Cutting electricity costs – which way to pay?

Posted 14 September 2012 by Richard Gardiner

light bulbCoping with the worst recession in living memory has forced businesses to leave no stone unturned in the quest to improve their bottom line.  Electricity is one cost that impacts on everyone and businesses impacted by the deregulated NZ energy markets fall into two basic categories:

1.  Non-time of Use customers

Businesses with energy usage per ICP (Installation Connection Point) below approximately 200000 kWh per year (the actual figure varies dependent on the local lines company) are likely to be supplied on a non-time of use basis.  These sites will have a standard non-TOU meter and be billed per kWh used and days supplied.  This billing approach is similar to the metering of residential customers, although business electricity rates are generally significantly better.

2.  Time of Use customers (TOU)

Businesses with energy usage per site above the 200000 kWh threshold will most likely be TOU customers. TOU rates are typically split into either 48-rate pricing (4 energy rates per month) or 144-rate pricing (12 rates per month).  TOU pricing is customer specific although it is heavily impacted by prevailing market conditions when going out to tender.

With large TOU businesses using over 10 million kWh per year (preferably per site), there is the additional option of signing an electricity contract for difference (CFD) with one of the energy retailers.

When planning for an electricity negotiation, key points for consideration include:

 

  • When is the best time of the year tactically to go to market?
  • What contract term best suits the customer?
  • What type of supply agreement best fits your needs – spot market based pricing, traditional fixed price variable volume (FPVV) or a CFD hedge (if you are a large energy user)?
  • For multi-site customers is it best to deal with a single energy retailer or more than one?
  • Also with multi-site customers, is it better to synchronise contract expiry dates to maximise your purchasing power or to stagger your contract expiry dates to spread your commercial risk?

The advantage of FPVV is that both the price and volume risk are taken by the supplier – the disadvantage is that you pay more per kWh for your reduced risk exposure.

Spot rates – the pros and cons

The advantage of being on spot rates is that in the long term (over three to five years) you will pay less on average than with the equivalent contract options – whether FPVV or CFD.  Spot rates over the past decade have generally been favourable.  The disadvantages of spot however include:

  • A greater risk attached (tantamount to taking a calculated gamble).
  • Pricing can be highly volatile
  • When sustained high spot rates occur, it can be very hard to ‘jump ship’ and move to fixed contract rates of either type without signing up to poor contract energy rates.  As such, you run the risk of locking in to higher long term contract energy rates based on adverse shorter term spot      market considerations.

Hedging your bets

By going down the CFD hedge route the fixed energy CFD rates are significantly better than with competing FPVV prices – particularly with a baseload (flat load/hour, 24/7 throughout the year) rather than a profile hedge (daily and seasonal variations in energy usage allowed for). But you need to remember:

  • You are still open to a degree of spot market exposure when plugging the gap between your actual usage and contracted kWh
  • If you use less in practice than the hedged kWh, you are locked in to a ‘take or pay’ structure
  • Some energy retailers do not currently provide Energy CFD’s.  Others prefer to supply either very large or smaller sites depending on their in-house constraints

As already mentioned, CFD hedges are designed for large customers using at least 10gWh (10 million kWh) annually.  Baseload hedges come into their own with customers operating 24/7 throughout the year.  Profile hedges are sculpted to fit the actual energy using profile of the customer but you pay a premium compared with a baseload hedge.

With both hedge options it helps if the customer in question has the ability to curb production/resultant energy usage quickly in response to spot market price signals i.e. in a situation where they are using significantly more kWh than their hedge kWh.

Where customers have a degree of spot market exposure, we recommend that in the good months, when spot prices are less than prevailing contract rates, they build up a monthly energy provision in their P & L accounts to finance high spot price periods when the market has moved adversely.

Specialist advice

The negotiation of Energy CFD’s is a specialised area because of the scale of the expenditure involved and business risk entailed.  Only three energy consultants in New Zealand were approved by the Financial Markets Authority to negotiate these contracts as of November 2011 – TUMG is one of them.  If you would like more information or need specialist advice, call us on 09 576 2107.

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