Suppliers weather the storm

Falling wholesale prices, rising non-energy costs, increasing renewable generation and unprecedented weather… suppliers had a lot to cope with in 2015, says Stuart Lloyd-Evans.

Last year there was a shift from old- style power generation to renewables. Aided by extreme weather, output from renewable sources reached new heights, especially during the stormy end of the year.

The move away from high-carbon generation is becoming noticeable in politics and in customers’ bills, which reflect the costs of delivering the changes. These costs have clearly been on the government’s mind as it has sought to control the impact of high capital cost renewables in a low-priced commodity environment. Does anybody remember 2008, when the brightest city analysts predicted an oil price of $200 a barrel?

Wholesale energy prices continued to fall in 2015. Oil, gas, coal, freight… the super cycle is well and truly over (until next time).

The rate of decline and the lows reached are unprecedented. Even geopolitics has failed to stymie price falls. Looking at a simple chart of front month price change over the year, there is a consistent pattern of price decline across oil, gas and power. For electricity and gas, it is notable that the end of year gradient was steeper than that at the beginning. The final months of the year represent the onset of winter – and increased demand – so it is unheard of for these prices to be below the “warm” part of the year.

In the final quarter, the combined impact of global commodity events and the delayed onset of winter led to sharp price decreases. The effect of the weather has been phenomenal in the final quarter, with both temperature and wind speed edging towards the limits of what could be expected.

Wind generation smashed all records.National Grid reported that 11 per cent of electricity was generated by wind in 2015, and 17 per cent in December. This helped push prices lower as demand for gas generation fell, on top of the warmer weather.

Future energy price

Electricity Market Reform (EMR) started last year, although nothing has been generated under its mechanisms. Unlike other low-carbon subsidies, the cost per unit produced is fixed each year, irrespective of wholesale cost. Generators receive a top-up to energy prices when they are low and pay back when they are high. For suppliers this introduces a new risk that will become more complex as the number of assets under the scheme grows.

The Hinkley Point C project has been developed under the new contracts for difference (CfD), initiated by EMR. Although this looks expensive at today’s energy prices – £92.50/MWh compared with about £36/MWh for 2016 at the time of writing – only our children will know if it was a good decision.

Non-energy price

As energy prices fall, the rise of non-energy costs continues. For electricity customers these represent over 40 per cent of the delivered price – and have influenced the fall in end user prices. In recent years there has been a rapid increase in the costs of low-carbon generation in the form of Renewable Obligation (RO) and feed-in tariff (FIT). The increase has been a major headache because they are not linked to any market index.

The RO has supported growth in low-carbon generation, but the obligation on suppliers has quadrupled between 2011 and 2016, and keeping pace has been somewhat challenging – and made it difficult to explain to customers what’s driving prices up.

FIT costs have risen rapidly beyond initial forecasts. This has created challenges for suppliers to recover the correct amount from customers; and for government because costs have far exceeded the amount expected under the Levy Control Framework (LCF). In 2015 (year five) the costs were much higher than the amount nominally set aside for suppliers to recover to pay for the scheme.

As a result of the costs, the government has reduced the rate at which new FIT installations get paid, and introduced a cap on the rate of growth at £100 million a year. From an energy supplier perspective, this will make it easier to forecast the future cost. Solar subsidies have been hit particularly hard, with domestic rooftop installations initially targeted with an 84 per cent reduction in income, and ending with 64 per cent. Nevertheless, it looks likely that the impact of solar on the energy mix will grow.

Energy prices have fallen, and can go down further. Non-energy prices are set to continue to rise and get more complicated. The most important message is probably that the impact of the weather is now stronger than ever – not only does it affect customer demand, it also influences the price of energy because there is so much weather-dependent generation capacity.

Stuart Lloyd-Evans, director of risk and trading operations, Opus Energy