimise exposure to high costs and increasing volatility.
“If you do not have the ability to avoid price spikes or policy charges you need robust risk management; a hedging strategy and exposure to risk that suits your business,” Spry advises. “And it’s always worth reexamining energy efficiency measures to use fewer kilowatt hours in the long run.”
While there is still value to be had – energy prices for summer 2019 were trading in the mid fifties per megawatt hour as The Energyst went to press – Spry thinks there are “enough supporting anecdotes” around rising commodity and non-commodity costs for businesses to justify looking at energy efficiency more seriously.
“The evidence suggests energy costs are set to dramatically increase to 2030, so now is the time to do something about it. Energy should now be quite high on the agenda because of the risks businesses may face,” he suggests.
David Oliver, senior energy consultant at Inenco, agrees that a robust hedging strategy is now vital for larger energy consumers. That strategy must be both long-term and flexible, he suggests. Taking that approach means Inenco’s customers that bought “two to three years ahead last year when prices were very low are in a good place right now”, says Oliver. “They are paying about half the current market price for gas, 30p per therm (ppt) versus 60p”.
While it is too late for firms that did not take that approach, “there are still opportunities to buy in the forward markets,” says Oliver, “and a long-term strategy enables you to do that”.
Commodity markets are hard to forecast due to external variables. Non-commodity costs, however, are easier to predict, and make up the bulk of the power bill.
Oliver says non-commodity costs will rise in 2019, but will not be as marked as the “massive” year-on-year increases that were driven partially by the Renewables Obligation (RO), which is closed to new schemes. The RO, which makes up about 20% of the power bill, will still increase with inflation and businesses will have to pay more if government decides to exempt a larger number of energy intensive firms from the scheme.
Meanwhile, Oliver thinks increases in contracts for difference (CfD) costs will be softer than anticipated partly due to higher wholesale costs (CfDs pay a top up to generators if wholesale prices are low) and because ‘strike prices’ taken by offshore wind farms in recent auctions have fallen.
For CfD costs longer term, he says Hinkley C would “add three or four pounds per megawatt hour to bills overnight”.
Another significant non-commodity charge for larger businesses is the Climate Change Levy (CCL). For electricity it will increase by more than £2.50/MWh in 2019. However, it will fall for the following two years as Treasury moves to transfer the cost to gas. The tax rate on both fuels should align in the mid 2020s, at which point it will be around £6.50/MWh, said Oliver. “So if you are a big gas user and not in a Climate Change Agreement, that is quite a big impact,”, he warns. “It will be more than 10% of the cost of gas.”
People need to understand that when they use energy will make a big difference in the price they pay, says Dan Smith, deputy vice-president, I&C Supply at Smartest Energy. He says that shift means energy procurement must engage all parts of a business – from engineering to finance and commercial.
“Consumers have grown used to non-commodity rises but we have seen commodity cost increases for contracts this winter,” says Smith. “I think [the combined effect] will shock some buyers, some have come to market late and are paying about 25% more as a result.”
Businesses therefore need “not just a procurement strategy but an energy strategy, a long-term coherent vision”, says Smith.
“The market is becoming increasingly complex and you can no longer do procurement and FM in isolation, it has to be across the whole company.” Otherwise, he says, a missed opportunity, i.e. saving cost, becomes a threat, i.e. paying more while others reap the benefit of taking action, which pushes up overall business costs and reduces competitiveness.
Get off the grid?
Major changes to the energy market and the way charges are applied compound uncertainty exacerbated by Brexit. As a result, consumer interest in getting off the grid altogether is increasing, says Smith.
While Smith believes the ‘prosumer’ approach is “definitely the future”, there are less extreme means of risk mitigation available now, such as power purchase agreements (PPAs), where power users contract to buy power directly from generators.
Smith thinks PPAs are a useful means of providing cost certainty and says “the gap is closing” between the rates generators want and the prices consumers are willing to pay. Meanwhile, some generators will accept shorter terms, which may open up the PPA market.
The year of the PPA?
Chris Bowden, managing director at Squeaky Energy, believes 2019 will be the “breakthrough year” for corporate PPAs.
Squeaky’s peer-to-peer platform connects buyers with sellers, enabling firms to buy clean power directly from generators.
“I think we are going to see a structural shift in how the market operates. Corporates will replace utilities as the primary offtakers of their power,” he says.
Bowden thinks costs have reached “an inflection point”, and points to solar deals that are “sub-fossil fuel prices” by way of example.
“Wind is very close [to that point] while in the secondary market [where older renewables schemes are coming off subsidies] you can do shorter term deals – and there is a lot of interest there,” he says.
Bowden says those market shifts mean PPAs are now viable for mid-sized firms.
“If you are spending a few million a year on electricity, what is wrong with doing a quarter of spend via a PPA and locking it in for five to 15 years? I think a lot more people are coming around to that view.”
This article was originally published in The Energyst’s January print issue. If you have some responsibility for energy or carbon within your organisation, you probably qualify for a free subscription.