Wholesale Energy Market

There is a pretty good chance that within seconds of the commencement of any interview or official statement or pronouncement that the wholesale energy market will be referred to and either blamed or pointed to as illustrative of the rip-off nature of energy supply tariffs.

The underlying relationship between the wholesale energy market and the energy tariffs is almost never explained and expanded upon. For the record the wholesale price is not comprised of one single benchmark price with the unfortunate consequences that you can make various different cases with it to support whatever theory or justification you may require to be demonstrated. Rather it is a market where a range of different prices exist for a range of different delivery periods at some point in the future. That future could become the present in as little as 1 hour – or it could yet be 3 years away. Yet despite all these very different prices and products that refer to specific periods (both overlapping and exclusive points in time) in the future, somehow an idea has been allowed to take root that you can trace in some convenient linear progression a direct line from the current wholesale price and the prices being quoted in the form of tariffs by both the big six and the other players on switching sites such as myutilitygenius. Does the current wholesale price mean today’s price for tomorrow, today’s price for next month, today’s price for next year, an average of the price for next year as calculated using an arithmetic average over the last month/quarter/year? This approach is a bit like saying that I am fat because today I ate two magnums, a KFC bucket and a large box of popcorn. For all anyone knows that is my once in two year blow out and the rest of the year I survive on meagre portions of quinoa and gruel.

The other thing that it is important to realise is that a wholesale market price, for whichever period in the future, assumes that there is constant delivery of the energy over that period. It does not reflect the constant adjustments between the financial amount of energy purchased for the future and the physical amount of energy used when that future becomes the present. So if the temperature was always the same and we just sat in front of the TV 24/7 eating non refrigerated salads and made no variable use whatsoever of any household or business appliance then the financial future and the physical reality might match. Of course that isn’t the case and the disconnect between these two realities is a risk that the supplier bears, tries to manage through trading but inevitably builds into any price that becomes their reflection of the view of the future.

This additional complication is a function of both gas and power being what one might call “on demand” pull commodities. Effectively it’s a pay as you go plan! There are not many other things in life that have actual variable cost that you buy in this way (telecoms are not the same as you are paying off an infrastructure investment, variable costs to the telco’s companies are relatively low by comparison). Imagine pitching up at Tesco’s the day after your New Year’s party to ask them to give you a price for all the steaks you are going to eat that year.  You can’t tell them how many steaks you are going to eat (you might even be contemplating going vegan) and they have no idea whether or not the next foot and mouth outbreak is round the corner that is going to decimate the national herd meaning they might need to source steaks from Argentina to fulfil your annual order; or whether the grain crops used for winter feed are going to getting ruined by flooding leading to increased husbandry costs. All of this stuff does happen in farming all the time; the difference is that what we use and what is priced is always known and present. The crop risk is something we see in a less obvious way – the increase in the price of bread at the counter. And yet power and gas, one of which is impossible to store and the other for which we only have 19 days national storage capacity, are items that we expect to have price constancy in both the short term and the long term.

In brief, the following factors have an influence on the price of gas and power. This is by no means an exhaustive list. Each one of these things, once either hypothesised or known, could have an instantaneous (within minutes) impact on the local price of power or the international price of gas which is now a global commodity:

  • Deviation from seasonal normal temperatures, or the forecast of such a deviation.
  • Eurozone problems real or imagined
  • Slowdown or speeding up of the Chinese economy, either real or forecast
  • Posturing by Ahmadinejad, Bashir or Netanyahu
  • Increase or decrease in the non-farm payroll figures from the USA
  • Increase or decrease in US fuel inventories
  • The start of the US driving season
  • Any pronouncements from OPEC
  • Flare up of Russian use of gas as a political weapon
  • Disruptions to any pipeline infrastructure
  • Increasing costs of shipping
  • Rumours of green legislation and regulation
  • Actual  green legislation and regulation
  • Nuclear disasters anywhere
  • Maintenance schedules for power plants
  • War, terrorism or unrest in any fossil fuel producing country of significance
  • Unexpectedly deviant pronouncements from the various Purchasing Managers Indices (PPI) around the G8 and the BRIC’s
  • A rising or falling in the value of the US dollar against other major currencies
  • Outright speculation on oil direction

65% of your electricity bill and 70% of your gas bill is a function of this volatile supply and demand market. Energy suppliers have curve traders (buying and selling energy for the more distant future – months or seasons ahead), prompt traders (buying and selling energy for use over the short term – days and weeks), and day traders (buying and selling power especially today for later today). So with all this volatility and activity how is it that the earliest of the big 6 last changed their standard variable prices for gas and power in August last year? In the industrial and commercial market you won’t get the same price tomorrow as you get today, and many times you will be quoted a price at 10 in the morning for it to be refreshed and pulled three times by 4 o’clock that afternoon! Again then we repeat the question, why in the domestic market can they hold the price so stable for so long? When you understand the volatility that underpins buying this stuff you start to get an appreciation of how extraordinary it is that you can be quoted the same price week in week out for months with no commitment on how much you will buy from you whatsoever. As always, there is no such thing as a free lunch, nor is this wholesale – retail link as straightforward as the commentariat would have you believe. Suppliers undertake a gas and electricity purchasing policy that is loosely referred to as a rolling hedge. The power and gas that they buy for any singular point in time, say April 30th 2013, is a function of many purchases conducted at varying points over the 18 months preceding April 30th. So if I buy each future date’s worth of gas on 30 separate occasions, and I have a price target strategy, then any one day’s move in pricing for any or all products in and of itself is not sufficient for me to need to change my selling price as I have already locked down much of the price for the future stretching out not only 12 months but 18 months. As each chunk of power I bought in the past gets sold so I have to replenish the hedge with power and gas that is at a different price, but each transaction only represents 1/30th of my price. Therefore it is only once there is a sustained trend in place on the wholesale (or a load of government levies and taxes) that the selling price comes under review. All suppliers run rolling hedges so it is to be expected that their prices have a tendency to move in sympathy – to a degree. But it also allows them to deploy smoke and mirrors because not only do the bodies holding them to account not seem to be able to interrogate the wholesale-retail argument in a supportable way; but because the UK consumers are so apathetic that anyone who doesn’t follow the trend upwards is simply foregoing profits because the buyers don’t switch from the first movers to the laggards, they simply complain and suck it up.

The simple facts are that in 13 years of deregulation over 40% of households has never moved supplier. Our governments and our regulators have created the energy supply industry and we have colluded in bringing it to where we are now.

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