Options to reduce energy costs – Spot prices

Several years ago businesses in Australia enjoyed a global competitive advantage by operating in an environment of low energy costs . . . then things changed. High energy costs are now becoming critical, and we have seen many businesses (particularly manufacturing) close their doors and move off shore at least partly because of the high cost of energy. Therefore many companies are now seriously looking for ways to reduce those costs.

One of the frequently cited options is “Demand Response” – essentially reducing energy consumption during times of supply/demand imbalance. There are various ways commercial enterprises can participate in demand management exercises, but they are generally a lot of effort for marginal reward.

However taking exposure to the Pool price (E.G. Pool pass-through) is another option that can be considered. While it is not feasible for all businesses, the rewards can be very attractive where it works. But like many things there are risks associated with the rewards. The situation and circumstances will be different for every business and the risk/reward balance must be carefully evaluated.

Simply put, by taking a position on the spot market, an entity is taking on the risk that is normally borne by the retailer . . . and for which the retailer would charge a healthy premium. If the entity is able to manage that risk, it is feasible to reduce its energy cost substantially . . . 10 to 20 percent is possible. With some companies incurring energy costs of many millions of dollars, the savings potential is certainly worth investigating.

The big risk, of course, is being caught exposed to the spot price when it spikes . . . . and the spot price does spike occasionally when the supply/demand balance becomes very “unbalanced”. That is when this can become a very expensive exercise. The Spot rate can rise suddenly to a maximum of $13,800/mWh. A colleague who worked for a steel manufacturer once told me of his experience in taking a Spot price exposure. He said that all was going well for a while and that they had all the necessary hedges in place. But then something went wrong . . . Spot went to the maximum and stayed there for several hours and for whatever reason they were unable to implement their hedges. It cost them millions of dollars. They dropped the Spot exposure immediately thereafter.

But there is risk in everything, and risk can be managed. There are all sorts of hedges that an energy user can put in place . . . financial hedges, physical hedges and contracted hedges. The energy Retailers are very skilled in implementing a host of hedges to protect their positions. Ordinary energy users are less knowledgeable of the options in this area, but they still exist.

For the average energy user, the simplest hedge is “Demand Response” . . . or curtailment. . . . e.g simply stop using the electricity during periods of price spikes. The problem with this is that there is usually a cost for such unplanned curtailment . . . . e.g. shutting down production. In some circumstances it is simply not possible at all, in other cases it is quite expensive and therefore not a feasible option.

However, in some circumstances such as a refrigerated storage operation, the hedge comes at almost no cost at all. Through the phenomena of “thermal inertia”, a cold store operator is able to shut down the compressors on the refrigeration system completely without any noticeable impact on the product. In a cold storage operation where I worked several years ago, we actually turned off the refrigeration plant for several hours during the day just to see what would happen. We left the lights and other critical electrical circuits operating as normal. The result was: the air temperature rose only marginally . . . barely noticeable. The workers on the floor continued working and did not notice anything. And the product temperature was totally unchanged.

For many cold storage operations, energy costs comprise a significant portion of the total cost to the business – e.g. 80 – 90%. Therefore spot pass-through is particularly suited for cold storage operators.

Generally the Spot market price spikes do not last very long because when they occur, someone starts hemorrhaging financially very badly and will do whatever it takes to bring the supply/demand back into balance. Usually the big spikes only last for an hour or two and most of them are predictable. Usually they are weather related.

And if an entity has a “stand by” generator in place, this is a physical hedge which can be used as additional protection for Spot price exposure . . . or also to generate revenue via a number of Demand Management options. There are a lot of corporate stand-by generators in place primarily for emergency reasons . . . . and are not being used effectively to reduce business costs.

So why are so few businesses taking advantage of this opportunity to reduce their energy costs?

Perhaps they are unaware of the options as it is not widely publicized. It is not really in the major players’ interest to publicize this option.

The electricity industry & supply chain is complex and most senior corporate managers do not understand it. They are more focused on the production of their main product or service. Energy is simply a cost component which is mysterious and best left to the procurement people to negotiate the best rate available from their friendly retailer. . . . a pretty one dimensional outlook. This situation is again reinforced by the fact that most businesses do not have the luxury of having an energy expert on staff who can be “creative” in developing an innovative solution to reduce costs.

Also most senior managers are “risk averse” . . . especially when the risk involves a complex set of circumstances which they do not fully understand. Even if risk mitigating tactics are put in place, they would want some additional assurances that the “hedges” will be highly reliable and be available when needed. As a consequence, all too often other issues take precedence and creative energy solutions are pushed to the back of the queue.

But the rewards can be significant if the circumstances warrant. Businesses with significant energy costs should certainly look into the possibility of taking a position with Spot prices.

About our Guest Author

0eb9fc7 Roy Ranney is a consultant and commercial manager with more than 20 years experience in both Australian and international markets. In addition to his consultancy work, Roy is also the NSW Regional Manager for the Energy Users Association of Australia.
Further background to Roycan be found on Wayne’s LinkedIn profile.