How to cope with rising energy prices
British business is being battered by soaring energy prices. Clive Merifield looks at how organisations can cope with price volatility and uncertainty
Electricity and gas prices have risen to historic highs in the past months.
Prices are being driven by various factors, for gas these include storage, high global demand, coal to gas switching, LNG availability and the Russia/Ukraine factor. For power the drivers include gas price, carbon price, the weather and various plant/connector outages. Unfortunately, prices could go even higher (or pull back dramatically) – a lot depends on what happens in the future to European dependence on Russian gas.
Let’s look at consumption, flexible contracting and alternative options through the lens of coping with rising prices and high price volatility.
The digitalisation of data is key for consumption management and waste reduction. Organisations should review existing systems and seek to engage all energy stakeholders with a project to reduce waste by using techniques such as benchmarking. Most organisations have implemented basic energy efficiency measures. However, with energy costs high, organisations may consider shifting consumption and production to times when unit costs are the lowest.
Fixed and flexible price supply contracts form the bulk of UK energy procurement. Flex’s principal benefit is its ability to diversify risk by providing the ability to spread trade placement timing and volume throughout the contract period. Furthermore, because flex customers accept the price risk, the supplier risk premium (which is built into fixed price contracts) is reduced, creating a cost saving.
When procuring flexibly the proportion of volume an organisation can hedge is restricted by its ability to provide a volume forecast to a defined tolerance. It may be that a forecast of this accuracy can only be provided three months prior to delivery. Let’s take a theoretical example of an industrial consumer who has: • 12 months left on their existing flexible power contract
- low risk appetite and value budget certainty
- base load hedged for nine months. Peak hedged for three months;
- 20 per cent volume tolerance clause; and
- clarity on peak load forecast three months prior to delivery.
The company should look urgently to extend or re-procure its supply contract to provide the option to hedge over a longer period.
Turning to the hedging strategy, it appears the company has taken a speculative stance, counter to its stated appetite for budget certainty and risk avoidance. The company should therefore consider reviewing its hedging strategy and seek to reduce its exposure through hedging.
Looking at baseload, the company may consider shifting from hedging nine months to 12 months in advance. For the positions further out, the company may further diversify its price risk by trading 50 per cent of its 12-18 month exposure and 25 per cent of its 18-24 month baseload requirement.
Peak load hedging is more challenging; the business is limited to hedging three months ahead. Methods to improve peak load forecasting should be explored – such as a digital system for consumption forecasting with the objective to improve the peak load forecast duration to perhaps four or five months. This would enable the company to reduce its exposure to market price volatility.
The company should seriously consider implementing a cloud-based flex contract management platform to access live position monitoring and alerting. Ultimately, such a system would have allowed the company to better understand (and manage) its exposure, protect its budget and react quickly to price movements.
Onsite generation projects (such as solar PV) provide long term alternatives. They require capital expenditure and specialist expertise, but provide compelling benefits which include:
- security of supply;
- long-term price certainty;
- removal of commodity and non-commodity price risk;
- positive sustainability impact; and
- revenue from selling to the grid (optional).
Other options include Power Purchase Agreements PPAs) – which would diversify price risk over a longer term, reduce cost and improve sustainability. Batteries, meanwhile, could be considered an option multiplier – enabling flexibility, releasing extra benefits from onsite generation, and providing an additional revenue stream from selling to the grid.
Ultimately onsite generation, storage projects and PPAs should form part of a well thought through energy strategy due to their long-term nature.
Prices are currently high and extremely volatile – it’s entirely feasible they could go higher or pull back significantly. The basics – consumption reduction and flexibility – should be prioritised as a direct method to manage cost and eliminate waste. The digitalisation of energy management is key to achieving these efficiencies.
Flexible contracting’s ability to diversify price risk is valuable, particularly when markets are high. Taking a longer-term view to diversify price risk further is logical. It is important to ensure speculation is only taken in line with organisational objectives and risk appetite.
Having a digitalised platform for flex contract management is valuable to provide a constant watch on consumption, budget and hedging strategy implementation. In addition, a digitalised platform will generate alerts when action is needed to protect the budget and provide data to support decision-making.
Alternative options such as onsite generation, PPAs and storage should be seriously considered – they provide a method to mitigate rising prices once implemented. It is also important to acknowledge that long-term options shouldn’t be undertaken in isolation; they should form part of the organisation’s overall long-term energy strategy.
• Clive Merifield is business development manager at ZTP, a UK energy consultancy and software specialist
