Current Impacts on Energy Procurement
Our EIC experts, John Palmer and John Dawson, spoke about current events shaping energy procurement.
EIC Webinar, 14 June 2022
In partnership with Future Net Zero
As we face an unprecedented energy crisis, businesses are wondering what to do next with their energy contracts.
On Tuesday 14 June our EIC experts, John Palmer (Director of Flexible Procurement) and John Dawson (Energy Trade and Market Intelligence Manager) spoke with Sumit Bose from Future Net Zero.
They discussed the current events shaping the energy procurement landscape. John Dawson talked through the market movements affecting supply and demand in the gas and electricity markets, as well as concerns around European storage of gas. He also looked at the winter ahead, and the situation surrounding Russian gas supply. He discussed the advantages and disadvantages of reliance on liquefied natural gas, as Europe pivots towards LNG in response to the situation affecting Russian supply.
John Palmer gave advice on how to buy ‘smart’ in the current energy market, and how to reduce costs through smart energy procurement. He discussed the differences between fixed and flexible procurement options and why flexible procurement may offer advantages, in a volatile market.
You can view the full-length webinar here:
Alternatively, you can read the transcript below:
EIC webinar 14 June 2022
SB: Welcome to this future net zero webinar with EIC. We’re expecting lots of questions and of course, it’s a session that we’re all really interested in. What’s going on in the markets, how are you going to cope with what’s happening right now? Nearly everyone I’ve spoken to have never known anything like it, so how do you navigate it?
Today we’re joined by John Palmer and John Dawson from EIC.
JP: Morning everyone, I’m John Palmer and I’m Director of Flexible Procurement at EIC. I look after our flex team and work very closely with John (Dawson) who’s on the trading side of things.
SB: And John Dawson, a little bit about yourself?
JD: I’m the other John, so I’m the trading and market intelligence manager. I look after the trading team that manages flex contracts and market intelligence, following up the markets, writing up reports and letting you know what’s going on.
SB: I think you’re ahead of the markets, John. We have two poll questions as well, so you’ll get a chance to vote to do that. To end with, both our Johns will be happy to take questions offline so once you’ve heard the presentations you can email the guys, we’ll put their emails out. Without further ado, let me hand over to John Palmer who will take you through the slides.
JP: We’re obviously going to talk about the current impact on the energy market and procurement, so John will be talking about the markets, and I will be talking about what you can do next, and how you can procure. You’ve heard about who we are, so that’s just a bit of extra background for you. So we’ll jump straight onto the agenda. So, John’s going to talk about what’s going on in the market and the million dollar question of what’s going to happen next and I will then be talking about how we can help you to buy smart and what your options really could be in current market conditions, and then we’ve got time for questions at the end.
We have a poll today, Sumit if you wouldn’t mind launching the first poll and we’re going to be looking at – for your next energy contracts, are you currently considering fixed or flexible contract options?
SB: So the poll is up there, just go through it as you wish, vote now.
JP: Thank you very much. And I will hand over to John Dawson who’s going to talk about the markets.
JD: So for the next few slides, we’re going to go through the fundamentals of the market, both looking at demand and supply. We’re going to look at history and what’s currently going on, and possibly lay out a few scenarios of what could come. There’s quite a bit of information here in graphs and I’m hoping I can at least draw your eye to some of the aspects that I’m talking about.
UK Gas Demand
JD: Without further ado, let’s look at UK gas demand. So the graph you’re looking at, is looking at demand over the last two years. Pretty much from April 2020 when we were in covid lockdowns. This demand graph has several segments to it, there’s industrial demand, medium storage demand, exports through pipelines such as Moffat to Ireland, LDZ demand which has a very large domestic element to that, which is the dark blue portion there and we’ve got gas for power generation, which is the green coloured bit there. And we’ve got Interconnector Exports, these are demand on the grid when gas is being exported to Europe. Mainly through two pipelines, BBL pipeline to Holland and the interconnector pipeline to Belgium. We’ve overlayed on this the front month price. So on the left we’ve got the spend in m cubic metres and on the right we’ve got the price in pence per therm.
