Energy soon-to-be a boardroom priority – By Arthur Beattie, Commercial Director
Since the markets experienced full deregulation in the early nineties, we have witnessed periods of extreme pricing volatility, followed by long periods of stability. During that time, energy management as an agenda item has been in and out of the boardroom more times than Alan Sugar.
Having had the privilege of working in the energy industry for over 20 years, I have seen the winds of change blow in every direction and then back again. We have witnessed the introduction of the New Electricity Trading Arrangements, the implementation and spectacular demise of the Carbon Market and more recently, the Electricity Market Reform.
Our approach to energy management has also evolved over time with increased focus on data, renewable technology, sustainability, stakeholder engagement and well-being. Implementation of new legislation has changed the way we talk about energy as well as the mechanisms we use to report on our usage of it. Legislations that were driven by UK government, implemented on a global stage and then introduced into UK law.
A Perfect Storm
The wholesale price of energy in the UK fell steadily over a two year period from 2014 to 2016, though many commercial businesses did not feel the effect of this softening due mainly to the impact of rising non-commodity costs.
Historically, the cost of wholesale energy made up around 60% of the fully inclusive energy price. However, this has now fallen to around 45% and is widely expected to equate to only 35% by 2020. As a result, the impact on increasing non-commodity costs has negated any savings that might have been realised as a result of declining wholesale prices.
Non-commodity costs are those which do not form part of the price of energy typically relating to the delivery of energy to the customer. They include:
- Renewables Obligation (RO): To subsidise large scale renewable generation
- Feed-in Tariff (FiT): To subsidise small scale renewable generation
- Feed-in-Tariff Contracts for Difference (FiT CfD): To subsidise low carbon energy exports
- Capacity Market Charges: To encourage generation of additional winter capacity
- Transmission Network Use of System (TNUoS): For network installation and maintenance
- Balancing Service Use of System (BSUoS): For costs incurred in balancing demand and quality
- Distribution Use of System (DUoS): For operating and maintaining regional networks
Since the referendum vote on whether Britain should exit the European Union, we have seen the price of wholesale energy begin to rise again. This is due mainly to the weakening of Sterling, though short term gas storage has also been a major contributing factor.
We have seen unprecedented volatility in the price of wholesale energy with swings from £13/MWh to £270/MWh in a short timeframe. Longer term forecasts suggest that the wholesale price of energy will continue to increase for at least two years.
The hardening of energy prices, against the back drop of increased commodity costs is creating a perfect storm; it is estimated that commercial energy bills will increase by around 25% in the next 24 months.
On the back of this, we can expect energy to be firmly back on the boardroom agenda in the coming months.
Batten the hatches or dance in the rain
Risk and opportunity are born out of any change and the greater the implications of the changes, the greater the diversity of risks and opportunities.
Leadership teams must share a value of facing the future with positive optimism. If we must choose a mind-set, it makes sense to select one which empowers rather than paralyses. This is the attitude that will see businesses benefit and grow from the changing landscape of the UK energy industry. An industry that will deliver higher prices and greater volatility whilst demanding a commitment to actively reducing energy demand through the application of both legislative and fiscal penalties.
So what is the key to sourcing corporate nourishment from such a barren and forbidding landscape?
There is no silver bullet; no single answer. There are however a number of mechanisms which, when considered in the context of a wider, interdependent energy strategy, will see every business thrive in the new climate.
As wholesale costs begin to represent a far smaller proportion of the fully delivered energy price, many companies may begin to reduce the attention afforded to the discipline of energy procurement, claiming that efforts should be directed to areas that offer greater control. This would be a mistake.
The idea of an interdependent energy strategy is all inclusive and should begin with ensuring the lowest possible price is being set. However, the parameters for setting energy prices and therefore maintaining control over energy costs is changing. More emphasis must be given to the non-commodity elements of pricing; as energy is traded on a futures market, fixing many of these non-commodity costs can be dependent on the level of risk a supplier is willing to take. In this case, such charges can become a negotiable element of the energy price and therefore offer leverage.
The setting of wholesale energy prices should be a controlled process, driven by the specific objectives of your business, and taking into account your requirement for budget certainty and propensity for risk. Somewhere on this scale is a strategy that will suit your business and should be managed carefully to ensure you receive the benefit that is agreed at the outset of any procurement exercise.
