Recent changes to the legislative landscape change the nature of a risk managed energy & carbon strategy

Given the announcements in 2016 on the legislative energy & carbon landscape, consumers are now risking significantly more on exposure to non-commodity costs, levies & taxes than exposure to the wholesale markets at their current value.

 

Whilst the UK forward energy markets have continued to stabilise above the recent lows in April 2016, the month-ahead and day-ahead market continues to offer strong value for those consumers who are able to take advantage of near-term buying opportunities. Therefore, many consumers have either taken advantage of falling wholesale energy prices on longer term fixed price contracts or continue to adopt a short-term buying approach.

Recent volatility (albeit not as severe as in previous years) and fears over the long term trajectory of wholesale prices continues to raise concerns over the future of the markets as we move into the second half of 2016 and 2017. More recently (16th May) the Brent oil price reached $49/bbl in trading, prompting many to consider that the oil markets may continue through $50/bbl and stabilise.

However, continued healthy supply, strong participation from renewable fuels and a lack of adverse market drivers suggest that unless we see a continued rally in the oil price, risks in the gas supply chain, major generation outages or extreme weather conditions (affecting demand), there is likely to be a continued opportunity for consumers to take advantage of prices.

For those consumers continuing to take advantage of near-term prices (or those yet to fix contracts) there is a strong argument to consider opportunities to hedge all or some of future seasons out to 2020/21. Therefore, whilst this document is not aimed at providing wholesale energy market intelligence there is a credible argument to talk further with Beond on our thoughts as to the future markets.

 

Risk Management
Risk Management

From our experience many consumers are still adopting a stand-alone wholesale energy risk management strategy which provides guidance and regulation as to the methodology for engaging with a supplier, managing commercial and contractual terms within the supply agreement and places context on the decisions made as to how energy is bought on the wholesale market. Whilst these strategies are always subjective, and should be aligned to an organisations internal appetite and objectives, there is a wider and more pressing risk to consumers as we continue into 2016.

Non-Commodity, Regulatory and Legislative risks are the single biggest drivers based on the current wholesale price and the events of 2016 thus far.

Non-commodity charges (those charges in a delivered energy bill which are not the wholesale price) is a widely understood area as rising levies and taxes have formed part of the energy bill cost for consumers.

However, 2016 has been a pivotal year in the UK energy markets due to the challenges faced by the UK Government in continuing to deliver the objectives as set out in mandated legislation for carbon reduction. More notably, the UK Budget announcement in March 2016 that the CRC scheme will be closed, demonstrated that the UK Government will continue to rationalise and adapt the mandated carbon landscape to meet challenges.

Therefore, Beond expects 2016 and 2017 to be pivotal years where volatility in legislation, regulation, compliance, levies and taxes will continue to be significantly greater than the current and predicted wholesale energy price (based on the baseline scenario). This continued evolution of the markets is based around 3 fundamental risks which should be placed alongside and interlinked to the wholesale energy risk strategy currently utilised by many consumers.

  • Non-commodity charges will continue to increase based on the support for low carbon generation, the requirement to invest in our infrastructure and the risk in a shift from thermal generation to renewables.
  • The UK Government consultation on the simplification of the carbon markets will continue to adapt and evolve, causing consumers to adapt and change in equal measure. The principle of taxation as the major driver to consumer change will continue as the main focus for UK policy.
  • Given that consumer taxation will not deliver the level of carbon reduction required to reach our ambitious targets in the longer term, there is likely to be a greater level of mandated efficiency and reduction targets which will force consumers to act (i.e. ESOS phase 2 is likely to mandate consumers to act).

A base sample analysis of Beond clients (detailed below) for an October-2017 contract year suggests that the percentage of wholesale energy negotiable through a defined energy risk strategy will fall to 45.46% of the delivered energy bill. As an illustrative example of the challenges faced by consumers the recent changes to the Capacity Market (the early adoption of the scheme for 2017) suggests that the revised price estimates will increase the percentage of this levy from 0.01% of a delivered energy bill to 2.51%.

Risk Management
Risk Management

Whilst the attached chart shows the potential risks of not including a detailed non-commodity strategy into the existing energy risk management strategy, the charts do not include:

  • The longer term risks from the closure of the CRC and the increase in CCL taxation, on the basis that consumers exempt from the CRC will see higher CCL charges on all or the remaining CCL tax they pay. In addition, the re-balancing of the gas CCL levy will see greater impact on gas costs.
  • Further potential changes to the carbon reduction landscape, to include future mandated action to influence organisations to adopt technology and strategy based on minimum standards.
  • Future changes to the legislative landscape based on the potential June 2016 Brexit including other regulatory tax changes to the continued support for low carbon generation.
  • The basis that the UK Government has a limited pot of money to fund subsidies, and as such, a continued low wholesale price risks the financial framework for supporting the evolution of energy markets.

Whilst the initial October-2017 analysis is based on the baseline scenario, a dramatic change in the wholesale energy price (higher) will change the predicted value of levies and taxes which means that consumers must adopt a flexible and adaptable strategy.

What are Beond recommending?

Beond believes firmly that consumers should continue to enhance and innovate the existing energy risk strategy to consider the overall energy and carbon risk to an organisation based on a range of scenarios at least 5 years ahead. These strategies can be considered by Beond and take into consideration:

  • The current application of technology as a generation source or to reduce consumption / improve efficiency, based on the best fit technology to not only provide financial benefit now but consider the longer term risks.
  • The utilisation of scenarios to consider the non-commodity price risk, which in turn provides a key insight into the longer term decisions an organisation must make.
  • The potential legislative risk with a quantified view as to not only the financial risk but also the potential to change the compliance landscape – feeding into the longer term sustainability risk.

 

To download this brief please do click the download button below. If  you would like more information on the above or to talk about our latest innovations please contact the consultancy team on 020 8899 7385.

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Disclaimer: These views and recommendations are offered for your consideration and Beond makes every effort to ensure that the data and information in this report is accurate.   However, due to the volatile and unpredictable nature of the energy markets, Beond cannot guarantee the accuracy of both the information and the recommendations provided.  Beond does not accept any responsibility for errors or misstatements, or for any direct, indirect, consequential or other loss arising from any use of this information and/or further communication in relation to this information.