I want to draw your eyes towards the difference between the last two winters we’ve had. Winter ’20 was a much more prolonged colder spells whilst if you look at October ’20 and October ’21 there is slight differences there where there was more heating demand, more LDZ demand over that period. And in the latter part of winter and going into April ’21, compared to this April, this April the demand was less so. So overall demand is a very difficult thing to predict, there’s long-term forecasts weather forecasts which come out towards the back end of summer but they’re not entirely going to be accurate all the time. There will be some guidance given by analysts but what will actually outturn is almost anybody’s guess at times.
And given also our generation mix, wind is a very important proponent in that weather forecast. As you can see, as we went into last winter the prices were definitely on a really strong recovery off the covid lows. We’ve had three peaks there based on different things. The last peak is off of the Russia invading Ukraine and sanctions that followed thereafter. And demand in itself was muted as in respect of what the price was doing. Price was moving based on fear of supply, so it wasn’t a true reflection of what the demand was at the time. We can see that prices have come down, demand has reduced as we go into the summer period.
But again what you can notice here is the difference between the start of this Q2 versus what we had in Q2 2021. So if you look at just to the right of April 2022 we’ve got quite a lot of interconnector exports and that is elevating demand this summer relative to last summer. So what we’ve got here is a lot of LNG coming to the UK and a lot of gas supply and in effect what that has done is helped the front month to come off from much of the peaks that we’ve seen through the winter. So that is depressing the UK price and it’s just as a consequence of a lot of supply coming to us. And then a lot of that supply is making its way to the continent.
Peak electricity demand
JD: If we look at power demand, here we’re showing peak power demand over the last four or five years. Here you can see possibly the effect of covid shutdown. The yellow line shows the impact that shutdown had on overall demand, peak demand in this case. But what we wanted to show here is that there is almost a trend of weakening or reducing peak demand, year on year. This could be on the back of efficiencies, cost reductions, people taking advantage of triads whilst it’s still around and it’s possibly going to be an ongoing trend. And efficiencies is something that might be mentioned quite a lot and ways of reducing costs might have a direct impact on how this peak demand starts to look or continues to look over the years to come.
JD: So what will the current situation that we find ourselves in do to demand? We believe the higher prices bring about demand destruction. We are seeing, if you could look at the first slide, the industrial demand component in that graph has reduced, certainly in this last year. We are seeing that there are certain industries that are directly impacted by the cost of gas, as an input cost for production of things like fertiliser. And these industries are having to reduce output and therefore demand, because of the high cost. And it’s almost, in that situation where it’s not necessarily just in the UK as well, we’re seeing this across the globe. We’ve got places like in Pakistan and India where we’re having issues with procuring LNG and they are having power issues because of the cost of gas, they’re struggling to get product and it’s affecting their industry as well. And that’s obviously going to bring about more demand destruction.
Again on the demand picture we’re seeing massive exports to Europe so that’s increasing our summer demand as it were, relative to years past. We’re seeing very strong demand from storage – there is a need for security of supply as it were, and it seems to be more urgent going into this particular winter given the circumstances surrounding the market at the moment, given what’s going on with Russia. For winter demand it’s always an uncertainty. We never know what kind of weather we’ll get but the market is always trying to prepare for the worst and then see what the outcome is on a day by day basis and find out whether it’s been priced to high or priced too low and then make the adjustment through the winter.
And as I mentioned there’s energy efficiencies, I think those are going to be fast tracked and also things like onsite generation. That’s going to have an impact on the power demand. So these are just some of the things that will affect demand but it’s very difficult to calculate what that would look like – it’s an ongoing exercise as we get more and more data.
