Electricity spot pricing – rip off or reasonable?

04 March 2019

 [Electricity] Demand has, year on year, been steadily rising. This trend is likely to continue, so don’t look for much relief from higher electricity prices in the near term.

I recently talked to a businessperson who had signed up to an electricity contract that had his company effectively speculating on the spot market.

What the company didn’t realise (and wasn’t told) was that playing the electricity spot market was fraught with upside cost risk. In their case they are now paying more than three times the standard retail electricity rate for business, and facing significant fees if they attempt to get out of the contract.

What disappointed me in this case was that the consultant they paid for advice also took a trailing commission from the electricity service provider. In other words, no-one was representing the client’s best interests in a transaction that was fraught with risk.

Let’s talk about the situation our businessman faces and how it came about that the company is locked into a contract that will potentially cost it tens of thousands of dollars more than a simple retail contract offered.

It comes down to supply, demand and price uncertainty.

How the electricity spot market works

electricity spot pricing - hydro generationMost of our electricity is provided via South Island lakes. Lake water has remained at average levels for the time of year right through the summer period thus far. What has driven the price escalations is thermal outages. A large chunk of North Island thermal generation plant has been unavailable due to maintenance.

What was scheduled as a short-term outage has turned into longer ones as issues have been found that are taking time to remediate.

Even when it is running at full capacity, thermal generation is more expensive than hydro. The wholesale price of gas is escalating, and the price of coal has effectively doubled since 2016. The impact of this means that generators are less likely to offer thermal generation to the market if prices are low. Hydro has, therefore, been used through the year, reducing the ability for hydro generators to conserve water when the pressure went on summer lake levels.

National demand has also increased significantly. This summer so far, demand is the highest it has been in the past four years. Demand has, year on year, been steadily rising. This trend is likely to continue, so don’t look for much relief from higher electricity prices in the near term.

It’s not entirely bad news though. Even in a time of escalation, fixed prices have remained below where we were at this time in 2012. There was a significant market correction towards the end of that year and businesses have benefitted from attractive electricity pricing since.

Should we enter the spot market?

What does this mean for those businesses whose contracts have expired or will expire soon?

  • Unless they have an energy expert on staff, they need to think very hard before entering contracts that lock them into variable pricing based on the electricity spot market.
  • Negotiating an electricity contract can be complex. Good advice can save a business thousands, if not tens or even hundreds of thousands of dollars, depending on the size of the business and its energy use profile. Business should use a reputable advisor but be certain that he/she only represents the business’ interests.
  • Right now, and for the rest of 2019 at least, I suggest a fixed term, fixed price contract wherever possible. Yes, business may pay a small premium in some cases but there are numerous, reputable electricity retail firms that offer good pricing and carry the upside risk for their clients.