Energy purchasing - Electricity

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Getting a better power deal

This paper aims to explain electricity pricing, what is negotiable in electricity contracts, and strategies for negotiating the best deal on your power. It also provides information on minimising non-negotiable costs.

Due to a general fall in electricity prices, many farmers will see a reduction in ‘standard’ offers when they next go to market. However, it is likely that further reductions can be arrived at through smart negotiation, good timing and the selection of optimal contract configurations.

Understanding the electricity market (and the economic factors that determine the deals retailers are prepared to offer on a given day) places you in a stronger negotiating position. 

Negotiation tips

1.Maximise retailer participation. Keep things simple and involve your retailer in planning the contract renewal or tender.

2.Provide detailed and accurate data, including information about farm expansion and/or changes in stock, crop(s) or the proposed mix of activities, where known. Retailers need to evaluate your demand profile. Unforeseen demand costs them money and they will pass that risk on to your operation in the form of higher charges.

3.Don’t include unreasonable requests. You will pay for everything you ask for in the contract.

4.Keep to the contract negotiation timetable. That way, you minimise risk for retailers – they are costing your deal on the basis of projections made within a particular time window.

5.Be ready to make a quick decision. Prepare for internal sign-off once the contract is offered (24 hours is best).

Why prices fluctuate

The cost of electricity in NSW has increased by 50–100 percent in the past three to five years, largely due to increases in network and environmental charges. Electricity ‘commodity’ prices – as opposed to overall electricity costs that include network, carbon and other charges – have been decreasing since 2008–2009, when annual demand peaked. Since then, demand has fallen at an annual rate of approximately 1.2 percent. The medium-term future is still relatively subdued, with declining demand only expected to return to previous highs during 2014–2016.

It seems that the current low demand for electricity has reduced the occurrence of expensive wholesale pricing even during heatwave conditions. NSW electricity spot market prices are forecast to drop by about 26 percent between 2013–2014 and 2015–2016. This is in line with the predicted drop in demand and anticipated repeal of the carbon price (NERA economic consulting, 2013).

Bulk electricity is a unique commodity in that it can’t be stored cost-effectively and must be used immediately once generated. Price drivers of supply and demand are accentuated in these circumstances.

Electricity retailers purchase energy from generators to cover their customers’ load demand at all times. Generated electricity is therefore bought and sold 24/7. When demand increases dramatically, prices in the spot market (where retailers buy wholesale electricity) can spike sharply. While the 

independent market operator (AEMO) is responsible for ensuring that the required demand is satisfied at the cheapest possible prices, the extent of such demand often impacts short-term or ‘spot’ market prices dramatically. Small users, drawing less than 160 MWh of electrical power per annum, are subject to local tariffs regulated on an annual basis; thus, they are not impacted by changes in spot prices.

Role of spot market and futures market prices

When entering into retail customer contracts for fixed terms and prices, electricity retailers manage the risk of a floating and potentially volatile spot market price by charging a premium. Retail electricity contract pricing is therefore higher than the prices available on the wholesale spot market, as it includes a ‘retailer margin’ for managing risk.

Even though the spot market is a short-term market reflecting immediate supply and demand, it also impacts the longer-term pricing offered by retailers. This means that often, it is advantageous to go to market in periods of lower spot market pricing, even though your electricity contract may run for many years into the future.

To help mitigate or ‘hedge’ against longer-term price risk, retailers and generators often enter into electricity ‘futures’ or ‘forward’ contracts (i.e. contracts, set at a certain price, for the buying or selling of electricity at a future date). When the designated date arrives, the difference between the spot market and the agreed-on or purchased futures contract is settled between the retailer and generator.

The futures market thus becomes a proxy for what traders from the retailers and generators believe the electricity spot price will be at a future date. Electricity futures prices for financial or calendar years can be viewed on the futures exchange by accessing the ASX electricity futures website (Australian Stock Exchange, 2013).

Many drivers impact the wholesale short-term spot price, the longer-term futures market and, ultimately, the contract electricity price offered by a retailer on a particular day. These may include:

  • weather, e.g. the risk of high temperatures and
    seasonal change,
  • rainfall and water storage in dams, e.g. the amount of water available for making steam and cooling turbines,
  • generator fuel input prices, e.g. coal and gas prices,
  • generation mix – using a higher level of non-coal fuels will be expensive, and
  • government regulation, e.g. the carbon price, the cost of generators.

