Managing Energy Risk – Pricing, Volume, and Demand
When companies discuss energy risk management with consultants or brokers, 9 times of out 10 the conversation centers on electricity supply rates (the contract $/kWh) and who’s the lowest bidder. While the overall rates themselves are obviously important, how the rates are calculated and how the building operations impact the rates are arguably more important. Understanding why one building is different than the next, or why the rates have increased/decreased year-over-year empowers you as an energy buyer and allows you to make more strategic energy purchasing decisions (rather than transactional point-in-time exercises).
To understand how volume and demand affect your electricity supply rates, let’s first review the multiple components that determine the ultimate $/kWh you pay for electricity supply (depending on your location):
The energy price per kWh is determined by the forward market curve, the supplier’s view of the future, the supplier credit and risk premiums, and the on-peak/off-peak kWh split each month.
Line losses are determined by your utility rate class, so there shouldn’t be a difference in line loss percentage across the suppliers.
Ancillary services (e.g. regulation, voltage support, black start, etc.) can be either cost-based or market-based and are typically small charges relative to energy, capacity, and transmission. Where these costs become more noticeable is when you review full-pass through index pricing and ensuring which costs are or are not included in the contract price (e.g. balancing charges).
In a flat/declining price market (like we’ve been experiencing), any monkey with a dartboard can score you Y-o-Y savings. In these cases, true value is delivered by:
- ensuring the bids are apples-to-apples (i.e. all bids fix and pass through the same components)
- contracts are favorable with key provisions negotiated and included suppliers are properly vetted to ensure performance
- inclusion of additional energy management services (e.g. invoice management/auditing/reporting, budgeting, budget variance reporting, benchmarking, etc.)
- delivery of educational material, on-call analyst resources, and understanding of the regulated side of the market (i.e. delivery/tariff rates)
- transparent fee structure (there’s no such thing as “free”, the fee is buried in the energy price)
When prices are volatile (e.g. Polar Vortex 2014, Jan 2018), working with a consultant who understands proper block sizing and application is critical to risk management strategies. Based on historical analysis and forward market monte carlo simulations, a managed product should balance curtailing risk while optimizing potential market savings.
- Total Supply Cost (i.e. cost vs. rates) – If the total supply cost equals the supply rate * the kWh volume, then your total cost is directly impacted by the kWh volume you consume. Use more, spend more; use less, spend less (all else equal).
- Supply rate calculation – on-peak rates are typically more expensive than off-peak rates, so it makes sense that the more on-peak kWh you consume relative to off-peak, then the higher the blended $/kWh. For example, let’s review the two scenarios below. Property B has a higher blended $/kWh since it is consuming more on-peak kWh (while the off-peak kWh is the same, as well as the on- and off-peak rates).
|On-Peak kWh||On-Peak $/kWh||Off-Peak kWh||Off-Peak $/kWh||On-Peak %||Off-Peak %||Total kWh||Total $/kWh|
- Bandwidth – suppliers price your account based on historical monthly consumption, and there’s typically a provision that allows for a certain deviation vs. these contracted monthly volumes. If you’re outside of this bandwidth, the overusage is purchased at market rates, while the underusage is sold back into the market at market rates. All else equal, the wider the allowable deviation (e.g. 25% vs. 10%, full swing vs. 25%), then the higher the price (to compensate the supplier for the extra risk they’re assuming).
Up to 50% of your supply cost can be determined by your account’s peak load contribution. Your peak load contribution is generally determined by your account’s contribution to the grid’s overall peak load, with calculations specific to each of the ISOs (read more here – https://energywatch-inc.com/peak-load-management-primer/). By effectively managing your account’s peak load during the one to five coincident peaks (again, depending on the ISO), you can save tens of thousands of dollars off of your supply costs by reducing your capacity obligation (and transmission obligation in PJM). When reviewing $/kWh bids across properties, the main driver of the $/kWh difference is capacity/transmission obligations. For example, let’s review the two scenarios below. Each property has the same annual kWh, and the energy and capacity rates are the same. The difference is Property B has a PLC of 1000 kW, twice as high as Property A. This property needs to purchase twice as much capacity, and spread the cost over the same amount of kWh, so on a $/kWh basis, your capacity cost is twice as high. Therefore, the total supply $/kWh is higher at Property B.
|Annual kWh||Energy $/kWh (A)||Capacity PLC||Capacity $/kW||Capacity $/kWh (B)||Capacity Load Factor||Total $/kWh (A+B)|
Managing energy risk is not just sourcing what you think is the lowest price fixed price contract. It’s understanding:
- the contract terms and conditions
- the facility’s energy consumption load profile
- why and when the facility peaks, controlling these peaks when the grid is likely to peak in order to manage capacity and transmission obligations (where applicable)
- how both consumption and demand drive your electricity supply rate, and
- how future leasing/occupancy/production profiles, along with any planned energy conservation measures, may change your volume and demand profiles so you can optimize your procurement and risk management strategy
The process of understanding and managing all of these risks is complex and tedious, but it is necessary in order to make strategic energy purchases. Your electricity procurement strategy needs to align with overall facility operations, and your energy rate consultant should understand how to structure contracts for demand-supply optimization. Proper structure and timing of electricity supply contracts can result in hundreds of thousands of dollars in additional supply-side savings / or cost avoidance. Contact us to see how EnergyWatch makes it easier by providing market expertise and ensuring supply contract decisions are optimized for future operations at your facility.