What Makes up Your Energy Bill? Insights from Mike Davies, Managing Director of ClearCost Energy Limited
In this article, we will explore the factors which influence energy costs, as well as how businesses can reduce these costs. We will be taking insights from Mike Davies, the Managing Director of ClearCost Energy, an energy consultancy based in the UK.
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ClearCost Energy aims to bring “transparency and rigorous analysis to the energy market and explore some of the key steps that businesses can take to first understand and then begin to control their energy costs.” Mike himself is a Chartered Mechanical Engineer with a wealth of experience spanning industries such as coal, nuclear and renewable energy. For over 30 years he has been deeply involved in energy economics from the details of non-commodity charges to long term commodity price forecasts.
Mike aims to bring an independent, fully transparent view of energy costs to allow his customers to understand the cost implications of contracting strategies and capture the full benefit of projects aimed at reducing consumption and carbon dioxide emissions.
Leah Barron Stevens: To begin with, can you explain why now is the time to consider all of this?
Mike Davies: “Understanding the drivers of electricity costs means that businesses can take cost effective measures to reduce costs through contracting strategy. Businesses need to analyse the potential benefits of introducing projects to reduce consumption and carbon emissions.”
LBS: We all know energy costs are high right now, and carbon emissions are a key concern…
MD: “Yes, and changes in electricity industry charging structures introduced in April
2022 and forthcoming in April 2023 will impact on future costs. National Grid non-locational banded charges from April 2023 onwards are set to rise from tens of thousands to hundreds of thousands of pounds difference annually.
LBS: So how do providers come up with these costs?
MD: “The price of electricity is made up of different elements, some of which vary by location, voltage of connection, time of day, time of week and season. To simplify discussion, the charges can be allocated to one of the three categories: fixed charges, time dependent charges and time independent charges.”
LBS: Could you explain a bit about the different types of energy contracts, and how these costs affect them?
“The total cost of energy is heavily influenced by the 100% forecast commodity price, which has been very volatile over the past year.
“The cost of the time dependent charges is heavily influenced by the site's
Time Independent Cost consumption pattern. As a rule of thumb, costs are lower overnight in the summer than during late afternoon winter weekdays.
Most businesses opt for fixed priced contracts. This means that the electricity supplier is accepting pricing risk and consequently adds an unknown margin to mitigate the risk of changes in commodity and non-commodity costs caused by changes in consumption patterns.
Another style of contract is usually called passthrough. The supplier then bills each of the charging elements listed in the table separately and at cost. There are advantages to this, which include: cost transparency (so there is nowhere for suppliers to hide additional margins), the client has full visibility of costs for each half-hour period (allowing them to understand what drives their electricity costs) and the client can capture the full benefit of any cost reduction projects.
Generally, with this style of contract there is the option to purchase commodity in several tranches prior to consumption. The aim is to purchase at the lowest price. Unfortunately, the lowest price is not known until after the event.”
LBS: What should businesses remember when considering passthrough contracts?
MD: “the safest option is to purchase against an agreed budget price. The budget should be reviewed regularly as the commodity market evolves. The purchasing strategy should also consider what happens if prices are above the budget values.”
LBS: Who might a pass-through contract be most beneficial for?
MD: With a pass-through contract in place, it is possible to determine the cost for each half-hour period and understand what drives electricity costs on each site. Modelling of costs at the half-hourly level is a useful tool to explore the cost benefit of potential changes and find which will deliver the highest return on investment. Typically, projects that are considered are:
Energy efficiency improvements to reduce consumption, particularly during high-cost periods.
Changing the timing of processes so that electricity demand is moved from high to low cost periods.
Installation of electricity generating plant such as solar PV and wind turbines.
Displacement of fossil fuels with electricity for space heating and hot water.
Battery storage charging during low-cost periods for discharging during high-cost periods to reduce overall costs.
Different charging regimes for EVs.
LBS: How are energy cost breakdowns changing?
MD: I have a graph which shows the percentage contribution of each of the three cost categories to the overall annual costs. (see Fig. 1) We can see Fixed and Time Independent costs will become more crucial and Time Dependent Costs less crucial to overall cost.
Fig 1: Shifting cost breakdowns
LBS: Could you explain more about what affects these different costs and how can we control and reduce them?
MD: Currently cost control needs to concentrate on the Time Dependent Cost, which is mainly driven by commodity prices. So, emphasis must be given to energy purchasing strategies, shifting of consumption from high-cost to low-cost periods and general energy efficiency improvements. Longer term the Time Independent and Fixed Costs grow in influence, assuming commodity prices decline in the future. Fixed Costs are mainly driven by the site’s Maximum Import Capacity and Time Independent Costs by consumption and environmental levies.
LBS: Just how important is time of day when it comes to energy costs?
MD: Commodity costs vary with the time of day, and it’s important to consider the introduction of high-speed EV charging points and battery storage very carefully because of this.
In the N2EX Day Ahead market, even in January 2022, when costs were very high, there were times when prices were negative, i.e. sites were being paid for consuming electricity. The average difference between daily and maximum and minimum commodity prices over recent seasons are shown in a table (see Fig. 2).
Fig 2. Difference between Daily Max and Min Commodity Prices by Season and Year.
Developing strategies to take advantage of commodity market price fluctuations will be increasingly important in the future as more renewable energy and nuclear generation is built. Gas is likely to remain the backup fuel for electricity generation for a number of years and prices will continue to fluctuate widely in response to the sources of generation being used at any given time. This means that the difference between the maximum and minimum commodity price within a day is likely to stay high.
LBS: To sum up, what are some key things for energy consumers to remember?
MD:
The use of fixed supply contracts can lead to businesses paying much higher prices than is necessary.
The use of pass-through supply contracts the financial risk associated with changes in consumption patterns from the supplier to the business. A business is best placed to manage its consumption pattern to mitigate this risk. Also, the risk premium applied to a fixed price contract by the supplier is removed.
Understanding the drivers of electricity costs means that businesses can take cost effective measures to reduce costs.
Changes in electricity industry charging structures introduced in April 2022 and upcoming in April 2023 will impact on future costs, significantly in some cases, and introduction of EV charging may lead to some unpleasant surprises in 2023.
The electricity market is never static so reviewing contracting strategies and consumption patterns should be undertaken regularly.
To learn more about Clearcost, please visit www.clearcost.energy. If your business is looking for ways to save energy, GridDuck can also help. Schedule a quick and no-obligation call with our sales team today.