If you are a medium to large consumer in a developed, mature market, there is a likelihood that you have been approached by an energy supplier or broker offering a brand spanking new flexible energy contract. These contracts are not necessarily a completely new offering and have been around for a while.
But what has definitely changed is customer perceptions of this product offering. Flexible contracts have been shown over the last few years to consistently produce a competitive edge for those who implement them as part of a wider energy management strategy. The lucky first few have reaped the benefits for their bravery, and rightly so.
This has certainly not gone unnoticed by other competing businesses who haven’t taken the plunge yet… Suppliers and brokers alike have recognised the current climate, and seem to be pressing the matter.
Which returns us to our original opening point. You have probably already heard from brokers and suppliers, and if you haven’t, you likely will soon.
Failing to prepare is preparing to fail, so let’s have a quick crash course in flexible energy contracts.
Modern flexibility in today’s world
Flexible contracts are a somewhat new contract type that helps to pass on the benefits of the wholesale energy market to consumers, with the price they pay for their energy being dependant on movements in wholesale price.
The profile shape of the customer’s demand (consumption) trend is split into two separate categories. These are the baseload and peak.
The baseload can be thought of as the bulk of demand and is the predictable portion of the customers energy. Most businesses will be able to provide very accurate estimations as they have access to much more detailed levels of data. This is usually through combinations of smart meters, sub-meters, and even auditing.
The peak is essentially the spike in demand outside of predictable baseload that nobody foresaw needing. This peak demand makes up the tradeable volume which is able to be traded within flexible contracts.
The wholesale market trades this volume in set blocks, although the match-up between the block and customer profile may not entirely match. As a result of this, customers are able to buy a block of energy that may or may not exceed their total usage. There are actions to resolve any mismatches of demand and purchased volume.
Where the purchased baseload and peak volumes exceed the customers profile the gas can be sold back to the supplier. In addition to this, when purchased baseload and peak volumes fall under actual customer consumption needs, customers are able to ‘top-up’ and purchase extra volume in smaller blocks.
This is where the term ‘flexible’ energy contract really comes from – it allows a much greater degree of freedom to the customer. This is the vector by which the risk and reward of the wholesale market is passed onto customers.
A brief history of flexibility
In most regulated markets, consumers would be paying tariffs that contained multiple variables. The pricing structures used would be closely linked to consumption patterns with capacity and consumption terms, off-peak and peak, weekend, and even further differences based on seasonal changes.
Price would be inherently linked to the underlying supplier cost changes. An example would be the oil-indexations of the utilities’ long term gas contracts.
As you can imagine, the result of this was a complicated and non-transparent energy pricing process. For buyers that crave and thrive off of budget stability and forecasting? This is… not so good, to say the least.
As markets began to slowly open to increased competition, the practice of forward fixing prices became much more popular. The development of exchange-traded and OTC futures began to take off, including forward market where suppliers hedged fixed prices they offer to clients.
As hedging procedures too were streamlined, suppliers saw an opportunity to pass on the risk they faced from delving into the wholesale market, an incredibly clever move. This left customers baring the full price volatility risk of the wholesale market (if they so choose).
This means that if the wholesale price rose from £20 to £30 per MWh, the customer shoulders the price burden. Large consumers soon began to realise that the moment of closing the contract is the most important price-setting factor. Soon, it was not only large consumers that realised this, and more clients began to understand that fixing prices in one solitary moment is a win all, lose all situation.
This can be thought of as the birthing point of a new contract type, which for the record, is now incredibly popular among medium to large consumers of energy – especially in North-Western Europe. The name?
The Clicking Contract
Although still essentially a fixed price contract, the client having a set price for all MWh’s that they consume before the period of consumption starts.
It may be a little difficult to understand initially, so here is a short explanation.
Say a customer has a clicking contract for 2014. The contract has formula that will tell the customer how price will be calculated based on the Cal14 contracts, base and peak. The customer can keep track of the Cal14 contract every day on the exchange. When the customer believes an opportune moment to purchase has arisen, they can “click”.
What this does is fix that day’s Cal14 price for a certain percentage of the customers annual consumption. If the customer decides on six clicks of equal proportions, the price that the customer will pay in 2014 will be a fixed price that is based on the price formula contained in the contract. This will use the average of the Cal14 prices on each of the days the customer chose to “click”.
This spreads the risk of price-fixing out to six separate instances. This removes the need for a single solitary “win all, lose all” moment.
As is the case with all businesses in the modern era, customer needs began to become more complicated to satisfy. When customer’s needs to hedge wholesale energy prices risk became more sophisticated, suppliers responded by offering varieties of the original clicking contract.
1: Vertical clicks
In the early days of development, vertical clicks were introduced. Instead of fixing on Cal products for percentages of annual volumes (which is referred to as horizontal), customers could now fix on quarterly products and for volumes per quarter.
2: Combinations of vertical and horizontal
Soon, combinations of both vertical and horizontal clicking began to appear. These contract types would allow customers to fix their price for half of consumption with four clicks on Cal products, and their remaining half with one click on each of the quarters.
3: Many clicks
Customers with many clicks found that it was incredibly difficult to ‘beat the market’ so to speak. For some businesses and organisations with poor energy procurement strategies, “making the click” soon became known as a responsibility that no-one was eager to take. To remedy this, energy suppliers then started offering contracts where price would be based on the average of a Cal, quarter, and/or Month product during a certain period.
This is again, a little difficult to understand at first reading, so here is another short example:
An example customer’s 2014 price will be based on the average of the Cal14 price for each trading day from the 15th of January 2013 all the way through to the 15th of December 2013.
4: Spot Market
In more recent history, spot markets have comprehensively and consistently beaten forward markets. This has led to customers wanting parts of their energy price indexed to the spot markets – some even going so far as to a 100% spot-indexed natural gas or electricity contract.
Many stuck with clicking contracts, but saw the value of building in the possibility of indexing a percentage of the consumption to the spot market.
This percentage can be defined at the moment of signature of a contract, but often contracts will allow the chance to swap a click for a spot indexation.
An example of this would be the following:
If a customer with a contract with 10 clicks on the Cal product doesn’t execute all of their 10 click by the 15th of December, the remaining clicks are transposed into spot-indexation.
At this point in the article would usually be where the introductory knowledge is developed further into worked examples or used as a basis for (hopefully) insightful commentary.
But as we have just showed through our brief history of flexibility, good things will come to those who wait.
Flexible contracts were not a one-day miracle, and neither will this article – there is simply too much juicy knowledge to include in one solitary piece!
So, join us next week where we continue on with our exploration into flexible energy contracts!
Industry insight, from industry experts
At Niccolo Gas, we are committed to producing as much educational material for our customers as possible.
Because we are sick of seeing the power imbalance between customers and suppliers continue to be so one sided.
For too long energy suppliers have hidden behind excessive small-print and energy jargon – making it hard for customers to see what is best for them.
We believe that by providing insight for customers into the energy industry, we will take the first step towards a better, fairer UK energy market.
If you would like to find out more about how Niccolo Gas can help your business, you can contact us in the following ways;
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We look forward to hearing from you!