JD: So now we’ll look at the supply fundamentals. The bigger picture here – there’s a decline in domestic production. This would be UK North Sea’s own production, a Norwegian production, there’s a finite amount of what’s there and it would require more exploration and money to try to extract more from existing sites or other sites that haven’t yet been explored. We’ve got the likes of Groningen gas field in the Netherlands that is shutting down – it’s debateable whether they will or not, the Dutch government is holding its ground, it’s more of a political question perhaps on that one. It’s a massive field that would alleviate to some degree a lot of supply constraints coming from Russian supply. It’s an important field but given the seismic impacts that it’s brought to the region as a result of extraction of gas from there, the Dutch government had made that decision that there’s not going to be much more to be taken from there and its cost those who’ve put money into that project quite a bit of money.
Because of declining production, the UK is quite reliant on imports from different sources – the pipeline supply from Norway, imports that come in from BBL pipeline or the interconnector pipeline from Europe, as and when we price above Europe.
And we’re also quite reliant on liquefied natural gas. That comes from sources such as Qatar, the US, and more recently from Peru and we’ve got west coast of Africa and also Russian energy supply. Europe, and specifically Germany, is very reliant on imports from Russia. And without much of an increase in domestic production we’ll just have to rely on imports and as such it kind of brings everyone closer and makes the world a bit smaller. And liquefied natural gas has made that the case.
Things that can happen – in Japan, if you can recollect what happened after Fukushima, a lot of liquefied natural gas made its way to Japan and made them the largest LNG buyer in the world as a result, because they had to switch off all of their nuclear generation. And everybody else had to compete against that. More production came on and alleviated some of that shortfall, but any issues – we’ve just seen a fire break out at an LNG terminal in Texas in the US, that’s going to have ripple effects across the market both for Europe and Asia as there is a reduction in supply. As everybody is reliant on these imports and LNG makes it a smaller and much more connected market, things that happen in different pockets of the world will have an impact on price that we pay.
There’s also the share of renewables, we know that there’s an expected increase in the coming years, quite a lot of wind generation is anticipated and this will have an impact again on the relationship, certainly for the UK between gas generation that we have versus the load of wind generation that’s on the grid. We know there’s that story where if the wind doesn’t blow what happens? Or if there’s excess wind, so the relationship between those two and possibly something that binds them would be battery, some way of storing that electricity would help manage that particular situation. It could have quite an impact on the market and on price, if you could store the power for longer and if you could take it at the times when it’s, to smoothen that, when it’s not needed as it’s being generated but being able to use it again at peak times, if that can be smoothened out it would definitely have an impact on the market and on prices.
For the UK, we’re very reliant on gas for power generation. That share between renewables and gas will be a challenge as we go forward. And on Russian supply we know that some countries in Europe have decided to end ties and most of them have their contracts coming towards an end. It is estimated that around 50% of the volume that comes into Europe has ceased in that respect.
We do know that there hasn’t been a reduction in stream one flows, that would imply that Northern Europe countries, more specifically Germany, must have acquiesced to pay in roubles as we haven’t seen any shortfall in supply, we haven’t seen any cut offs. So it looks like Russia is commoditising its currency where it can and it has done so now with gas.
We don’t know if there is going to be future EU sanctions, the longer the situation between Russia and Ukraine pans out there is always that prospect that the drums are going to beat louder that there should be sanctions on gas as well, as there has been on coal and, to a large degree, oil. Will there be more pressure that sanctions on gas are passed through and what does that mean as well? Substituting that gas supply in its entirety doesn’t seem possible in the short to medium-term, if it was cut off, so that would be a risk for the market.
Going into this winter
JD: So as we go into this winter it’s all a question about storage, about LNG and this Russian gas supply. So European storage is important from a global perspective as well. We did see it during the Covid shutdown, it took a long time for liquefied natural gas to adjust to the drop in demand globally and Europe is the only place that has the infrastructure, storage, and the capacity to absorb a lot of this excess supply relative to the demand, and was able to take that.
And for the UK we’re quite reliant on that security insurance policy because we haven’t got large storage sites, again there’s talks of maybe that turning around. And so when we actually do need to meet elevated demand in the winter, we have to attract that gas from Europe out of their storage to come to us, if the LNG that we’re getting plus pipeline supply isn’t sufficient to meet that demand. We’re seeing mandates by some governments within the EU, with some EU countries mandating that storage has to be filled up to certain levels. And this is a change, specifically for Germany, given what happened at the start of this winter that just passed, which I’ll get to later.
