Updated Thursday 23rd January 2020
When the time comes for your business to review its energy procurement strategy, it can be difficult to know which contract options are best for you. With the recent rise in non-commodity costs, those whose procurement contracts are ending shortly may be wondering what the best approach is for their business: to fix, or to flex?
The UK’s wholesale energy markets have seen significant turbulence in the last year, driven in part by uncertainty surrounding the UK’s continued relationship with the EU after Brexit.
Assuming the European Parliament gives the green light, the UK will formally leave the EU on 31st January with a withdrawal deal – and will then go into a transition period scheduled to end on the 31st December 2020.
With regional supply security all but assured post-Brexit, much of the current market uncertainty surrounds the UK’s Emissions Trading Scheme (ETS). The UK will leave the EU ETS after Dec-20, toward a flat carbon taxation for UK installations. Although UK ETS guidelines have already been released by the Government, accelerating climate change action globally may drive alterations to the scheme, subsequently buoying wholesale energy costs.
What’s the market outlook?
It’s not just Brexit that will affect the market – there are such a wide range of factors that influence the UK’s supply of energy, adding complexity to predicting whether prices will rise or fall in the future. Several factors could push prices up; as the UK’s nuclear fleets continue to age and we become more reliant on intermittent renewable generation for example, a risk premium could be added as a result of supply security anxiety. What’s more, future investment in new nuclear may be passed on to customers with the Government currently reviewing funding strategies for new builds.
Other factors could cause wholesale prices to fall. Liquified Natural Gas (LNG) is becoming more important in the UK, for example, and the global supply of LNG is increasing. Downward pressure on wholesale energy prices could be further compounded by growing continental supply from Russia, particularly as the RUS-GER Nord Stream 2 pipeline looks set for completion by the end of Q1-21.
When it comes to non-commodity costs, however, a significant increase in coming years is fairly certain, with our energy system continually having to meet increasingly complex supply and demand balancing.
Should my business fix or flex?
The potential for wholesale prices to rise causes many risk-averse businesses to opt for a fixed price contract, but it’s important to recognise that there is a level of risk involved regardless of whether you fix or flex. Many see flexible contracts as inherently riskier than fixed products due to the multiple purchasing decisions involved, but this risk can be mitigated by making well-informed decisions about when you buy your energy and how much you buy.
Fixed products also aren’t without risk – in fact, there’s a risk premium built into fixed contracts, so you’re always paying more than cost for your energy. They are also never truly fixed, as if your supplier faces new charges, then they will be passed through to your energy bills. So, while your appetite for risk should be a key consideration when choosing a procurement strategy, remember that ‘fixed’ doesn’t mean ‘risk-free’.
You should also assess whether you will need external support with procurement. If you don’t have the support of external experts, such as Inspired’s procurement team, you may find it difficult to access the full benefits of a particular product. The biggest benefit of a fixed contract, for example, is buying and locking in when prices are low, but you may need expert support to gauge when a market low is present. One of the biggest benefits of a flexible contract, on the other hand, is being able to buy your energy when prices fall – but once again, gauging when is best to buy often requires support from experts who have well-rounded insight into the market.
You may also need help with more than just your procurement. While fixed contracts come with relatively simple bills, their simplicity can also lead to a lack of transparency around both commodity and non-commodity costs. If you choose a flexible contract, you gain total transparency around your costs, but your bills will also be more complex. This makes billing errors more likely, so if you have a flexible contract it is wise to have support with billing validation to ensure you’re not being billed incorrectly.
Is there another way?
If the benefits of both fixed and flexible contracts sound appealing to you, you don’t have to choose one or the other. Taking a portfolio approach to energy buying can give you the ‘best of both worlds’, as you spread your volume across multiple buying strategies – fixed and flexible. This enables you to benefit from a procurement strategy that’s tailored to your organisation’s unique needs.
Portfolio strategies do require external support, however, and Inspired’s procurement experts are best placed to help you build your ideal portfolio. We can help you to take an entirely bespoke approach, or a more collaborative approach, aggregating your volume with similar businesses to enable you to reduce the risk of breaching your volume tolerance thresholds.
Our team will use best practice and our extensive experience to make well-informed purchasing decisions. We’ll also provide you with a forecast fully delivered cost per month, giving you transparency and peace of mind around your energy costs. To find out more about how we can support you with a fixed, flexible or portfolio approach, visit our Procurement page.