Act now to reduce the impact of business disruption on energy costs and risks

Act now to reduce the impact of business disruption on energy costs and risks

The sudden shutdown of operations imposed on many organizations by COVID-19 is having profound impacts on organizations and the people within them. With sudden and widespread change, it is hard to identify all the necessary actions and prioritize them. For many organizations, the change in operations will affect their need for energy. Here are some steps that organizations can take with respect to natural gas and electricity supply to reduce cost, reduce risk, and manage credit and cash flow in these uncertain times.

ACTIONS ON YOUR GAS SUPPLY

Adjusting gas purchase volumes

Many organizations in Ontario and Quebec will be in gas supply arrangements under which they supply gas to their local utility on a different schedule than they consume it. For these users, reducing your consumption does not automatically reduce the volumes you are purchasing from suppliers.

The rate at which you are purchasing gas was likely set based on a forecast of consumption that did not account for the current crisis. Left uncorrected, this means you are buying gas you may never need and you will be forced to sell it off later.

Taking the necessary steps as soon as possible to reduce your purchases will reduce your cash outlay now for gas you do not need and will reduce the risk of selling surplus gas later at a loss.

Pricing strategies to reduce gas price risk

Many buyers price their gas supply with a mix of fixed prices and floating or “index” prices, reflecting their organization’s tolerance for gas price risk. With strong North American gas supply, plentiful storage balances after a mild winter, and with the demand destruction resulting from widespread business shutdowns, the risk is low for a significant increase in gas prices in the near term.

If a business’s operations – and therefore gas needs – are uncertain over the next few months, it makes sense to buy gas on short term arrangements or on a floating “index” price. Gas bought at an index price can generally be sold off later on the same index without a significant loss. Gas bought on a fixed price may return a much lower price later if the gas has to be sold in a distressed market.

Bear in mind that “basis” or locational differentials are part of this fixed price risk. Gas for delivery at the Dawn hub in Ontario that is priced at the Alberta 5A index will include a fixed basis to account for the locational difference between the Alberta and Dawn markets. This fixed basis is part of the buyer’s fixed price risk. Consider pricing gas at Dawn for Dawn purchases to reduce this risk.

Managing credit

Energy suppliers may perceive an increased credit risk when their counterparties suffer a major business disruption. This may lead them to impose credit limits on energy buyers and require credit support for purchases above a threshold.

It is a best practice to have a portfolio of energy suppliers. A buyer can manage their credit by spreading purchases among suppliers in the portfolio, avoiding accumulating a volume of purchases from one supplier that reaches a level requiring credit support.

Buying gas on a series of short-term arrangements (for example, month-to-month instead of one year ahead) will also reduce the credit risk of the supplier and help avoid the need to post credit on energy supply. This will preserve credit for application elsewhere in your business.

MEASURES REGARDING ELECTRICITY SUPPLY

Price risk for Class B electricity consumers

Many business and institutional electricity buyers in Ontario are Class B consumers for the purposes of Global Adjustment cost allocation. Class B consumers pay a unit cost for Global Adjustment (GA) derived by dividing the GA dollars to be paid by this class in the month over the total consumption of energy by this class in the month.

April and May are often “high GA cost” months because lower market demand in the shoulder months reduces HOEP and therefore increases GA costs, plus lower demand means there are fewer units of consumption to amortize the GA costs. This expected seasonal cost bump will be exacerbated this year, as the impact of widespread business shutdown will be to further reduce demand. The impact could also persist into June and July, depending in part of the onset of summer weather.

There is nothing a Class B consumer can do to affect this impact on unit prices, but by being aggressive in eliminating all unnecessary consumption during a shutdown, a consumer can mitigate as much as possible the impact of these higher prices on the organization’s costs.

High 5 risk for Class A electricity consumers

Class A consumers face significant financial risk with respect to identifying the 5 highest demand hours in Ontario, in order reduce their demand during those hours. Electricity demand in Ontario is being affected by the degree of business shutdown. Demand is generally lower, but the daily load shape is also changing.

July and August are usually high probability months for High 5 hours to occur. If the observed electricity demand distortions extend into the summer months, it may affect what days the High 5 occur on, perhaps displacing some from July and August into September or winter as economic activity is restored. Importantly, since the daily load shape is changing, the usual HE17 and HE18 may no longer be the high -risk hours, and the peak demand could shift earlier in the day.

Class A users must ensure the predictive algorithm they rely on is adapting to the new conditions.

The current environment involves uncertainty, and uncertainty means risk. Prepare your energy supply arrangement for resiliency and flexibility as your organization navigates this uncertainty.

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    The sudden shutdown of operations imposed on many organizations by COVID-19 is having profound impacts on organizations and the people within them.

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