How to de-risk your energy purchasing strategy and get the best possible deal.
In an article written for the Independent Schools' Bursars Association (ISBA) magazine The Bursar's Review, Richard King, Energy Trading Manager for Inprova Energy, advises on how schools and other organisations can take a smarter, less risky approach to energy buying via collective purchasing.
At a time of unprecedented volatility in the wholesale energy markets, it's very easy to take a wrong turn or buy at the wrong time and end up losing large amounts of money.
In the last year, wholesale power prices swung by around 45%, which is twice as volatile as the previous five years. Those who fixed their electric bill for the next three years at the height of this market could end up paying hundreds or thousands of pounds more than other organisations, who may have taken a more calculated, less risky approach, or just been luckier with their timing. The gas and electricity commodity markets tend to move in tandem, so are equally volatile.
Collective energy purchasing
More and more organisations are now turning to collective energy purchasing to reduce risk and save time and money by joining together to purchase energy as part of a group.
This managed collective strategy offers access to smart purchasing options that are only usually available to larger energy buyers. This means that organisations can move from fixed price contracts to flexible, risk managed purchasing strategies, which may otherwise be out of their budget. This also provides access to expert live trading and risk management teams in the same way as large corporations.
By purchasing gas and electricity in 'chunks' on the wholesale markets when prices are more favourable, bursars can benefit from market dips and avoid costly spikes.
Fixed vs Flex
It's often thought that fixed rate contracts are less risky than flexible contracts, which is a fallacy. Fixed rates do provide budget certainty, but the odds are 1:365 of picking the right day, when the market is lowest, to fix your deal. Those selecting the wrong time in the current volatile markets will certainly feel the pain.
With flexible purchasing, the risk is spread via multiple purchases rather than a single fixed transaction. The danger with either method, however, is hitting the top of the market. This is why any procurement strategy must be underpinned by a robust risk management system and trading strategy to limit potential losses and maximise gains.
Types of collective
There are many different types of energy collectives to reflect the attitude to risk and whether sites use half-hourly meters. The two main types are:
1. Fully flexible collectives - that allow the trading team freedom to buy opportunely at advantageous wholesale market rates. This is likely to combine ‘forward purchases’ during periods when wholesale prices are lower than an agreed target price. Thus, prices are hedged, and purchasing can be topped up with near-term buying as the market dips.
2. Fixed-flex collectives - for those requiring more budget certainty. This involves forward purchasing the total energy volume required at wholesale rates and then locking into these prices. For added certainty, these agreements can be made after the annual publication of non-commodity costs, which are published each April for the year ahead. These costs can then also be included as 'pass-through costs' to provide added certainty.
Buying power and efficiency
It stands to reason that the more energy you buy, the better price that can be negotiated. In addition, by aggregating spend, schools dramatically reduce suppliers' margins, which can typically add 6-8% to an energy bill.
Collective purchasing removes the administrative burden – freeing up time and stretched resources. Buyers are saved the headache of approaching multiple suppliers, evaluating and comparing offers (which aren't usually like-for-like), and negotiating contract terms. Schools and other organisations benefit from best practice concerning contract negotiation, risk management and ongoing bill validation to ensure that billing aligns with consumption and that all charges are correct. Although purchasing is centralised, individual schools will still receive an individual contract, billing and validation services.
The management of collectives is usually undertaken by an energy procurement consultancy, who will agree on a trading and risk management strategy. Their analysts will be responsible for managing all purchases for the duration of the contract. This role also includes analysing the energy and risk profiles of the potential collective members and assigning them to the best purchasing consortia.
The analysts will constantly monitor the wholesale gas and electricity markets to make purchases when market conditions are most favourable. They will also align purchasing with a detailed risk management strategy that supports decision making and sets pre-defined risk limits. The service should also include a full invoice validation service to ensure the accuracy of billing.
A team should execute procurement with live market price feeds, the right monitoring and reporting systems, and the ability to recognise and rationalise changing market conditions. This team should be proactive in advising customers on the best energy procurement routes, and review and amend the strategy, with the aim of avoiding market shocks.
Energy market conditions
As the past 12 months have shown, the wholesale energy market is extremely turbulent. But massive price swings provide an opportunity to buy at times when the market dips. This often involves looking ahead to lock-in to attractive forward prices. Getting the timing right is very complex, but collective purchasing provides schools with access to the expertise to navigate wholesale energy markets.
Wholesale costs are generally much higher than in the past 2-3 years, and there are many market triggers behind recent dramatic price movements. One of the major drivers is strengthening oil prices, which are directly related to the price of gas, which in turn influences the price of electricity. A tightening oil market combined with geopolitical tensions in the Middle East and the threat of US sanctions on the export of Iranian crude have seen the price of a barrel of oil rebound from 45 dollars last summer to as high as 80 dollars this year.
Other market triggers include the impact of adverse weather conditions on demand patterns, with the extremely cold conditions of late winter being replaced by heatwave conditions across Europe this summer, which is driving additional electricity demand for air conditioning.
Currency fluctuations caused by the ongoing Brexit negotiations, as well as supply issues caused by capacity problems in continental Europe, are also leading to higher levels of market volatility. Energy is a global resource, and huge population growth and the rapid expansion of developing economies is putting ongoing pressure on supplies and, therefore, on prices.
Nothing's ever certain in the highly volatile energy markets, but we're unlikely to witness the very low commodity prices of winter 2016, largely because the price of oil has increased so dramatically. Nevertheless, it is still possible to benefit from the large fluctuation in market costs and mitigate the risk of higher prices.
Collective energy purchasing strategies are already paying off for many organisations – helping time-pressed managers to free themselves from the administrative headaches of managing the complexities of energy billing, while reducing costs.
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