'Progressive Purchasing' of electricity gaining traction in the New Zealand market

In the New Zealand electricity market many retailers now offer ways of purchasing electricity known by such terms as ‘progressive purchasing’ or ‘flexible purchasing’. 

In simple terms, these contracts allow a customer to agree that the particular retailer will supply their sites with electricity for the term of the contract. However at the time of signing, the price of this electricity is not locked in, only the premium they will pay above a transparent index such as the ASX Futures market. The customer then makes decisions as to when to lock in this future pricing, when they see opportunity in the market. These ‘lock-ins’ can be for individual quarters in the future, and can also be for a proportion of the load, ie. you can choose to lock-in 25% of Q2-22 load today.

I strongly believe this is the future of electricity contracting for Commercial & Industrial sites, which is evidenced by substantial take up in Europe (anecdotally it would be unheard of for an entity consuming >100 GWh p.a. to sign up to a fixed term three year deal in the UK these days) and Australia. Whilst the New Zealand market is a little different to those, primarily around the lack of C&I retailers who aren’t backed by generation, as well as (and possibly because of) the lower level of liquidity in the Futures market, I see no reason why this contracting method will not become increasingly used.

What’s the rationale behind contracting like this?

The key concept to grasp is that when you go to market for an electricity contract, be it a traditional fixed price variable volume contract or a Contract for Difference contract, the price you are being quoted for future pricing is predominantly driven by the ASX wholesale electricity Futures market at the time, which is a transparent platform where generators, retailers and speculators trade.

Because of this, when a large consumer goes to market, the pricing they get back from most respondents will generally be relatively close, varying a little based on the retailers current book, and how keen they are to hold on to an existing customer or acquire a new customer.

So market timing is far more important than the competitive tension gained when conducting a traditional RFP. The graphic below shows an indicative makeup of a retailer’s pricing – all retailers are pricing out of the same wholesale market, which constitutes around 90% of the price and can vary by up to 40% depending on timing – it makes sense to concentrate on this element!

Volatility tends to be your friend under these contracts

As pointed out above, the wholesale markets seriously influence the price that you will get for your electricity contract at time of asking – and in New Zealand these are quite volatile, as shown in the chart below. 

This example is showing the price of quarterly electricity in 2022, from when it started trading back in October 2018. 

Worth noting is the fact that the quarterly Futures do not necessarily move with each other, they are somewhat independent (often more likely to be following what the previous year of that particular quarter is doing) – Q1-22 & Q2-22 dropped on news of the Rio aluminium smelter considering its future (22/10/19), whereas Q3-22 & Q4-22 didn’t on that day. 

This produces opportunities to lock out particular quarters, rather than take the whole year at a time. Q4-22 has had a number of days where it decreased close to $8/MW, when at those times other quarters were steady or even increasing.

Whilst those sort of movements don't happen every day, locking in a quarter at +/- $8/MW would result in a difference of $17,500 for every MW demand in that quarter – if the average C&I customer demand is ~5 MW, that’s a range of $87,600 up or down on the spend for that quarter or over $350,000 annualised, based purely on when they go to market.

Benefits of Progressive Purchasing contracts

• In theory it should reduce the risk premium built into Fixed Price or hedge contracts, as the retailers have no price risk in their offer – leading to lower commodity cost overall.
• You do not have to trade budget certainty for lower cost - by setting buying triggers and managing appropriately you can have budget certainty when you need it
• Ability to lock-in pricing in a number of tranches across a number of quarters resulting in better risk management
• Not considered a financial product - no requirement for collateral or counterparty risk, or special accounting treatment
• Ability to adjust exposure based on business strategy or changes – lock out pricing for the rest of the contract at any point if you need to.

Who is this available to, and who’s doing this now?

This sort of product is available to portfolios with annual spending of approximately $1.0 million or using approximately 10 GWh per annum, in either the North or South Island.

Many innovative organisations are already purchasing their electricity in this way, including the likes of Whakatane Mill, OI Glass, Silver Fern Farms, Juken New Zealand, Accor Group, Americold & ANZCO - consuming more than 700,000,000 kWh per annum between them.

In this link, we debunk some of the myths surrounding progressive purchasing contracts, including misconceptions around risk, budgeting and workload needed to manage them. 

Summary

This is not a silver bullet to avoid high prices – you can’t ‘short circuit’ the market, but should be viewed more as a long term risk play. By using this approach you are unlikely to get caught with significant sharp increases between contracts in the future.

In many cases we believe that the progressive purchasing methodology will lead to ultimately securing the lowest possible energy cost over time. This type of product means that you are set up to take advantage of sudden movements in the market (as happened when the Rio smelter announced it was considering its future), but does not commit you to pricing too far in front, where there is uncertainty around future pricing holding at these levels due to possible industry pullback, increased renewables penetration and perhaps increased government intervention.

Like all things, there are pros and cons, and you can read a summary of these for all types of contracting methods here.