What Dopamine & Dirty Harry Teach Us About Buying Energy in Europe

July 11, 2018 Richard Badham

What Dopamine & Dirty Harry Teach Us About Buying Energy in Europe

“You’ve got to ask yourself one question: ‘Do I feel lucky?'” ~ Dirty Harry

If the answer to this is yes, you can stop reading. If it’s no or you have any type of accountability for energy expenditure, keep reading …

Volatility in energy markets is nothing new and neither are the ways in which the resulting risks can be managed. And that’s possibly a problem; it’s not novel. As humans, our brains have been wired to seek novelty, and when we find it, we get a surge of dopamine. Dopamine has many functions in humans but for the purposes of this, it’s sufficient to know it helps regulate the “reward” centers of the brain. And if you’re wondering why you keep checking your phone, social media and various apps – then you can thank (or blame) dopamine again.

Energy innovations and novelties are highly newsworthy and growth in renewables leads to a steady stream of record-breaking headlines. The echo chamber effect can also amplify the interest in new solutions and technologies whilst drowning out some more immediate and potentially equally as important signals. And the increasingly geopolitical nature of energy means the media would be remiss not to take some ad hominem swipes at whoever the political villain of the day is even if the outcomes of their actions are not quite as reducible as the headlines would suggest.

So while your own neurochemistry and the media have been intent on serving you something new, it’s entirely possible you may have missed what’s been happening to European commodity markets.

Oil Prices

European gas prices M+1

European Power Prices M+1

Leaving aside the cyclical prices seen in gas (winter prices are higher because demand is higher), gas and power prices have been trending upwards in many markets for months.

What’s the reason? Sadly, there isn’t just one. But here’s a few:

  • Oil prices have increased as OPEC agreements to curtail production have worked
  • Trump’s actions around Iran (potentially limiting directly and indirectly who buys Iranian oil) have also helped stoke oil prices
  • Higher oil prices feed into gas prices over time given that some gas contracts are indexed to oil
  • Gas prices have their own fundamentals – and in Europe, domestic production in key regions is declining
  • Europe had a colder and more protracted winter, so gas stores are lower than usual; they normally get replenished with ‘cheaper’ summer gas but this time, they’re actually supporting prices as more gas needs to be injected
  • Despite the growth in renewables, in many cases, fossil fuels still represent a significant proportion of how power is generated – so with oil, coal and gas prices up, power follows too

And if increases to commodity costs weren’t enough it’s important to that remember in most EU countries, commodity costs represents less than 50% of total energy costs. The other 50%, which represent network and system costs, taxes, levies and mechanisms to incentivize renewable and low carbon growth, are typically on the incline too.

By now I can imagine you’re feeling less lucky. So let’s talk solutions.

  • Get the basics squared away – if you don’t know how many supply contracts you have, who they are with and when they expire (and/or what termination requirements they have) and don’t have access to recent consumption data, then getting new contracts is going to be tough.
  • If you can aggregate your sites and go to market “as one”, you increase your buying power (the prospect of securing greater volumes/sites will often mean lower prices).
  • Get access to energy market intelligence and be able to act quickly – detailed, reliable energy market intelligence will cut through the noise and give focus on the things that count. But making full use of that intelligence is only possible if you have the internal procedures to respond quickly – prices change rapidly, so your internal sign off process needs to be measured with a watch, not a sundial.
  • Ensure you have a competitive tendering process but apply the ‘3 Bears principle’ “just right” – too few bidders means competition isn’t assured, too many and your ability to assess, negotiate and respond will be hampered.
  • Know which suppliers to invite – in most markets competition is strong and there are many suppliers to choose from but not all can deliver what you need nor will they be competitive in all scenarios. Understanding from a trusted advisor who regularly sources in your markets and who would be competitive, can help.
  • If you consume higher volumes of energy, it’s likely you’ll have access to more sophisticated, flexible energy contracts that, although more complex, will give greater opportunities to actively manage your commodity risk
  • If you do opt for a sophisticated, flexible energy contract, ensure you have the appropriate governance, measurement, reporting and decision making infrastructures to make the most of it (it’s also one less thing for your auditors to red flag).
  • Consider whether signing renewable power purchase agreements (PPAs) is right for your company. In many global markets, companies that sign PPAs have the opportunity to lock in fixed energy prices to manage market volatility and decrease energy costs. 
  • Get support and advice to understand the impacts of increases to non-commodity costs. At the very least, budget for and understand these changes and how they can be optimized.

Things to avoid

  • Contract expirations and fiscal calendars should not drive energy procurement decisions (see point 3 above)
  • Not seeing the wood for the trees – securing another 5 days on your payment terms after 4 weeks of negotiation may seem like a victory. But if the market kept on rising, it’s probable you just won the battle and lost the war.
  • Having got the right offer, from the right supplier – and then not having anyone to sign the contract in time.
  • Having a robust, well-governed approach to managing your sophisticated, flexible energy contract – but only focusing on the term of that contract (hint: time did not stand still past the expiration date).
  • Assuming understanding commodity costs in isolation will give a complete picture of energy costs in total – it won’t.

“Success is neither magical nor mysterious. Success is the natural consequence of consistently applying the basic fundamentals.” ~ Jim Rohn

To find out more, download our eBook on Understanding Energy Costs in EMEA.

 

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