The NSW Wholesale Electricity Futures market’s response to regulatory announcements in the recent past – specifically, to changes in carbon legislation between 2009 and 2011 – is illustrated below. Futures pricing is inclusive of carbon, so the more likely it seemed that a carbon scheme would eventuate, the higher the futures price became. To illustrate the effect of carbon price futures in Financial Year 2012/13 (Fin13), a dotted line indicating an estimate of the futures price without carbon has been added to the graph. This shows that traders were factoring in a carbon cost of around $20 or two cents per kilowatt hour from the time of formal announcements in 2011.

Electricity prices NSW
Figure 1: NSW Wholesale Electricity Futures Prices and the impacts of carbon legislation issues 2008–2011.
Energetics

Drivers of spot and futures market prices

The wholesale spot and futures price response to key drivers will be determined by their impact on supply and demand. For example, prices may increase where supply is reduced, such as when a generator goes offline or is phased out; they may decrease in a global recession when demand for electricity to produce goods lessens. Human factors, such as the buying and selling behaviour of electricity traders, may also influence the extent of the market’s response to underlying fundamentals.

What is negotiable in my electricity contract?

When looking at your overall energy costs, you’ll find that only some portions are available for negotiation. The graph below shows a typical electricity-cost split for a farmer in country NSW and identifies the negotiable components.

Electricity cost breakdown
Figure 2: Typical electricity cost components for NSW farms in 2013.
NSW Farmers

Although only 38 percent of electricity costs are negotiable, it pays to spend the most effort on the cost items over which you have the most negotiable control. These are:

  • energy,
  • environmental charges, and
  • metering charges.

Energy charges

The contract price you receive from a retailer may fluctuate depending on the day you go to market and the price drivers in play at that time. Negotiations may also be significantly affected by the duration of your contract, as well as the accuracy and attractiveness of your electrical load to the retailer. A peaky or inconsistent load will be less attractive to the retailer unless it’s a significant volume of electricity or gas.

Strategies to consider when negotiating the best energy price are discussed below.

Environmental charges

Environmental charges are typically based on retailer or generator compliance with government schemes designed to increase efficiency or reduce greenhouse gas (GHG) emissions - eg The Renewable Energy Target (RET) charge designed to support R&D into renewable energy sources for agriculture and other industries. Environmental charges often involve the surrender of certificates by the retailer which has an obligation to acquit enough certificates to cover it sold energy. The retailer then passes this cost on to end users, proportional to their energy usage.

Many consumers don’t realise that environmental charges are contestable and in many cases will vary significantly from retailer to retailer. It is worth checking the rates before contracting and also looking at ways to control cost, for example, agreeing to fix certificate prices with your retailer so that you have more budget certainty.

Metering charges

Negotiating a metering contract can be important if the farm has a number of meters. Each retailer has a preferred metering supplier and if you elect to go with that preferred supplier you will avoid an administration fee. The best strategy is to find out the fee and see if you can negotiate a cheaper deal covering your own direct metering contract with another supplier plus the administration fee.

Carbon charges

Until the carbon tax is repealed, regulations driving the price on carbon will remain in force (at least until 30 June 2014).
In previous years, many retailers offered ‘carbon inclusive’ pricing which means that the carbon price is not only incorporated into their energy rates, but also that the
rates will apply even if the carbon price is repealed.

In recent times, the carbon-inclusive price had become very competitive as the ‘included’ carbon component was low, based on expectations that the carbon tax would be repealed. However, given the Government’s intent to repeal the carbon price legislation it is potentially risky to opt for a carbon inclusive contract that extends beyond July 2014.

If your current contract is carbon-inclusive and there is no separate carbon cost line on your bill, it may be prudent to check the contract expiry date and the clause in your electricity contract that relates to carbon (with respect to what happens if the price is repealed or changed).

Where a contract is carbon-inclusive, the electricity rate will include the cost of carbon and will appear as a single fixed-rate figure on your bill. This rate will vary depending on what value of carbon is implied by your retailer for a particular time frame in the future and this value is then applied to your contract.