LNG supply to the UK reached record amounts in April. In response to the higher prices we did see quite a lot of LNG come to the UK, and a lot of that excess supply can’t be held in the UK, and that’s why we’re seeing it sent to Europe. As mentioned with Russian gas supply we’re not too sure yet, it’s always going to be hanging over the market as we go into the winter whether there’s any escalation, or de-escalation that would be price supportive; de-escalation would certainly help prices to come lower.
We know Nordstream 2 had ceased and Gazprom pulling out of its Gazprom Germania entity has left Germany in a tough spot as it has to fill up storage there at a much more expensive rate. There’s possibilities that the German government will have to help as far as costs there are concerned.
UK Gas Supply
JD: So if we look at gas supply over the same periods as we’ve looked in the previous graphs, North Sea supply. We’ve got Langeled gas coming from Norway, we’ve got LNG as a grey bit, storage withdrawals that help to top up and European imports from the two pipelines BPL and interconnector. And again we’ve overlaid the front month over the course of this time period.
We know North Sea supplies are decreasing so we’re ever more reliant on those imports through Langled or from Norway and liquefied natural gas. If we look at the two winters again we can see the grey portion there’s a massive increase in that grey portion, winter on winter. So last winter was as a result of the higher pricing. UK and European prices were competing with Asia, as a result we pulled a lot more product into the UK and Europe, at the expense of Asia and other countries like Pakistan and India.
This excess has come, if you look at the very right hand side of the very last peak, demand was quite deflated and we had a lot of LNG come in which has helped a lot of the UK storage to start filling up quite quickly. We certainly saw that in April when overall demand was weaker. There is pressure on the summer pricing because of the excess amount of supply, relative to what we can actually take and send to Europe. But the question will be, what’s that going to look like going into winter?
JD: This (graph) is showing European storage over October year. If we start at the very left we can see the red line was showing what October 2021 storage levels looked like. It was well below average and this was as a result of Gazprom-owned sites in Germany not necessarily filling up over the last summer prior to winter. Which is why the German government has now mandated that storage get filled up but Gazprom has now pulled out of that venture. So it’s been left to the entity that’s there now, that is backed by the German government to try to ensure that the storage sites there try and fill up. But again they’re having to buy at market rate right now so it’s quite a cost difference between getting that directly from Russia.
Over the course of the winter, as storage was being drawn and the red line drops, there were worries over how much was being used and what the rest of Q1 ’22 was going to be like but we did have quite a mild February and a relatively mild March. But with pricing so high relative to Asia that has attracted a lot of supply.
And noting that Russian supply hasn’t necessarily been disrupted up until a couple of weeks ago. And specifically those wanting contracts in Northern Europe, all of that volume is helping the storage picture look a lot better than where we were at the end of March. With a lot of concern about how that was going to fill up. This rate of injection can’t necessarily be maintained. There’s going to be maintenance over the course of the summer for producers that’s going to affect overall supply, so that’s not necessarily going to be as strong as it is currently.
Where we end up is more the question. Will there still be a deficit? Will there be an excess relative to the average? Will we get to a place where the market feels comfortable that there is that security to rely on?
Average UK Electricity Generation
JD: When we look at UK generation, power generation here. We’ve got imports from Europe, so if you look at the pink section that is quite small going into this summer. So Europe’s power prices are a lot higher so we are actually exporting power to Europe. The other thing you can notice here is that wind generation tends to be quite strong over the winter periods, relative to the summer, because of the weather patterns that we do get. And over last winter wind generation was quite strong in the February period. It was quite mild and windy at the same time which is what helped overall demand to be quite weak. Again, going into this winter it’s what kind of wind speeds are we going to get. It doesn’t help when we have cold and very low wind situations because that’s a higher load on the system. Whereas if we do have a mild and windy winter then it does help reduce that demand quite a bit.
JD: We’ll go into market prices quite quickly.
