A procurement professional’s guide to energy costs

Energy contracts can be secured a number of ways. Directly, through public or private buying groups, or through private sector brokers. At times, each option can be seen as unattractive.

Historically procurement professionals do not have the niche expertise to manage the supply chain when it comes to buying energy, so rely on third party expertise.

However the relationship with third parties can be managed much better if procurement professionals acquired some fundamental knowledge of energy costs. This starts with an understanding of what we pay for in our energy bills. A better understanding of the fundamental cost elements of energy bills and fundamental procurement options will allow organisations to make better procurement decisions, either directly or when managing the supply chain.

A rough breakdown for electricity would be – the wholesale cost accounts for 45 per cent, transport 40 per cent and taxes 15 per cent of the total bill. For gas, wholesale cost makes up 80 per cent, transport 16 per cent and taxes 4 per cent.

Fundamentally when we sign our energy contracts for gas or electricity, the timing of the purchasing decision only affects the wholesale cost. Wholesale energy costs vary day-to-day depending on the wholesale market. So access to simple historical wholesale graphs from the third parties can assist in the decision when securing energy deals as the wholesale energy costs can be placed in historical context to see if they offer value.

A fundamental misconception - often due to misinformation provided by the third parties - is that by fixing prices for a one, two or three-year term you can achieve the lowest cost. Although long-term rates can be attractive, it is incorrect to assume this offers the lowest cost. It does offer more cost certainty but not lower costs and the difference between the two must be understood.

To achieve lower or the lowest wholesale energy costs, users need to consider flexible procurement strategies that buy the energy closer to the period of consumption over a sustained period of time. The dynamics of wholesale energy costs in the UK mean it is likely costs will be cheaper during these periods. But this does forego the certainty of knowing what your unit rates will be each month/quarter. There can be significant financial upsides, particularly in relation to gas contracts where 80 per cent of the costs are made up of the wholesale energy costs.

A large element of electricity costs are due to transportation. These are primarily the local and national costs of bringing the electricity onsite. Again, these costs can be mitigated through a better understanding of these charges - a large proportion are calculated by measuring how much electricity is used between 4pm and 7pm, Monday to Friday (or “peak time”).

By asking the supplier not to include these transport costs in the unit rate and charge them on what’s known as a “pass through” basis, these costs can be made transparent and the user can see the proportion of transport costs they pay for each day, week or month, etc. Any attempt to reduce energy use during these times, or switch to alternate energy sources can then immediately reduce their impact. This is demand management and is practiced widely in the manufacturing sector. Although it can be more difficult for the other sectors like leisure to implement demand management strategies, we believe that at the very least other industries should be auditing their premises to see if any demand management strategies can be implemented without compromising services, as lower transport costs can be the net result.

Ben Dhesi is managing director at Pulse Business Energy

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