Energy Market

Market Pricing

Electricity Pricing: what's it all about?

Your retail energy contract rate is essentially base energy cost plus margin. Retail energy contracts are signed at a point in time for a future period. It is you and your retailers perception of future energy costs at the time when your contract is negotiated that determines your energy contract rate.

Customers enter into retail energy contracts to protect themselves from the fluctuations in energy price, and to simplify the process of buying energy. Retailers enter into energy contracts with customers in order to lock in their revenue and margin for future periods. EnergyAction efficiently exchanges these contracts via an online reverse auction which provides customers with more access to and power over the market than they would have otherwise. EnergyAction provides retailers with more information over the price of energy so they can win more business more efficiently.

Base Energy Cost

The base energy cost for retailers is a combination of the actual price of energy on the spot market, and the price of forward contracts the retailer has purchased to limit their exposure to the spot market. The higher the price on the spot market, the higher the cost to the retailer of energy used and not covered by a forward contract.

Expectations of supply and demand over the future period set the retailers' expectations of costs for energy at that period. Today's perceptions of supply and demand at a point in the future, and the likely price of energy at that point of time, set the forward price of energy. In order to manage their exposure to fluctuations in the forward price of energy, retailers and generators trade forward swap contracts for peak, off peak and flat (24 hr, 7 day) energy over defined periods in the future. So on any particular day, there is a view of the forward market which has significance to retailers, generators and customers as it defines the basis cost of energy for retailers.

Current pricing on the spot market has a significant bearing on the perception of future supply and demand: when demand is high and approaches the supply capacity of the market, market power shifts to the generators. In this environment, energy retailers come under pressure to avoid future high costs in a constrained market, and buy forward swap contracts at generator prices. When current demand and prices are low, retailers have the upper hand as generators are forced to compete for future market share, and are willing to drop forward prices.

In the short term, energy demand, and therefore base energy cost, is closely linked to temperature. In the longer term, technology and economic cycles drive energy consumption. The correlation between energy demand, price and temperature is obvious: when temperatures rise through summer, air conditioning is switched on. And recently, in states with only low penetration of gas distribution, when temperatures drop through winter, air conditioning is switched on. Where the capacity of the market to supply electricity is threatened by short peaks in air-conditioning use, prices and volatility increase accordingly. The more prone a market is to sharp and short peaks in energy usage, the more capacity is required to meet demand, and the shorter the payback for that capacity. In turn, the higher the price per unit to provide that capacity.

Another key dynamic for the base cost of forward electricity contracts is the J curve. The J curve describes how the price of a forward energy contract is high when the period is a long way out (say 5 or more years) due to the uncertainty of economic cycles and generator capacity over that period. As economic and generator capacity information improves about that period, the price for forward contracts for that period may decrease. This decrease may be a result of generators competing for future market share. As the period nears however, market power returns to the generators, and they are in a position to increase prices to retailers who have not locked in sufficient forward contracts.

As a consequence of the J curve, forward energy contracts are generally cheaper when there is a longer period before the start date of the contract, rather than immediately prior to the contract start. By the same token, retail contracts are generally cheaper for the period where good information about likely supply and capacity requirements are known (generally within 5 years), and when the customer has power over the retailer: when the retailer is looking for future market share and revenue certainty, and willing to trade margin to secure future business. As a general rule, the closer a customer is to the start date of their contract, the higher the price the retailer will have to pay on the market to cover their base costs, and the more margin they are able to pass on to the customer as they know the customers choices in suppliers are limited.

Margin

The margin which a retailer adds to their base energy cost provides the retailer with the incentive to cover the risk of your energy usage on the market. This margin covers operating expenditure, some risk exposure and profit. As in all markets, the margin between the base costs and the sell price is protected as closely as possible by energy retailers, as their ability to manage this margin is the point of differentiation between themselves and their competitors.

The costs in energy retailing, including the prudential requirements to participate in the National Electricity Market, are not insignificant. However, in spite of this, margins do fluctuate between retailers as their priorities in the market and their behaviour changes. At present, margins are hotly contested between retailers as a result of tensions between market consolidation (sale of retailers), and increased liquidity (new entrants seeking to build a sustainable market share). Generally, the more liquid a market is, the more power customers have over suppliers. And just as significantly in the short term, the more tensions there are determining the level of market liquidity, the greater the opportunity for customers to find good pricing in the market.

And this is where we come in...

EnergyAction, as Australia's leading exchange for the trading of retail electricity and gas contracts, has developed significant expertise in assessing and managing contract risks and outcomes in Australia's complex energy markets. We work on your behalf to find you the best deal for your electricity contract, using our unique reverse auction technology.

Our reverse auction model operates like a house auction, but upside down: so many suppliers bid for the right to supply one customer with their energy. Like a house auction, the longer the auction runs for, the better the price: our auctions run for 15 minutes, with extensions to ensure a right of reply is granted to all suppliers. This time-frame strikes the perfect balance between efficiency and giving your contract the attention from the market which it deserves.

Over the years, we have significantly evolved the technology and method of a reverse auction to ensure that our model of energy procurement does exactly what we say it will do: find the best deal for energy on any day of the year for our energy customers and our energy suppliers.

For more information about our auctions, contact one of our business development managers, on 02 9891 6911 or complete our online form, and we will be in touch with you directly.

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