Energy market volatility: is this the end of fixed price electricity contracts?
Since 2020, energy markets have been dealing with a constantly shifting set of variables. From a global pandemic to extreme weather events and unexpected geopolitical factors, never before have energy markets been under so much pressure from so many different angles. Viewed against that backdrop, Jonas Strom, Senior Energy Market Consultant for Montel Group outlines what this all means for consumers and energy suppliers and how supply contracts are changing to fit the new energy market environment.
Historically, electricity supply companies in the Nordic countries have sold electricity contracts to end customers both on fixed and variable rates. And there have been rather big differences between the countries; where in Norway almost all customers have chosen variable rates, around 25 % of Swedish customers have a fixed price electricity contract. Looking back only 10 years ago it was much higher still, with 40 % of Swedish energy consumers on a fixed contract.
Energy prices have spiked overall in the Nordic region. However, some areas such as northern Scandinavia - heavy with production from hydro and wind - have seen only small increases in prices.
This has caused huge price differences between the price areas, which is something completely new for the market. These differences are now traded in the so-called Electricity Price Area Difference – EPAD.
Part of the reason for this change, is that the electricity market has transformed in the last few years. With extreme volatility and record high prices for electricity becoming the normal, energy suppliers and utilities are now also adapting to find new ways of selling electricity and how to price it."
Up until now, fixed rate contracts have been hedged with financial contracts where the electricity supplier purchases the same amount of electricity in the futures market as they have sold to the customer.
The only thing that is fixed for the customer here is the price - so they are free to consume as much or little as they wish - leaving the supplier with the volume risk, which means they must buy or sell the correct amount of power in the spot market to match the actual supply by the end of the contract.
The supplier also usually hedges their futures sales of electricity with standardized contracts listed on electricity exchanges such as Nasdaq where the volume is the same for the whole period, , whilst the end customer will consume differently over the day, the month and over the year. That leaves the supplier with another risk: the so-called profile risk.
Also, it is important for the supplier to hedge the price for the area where the customer lives or has its business, meaning they need to purchase the EPAD for that area.
Until now, volume and profile risks were something that most suppliers could calculate and get paid for, whilst the differences between the price areas in the Nordic region were typically both low and predictable. As a result, offering fixed rates to customers was not a big problem.
This has changed in the new energy market environment. High prices and high volatility, combined with large differences in prices in the different price areas, has made it difficult or sometimes impossible for the electricity supply companies to hedge their future sales of electricity due to the increased high profile and volumes risks.
This is why most of the electricity suppliers have stopped selling fixed rate contracts for electricity. The risk to them is simply too high, meaning the price for fixed contracts to the end customer is also prohibitively expensive."
So, what are the options for the suppliers if they want to offer their customers an alternative to the variable rate but don’t want to be stuck with the profile and volume risks? Some customers still want to have some kind of insurance against price spikes and feel more comfortable when they know what the price will be going forward.
One alternative that is attractive to both the customer and the supplier is a hybrid solution, where the electricity contract is based on a variable rate, but the customer also receives a fixed amount of electricity at a fixed rate on top of that.
With this contract, the customer has a variable rate per hour and a fixed rate for a defined amount of power over the lifetime of the contract. This enables the consumer to get the benefits of a falling market price and also enables them to optimize their consumption during the hours with the lowest electricity price.
At the same time, they have an insurance against high prices to manage their own energy price risk. The supplier can also offer this kind of a contract with a cap on prices, so they are not stuck with large profile and volume risks.
The Montel Advisory team is supporting several energy companies in their product development journey as the transformation of electricity markets drives changing customer needs. Taking the vital step to offer their customers a new product for electricity is just one of them.
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