Getting smart on energy procurement

• 5 years ago (2018-05-07)
• Junior Isles

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Chris Maclean , CEO, Open Energy Market shares his insight on how flexibility in the procurement market is changing the game.

While the domestic market has had Ofgem-imposed regulation to clean up complex tariff structures in a bid to reduce complexity, the commercial market still retains the tariff flexibility that can lead to significant cost-saving opportunities. Removing the risk premiums and generating more insight is the objective, and proactive businesses need to unlock these opportunities by initially switching to a “pass-through” contract over the historically favoured fully inclusive option.

By opting for pass-through contracts, businesses will ensure all the non-commodity components of an energy bill are passed through at cost and separated as different line items on an invoice. This means they can:
- avoid the bulk of opportunist or risk charges added by suppliers;

- take full advantage of any efficiency improvements that they make;

- actively manage exposure to each part of their bill.

With more line items on an invoice, pass-through contracts do bring a level of additional complexity to an energy bill, and in the past, only the largescale businesses who have been able to invest the time and resource into understanding their bills and the opportunity the contract provides, have been able to capitalise. What’s crucial now is that the latest technology can bring that same level of understanding to a wider audience, mitigating concerns and risks, simplifying the level of detail hidden within energy bills and providing analysis and suggestions, that will open up the opportunities for all businesses to find areas to cut their costs.

With minimum effort and a deeper level of understanding about all costs making up an energy contract, businesses of all sizes can now make significant reductions in their energy bills, which should also enhance market efficiency by removing what economists call “externalities”, or the cost of doing business in a market. Suppliers in the UK’s energy markets rarely lose out on fixed price deals and can make significant gains. In a more efficient market, that margin ends up being retained by the business.

Overcoming inertia

Attracted by certainty and security, most businesses buy inclusive, fixed price energy contracts that use historical data to define forward pricing for all distribution, transmission and legislative costs. But these deals will involve a substantial risk premium to the supplier in order to guarantee or fix the rates. However, the rates on the whole are predictable and on average out-turn as forecast. So why pay the margin for another organisation to take on the risk?

If you fix them, you can’t impact them. Changing shift patterns to avoid substantial distribution costs at peak times won’t make a difference. The individual charges can be worked on and negated. Why remove that opportunity?

Greater procurement flexibility means a company can fully optimise any investment in energy efficient technology, extending savings beyond just simply reducing their overall consumption. Another example is the Triad charge, which relates to energy consumed during the three highest demand periods of winter – and has a significant effect on a business’ overall energy cost: this should be a target for most companies keen to cut costs. But they cannot be influenced under an inclusive deal.

Carrot and stick

The government has clear policy objectives to encourage renewables, and these are reflected in the market through price fluctuations and government charges. But the only way these will be effective in changing behaviour is if the business is exposed to the prices and charges, and begins to understand them – rather than those charges being hidden in an inclusive price.

By not being exposed to price signals that result from government decarbonisation policies, companies are not incentivised to respond to the policies. This undermines progressive businesses that are investing in innovative and often carbon-saving measures. Such companies are increasingly looking to get a competitive advantage through smarter energy procurement, as well as to ensure they comply with sustainable development goals – and they should be encouraged to do so.

In the past, businesses were happy to trade any potential savings for a simple understandable invoice. However, energy prices are going up, the non-commodity charges are increasing and therefore the saving opportunity is also growing. New technology is removing the complexity and businesses need to be more progressive on how they view their energy costs.

As in the case of market competition, which will only work if households switch to the lowest price suppliers, the government’s policy objectives relating to decarbonisation and matching demand to supply, will only be met if business consumers are exposed to the charges and change behaviour to minimise them. In both cases, markets become more efficient and the savings can be substantial, but once the incentives and technology are there, the business still needs to act.