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Pricing Volatility

Price volatility in the gas and electricity market

Domestic energy quite understandably grabs all the headlines and is the focus of the political commentary, but the truth is it is businesses that are more exposed to the energy markets.

The Government and regulator have been slow to react to this fact but are beginning to wake up to the realities of what businesses face in the energy market. Whether it is through the cross-industry working group for Number 10 or Ofgem's Retail Market Review, action, albeit belated is coming.

If we look at the energy market as a whole we can split it into 3 general sections:

Residential

This sees a broadly uniform movement in prices by the energy suppliers once, maybe twice a year.

SME

More exposed than the residential market; yet somewhat insulated from wholesale market movements by 'tariff sheet pricing'. 

Corporate

Corporate customers face the greatest exposure to wholesale market movements due to their size and volume of energy usage.

Residential Market

Though the size of these price changes cannot be treated lightly, and quite understandably receive a great deal of scrutiny and attention, they are dwarfed by the regularity of price movement in the business energy market.

The SME Market

This is where a business energy supplier will purchase energy in advance and therefore guarantee a fixed price for a fixed period for a set volume of customers. However once that price allocation has gone it is gone and the business that comes too late for the offer will be exposed to a new potentially higher price relative to the level of the current market.

There is a complication though. The tariff sheet price, unlike the residential offering, is subject to a wide range of criteria each combination of which can deliver a different pricing outcome.

The suppliers, each have differing commercial strategies, differing access to generation and a pricing methodology based on region, profile, meter type, consumption, business type, credit rating and payment type. Therefore the combinations soon start to stack up. As inevitably does the confusion for the average SME customer.

In addition to these commercial considerations there is the live wholesale market to contend with. A market that steadily and sometimes not so steadily erodes the margin of the supplier as the variable cost of raw energy rises.

As this volatility occurs, suppliers will withdraw their tariff sheets for re-pricing before re-releasing the revised prices to the market once the energy required to support these prices has been secured.

On average the SME market sees around 30 price changes a month, or 360 a year, compared to 1 or occasionally 2 a year in the residential market.

This is however dwarfed by the 48 half hour price periods each day that drive the wholesale market itself.

The Corporate Market

It is the final segment of the market, the Corporate customers, who face the greatest exposure to these wholesale market movements.

Because of the sheer size of these customers and therefore the significance of the volumes of energy they use, suppliers do not wish to be exposed to any variability in customer behaviour. Such variability may lead them to be short in matching supply with demand and force them to purchase energy in the costly and at times cost prohibitive short term market.

Because of this there is a bespoke pricing market for Corporate customers where the price they pay is directly related to the level of the wholesale market. The  wholesale market in electricity is priced on a half hour basis. In other words in every half hour a fresh price is posted for energy for any given contract. As a result because the underlying prices change every half an hour the price offered to a Corporate customer will theoretically be subject to change until the customer has locked in a specific price for a specific period.

Given a price in a single half an hour can also differ dependent on when that energy is due to be delivered the range of potential prices a customer will see will vary greatly.

In effect the retail price offered to a Corporate customer is subject to the same volatility as the underlying wholesale market.

That is even before the commercial considerations of the supplier are taken into account such as to what length of contract to offer, when to purchase the energy, how much energy to purchase and at what price it can be accessed.

In effect a price can be seen and the opportunity gone for these businesses in the time it takes to open your business in the morning.

Comparing the markets

Whilst the Corporate segment sees market volatility at its most extreme, the SME market is subject to much the same volatility albeit smoothed based on a supplier's ability to ride the market via tariff sheets.

In comparison the domestic market looks serene.

Despite, or rather because of this volatility, one of the key features of the business energy market is the opportunities that are constantly created for accessing an advantageous deal.

In the residential market the suppliers move their prices largely together and on a similar trajectory, so once you've switched and the savings banked, the opportunity for significant future savings is limited.

By complete contrast, because the wholesale market moves both upwards and downwards, and because the electricity marked is priced 48 times a day, the level of price accessible to a customer can vary greatly.

This provides strong opportunities to strike an advantageous deal even in what seems from a distance as a market on a linear upward path.

Out of chaos then can come some good.