Is the wholesale market the place to be for energy procurement?

Lancaster, UK -- While the major energy users in industry have for years had the benefit of access to the wholesale energy market for their energy contract needs, a large number are still not taking advantage. For process industries, with their potentially huge annual energy spend, the issue is particularly pertinent.

Activity in the wholesale market allows for longer-term positions to be taken. With active management of 2008 contracts and beyond now well underway, it is important for those considering entering the market for the first time to understand the issues, and to take action without delay, in order to take advantage of the benefits on offer.

Historically, energy price was a subject that raised limited concerns, particularly as prices fell in the mid 90’s, but it is now very much back on the agenda. Volatility, uncertainty and the transfer of price-risk from the supplier to the consumer, have caused more than a little concern in boardrooms across the UK.

Those companies not taking advantage of the wholesale market were taken unawares by the market movements in 2005/6, which saw 30-40% annual increases in costs break through and impact significantly on annual budgets. Financial directors saw thousands taken off expected bottom-line profit levels on fixed product sales contracts, negotiated months before.

Many companies, having been hit by price surges in 2005, entered into longer-term retail contracts -- conventionally tendered one-off contracts -- last year and now have the “double whammy” of being unable to benefit from lower cost levels in 2007/8.

This new volatility in the markets brings with it a considerable risk element and many companies do not have the time or indeed, the knowledge and expertise that develops over time, to escape the, sometimes, dire consequences.

Most energy contracts are signed off at board level and directors, engaged in the areas of the business, which are their primary responsibility, may be unavailable at short notice. This presents an additional risk as contract options in the retail market have a very limited shelf-life, a matter of a few hours at best and most contract offers lapse before they are even discussed.

Most companies still run energy procurement on the traditional annual tender model, believing that retaining the authority to sign off on a given contract gives them a level of control over events. It does not. The fact is that by determining the date when a company goes to market, without any real knowledge of the current market levels or trends, means that they are placing the success of their whole strategy on chance.

It is no more than a lottery, generally with very few winners and probably none on a long-term basis. It is thought that sooner or later the market will bite and bite hard, with any gains that may have been achieved, more by luck than good management, flowing quickly away.

Previously, companies had little choice other than to remain in the retail sector and contract for energy, either directly or through broker companies, but in the end, the result was the same. Most energy is contracted on a single day for the next 12-24 months, but as prices can vary by as much as 20%+ in a matter of weeks, the risk can be immense and the contract timing is critical.

Decision makers are largely unaware that an alternative exists. Access to the wholesale markets is now a possibility for companies with energy spends between £100,000 and £5,000,000 per annum.

However, wholesale purchasing contracts now allow smaller companies to take advantage of what was previously only available to the major energy users -- access to competitive market pricing for the majority of the contract spend rather than the limited amount currently accessed via the retail sector.

In round terms, the energy bill, be it electricity or gas, is made up of three distinct areas of charge, namely; commodity costs (75%), delivery cost (20%) and supplier cost (5%). Retail pricing offers negotiation only on the smallest element of your bill, with the supplier often limited to very small margins, possibly as little as 2%.

This limited variance figure can be easily lost by wholesale price movements within the day, but access to the wholesale market provides control over the majority of your costs, procured through 25 or more energy market traders on live systems every day.

Trading energy on a bulk basis allows the opportunity to benefit from scores of market trades in the build up to the overall load profile covering all the clients of specialist energy purchasing companies.

Expert consultants, with up to date market information, monitor trends and forecasts to identify opportunities that may arise to purchase energy, offering professional risk management services, previously unavailable to most companies.

Risk management is a well-practised and growing area within most UK business activities; energy should be no different. Designed as a strategic tool, within the wholesale energy markets, it will allow companies to navigate through often hostile waters, offering competitive advantage against less commercially astute organisations.

Energy procurement can no longer be undertaken on a part-time basis, the risks are just too great. World events add thousands to contract values, within hours, unseen by hard working employees whose direction has moved to matters of production, sales or other company strategies. The process industries need to act now to maintain their competitive edge.

Phil Hallsworth in MD of Quantum Energy Ltd, a specialist company which offers access to wholesale energy purchasing. Quantum has recently teamed up with engineering company Haden Freeman to offer energy management advice to industrial companies