Archive for October, 2013

At the October Major Energy Users Council conference in London npower presented a useful overview of the factors likely to impact energy prices over the winter and beyond. Issues that could help keep a lid on wholesale prices include:

  • a slowing Chinese economy reducing international gas/LNG demand
  • continued uncertainty around the government’s carbon policy and the impact of the much anticipated Energy Bill on current carbon policy and taxes. The outcome of next year’s review of the UK’s carbon reduction targets will also have a longer-term impact.
  • at present coal-fired generation is the cheapest (yet most polluting) source of electricity; if prices remain low that could reduce price pressures (but threaten legally binding carbon reduction targets)

On the upside, the factors threatening to push prices up include:

  • continued tensions in the Middle East and particularly Syria; if the conflict widens into neighbouring countries supply risks will inevitably increase
  • concerns over gas supplies: with the UK relying increasingly on imported gas, unexpected pipeline shut downs can quickly reduce gas in storage and drive prices up
  • LNG imported by tankers is an important source of the UK’s energy, yet the global nature of the energy market means that, even when en route, LNG tankers can be diverted if they can receive a better price elsewhere. The UK is now competing with Japan, China, India and others for energy supplies, with implications for the price we pay.
  • an unusually cold or long winter would increase demand, reducing gas in storage, adding price pressures and volatility to the market
  • reduced generation capacity due to polluting (mainly coal) power plants closing to meet the EU’s Large Combustion Plant Directive (LCPD)

While wholesale markets will have priced in many of these risks, unknown factors – winter temperatures, erratic LNG deliveries, Middle Eastern geopolitics, pipeline shutdowns – are set to have the greatest impact on prices over the next 6 months.

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Amid the current firestorm over inexorably rising energy prices the prospect of imminent power blackouts has been slightly overshadowed.

According to the National Grid, the difference between peak electricity demand and available supply is now just 5% compared to 16% two years ago.

A report by the Royal Academy of Engineering, commissioned by the Prime Minister, also warns of future power shortages, with supply anticipated to come under particular strain in the winter of 2014/15.

While the National Grid maintains that we won’t see black outs this winter, the diminishing margin between supply and demand is one of the factors driving the current price rises. Older polluting power stations (particularly those using coal) are being closed while progress in building new plants is slow, stretching the UK’s energy system; the first new generation nuclear station won’t be operating until at least 2023.

Meanwhile, the UK’s growing reliance on imported gas makes us more vulnerable to international energy price shocks, while supply interruptions or power station outages can also hit supply and prices in the short-term.

This means that business users could experience more volatile energy prices than seen over the last year or so, making the timing of procurement decisions more important than ever. Waiting until your contract renewal is due raises the risk that you’ll be hit by a sudden price surge, whereas monitoring prices 12 months or more in advance means you can pick the most opportune time to renew.

The anticipated Autumn price rises have come to pass, with npower following in the footsteps of SSE and British Gas in announcing a domestic price rise of 10.4% from 1 December, slightly higher than SSE and BG.

The remaining members of the ‘big 6’ suppliers are expected to announce their own increases shortly (presumably hoping that the media focus has waned by that time).

The companies blamed increasing wholesale energy costs and growing government green taxes for the price rises.

The announcements generated significant coverage, anger and accusations between suppliers, government and opposition politicians as to the causes, profit levels and means to reduce future price rises, but apart from considerable quantities of hot air, there was little comfort for either domestic or business users.

To add to the energy storm, Scottish Power was the latest company to be fined by Ofgem for misselling, £8.5 million for misleading doorstep and telephone selling during 2009-12.

With price rises now seemingly a fact of life, the main way to minimise future increases is to procure smartly: don’t wait until the few weeks before renewal to look at your energy contract; start reviewing the market at least 6 months in advance so you can minimise the risk of volatile and rising prices.

This doesn’t commit you to anything, just ensures that you have the flexibility to sign your next contract when prices are low, rather than waiting until nearer renewal when you’re at the mercy of a volatile wholesale energy market.

Ed Miliband’s announcement that Labour would freeze energy prices for 20 months if they win the 2015 election generated headlines, hot air and hysteria, while also putting the Conservatives on the back foot.

According to Labour the plan would save households £120 and businesses £1,800, and is required because the ‘big 6’ suppliers have repeatedly failed to pass on falls in the wholesale cost of energy. The response from Centrica (owner of British Gas), npower and others was predictable, with the companies maintaining that a price freeze would deter desperately needed investment in new generation capacity.

Energy price pressures

UK energy prices are determined by three primary factors:

  1. wholesale energy markets: affected by fluctuating demand/supply internationally, economic factors and unexpected incidents (eg the Japanese earthquake and nuclear disaster caused gas prices to spike)
  2. 3rd party, or non-commodity, charges: distribution and transmission costs are rising as investment in the UK’s energy infrastructure increases to link new renewable generation to the national grid
  3. government taxes: green taxes such as the Renewable Obligation and Feed-in-Tariff

In 2007 third-party charges and taxes accounted for around 25% of total electricity costs; that proportion is now nearer 40%, accounting for a significant proportion of prices increases over the last few years.

Questions for Labour

While the price freeze certainly sounds appealing for hard-pressed families and businesses, there remain numerous questions as to its feasibility

  • will the price freeze cover all elements of energy costs?
  • if so, does that means transmission and distribution infrastructure investment will be capped/reduced to prevent prices rises for 20 months?
  • what is to stop energy suppliers raising prices the month before the May 2015 election?
  • what is to stop energy suppliers hiking prices 21 months after Labour win the election?
  • if energy companies freeze investment in new generation capacity what are the implications for the UK’s ability to keep the lights on?

What to do…

If Labour win in 2015 and attempt to impose a price freeze it’s likely that there will be legal challenges from the big suppliers, so there’s no guarantee that the price freeze will actually happen.

In the meantime the best way for businesses to minimise future price rises is to monitor the energy markets to identify the best time to contract. Depending on your corporate requirements, the vast majority of businesses can fix prices for up to 3 years, which reduces the risk from price spikes as just effectively as Miliband’s plan.

The key thing is not just to wait until your annual renewal: your next energy contract can be agreed up to 3 years in advance so don’t wait until your renewal notice.