JD: We’re looking at forward prices here. The winter ‘22 contract as we can see has a massive premium to future prices, so the market is basically in backwardation here. But pricing higher in the situation right now relative to the future. So the market is still quite concerned about supply for the coming winter. It is interesting how the 230p level seems to be holding support. But also what is interesting here is that the backend has been moving up as well and it’s showing that the market has noticed there’s a pivot, by Europe moving away from Russian supply to LNG. So there’s going to be more competition. So for the UK it does bode questions of, we will be competing with another big buyer in the market in the years to come as things pivot in that direction.
So the trend is definitely up. The summer ’23, winter ’23, summer ’24, all that has been relatively sideways since March. That March peak, it does look vulnerable to another push up. And the winter might bring more surprises, or the journey to winter between now and then might bring more surprises that might help this market keep staying elevated. But the positives to take away from here is that the storage is looking good, LNG is looking good.
We’re relatively pricing in competition with Asia this time round so we should be getting more LNG going into the winter but if the Asian demand picks up quite strongly we will have to stay close with that to ensure we’re also receiving supply.
JD: And it’s kind of the same with the power, where the backend as well is moving up. The winter has a large premium over the backend. We’ve been very sideways since the March drop and it looks like the market is kind of waiting to see what’s going to happen as we get into winter. So there’s a consensus between buyers and sellers around the 240 mark. There’s going to be a catalyst at some point that’s going to either cause prices to break higher or alleviate some of the risk premium in the market and cause the price to come down.
There’s various scenarios as to what that will bring and Russian supply being one. Economic impacts as well – we know that there’s talk of a recession that’s building up. The higher price is going to cause demand destruction as well. We might see a change in behaviour from ourselves when we’re dealing with our thermostats over the winter, so there is likely to be some catalyst that will help the prices to come lower. At this point in time, we don’t have any additional data to say yes that is definitely what will happen but there is a consensus in the market at this point in time.
JD: Very quickly, game changers. Some of them are more close, will have an impact in the short-term, some in the medium-term, some over the very long-term. The pivot by Europe to LNG is a big one. It does change the dynamics in the LNG market. It does mean more competition. LNG as a product, it’s a ‘good to have’ but its responsiveness as well is a problem. Prices will tend to go up, you can’t turn on a tap to increase the supply when it’s needed right there and then. Instead three London buses come at once when you’re waiting for one. You’ll just get an influx of LNG come in but its responsiveness to when it’s needed is an issue.
But equally the US LNG terminals need to be built and this will be three to four year time horizon before a lot more LNG can come from the US. UK and European production as we mentioned depends on whether more supply can be tapped, probably goes to point 6, government incentives – will there be more of a tap into production there? Certainly in the UK storage is a big thing, does rough storage come back? Does more storage get built to help alleviate some of the concerns for winter?
Nuclear generation, we know France is having issues at the moment, do those units come back quicker ahead of winter? We know Germany changed its policy on nuclear, as did Japan after Fukushima. Does the cost of gas remain so high that it starts to change some of the policy around these? If more nuclear generation was to come on, it would certainly alleviate the demand for gas, and so that’s where it locks into point 5 where there’s alternatives.
Coal generation in Europe is a lot cheaper and it’s staying on for as long as possible. Some countries are trying to leave things on for as long as they can. Just from a cost perspective. Again, that’s a demand destruction on the gas side. So these are just some of the things that could impact price going forward. Some will be short-term to come into effect, others will take a longer time before they come into effect.
Sorry that was a rush but I’ll pass onto John Palmer to finish the presentation. Thank you for your time.
How to buy ‘smart’
JP: Brilliant, thanks John. So I’ll talk a bit about how you can buy perhaps differently, or look at how you’re buying to try and reduce costs. It’s worth highlighting that gas and electricity costs are made up of both the wholesale and non-commodity charges. That’s a bigger element for electricity so the graph here gives you an idea of how the wholesale, which is the blue, plays into that total cost. And when you’re buying it’s really looking at how you can attack both the commodity and non-commodity side of that cost.