There is no indication that in the changing political climate, the requirement to comply with energy based legislation will diminish. In fact, legislation instigated under EU directive is already enshrined in UK law and will certainly survive the implementation of article 50. Looking beyond this, there is a clear indication that the UK will want to continue to deliver on the agreements laid out under the Kyoto and Paris agreements regardless of our position within the European Union.
The long term forecast is that energy taxes will become simplified as the Carbon Reduction Commitment is wrapped up into a wider ‘energy super tax’ along with a number of other elements that appear on your existing energy invoices.
In the meantime, commercial landlords are being required, amongst other things, to deliver more efficient properties (Minimum Energy Efficiency Standards), with greater transparency on billing mechanisms (Heat Network Regulations) and increased ownership on internal building systems (Building Network Operators).
The key to an interdependent energy strategy is first to understand what you have to do, then consider what you should do in order to understand how each of the related issues affects the behaviour and development of your energy portfolio.
First came metering, then came data; this unfortunately is where for many businesses the story ends. Getting the data right is critical and this can only manifest where an effective measurement discipline is in place. However, the art of energy management is interpreting data to deliver information.
Energy technology has grown at a fantastic rate in the last twenty years and yet the basic principles of good energy management have not changed in the last fifty. The difference now is that businesses can be empowered with the information they need to make decisions on how to improve profitability, reduce operating costs, increase plant life and lower carbon emissions. The reality however is that very few businesses do so; this is because of an inherent distrust in the data or information that is provided to them.
A truly interdependent energy strategy avoids the need to seduce the boardroom with isolated initiatives that promise the world based on forward projections of nonsensical achievements. It instead highlights what must be done based on factual information that highlights the most cost effective route to achieving the overall business objectives.
As we move out of the Industrial Revolution, where workers clock in at 9am and clock out at 5pm, the lines between work and social are becoming less defined. In an age where a millennial business person can operate a multimillion pound business from a laptop in a coffee shop, across multiple time zones, we must accept that whilst the principles remain the same, how we deliver energy management is evolving.
Businesses are entering the market seeking office space that offers ‘well-being’, social space and improved air quality over some of the more traditional buying requirements meaning we cannot simply focus our attention on ‘what was’, we must focus on the ‘what is’ and the what is ‘going to be’.
Energy strategies of the past have focused on near term benefits at a fixed point in time before being banished to the boiler house shelf to collect dust. In order to be effective, the interdependent strategy must be dynamic, continuous and part of the fabric of an organisation.
The optimisation of assets must also be one of dynamic consideration. There is an overused phrase in energy management ‘every building is different’. This could be adapted to read ‘every building is different, because of what it has become’.
In almost all cases, the moment a building becomes occupied, it begins to evolve to meet the operational requirements for those using it as opposed to the purpose for which it was built. In one example of this, a landmark building that was constructed in the nineties as a highly effective office block, now has a data centre in the basement, a call centre on the third floor and an atrium built into the lobby. Yet the plant continues to be replaced on a like-for-like basis with the occupants celebrating small increases in efficiency due to advances in technology.
Imagine a different way. A programme that set out to evolve the existing plant setup into a model of excellence that catered for the changing behaviour of the building whilst providing the flexibility that allows the building operation to become scalable. Imagine also that the implementation of such a maintenance strategy did not require considerable capital investment, but actually reduced the cost of maintenance over a five year period that would have seen plant replaced in line with the original, considerably outdated, building specification.
This is not fantasy, this is intelligent plant evolution and is only possible when you accept that all energy management is interdependent and that no element can be considered in isolation.
Having identified realistic targets, based on an integrated understanding of individual buildings and their behaviour, communicate them.
The board will open the door only once a fully detailed business plan has been produced, costed, approved, abridged and then condensed into a single paragraph – but for the right business plan, they will open the door. This will happen when you are able to clearly articulate the interdependent requirements of energy issues. How the need to comply is going to require investment; how that investment can also work to improve the efficiency; how that efficiency can improve plant life cycle; how evolving plant can improve the quality of the office space; how that improved environment can attract new tenants. How all of this can reduce operating costs, increase profit and have a positive impact on property investment yield.
It is also important to engage other key stakeholders – clients, shareholders, local communities, environmental bodies, the press and any relevant other CSR teams. Because as the strategy is interdependent, so is the impact. With so many potential beneficiaries, effective engagement is critical to realising the true output of an interdependent energy strategy or as I call it 'Energy Excellence'.