Understanding the current energy price turbulence – and what action to take

Understanding the current energy price turbulence – and what action to take

It seems that not a day goes by without energy prices hitting the headlines. Businesses are understandably concerned about the implications of sudden and unexpected rises, and how to best manage the implications.

Help to understand the situation – and what it means for both the commodity and non-commodity elements of energy invoices – is often a key ask from business customers. Knowing what measures to then take to minimise price exposure is another common request.

So we asked market and industry expert Gemma Eagle-Bruce to provide a succinct overview…

Understanding market drivers

Firstly, when it comes to wholesale prices, a range of factors has created the situation we currently find ourselves in. These include:

  • Europe’s low gas storage reserves
  • Fierce competition from Asia diverting liquified natural gas (LNG) deliveries
  • A fall in imported gas supplies into the Continent from Russia
  • A reduction in 1-2GW (potentially around 7%) of the UK’s energy supply until March, due to an interconnector fire
  • Lower-than expected wind and solar power output over the summer, and on-going low wind and renewables generation

You can read more about these factors in our recent blog.

As a result, last week we saw day-ahead gas prices at their highest-ever levels, reaching 355.00p/therm, around 66% higher than for the same period last year. And power prices are mapping this upward trend, with day-ahead power prices on 8 October almost 340% higher than the same day a year ago.

Why supplier failures add £££s to energy costs

Along with record-breaking wholesale energy prices, we’ve also seen record numbers of energy suppliers go bust, unable to cover their costs thanks to the Ofgem-imposed consumer price cap.

Safeguards mean customers of failed suppliers are automatically transferred over to new suppliers, with no interruption in service.

However, these customer transfers incur a cost to the new suppliers – to honour credit balances, on board customer accounts and purchase sufficient energy volume to meet the extra demand, at a time when energy costs are so high.

And it’s these costs, as well as a raft of unpaid industry charges, that will be passed on to all consumers in the form of higher non-commodity charges.

For businesses, these include:

  • Local Distribution Zone (LDZ) charges for gas – around £0.6/MWh extra from next April for the 2022/23 year.
  • Renewables Obligation (RO) charges for power – an increase of around £0.2/MWh, and potentially higher as more suppliers go bust.
  • Balancing Services Use of System (BSUoS) charge for power – additional costs of around £3/MWh from this winter onwards.

We covered more of the background detail in this recent blog.

Impact of uncertainty to suppliers

In addition to all the non-commodity charges added to energy bills – which can account for as much as 60% of the overall price – suppliers themselves face increasing costs to manage supply on behalf of customers.

For example, the current volatility is making it more difficult for suppliers to accurately price elements such as the imbalance and shape fees included in energy tariffs.

The imbalance element relates to the costs incurred by suppliers for any difference between their forecast volumes and the actual levels that are consumed. A typical imbalance level for a supplier will be 1-2%.

This doesn’t sound like much. But there have been large increases in system costs due to higher balancing costs this year. For example, due to a greater reliance on peaking gas and coal plants during periods of high gas prices, along with high demand and low renewables output.

These conditions are expected to continue and potentially get worse over the coming winter, leading to a similar scale of increase in imbalance costs for 2022 as seen in the current energy commodity markets.

Cornwall Insight has published more about the challenges facing business consumers and suppliers in its latest Energy Spectrum newsletter (in particular, see page 6). You can register to download it here.

What action to take

Firstly, given recent price rises and volatility, you should continue to engage with your supplier to ensure the most accurate projection of your volume is being used in your contract. This will help avoid any risks associated with under/over purchasing, as well as any penal volume tolerance clauses.

When it comes to securing volume, taking a strategic approach to purchasing is now more important than ever. So seek expert advice to agree the best strategy to meet your requirements, both now and in the longer term.

If you are on a flexible contract, you may want to consider managed options for your supply contract where a Client Portfolio Manager will help you devise an appropriate risk management strategy and then purchase volume on your behalf within that strategy and your budget.

If you’re on a fixed contact, engage with the renewal process well ahead of time – and ideally before the most volatile times of year (winter being a good example).

Finally, if you can be flexible around the times you consume, or are considering investing in on-site generation, now is an ideal time to investigate how taking a more proactive approach can help to mitigate rising costs.

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