How and when to buy your energy

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how and whento buy your energy

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“The era of cheap energy is over”“The era of cheap energy is over” – although these words were said by a leading UK utilities industry executive over a decade ago, they remain as pertinent as ever and serve to highlight one of the core challenges facing energy buyers today.

By their very nature, energy markets are subject to highly unpredictable levels of price volatility which can result in both major and rapid price movements.

Over the past four years benchmark UK gas wholesale prices more than doubled, increasing at an annualised average rate of over 17%. Power price pressures have been lower, though still significant, at an annualised rate of around 6%. As annualised averages these figures hide significant day on day volatilities. One such example of this was seen in March 2013 when a particularly cold period coincided with North Sea supply problems. Wholesale gas prices spiked to over 105 pence per therm, around 40% higher than where they had been just a week previously.

Set against this backdrop and the fact that energy markets are becoming ever-more complex and volatile, it is easy to see why energy needs to be treated as a unique activity, distinct and far removed from buying any other commodity or service.

This paper will explore some of the factors contributing to the complexities and vagaries of the UK energy market including global dynamics, non-commodity costs, decarbonisation and the a range of other market drivers. We will also highlight some of the price risk mitigation options open to you as an energy buyer.

Read on to discover more.

Christopher Lydiard -WilsonFounder and Chief Executive Officer

In 1992 Christopher founded, EnergyQuote JHA, he spearheaded the development of the world’s first energy e-procurement system to trade online in 1995 offering companies an alternative to traditional lengthy methods of procurement. Prior to energy, Christopher’s career was in stockbroking where he worked in the derivatives markets.

A Unique Perspective | How and when to buy your energy

EnergyQuote JHA, 66 Hammersmith Road, London W14 8UD United Kingdom.T: +44 (0)20 7605 2300 E: [email protected]

Christopher Lydiard -Wilson

The fundamentals of market fundamentalsLike any other commodity, energy prices are set by market fundamentals (namely the interaction of supply and demand). Whilst this has always long been the case, in recent years both sides of the supply/demand equation have become increasingly unpredictable and difficult to forecast.

Declining UK gas productionDecreasing levels of gas production have resulted in the UK becoming increasingly dependant on imported (and hence more expensive) gas supplies. North Sea gas production peaked in 2000, with there being a marked and rapid decline since. Current production is now only a third of its year 2000 level, and half as much as it was just 5 years ago. This decline will not only continue, but accelerate.

As soon as 2020 UK gas production will make up just 25% of supply, compared with 50% three years ago. Less than a decade ago the UK was producing not only enough gas to meet its own demand, but also created significant export volumes.

Much of the supply gap will be filled by imports of Liquefied Natural Gas (LNG), which comes with not only additional costs but also its own price risks. As with pipeline gas, LNG supplies are often found in the most politically unstable areas of the world. The Middle East is home to over 43% of the world’s gas reserves, whilst imports from Russia alone make up nearly a third of European Union gas consumption.

Inevitably, you as the end user, are forced to bear the financial burden of both higher gas import costs and also the associated price risks.

Until 2004 the UK was a net gas exporter, however

maturing North Sea production has resulted in the UK becoming heavily import dependent

At current levels of production, the UK has

just 7 years of proven gas reserves left

UK gas production is around a third of its

level in 2000


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Global factorsWhereas once energy markets were very geographically self contained, the past few years have seen a rapid globalisation, with the UK now increasingly impacted by market dynamics from further and further afield. Middle Eastern political tensions, rapidly rising Asian demand, the US becoming a gas exporter and other global dynamics conspire to create an impact on UK energy consumers, meaning close attention to global, rather than just local, energy market dynamics is more important than ever before.

Non-energy costsWhilst these upward movements in wholesale prices are by no means a new phenomena, and remain a core issue of concern, they now account for a decreasingly significant part of the overall picture for energy buyers.

Increasingly the role of non-energy costs (network charges, taxes, levies etc) is becoming the prime concern for industrial and commercial energy buyers of all sizes across the UK. As recently as 2011 non-energy costs made up around 30% of a typical industrial and commercial sector power bill. Currently the figure is around 36%, with our forecasts indicating this will rise to as much as 42% within 3 years.

