Are you paying too much for your electricity and natural gas?
15 February 2017
Do you purchase natural gas and electricity on a fixed-price basis? If you do, then you are probably overpaying by around 15% on your electricity costs and by as much as 30% on your natural-gas costs.
Over the past three years, we have witnessed and welcomed the collapse in crude oil prices, from around $110 a barrel (a level that had been sustained for almost three and a half years) to below $50 a barrel. This has been a key factor in pushing wholesale natural gas and electricity markets lower and many large energy users have benefited as result.
Of course, there are also many who have failed to reap the full extent of the benefits available, mainly those availing of fixed price contracts.
For the years 2014, 2015 and 2016, large energy users who contracted on a fixed-price basis have typically paid around 15-20 cent/therm above the cost paid by those engaging in flexible supply contracts. That equates to an over-spend of around 1.10-1.40 cent per kWh in a delivered electricity price. For large energy users, that’s a cost that can and should be avoided.
There are various reasons for this premium, including:
1 Gas and power market’s slow response to oil price movements:
A decline in crude oil prices generally delivers a corresponding decline in wholesale gas and electricity prices but the timing of this is not as straightforward. Buying retail energy supply contracts too quickly in a declining oil market generally delivers unwarranted price premiums… and this has absolutely been the case over the past three years.
2 The difficulty in finding a good time to fix prices:
Do you fix your costs when prices rise to protect yourself or do you fix after prices have fallen? What if prices fall after you fix? Perhaps you fix your costs when preparing your budgets, or before you take annual leave?… Yes, it happens! In short, it is very difficult to find a good time to fix and fixing everything at once rarely delivers a low cost.
3 Forward market risk premium:
All other things being equal, or ceteris paribus, commodity futures tend to include strong risk premiums. This is the premium you pay for price certainty. For the natural-gas market, that premium tends to be a lot stronger than in other commodity markets and paying it on an ongoing basis can prove costly, for energy costs and for careers.
4 All other things are almost never equal:
Of course, ‘all other things’ are never equal – well, almost. Governments change, energy-policies change, the seasons change and energy markets change: to buy energy effectively and competitively, energy-purchasing strategies must be flexible and adaptable.
Engaging an effective energy price-risk management strategy
So now we know, wholesale energy prices don’t only fall, they also rise, and they also rise and fall. At times, volatility can be significant, making it difficult to decide on when to buy forward. With the deployment of an advanced risk-management strategy, you can effectively manage the risk and uncertainty inherent in purchasing energy.
Kore Energy is the leading provider of energy price risk management services to Ireland’s commercial and industrial energy users. It provides services to leading multi-nationals in the pharmaceutical, IT and food sectors and to leading Irish and UK businesses. The risk-management strategies that it deploys on behalf of its clients are designed to optimise price while minimising risk. In short, the key objective is to ensure that you achieve price certainty at a competitive price.
Experience tells us that there are some simple but critical components of an effective energy price risk management strategy:
1 A properly structured energy-supply contract:
It might sound obvious, but the formation of the energy supply contract is the first step towards implementing an effective risk management strategy. Key elements of the contract include options to fix and unfix forward positions, appropriate treatment of currency exposure, trading protocols, transparent access to wholesale market pricing and imbalance pricing.
2 Pre-agreed triggers for fixing and un-fixing forward positions:
Energy markets can move very gradually but they can also move very quickly. That’s why it is important to incorporate pre-agreed default trade rules within your risk management strategy. In the absence of any alternative decision, these triggers will ensure that your exposure to market changes is managed in a manner that fits with your risk appetite, closing positions and reducing risk in a rising market and opening positions and increasing your exposure to a falling market.
3 Appropriate balance between budget risk and market risk:
Every business needs to protect their budget but every business also needs to remain competitive. With the correct mix of fix and un-fix triggers, stop-loss limits and capital at risk provision, budgets can be properly protected without conceding the opportunity to buy at lower prices in the event that wholesale prices decline.
4 Risk-management policy:
Your agreed risk-management strategy should be signed off within a risk-management policy document, ensuring clarity around objectives, responsibilities, authority, strategy deployment and review.
Too complicated? It doesn’t need to be
Implementing an effective risk-management strategy and reducing your energy costs can be easier than you think. Kore Energy offers a fully managed solution for energy procurement and energy price-risk management. We have a proven track record in delivering value to our clients and we are determined to continue to add value into the future.
Key deliverables from our energy procurement service:
- We collect and collate all relevant data from market operators and suppliers and from you;
- We prepare and issue tender documents to suppliers, tailored to your specific needs;
- We evaluate all suppliers’ proposals, providing you with a comprehensive but accessible overview of the supply options available to you;
- We discuss and review your options with you and recommend a way forward;
- We review all supply contract documents and validate through to contract sign-off;
- You just sign the supply contract.