COVID-19: B2B Volume Risk
Part 1 - Understanding your electricity supply contract
Published by Michael Layton | 17th April 2020
As a result of the the current pandemic, there have been severe and immediate impacts on many UK businesses; which are likely to be continued to be felt for a sustained period into the future. The level of electricity consumption use by many businesses has reduced and consumption behaviour may have dramatically changed. This leaves businesses exposed to potential penalties and increased costs within their existing and future electricity supply contracts.
This guidance is intended to support large end users and Third Party Intermediaries to understand the main features relating to volume risk within their supply contract.
The importance of actual consumption on your electricity invoice
Nowadays the majority of electricity meters are automatically read on a half-hourly basis and sent to suppliers to ensure your business is invoiced for the actual electricity consumed. However, for those meters where manual reads are still required, it is imperative you find a way to provide a snapshot of these to your supplier. This is to ensure you do not get over-charged on your invoices. Obviously reading meters can only be done if you are able to follow the current government safety guidelines, however if you cannot access your meter then provide information on your revised operating schedule to enable a more accurate estimate of your latest consumption. This enables you to reduce your current invoices at a time when you are likely to be cash constrained.
Contract Consumption Forecast
When you contract with an energy supplier, they will forecast your consumption usage for the upcoming contracted period. This is normally created by MPAN / site for every half hourly settlement period and this is then aggregated to form a forecast of the electricity you will consume across the contract period. This forecast is usually based on historical usage for HH MPANs or on Estimated Annual Consumption (profiled to HH granularity) for NHH MPANs. The Contract Consumption forecast is typically set prior to the start of the contract for the full contract term (e.g. 36 months) or it may be set annually (more typical in a flexible purchasing contract) for each approaching 12 month period.
It is recommended you provide and discuss any additional insight (site changes, planned outages, energy saving initiatives, the minimum period you are currently planned to be shutdown for) you are aware of to your TPI / supplier to feed into the consumption forecast generated. This sets the baseline for the volume risk treatment within your contract. Whether you are signing up to a fixed price or flexible purchasing contract, with or without any consumption/ usage clauses; it is imperative you ensure the supplier provides a view of this forecast. You then need to check it at at a minimum of a monthly level of granularity to ensure your confidence. In the least it provides greater invoice accuracy, but at best if will minimise your exposure to penalty clauses.
Volume Tolerance Clauses
Volume tolerance is normally set as a percentage above and below the contracted forecast consumption. This provides protection from additional charges being levied when your actual usage varies. A volume tolerance can be set at different levels of granularity with these typically being annual, quarterly or monthly and this impact the level of risk your supplier needs to build into their pricing as a risk premium. You need to select a tolerance structure that protects you against normal variance and to determine how much protection you wish to pay for to cover against exceptional events.
Additionally, there are different charging mechanisms that can be applied either only for volume sitting outside the tolerance or alternatively for all volume variance away from your Contract Consumption Forecast position (once the volume tolerance threshold has been breached). Typically these costs will be applied using spot or balancing mechanism prices, however it is important to also understand whether these have been averaged or are applied on a half hourly basis where the prices may be far more volatile.
Previously, volume tolerance clauses were in a vast number of contracts, however many are being replaced with incentives to work with your supplier to re-forecast without the need of a tolerance. This is something to look for in future contracts.Working together, where you can, however you best can, should reduce your supplier costs and the risk of an unwanted exposure at times like these.
There are a couple of volume risk related cost components which are at risk of being increased moving forward as a result of your consumption becoming more variable due to the existing circumstances. These may be set reviewed annually or may simply impact your next contract renewal, they are worth watching out for and challenging where the change in behaviour is unlikely to be repeated.
Imbalance / Balancing Risk
For every settlement period (half hour) a supplier will have contracted (traded) volume based on their view of the expected generation/demand of all the sites they supply. After the delivery period this is compared against the actual (metered) usage and the difference between these is the imbalance volume. There are two imbalance prices for each settlement period System Buy Price (SBP) and System Sell Price (SSP) and these are used to settle the imbalance volume. (click here If you would like more information about these).
Your supplier will pass on these charges within your contract and they may be different depending upon the product you are contracted on and the predictability of your business’s usage pattern. In the majority of contracts imbalance will be fixed for the energy charge period but for those where the imbalance charge is not fixed this could lead to increased cost, if in doubt I would recommend you check with your supplier / TPI. During the current pandemic the predictability of your usage will have reduced for a number of businesses and therefore providing forecasting information to suppliers is useful not only for the supplier but for your business to ensure imbalance costs are minimised.
A shape charge is normally applied within the standard flex contracts and may be fixed or set every energy charging period. As the shape charge is based on a forecast view of consumption any major change to the consumption usage would have an impact on shape costs. Again, like imbalance it is worthwhile checking your contract to ensure no additional shape charges (resulting from COVID-19) can be applied to the current contracted period.
Even if there is no volume tolerance clause, still check for other clauses that may recover costs due to a significant change / drop in usage. Normally, these are based on the annual/contracted usage; so dependent upon how long the pandemic impacts your business and the time period granularity they may present more risk / cost. Again, if in doubt expertise is always on hand to assist. Within most contracts there may be a clause that states that should your business become aware of a significant change in consumption you are obliged to inform the supplier. A supplier should have a process in place for receiving and processing any re-forecast information. The supplier may also be monitoring forecast v actual consumption usage and could well be in touch off the back of any significant variance that they have noticed, so get on the front foot if you can.
1. Ensure you agree the forecast shape used as the basis for your contract
2. Ensure any volume tolerance covers variance in normal behaviour and consider if buying any further protection is wise.
3. Always have a good understanding of all the contractual clauses relating to consumption usage.
4. Ensure you are clear on processes for re-forecasting during the contract delivery period and the impact this has on your costs..
5. Challenge any year on year increases in volume related supplier charges that may related to unrepeatable behaviour.
Michael Layton has worked in the UK Energy Industry since 2000, having worked in various commercial roles for E.ON and Npower and most recently for the TPI Energimine. He has deep industry knowledge and it enables him to be able to explain complex topics clearly and precisely. Michael’s understanding of the workings of B2B flexible purchasing contracts is second to none, as is his understanding of non-commodity costs and related supplier processes. Michael is well positioned to support large end users, TPIs and suppliers in reviewing their supply contract structures & pricing; to best ensure volume & price risk are managed effectively and to ensure contracts are structured appropriately for the customer behaviour. Michael has been a TUME Associate since March 2020.
The Utility Market Experts offer risk mitigation and structuring guidance when dealing with complex energy contracts
The COViD-19 pandemic is rapidly leading to the largest reduction in energy consumption since 2008’s credit crunch; and it is quickly starting to move beyond this. Energy contracts are designed to provide the flexibility end users require, but typically the more the flexibility the higher the risk. Some suppliers have standard product offerings and some TPIs have preferred structures, however it is important your solution matches your own requirements from day 1 and that you know how best to manage situations like the current one being faced.
Whether you are a supplier, a Third Party Intermediary or an end user; an expert second opinion should always hold value. Whether dealing with the expected (embedded assets installed or efficiency measures implemented) or unexpected (such as the existing pandemic). A few hours of support from an expert (such as Michael) via TUME Interim, ensures increased confidence in your approach. Please contact us below or link in with Michael here if you would like to start the conversation…