Given that around 40% of UK power generation capacity is gas fired, the price of gas exerts a significant influence on the price of power

The on-going decarbonisation agenda is creating significant upward pressures on underlying power prices

Tightening environmental legislation is leading to widespread closure of fossil fuel plant


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Uncontrollable variablesEnergy markets have long been known for their peculiarities and unpredictable nature. Amongst a number of other factors, the unpredictability of diverse factors such as weather patterns, politics, geopolitics, macro-economics, European initiatives and (amongst others) technical factors exert a price impact.

Prices on the spot market (that is energy for near-term delivery) are particularly influenced by weather conditions, with spot prices increasing historically by over 30% on a daily basis during particularly cold periods when supply is unable to keep pace with high demand.

As well as spot market sentiment, forward prices (energy for delivery further out) are also influenced by global energy events, many of which are essentially unforecastable. For example in March 2011 Japan was impacted by an earthquake which resulted in the shutdown of its nuclear power stations. The resulting supply gap lead to fears in the UK that there would be a shortage of gas given the need for Japan to import volumes of gas that may have otherwise been sent to the UK. The result was an instant jump in UK gas prices of around 30%, with power prices consequently rising by over 20%. Energy buyers needing to buy their power on a particular day around this time would have found themselves at a distinct competitive disadvantage to their competitors who had bought at other times.

Electricity suppliers will be exempt from

some of the costs associated with

CFDs

Government analysis suggests an average

of £0.20/MWh will be added to electricity prices

for non-exempt consumers from

2015 to 2020

The government does not expect non-UK

projects to be eligible for CFDs until 2018

at the earliest


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Rising decarbonisation costsThe decarbonisation agenda has risen rapidly to the top of the political and economic agenda in recent years. Producing lower carbon energy and promoting energy efficiency have been central to this – though inevitably the additional costs associated with this are passed through to energy buyers.

In the UK tightening environmental legislation and naturally occurring plant retirements mean that the amount of available generating capacity will diminish markedly in the medium term. By 2020, a quarter of the UK’s current generation fleet will be retired, much of it as a result of environmental legislation.

The Large Combustion Plant Directive alone, an EU wide directive aimed at reducing carbon emissions from power generation, will close 11 GW of generation capacity (the equivalent of 10 large-scale power stations). The upward price pressures caused by this have been compounded by the fact that significant delays have been experienced in developing new power stations to fill the supply gap.

Under the Government’s Renewable Energy Strategy it is anticipated that by 2020 about 30% or more of total power production could come from renewables, compared to around 10% today. The longer term target is to have an 80% carbon reduction target by 2050. However, the economics of renewables remain challenging, with greater production costs pushing up end-user prices.

The cost of carbon credits, a Government scheme aimed at encouraging greener power generation, remain a key factor adding to the cost burden of the decarbonisation agenda.

Electricity suppliers will be exempt from some of the costs associated with CFDs

Government analysis suggests an average of £0.20/MWh will be added to electricity prices for non-exempt consumers from 2015 to 2020

The government does not expect non UK projects to be eligible for CFDs until 2018 at the earliest


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OptionsHowever, despite the vagaries of volatile energy prices, governmental legislation, market fundamentals and rising non-energy costs, there are a range of options open to energy buyers of all sizes to plan for and to mitigate energy price risks.

Demand side management, energy efficiency, on-site generation, hedging and risk management all provide excellent and valuable opportunities to mollify the bottom line impact of these rising costs.

Our unique perspective1. Be prepared to move quickly in order to take advantage of favourable

energy market conditions when they occur.

2. Reduce consumption as far as possible – the cheapest unit of energy is the one you do not consume.

3. Stay up to date on energy market dynamics.

4. Understand changing governmental and EU legislation and how it impacts you and your industry.

5. Avail yourself of all the available tools in terms of (amongst others) hedging, fixed or flexible contracts, demand side managements, load management, self generation and competitive tendering.

There are a range of options open to help

mitigate risk

Monitor the market

Equip yourself with an energy buying

toolkit


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If you would like to know more please contact our Business Development Team:

+44(0)20 7605 2314


© EnergyQuote JHA. All rights reserved.EnergyQuote JHA is the trading name of Energy Management Brokers Limited (Registered No: 2500956).Registered Office: 66 Hammersmith Road, London, England W14 8UD.EQ0235.01.2015

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How and when to buy your energy