For anyone who has bought fresh fruit or vegetables from the side of the road, how rewarding was it? You paid the farmer, knew where the produce came from (organic, local), and probably saved money by cutting out the middlemen (distributors, wholesalers, supermarkets, et cetera).
Now imagine doing this with energy.
Some businesses are doing exactly that, by becoming “wholesale” electricity customers. And it’s something that’s likely to become more commonplace as our energy market transforms.
From a retail customer to a wholesale customer
Most businesses via retail electricity contracts. Retailers buy power from the wholesale market and on-sell it to their customers. Wholesale electricity prices vary every half-hour – ranging from negative prices (a story for another day) up to $14,000 – for each megawatt-hour of electricity that is generated. Retailers smooth out these prices for consumers by charging a flat rate – or a peak, shoulder and off-peak tariff – for different parts of the day.
The retailers use financial instruments (such as hedges) to manage their own exposure to the price fluctuations, especially high-price events.
However, retail contracts disconnect businesses from the wholesale price (that is, the real price) leaving little incentive for businesses to use less electricity at peak times (such as during an extreme temperature event in summer).
During the highest demand days, the grid mostly relies on expensive “peaking” gas plants to switch on. To use another food analogy, this is the equivalent of an “all you can eat” buffet: where customers use as much electricity as they want – when they want – with no concern for its real cost. But everyone pays for this inefficiency because the costs are passed through to all businesses and households.
Customers who are prepared to become wholesale electricity customers, and expose themselves to the fluctuating market price, can buy cheaper energy by avoiding the premiums charged by retailers.
Essentially, it’s all about managing the risk of being a wholesale customer.
Thus, the study by the University of Technology Sydney’s Institute for Sustainable Futures (ISF). The study was commissioned by Flow Power, a retailer that offers wholesale energy to business customers, in partnership with WWF Australia, to assess the potential cost benefit for customers of using demand response to adjust their electricity demand relative to the electricity spot price and other factors.
For those involved in electricity and energy for businesses, it may feel very strange and risky. But in many other aspects of our lives, we accept and manage such risks.
For example, we buy petrol for our cars each week, with the price changing from $1.20 to a $1.80 per litre, instead of trying to sign a two-year set contract at $1.50 per litre.
It’s common wisdom that electricity is not core business for most organisations, so this price risk is best managed by electricity retailers in a competitive market. Such retailers can enter into contracts with electricity generators, forward purchasing electricity on behalf of their customers and providing fixed prices for two to four years.
This strategy is not really a strategy at all. Historically, future prices sat at around $40 per megawatt hour, or four cents per kilowatt hour, for years. This saw larger businesses offered prices of around five cents per kilowatt hour in Queensland, NSW and Victoria for the energy portion of their bills, with network and other charges on top. Times were good.
But in October 2016, the owners of Hazelwood Power Station announced it would close the following year. This drove-up future prices to $110 per megawatt hour or 11 cents per megawatt hour in Victoria and NSW, with even higher rises in South Australia.
This showed businesses that retailers can only manage pricing risk in the short-term, and not in the medium to long-term, beyond the end of a retail contract. So, businesses are taking matters into their own hands.
Contracting renewable energy to protect against high wholesale prices
Interestingly, many customers of the retailer which commissioned the research have considered signing additional renewable power purchase agreements(PPA) to buy a share of the output of a wind or solar farm. This means that if prices are high and their contracted wind or solar farm is generating, they are already protected from high costs.
Renewable energy generators generally need an agreement for their power before they can get bank finance to build. Businesses can support new solar and wind farms through a corporate renewable PPA.
The motivations for businesses entering these power purchase agreements vary from wanting to reduce costs and improve business certainty by fixing a portion of their electricity costs, to meeting sustainability goals.
However, a residual risk remains when prices are high and renewable energy is not being generated: what happens when the wind isn’t blowing, or the sun isn’t shining? This is where demand response comes in.
Reducing demand to protect further against price risk
Demand response involves electricity customers deliberately reducing their demand in response to high spot prices or other incentives, in order to manage the risk of very high prices in the short-term. It can include the shutdown of a non-essential plant, the use of onsite generation or energy storage (such as battery or thermal), or load shifting to later times when the price is cheaper.
Businesses generally have more flexibility to shift demand than they realise, and new technologies are making it cheaper and easier to do so.
It also has the potential to enable customers to protect themselves from short-term high price events, and lock in the savings from being wholesale customers with a corporate renewable PPA.
The study focussed on three customers based in Victoria in 2017 and 2018 using actual consumption and price data. They could have saved between two percent and 33 per cent on the energy portion of their bills, in addition to savings made through wholesale pricing and corporate renewable PPAs.
While the exact savings will depend on multiple factors (such as wholesale pricing, customer demand, corporate renewable PPA generation, and the ability to implement and execute demand response successfully each year), there were some interesting insights realised during the study.
The most effective type of demand response was where energy demand was significantly reduced for short periods in response to price signals. This was better than planned load shifting, due to the ability for prices to rise significantly, from a normal price of $40 to $80 per megawatt hour to as much as $14,200.
It is also as much about risk management as potential cost savings. If there is increased market volatility, then it is more advantageous to be able to know you are ready for the bad days (or months or years) and to be able to manage electricity costs during those times.
There is a strong outlook for businesses willing to adopt new models and become more proactive with their energy management. With significant new renewable energy projects underway, it becomes more likely that wholesale electricity rates will reduce below the price of short term contracted electricity.
The study showed that, in the current market, it is possible to get the best of both worlds by increasing adoption of renewable energy whilst reducing costs and managing risks with demand response.
Jonathan Prendergast is a research consultant at the University of Technology Sydney’s Institute for Sustainable Futures (ISF). This article is based on an ISF study that was commissioned by Flow Power in partnership with WWF Australia.
Download the Best of Both Worlds: Renewable Energy and Load Flexibility for Australian Business Customers report for further information.