Risks to avoid and opportunities to seize
2020 has been a year unlike any we’ve ever experienced. As the novel coronavirus, COVID-19, has made its way around the world, economies have been shut down. Sickness and death have become common topics of discussion on the nightly news. We now have a whole new set of terms that have become commonplace lingo, such as social distancing, contact tracing, and Zoom. Until recently, the idea of wearing a mask was relegated to kids at Halloween or those planning on robbing a convenience store.
The world of energy supply has also been impacted by the pandemic. Buyers and sellers of energy, users, and generators have been affected in ways that may linger for years to come. You, as a user and purchaser of energy, need to understand these changes because they create both risks to avoid and opportunities to seize.
Pandemic-Related Changes in Usage – and Why it Matters
It would be extremely logical to expect that if your usage of energy increases, so does your cost. You use more energy, and you pay for more energy – very simple. However, that’s not always the case. It may be counterintuitive that, if you use less energy, you actually end up paying more. But this is the dilemma that many organizations are faced with in the wake of the COVID-19 pandemic.
Because of the quarantines, shutdowns, and ensuing economic collapse, many businesses and organizations are using significantly less energy than they ordinarily would. Unfortunately, their decreased usage does not equate to decreased cost. The terms and conditions of many electricity and natural gas supply agreements include clauses that address such changes in usage and outline recourses the supplier has in these cases.
Much has to do with how supply contracts are negotiated, a topic we have written about extensively. Deviation from your expected estimated monthly energy usage is addressed in supply contracts by typically giving the supplier the ability to recoup costs associated with meeting your energy usage needs when they deviate from the expected – whether up or down. This means that, even though your usage is down, you’re still expected to cover your contracted amount.
Risk of Increased Energy Costs
When an energy supply agreement is executed, the supplier is hedging its position in the market by purchasing that energy for you. This puts them at risk of needing to either buy extra energy if you use more than expected or sell back unused energy if you use less. When you use less energy, penalties may be assessed to cover losses the supplier incurs or administrative costs involved with selling the unused energy back into the market. These penalties may prove to be more costly than if you used the estimated amount of energy you would have before COVID-19 interrupted things.
These risks can be mitigated by negotiating a “bandwidth” around your estimated energy usage. A 25% bandwidth clause would mean that your usage could go up or down 25% without resulting in any penalties. Sometimes there are “material adverse change” clauses in these contracts that mean a substantial change in usage (such as has been occurring as a result of the pandemic) can then allow the supplier to assess penalties or even implement a new rate. A key aspect of addressing this risk is to either negotiate a contract without such a clause or better define the clause so that you have greater protection.
In any event, the majority of energy supply contracts have clauses and terms that can lead to increased costs if your usage decreases – especially in such a dramatic fashion as has resulted from COVID-19. Being savvy enough to identify and properly negotiate these clauses in the future will help provide greater protection to your energy budget.
Opportunities to Improve Your Energy Budget
Because the pandemic has shut down or curtailed many operations, we have seen a widespread decrease in energy use. This includes decreases in transportation, with a resulting decline in the demand for fuels such as gasoline and diesel. We just addressed the risks to you as a consumer under a supply contract where you are using less energy. The flip side of this situation is that this lowered demand for energy has created an abundance of supply.
Economic theory tells us that increased supply in light of decreased demand leads to lower prices. The energy markets are no different. COVID-19 has led to lowered prices for both electricity and natural gas in many markets. For those organizations in a position to take advantage of it, there are opportunities to secure future supply agreements that may create greater savings than what you are currently paying.
Some markets allow for the consumer to negotiate supply contracts many years into the future. You could negotiate a contract for electricity, for example, that may be 15% lower than your current contract costs – and you might be able to lock in this rate for five years or more. This reflects the “upside” to what the pandemic has done to the energy markets: You can actually lower your energy budget by securing deflated energy rates for your operations.
As a country and a world, we’re all dealing with the “new normal” resulting from the global health crisis. We in the energy consulting business see both risks and opportunities. The wise consumer – the savvy procurement specialist – will take the appropriate steps to protect against the risks. At the same time, you will position your organization to seize the opportunities.
While the pandemic hit everyone unawares, we are starting to see the recovery. Regardless of how your organization has been negatively affected by the initial impact of COVID-19, you can take steps today to arm yourself with the knowledge that will lessen future impacts while also benefiting the bottom line of your organization.