Background
The problem:
Australian electricity prices have increased significantly over the past five years due to a combination of factors including tight supply, changes in the generation mix, and a lack of national energy policy.
The result:
Highly energy-intensive businesses have been hit hard, and in many cases off-guard, as energy costs have become one of the highest operating costs for many businesses. In fact, energy costs now are placed amongst payroll and rent as key costs in operating a business.
Consequently, business operators are now being forced to take an active approach to manage their energy costs. This includes proactive energy procurement strategies, together with investment in site upgrades to reduce any usage and onsite (behind the meter) generation such as solar.
This article focuses on energy procurement and the types of offers and contract types available to large market electricity customers. This article is less relevant to SME and residential customers.
Energy Procurement – What types of electricity supply offers are available to businesses?
Energy users now have a range of options to procure electricity from energy suppliers:
1 – Retail – Fixed price forward agreement:One option is to enter into a fixed price forward supply agreement with an energy retailer. This type of deal involves purchasing energy for a future time period at an agreed rate.
Assuming the business is classed as “Large” by the network, contract terms typically range from 1-5 years. The product is relatively simple, provides cost certainty but the customer risks locking into uncommercial rates if the procurement process is not timed well (ie. the customer locks into the contract when the market is high).
2 – Retail – Progressive purchasing forward agreement: This option is offered by some electricity retailers and enables customers to progressively lock in rates throughout the period of the supply agreement. The product is more complex and requires active management to help ensure rates are locked in at optimal market times.
3 – Retail – Pool Price Pass-Through: This is a high-risk option that enables the customer to ride the volatile electricity spot market. The product is suitable for businesses that can proactively and rapidly adjust consumption to respond to spot market volatility.
4 – Corporate PPA: Also available on the market is entering into a Power Purchase Agreement. This normally involves buying electricity at an agreed price for a fixed period which usually ranges from 7 to 20 years. There are a number of PPA structures but essentially they involve an agreement between buyer and generator (normally solar and wind) with the energy retailer facilitating the billing and account management process.
5 – Behind-The-Meter PPA: This is a Power Purchase Agreement but relies on electricity generated on-site (mostly solar). What’s great about a BTM-PPA is that the customer benefits from significantly lower electricity costs as they avoid paying network and other market costs associated with generating, trading and transporting grid-sourced electricity.
Regardless of which type of supply agreement you choose, there will be terms and conditions that come with the contract. But not all contracts are the same, and a lower rate will invariably be complemented with more onerous and risky contract terms.
Read the rest of our Energy Contract Checklist for some of the terms, conditions and contract features to look out for when procuring an energy supply agreement.
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Key considerations you should make:
Length of contract
One of the first things to consider when entering an energy supply agreement is the length of the contract you are signing up for.
The benefit of locking in for an extended-term is likely to come in the form of an attractive (low) price or else a firm (fixed) price for the term of the contract or ideally a combination of the two.
The length of the contract that a business chooses is about weighing up the risks of committing to a long term contract against the financial benefits that the agreement offers.
A longer-term contract will invariably come with more legal obligations and this should, therefore, be balanced by an equal or greater reward. If a long term contract is being considered, then close attention should be paid to the termination clauses should you need to exit the contract early.
Rate structure
Stepped or Smooth Rates?
Rates can be offered in a smoothed and stepped format.
\Stepped rates change at scheduled time intervals throughout the period of the agreement. Stepped rates change periodically.
Smoothed rates generally remain the same throughout the term of the contract assuming there are no contracted periodic rate increases (eg. CPI) provisions.
To compare “apples with apples”, you need to consider the rate structure in your analysis of the offers. Mistaking a stepped offer for a fixed offer and failing to consider CPI on some offers, could result in analysis and forecasting errors. The result: Your business could end up in an energy contract that is not as competitive as you first thought.
Fixed or Variable?
A fixed (or firmed) energy rate is an agreed rate that is normally presented in a rate schedule and covers a certain period of time. Fixed rates provide budgetary certainty for the energy user (the customer). Customers may pay a premium as the supplier of energy is bearing future pricing risk.
Variable rates, on the other hand, may change throughout the contract depending on certain mechanisms or events that are stipulated in the energy supply agreement. Variable rates place more risk on the customer as budgetary certainty is diminished.
Commissions to brokers and consultants
If you choose to engage a broker or a consultant, then these advisors may charge a commission payable by the supplier for assisting with the procurement of energy supply agreements. This commission will generally be built into the agreed energy rates.
The financial benefit of using the broker and consultant should outweigh the financial cost that is built into the energy rate.
When calculating this financial benefit consider the lower rate that broker/consultant has been able to secure through strategic market timing and a competitive tender process.
Also, consider time cost savings of having a specialist complete the service for you and the reduced risk in the offer analysis and comparison process. In addition, consider the ongoing benefits of having a broker/consultant that you can call upon with any contract and account administration processes.
Additional retailer administration fees
Next on our energy contract checklist is hidden fees. Retailers and other suppliers usually charge a fixed annual fee which is on top of the contracted energy rate. Depending on the energy supplier, these admin fees may sometimes be waived.
Consumption flexibility
Some energy contracts will contain clauses that add loadings onto your bill if you consume less or more than what was agreed on. The greater the load flex, the lower the risk to the customer.
Moreover, longer-term contracts are more exposed to load flex provisions because over time the electricity usage requirements of a business or site can change.
Such changes may occur due to changes to plant and equipment, the addition of solar, or simply as a result of changes in operating hours or business performance.
It is important to make sure that you try and get the best load flexibility deal to suit your business needs in the long term.
The right to renegotiate
What do you do if your current supplier’s rates are no longer competitive and there are much better deals on the market?
That all depends on what you signed up to. If your contract stipulates that you cannot exit the contract for any reason without paying a termination fee, then your business may be left financially exposed for the value of the residual term of the contract.
The longer the contract term, the higher the exposure.
Some energy retailers will offer Blend & Extend plans that give the customer the option to reduce their contracted rates in exchange for an extended contract term.
Payment terms
Most energy supply offers in the large market come with standard 14-day payment terms.
This can be negotiated but is likely to impact the rate being offered.
You should always check your payment terms to see if there are any penalties for missing a deadline. Some energy suppliers a harsher than others.
Credit Approval Process
Some energy retailers require a bank guarantee for credit approval purposes.
In a majority of cases, energy retailers will approve credit terms based on a simple credit check.
Customers that may be required to pay a security deposit or provide a bank guarantee are those that don’t rate well with credit agencies and new entities with limited credit history.
Find out if we can help you reduce your energy spend
We hope you found our Energy Contract Checklist useful. If you want to save more on your energy bill, get in touch with our Energy Management Consultants and we’ll see how we can reduce your energy costs.
You can check out our case studies to see the different ways we’ve helped companies in Australia lower their energy bills.
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