James Mulley, Product Development Manager at Britsh Gas Business, explores the complex world of energy buying and how businesses can get more value for money from their energy supply.
For many businesses, an energy bill is just another cost to be paid every month with little consideration for where that energy comes from or the process through which it was acquired.
The practice of buying energy on the open market is complex and understanding how it works, and how to buy more flexibly, is not straightforward. But for those who know how, it creates opportunities for significant financial savings.
Just like any commodity, the price of energy can fluctuate massively, depending on a whole range of influencing factors. For example, in Spring 2019 the global price of gas fell significantly because a milder winter meant that European stocks were much higher than usual.
Likewise, abnormally high winds at the start of March this year meant that wind farms were producing more energy than usual, bringing down the overall cost of renewable energy.
For most, the peaks and troughs in the price of energy go largely unnoticed and they are unaware of the impact it could have on the size of the bill they pay each month.
Fixed price versus fully flexible…
The price you see on an energy bill is, in simplisitc terms, made up of two roughly equal components – the commodity price of the energy and non-commodity costs, which include transmission and distribution charges as well as government levies. It’s the first of these elements that fluctuates with changes in the wholesale commodity market.
One way to guard against the risk of increases in commodity price is to choose a fixed-price tariff. This means the price per megawatt/hour (MWh) you pay stays the same, regardless of any changes in the wholesale commodity market – in much the same way as a fixed-rate mortgage protects a homeowner from rising interest rates.
But while this approach provides security when the wholesale price of energy goes up, it doesn’t allow a business to take advantage when the price goes down.
An alternative is to be fully flexible in the way energy is purchased, allowing a business to both guard against the risk of price rises and pay less when the cost is low. This is often the way large organisations, with in-house energy managers and buyers, will approach energy procurement.
But it is a complex and involved process that requires regular monitoring of the energy market and the factors that could affect it. For enterprises with little or no energy management resource and expertise in-house, this is not always feasible.
Flexible hedging strategies
Developing and implementing a flexible hedging strategy provides a way of managing energy costs within pre-defined parameters. A risk managed approach to energy procurement allows a business to set risk limits which trigger purchasing decisions when the peaks and troughs of the wholesale market hit these limits.
Adopting such a risk managed hedging strategy allows a business to effectively manage their commodity risk exposure whilst taking advantage of any price decreases over the course of an energy contract.As a simplistic example, energy may be bought well in advance or much closer to delivery depending on whether the wholesale price is increasing or decreasing over the long term respectively. A combination of these buying options, as part of a more complex strategy, can unlock value from price fluctuations in the short to medium term as other, often less predictable factors, influence the wholesale price.
By putting in place pre-set purchasing decisions, flexible hedging strategies enable a business to plan out their energy buying and gain control of the risks and opportunities created by the peaks and troughs in the cost of energy. This allows business to tap into the potential cost benefits of flexible energy contracts without the day-to-day management normally required.
A flexible future
The government has set a 2050 deadline for the UK to become carbon neutral and the shift towards renewable energy sources this is set to bring about may make the price of energy fluctuate more frequently, because wind and solar are less consistent sources of energy than conventional gas-fired power plants.
Considering this, a more flexible approach to energy purchasing will become increasingly beneficial, if not essential. But not all businesses can be expected to put enough time and effort into managing the risks and opportunities a fully flexible buying approach brings. Risk managed hedging strategies offer them a way to better manage energy costs in a more feasible and less time-consuming way.