The Price of Progress: Non-Commodity Costs

August 21, 2017 Richard Badham

Cost of Progress:  Non-commodity costs

The global energy ecosystem is undergoing fundamental and far-reaching change, presenting both significant challenges and huge opportunities for energy consumers.

Increased renewable energy, more connected devices and the decentralization of utility grids are creating a 'new normal' where consumers will be empowered to engage with energy in a far more active way.

The shift from a centralized model of mainly fossil-fueled power generation to a future where companies are becoming both producers and consumers of energy will create both challenges and opportunities for energy managers, utilities and policymakers alike.

Paid for by the consumer

Governments and system operators are facing the reality of having to replace aging, high-carbon infrastructure while ‘rewiring’ grids to connect low-carbon, intermittent renewables. Ultimately, energy consumers will pay for these investments as part of 'non-commodity costs' or the charges that make up an energy bill that are not for the electricity itself.

As a result, energy consumers will see:

1. Increasing grid tariffs to cover the cost of investment
2. Rapidly increasing subsidy costs for (initially) high-cost, low-carbon technologies

Non-Commodity

A view of the non-commodity cost landscape; download the full version here

This trend is across Europe. Germany, for example, has been subsidizing wind and solar installations to replace nuclear and, later, fossil fuels in the energy mix. As carbon-cutting installed capacity increased so did taxes and levies to cover the cost of policy support.

The intermittent nature of renewable energy has led to significant wholesale spot market volatility, with increasing incidences of both negative prices at times of high supply and low demand, and price spikes when opposite conditions prevail.

The increase in generation capacity has depressed forward wholesale markets, as low-marginal-cost renewables win the ‘merit order’, often squeezing thermal capacity and keeping a lid on the market price. This has placed stress on traditional utilities, resulting in a lack of investment in new thermal generation. The increase in intermittent renewables requires both base-load and backup capacity.

An example is the UK government’s commitment to guarantee electricity supplier EDF Energy an indexed ‘strike price’ of £92.50 per megawatt-hour, more than double the current wholesale price, for 35 years’ nuclear output at the planned Hinkley Point facility.

The policy cost will be met by consumers.

The Eurostat analysis below shows the significant growth in non-commodity charges as a proportion of the energy bill — even though Eurostat's analysis can be limited and significantly under-records non-commodity costs in countries such as Spain. 

Graph1    Graph2

 

New technology innovation

Grids are deploying carrot and stick methods to ensure there is enough ‘thermal gap’ availability. Supply-side incentives such as contracts for difference and capacity markets are used to smooth out peaks and troughs, in combination with demand-side measures. Large consumers are encouraged through pricing signals and incentive payments to shift load away from peak periods, switching to onsite generation or even exporting to grids. Technology will continue to enable this flexibility.

Subsidy support for renewable technologies is used to provide economies of scale to drive down generation costs. China and the US lead this effort, with more than 76 gigawatts of new global solar capacity added last year, increasing total installed capacity by a third. The cost of photovoltaic cells has fallen from $76 per watt in 1977 to $0.30 in 2015, and Bloomberg New Energy Finance forecasts that solar costs will fall a further 66 percent by 2040 and onshore wind by 47 percent. Subsidy costs have fallen dramatically, but the long-term nature of commitments already made will lock in higher commodity charges for many years to come.

Organizations are investing in onsite renewable generation to reduce reliance on both the grid and volatile commodities. Storage is the remaining missing link between intermittent renewables and reliable low-carbon power supply. New innovation and economies of scale are bringing storage solutions to the market, reducing costs for both utilities and consumers.

A challenge and opportunity

There is a huge opportunity for companies to be much more dynamic in how they source their energy, and interact with the grid and utilities. 

As grid demand falls, the cost of maintaining a connection to the system can rise further. This changing energy landscape will drive organizations to become more energy efficient and more flexible with the energy they use to keep costs low. In this near future, having a clear non-commodity cost optimization strategy will be vital.
 

The real cost of energy - an invoice breakdown

EMEA pie

For an in depth look at these costs, download our EMEA & Americas ebook

Research shows that non-commodity charges make up 56 percent of the budget. Yet central buyers are arguably far more comfortable and experienced in managing the 44 percent commodity cost across a portfolio, through effective sourcing and risk management strategies.

Regulated network charges, taxes and levies are opaque, complex and vary widely by country and commodity. As the needs of the energy transition have evolved, the charging structures required to deliver the transition have become ever more complicated, making it extremely challenging to stay on top of costs and opportunities.

This confusion can lead to inaction and a mistaken belief that regulated costs are a non-negotiable burden. However, just because these costs can’t be negotiated in the way that commodity can doesn’t mean organisations are powerless to manage, understand and optimize them. A simple dual approach can yield great benefits:

  1. Budget & forecast – Dive into the detail of current charges and anticipate future changes to quantify the short- and long-term impact of non-commodity elements.
  2. Optimize & manage – Audit all aspects and opportunities inherent in network and policy costs across all geographies. Highly significant structural operational savings can be made, releasing funds for investment elsewhere in the energy budget. While the upward trend in non-commodity charges is clear across major markets, with effective planning organizations can turn the challenge into opportunity.

Learn more about non-commodity costs by contacting one of our experts.

 

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