The alternative carbon-exclusive contract has electricity rates that do not include an implied carbon value but rather, carbon is an additional ‘pass-through’ cost. Typically, the carbon ‘pass-through’ cost under existing contracts will be calculated by the retailer, using a carbon intensity factor published by AEMO multiplied by the current carbon price. The ‘carbon intensity’ factor represents a calculation by AEMO of the carbon intensity of the generated electricity that day. This will vary according to generation mix, and the extent to which lower-emission or less carbon-intensive generation of power from renewable sources or gas has been dispatched.

For example, under a carbon-exclusive contract for a given month, a retailer may apply the average carbon intensity (ACI) for the month to the carbon price.

ACI x carbon price (e.g. $24.15/MWh in 201314) =
pass-through carbon charge.

If, in October, the ACI is 0.85 (Australian energy market operator, 2013) the charge is calculated as:

0.85 x $24.15 = $20.52/MWh or 2.05 c/kWh

Carbon charges are also discussed below in relation to strategies for getting the best prices.

Purchasing strategies

Going to market at the right time

One of the key challenges for all purchasers of energy is deciding when to go to market. Given that there is a futures market in operation, it is neither necessary nor advantageous to wait until close to your contract’s expiry date to start your purchasing exercise.

Naturally, not everyone is watching the market every day. Owing to fluctuation in prices over any given year, it is well worth investing the time to request offers on a lower-priced day or when market prices are in a downtrend. To do this, you’ll need to have market price information.

A number of free websites can deliver information on electricity futures and spot market prices. ASX (Australian Stock Exchange, 2013) and AEMO (Australian energy market operator, 2013) as well as D-cypha trade are the primary sources of this valuable information.

Contracting for the best duration

Contract duration should always be considered when going to market. If you’re unsure about the direction of the longer-term market, requesting pricing for, say, the next four or five years will help show you what the retailers believe. Note, however, that retailers typically build a duration-based risk margin into outer-year pricing. The underlying philosophy is that the further away the pricing is, the less certain retailers can be about what the actual electricity prices will be.

To determine the best contract duration, compare the prices retailers offer you with the electricity futures available, and consider these in light of any major price driver impacts and pricing trends. In a steadily rising market it would not be uncommon to opt for a longer contract. In a flat or decreasing market, it may be better to secure a shorter contract, with the aim of buying electricity at a cheaper rate in the future.

In 2013, for example, the NSW market was low and electricity commodity prices were close to experiencing five-year lows. Owing to uncertainty about government policy with respect to carbon and the volatile international economy, however, retailers were building risk margins into long-dated contracts. At such times, large-scale electricity users often consider limiting their exposure to these risk premiums by opting for two- or even one-year contracts.

TOU pricing
Chart 1: Time-of-use electricity pricing.
Aus Grid

Making your contract attractive

Retailers are risk-averse, or at least they will build premiums into their pricing to cover risk. So it is important that you make sure your prospective contract is as low-risk and as attractive to retailers as possible. It is also important to contact as many retailers as possible so as to get a truly competitive price. To make your contract appealing:

  • Provide an accurate picture of your consumption. The more electricity you use, the more important it is to request accurate meter usage data from your current retailer. Customers that produce meter data along with their request for a proposal are presenting an accurate history of their electricity usage for each half-hour period over 12 months. This gives the retailer an excellent understanding of how much electricity your farm uses in each time band of peak, shoulder and off-peak power. The better appraised retailers are of your usage patterns, the less risk premium for load fluctuation they need to build into their pricing.
  • Shift electricity usage to off-peak load. Retailers like contracts in which the power load is steady and predictable and often, they prefer greater load in off-peak periods when the market is less likely to be volatile. Where possible, it is advisable to shift your load to off-peak times and take action to smooth out any spikes in demand.

Following these strategies when negotiating your next electricity contract should deliver cost advantages and make your energy purchasing significantly more effective. 

Minimising non-negotiable costs

Network charges

Network costs constitute approximately 60 percent of electricity cost. This component is non-negotiable and is determined by your location. This means that the rates are set for your area. Often, however, there are two or more tariffs available, so the trick is to be on the best network tariff for your area and to optimise consumption to match that tariff.

