Andrew Toher, Head of Customer Insights, Enel X UK, discusses the risks and opportunities in navigating energy markets during the Covid-19 crisis.
The coronavirus pandemic has left many energy and procurement professionals grappling with a set of seemingly intractable problems.
On the face of it, historically low energy pricing in forward markets provides an opportunity for businesses to lock in attractive energy prices for future years. However, conversations with many of our customers show that there is a raft of issues to consider before committing to new contracts.
According to the International Energy Agency, COVID-19 has caused a “staggering” drop in energy demand. Many suppliers have been put in a perilous position as wholesale electricity prices have slumped to their lowest in a decade. On top of that, suppliers are having to manage a surge in bad debts, as some businesses struggle to make payments. Not surprisingly, suppliers are reviewing the way they do business so that they can stay in business.
Enel X works worldwide with major energy users across multiple commercial and industrial sectors, including manufacturing, retail, distribution and professional services; the majority of our customers have been affected in some way by the lockdown.
Recently we have seen suppliers ask for security deposits or upfront charges even for businesses that have enjoyed good credit ratings in the past. Suppliers are also attempting to limit risk through volume tolerance clauses and more onerous bandwidth provisions.
Some suppliers are refusing to take on new business if they think the risk is too great, and this is severely limiting the options available to customers looking to negotiate a better deal. Without the correct advice, customers may feel they have no choice but to accept increasingly onerous contract terms.
Major energy users have had their normal business demand patterns turned on their head. Where facilities are currently standing idle, demand has plummeted. For some operations, such as food distribution centres, demand has shot up due to the increase in activities and operating hours. Clients with mixed business-use portfolios are left trying to manage very complex situations where their retail operations are using less energy, data centre demand has remained constant or gone up, and their office facilities are impacted in different ways.
As well as dealing with exceptional patterns of demand in the present, energy managers have to try to predict future demand. With the uncertainties surrounding lockdown exit strategies, businesses have little idea when demand will return to normal, or indeed what normal looks like once lockdown is over.
For many businesses, procurement is just one dimension of an increasingly holistic and complex energy strategy. Additional responsibilities include achieving long-term sustainability goals, monetising flexibility and demand-side response, increasing efficiency measures such as asset optimisation, and deploying EV infrastructure to enable e-mobility.
Some responsible for managing energy supplies feel it is increasingly difficult to balance all these competing priorities. On top of this, getting board-level approval for major energy decisions is difficult when more pressing business issues take priority.
Successfully navigating today’s turbulent energy landscape requires a thorough understanding of the sector’s dynamics, including the approach being taken by each supplier. It’s apparent that there will be no one-size-fits-all strategy; the best course of action depends on the sector and each customer’s specific situation.
A typical business energy buying cycle looks two-three years into the future to satisfy medium-term needs, alongside a longer-term buying cycle that is more often focused on decarbonisation goals. Developers of renewable schemes typically offer 12-15-year power purchase agreements (PPAs) with off-takers.
One dilemma facing many buyers is that while they are tasked with decarbonising their business’s energy systems, they are looking to procure energy at minimum cost. Plunging prices for short-term energy deals make long-term renewable PPA commitments look relatively expensive today. However, this comparison may be flawed; there is nothing to suggest that today’s exceptional short-term price trends will change the long-term outlook for energy prices. A PPA that looked like a good deal a year ago may still be a good deal today. Buyers shouldn’t assume that procurement forecasting models using today’s energy prices will be valid over the medium to long term.
Customers have to buy energy to sustain their business operations today; they cannot easily delay short-term purchase decisions. While the best approach for each business will depend on their specific circumstances, there are a number of strategies that apply across the board.
Suppliers’ terms of business vary, and we recommend that buyers perform due diligence to assess the deals on offer and aim to invite suppliers of good standing to tender.
It is important that buyers perform a detailed review of any terms on offer. What can seem like innocuous clauses in a contract can have far-reaching consequences. Having access to experienced procurement professionals with expertise in assessing energy contracts will help to manage the risks.
Suppliers are looking to offset their risks as far as possible and one way to do that is with tighter volume tolerance clauses. If customers have to sell back their unused volume, this would shift the risk to them. Consequently, it has become a lot more important to forecast volume – or the amount of energy the business needs – as accurately as possible. Some sectors, such as manufacturers with variable production runs, are more used to dealing with volume risk and forecasting accuracy. For other business sectors, such as offices and retailers, forecasting volume requirements may be less straightforward than in the past.
Whatever a business’s contract terms, it is important to evaluate agreements and assess contract rates. Customers should notify their suppliers of significant operational changes and work towards a mutually acceptable renegotiation of rates and terms.
With a complete and transparent understanding of a supplier’s terms and the associated risks, customers may be able to take advantage of today’s prices in retail markets to satisfy their energy needs.
As we begin the process of exiting lockdown, the transition back to work will be a gradual process for many businesses, with social distancing continuing to impact operations for some time. Companies will be under enormous pressure to control their costs as they rebuild, with energy spend in particular coming under the spotlight.
There is growing evidence linking air pollution with the health impact of coronavirus, which may increase pressure on businesses to accelerate their decarbonisation initiatives. Some governments are already demanding steep emissions cuts from certain sectors in return for bailout packages. With this in mind, it’s unlikely that businesses would want to dilute their decarbonisation commitments in order to benefit from cheaper power.
We should expect continued turbulence across the energy sector for some time. Combining a detailed understanding of the dynamics of today’s energy landscape with a vision for the long-term horizon will enable businesses to build agility and resilience into their procurement strategies. l