Before looking at procurement options
JP: First thing to say really, before looking at procurement, can you reduce energy consumption? That’s going to be the biggest win for you. Can you generate your own energy on-site? Because again, if you’re generating your own electricity, you’re avoiding those non-commodity charges through actually importing energy to your site.
Another thing to look at is invoicing – are you actually being invoiced correctly for your energy? It’s amazing how often you find there are problems with energy invoicing, and certainly our bill validation team have found quite significant cost savings as a result of invoicing errors that have been discovered.
How to buy ‘smart’
JP: In terms of buying, how can you buy smart? Purchasing energy effectively, so understanding what you need and what kind of contract might work best for you – is it a fixed contract, a flexible contract? Should you be fixing or passing through your non-commodity charges. Those increasing non-commodity charges will result in higher costs unless you can mitigate them.
There is another year of triads so if you can be flexible with your demand that might be an opportunity to save some money if you’ve got a pass-through non-commodity charge.
Obviously having an idea of long-term costs and long-term budget forecasting is always helpful, particularly when you’re looking at things like onsite generation and the payback for things like energy efficiency projects. So long-term forecast reports, that’s something that EIC can provide. Also looking at whether you can benefit from asset optimisation and demand-side response schemes, again if you’ve got that ability to be flexible with your demand then you might well be able to save some money or even make an income from those kinds of schemes.
Fixed or flexible?
JP: Fixed or flexible contracts, so depending on your consumption, I think it’s key to understand whether a fixed or flexible contract is the right thing for you. Fixed contracts is a simple option, all of the energy is bought at the time that you actually signed the contract. So you’ve got price certainty and budget certainty for the duration of the contract. But in current conditions, with market prices quite high, there isn’t an opportunity to improve the price if the market moves lower during your contract.
Whereas with the flexible contract, you can buy the energy and sell the energy right up to the point that you actually consume it. So you do have that opportunity to improve your price if the market does move lower. Flexible contracts are more complicated, they involve risk management which can be quite a scary concept for people and certainly when discussing that internally it’s probably a harder sell sometimes for organisations, particularly when moving from the certainty of a fixed price contract. But a trading strategy that goes alongside the flexible contract can be used to provide that high level of budget certainty but still give you some opportunity to improve your price.
So really looking at fixed or flex, the grey dashed line here is the point of the contract renewal and it’s really looking at what might happen over time. So in that market with prices rising at the start, falling just before the contract renewal and then rising again afterwards, at what point do you actually fix your contract? Do you panic at the start and fix it when prices are very high? Do you wait and take a measured approach to where you actually buy? Do you get a bit lucky and end up buying at a relatively good time?
It’s difficult with a fixed contract to know whether you’ve made a good decision until you look back. Whereas with the flexible contract, you’ve got that opportunity to buy at different times and even sell back to try and manage that cost. So if you did panic at the start and buy, you have that option of starting to sell back when prices fall to improve your position. So that’s why a flexible contract will certainly give you more opportunity in terms of the wholesale element of your contract.
I think in terms of the way you procure, it’s got to be right for your organisation. If you need absolute budget certainty, a fixed contract probably still is the way to go – it’s about timing when you actually fix that contract. If you’re looking at flexible contracts it’s about understanding what you’re trying to achieve with that contract and getting the right risk management strategy to give you the best opportunity to get what you need out of it. That might be getting something that’s more market reflective or more aggressive in the current market to try and drive down costs.
It might be about having budget certainty with at least a bit of an opportunity to make some savings. So it’s really a decision to take around what type of contract works for you as an organisation. But it is important to understand that with a flexible contract there is always the option to fix everything out and sit and wait. Whereas with a fixed contract, once you’ve done that, you’re stuck with it.
You can look at our website, eic.co.uk, and there’s a lot of information on procurement as well as carbon and energy efficiency on there so there might be some useful resources. And in particular, we’ve got some free guides for you, so smart procurement and the A-Z of your flexible bills could be useful when you’re thinking about fixed or flexible contracts and particularly the complexity of flexible contracts, trying to make that perhaps a little bit less scary.
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