The two main tariff types are time-of-use and demand-based. In country NSW there is also a tariff that is both time-of-use and demand-based. Many farmers are on this tariff and unfortunately, may have little choice in terms of switching to another tariff.

If you do not have access to a better electricity tariff, your easiest option for reducing costs is to optimise power consumption to match the lower rates. For the time-of-use component of the tariff, power is cheaper at off-peak and shoulder times (see figure for an example of time-of-use periods) – consider switching or shifting power-guzzling activities to off-peak and/or shoulder times where possible.

The demand component of the contract is determined either by your highest demand for electricity during the past 12 months or your highest demand at particular times of use – so a single high-demand event could have a big cost impact.

Strategies for reducing maximum demand might include:

  • Avoid starting up lots of energy-intensive electrical equipment at the same time, as more power is consumed during start-up than during operation.
  • Consider whether your load could be shifted, say, by running machinery in isolation rather than concurrently.
  • Examine power factor correction, meaning that usable power has been maximised relative to the amount of power that is paid for through your meter. This is further discussed in a separate NSW Farmers fact sheet.

Essential Energy (Formerly Country Energy) has a tariff analysis service that can help you to identify the optimal tariff for your farm. To access the service, call the energyanswers team on 1800 ENERGY (1800 363 749) or email energyanswers@essentialenergy.com.au.

Switching fuels

One way of reducing non-negotiable cost is to use less energy from the network by switching to renewable or alternative energy sources such as solar generation. In this regard, it is worth investigating the suitability of power purchase agreements for your property. See NSW Farmers fact sheets on renewable energy options.

Power purchase agreements

Despite the withdrawal by the NSW Government of feed-in tariffs (i.e. payment for feeding energy into the network), attractive solar photovoltaic (PV) deals are still available in the market under power purchase agreements. Under this model, suppliers/installers typically agree to install a solar array and maintain it. To pay off the equipment, the user simply purchases the solar electricity created directly from the installer until both installation and equipment is paid off. This means that potentially, the up-front costs are zero.

This kind of ‘power purchase agreement’ is ‘behind the meter’ and therefore no network charges are due, as all the electricity generated is used on-site. The longer the duration of the agreement, the lower your electricity price becomes. Most such deals will be cost-competitive with energy from non-renewable sources if the deal duration is more than 10 years. As with a traditional fossil fuel power agreement, it pays to shop around for the best deal available. It is also prudent to source and research reputable providers of proven equipment.

There is a risk that demand charges may not be reduced if the load from a complementary renewable source is not co-coincident with peak demand (e.g. one cloudy day could negate the impact of a solar PV system on the peak demand
of your site. Refer to supplementary paper, Solar photovoltaics.

It’s important to note that your current electricity contract may have a minimum annual quantity, typically 90 percent of your contracted amount. So before implementing new major actions to reduce usage, through fuel switching or other means, consider the timing. If just you’re about to enter into a new electricity contract, you should of course factor in  reduced consumption and the timing of the change – for example it might not occur or may not decrease your energy usage until the second year of the contract.

Further information

Farm Energy Innovation papers

Energy in sheds: Power quality – Power factor correction - What is power factor? And how does it influence electricity purchasing and pricing?

Energy in sheds: Power quality – Voltage optimisation - How voltage optimisation can improve delivered power quality and reduce existing demand.

Other sources

The Australian Power Market - The Australian Stock Exchange website provides energy market pricing and details on market factors.

The Australian Energy Market Operator (AEMO) - AEMO’s site has regularly updated power pricing and demand information on energy sources including electricity and natural gas within Australia.

The Australian Energy Regulator: For Consumers - Information about consumer rights with regard to energy purchasing.

References

ABARE, 2006. Farm Costs and Returns – Statistics, s.l.: Australian Bureau of Statistics.

Hanna, M. & Ayres, G., 2011. Fuel Required for Field Operations. [Online]

Intelligent Energy Europe, 2010. Efficient20. [Online]

Svejkovsky, C., 2007. Conserving Fuel on the Farm. [Online]

University of Nebraska-Lincoln, n.d. Nebraska Tractor Test Laboratory. [Online]


This content was produced with assistance from Energetics
www.energetics.com.au

 

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