Energy is likely to make up a substantial proportion of your business’ monthly bills, so it’s important to have a clear understanding of what it is you’re paying for. A number of expenses are incorporated into your energy bill. These include network costs, operating costs and government policy costs, as well as VAT, supplier pre-tax profit and certain other direct costs. However, the single biggest factor affecting your bill is the cost of wholesale energy. This typically makes up more than a third of total bills.
So, what exactly is wholesale energy, how does this market work and can you expect wholesale prices to rise or fall over the coming months and years? Keep reading to discover the answers to these questions and more.
What is wholesale energy?
The wholesale energy market is where energy is traded between generators and suppliers. Suppliers purchase energy from generators at wholesale prices, before adding a mark-up and selling it onto their customers at an increased price.
Because the wholesale energy market is impacted by a wide range of variables, including continually varying supply and demand, it can be highly volatile – meaning that prices can rise and fall dramatically over short time periods.
As a consumer of energy, you don’t deal directly with wholesale energy costs. However, it is useful to have an awareness of what these costs relate to as they do impact on the retail prices you pay to your supplier.
Wholesale energy vs. retail
In contrast to the wholesale market, the retail market is where energy consumers (including the vast majority of businesses) buy their gas and electricity from suppliers. You can choose from a wide range of suppliers in the UK. In fact, although the market is dominated by the ‘Big Six’ (namely British Gas, E.ON UK, EDF Energy, npower, SSE and Scottish Power), there are around 60 of these companies in total.
With so many suppliers and a wide variety of tariffs available, it is possible to find highly competitive deals for business energy on the retail market.
As mentioned previously, the amount you are charged for gas and electricity by your supplier will depend on a range of factors – and prices in the wholesale market is one of the main variables to be aware of. If the wholesale price of electricity and gas increases sharply, this is likely to be reflected in an increase in tariffs charged by suppliers.
How does the wholesale energy market work?
Energy supply in the UK involves three key elements. These are generating energy, transporting it, and selling it to the end user. Energy companies can work in any of these areas, and some operate in all of them.
Here, we take a closer look at how the wholesale markets for gas and electricity function.
Electricity is a unique product because it can’t be stored in large amounts. The means that supply and demand must be balanced, or matched, at all times. In the UK, this is primarily done by generators, suppliers, traders and customers buying and selling in the wholesale electricity market.
Trading takes place in a number of different forms. For example, it can be done on the basis of bilateral agreements. This refers to contracts struck between generators and suppliers for the purchase of electricity. Usually, these agreements are framed by a master contract that is struck for a set period of time and that establishes overarching trading principles. Individual trading agreements then establish the set amounts of electricity to be bought, as well as the trading price. To help avoid supply and demand imbalances, generators inform the National Grid of the volume of electricity traded before this power is delivered.
Wholesale electricity trading can also be done on the basis of same day or next day exchanges. This involves an auction process that matches selling prices offered by generators with bids from suppliers. Again, to avoid market imbalances, the National Grid monitors the traded volumes of electricity.
On a more long-term basis, electricity is traded through electricity brokers. Wholesale trading prices are established on the basis of forecast market development.
As the ‘residual balancer’, National Grid Electricity Transmission (NGET) is responsible for ensuring that the supply and demand of electricity are matched on a second-by-second basis. One of the tools it uses to achieve this is the Balancing Mechanism, which allows NGET to accept offers of electricity and bid for this energy at very short notice.
The wholesale gas market in the UK involves the buying and selling of natural gas after it has arrived from production sites based offshore. Sources of natural gas include liquefied natural gas terminals, storage sites, interconnectors with Europe and pipelines from other countries. There is one price for wholesale gas regardless of where it comes from. This is referred to as the National Balancing Point (NBP) price.
The companies responsible for bringing gas to Britain, called gas shippers, buy and sell gas and provide suppliers with this energy source to then pass on to end users.
The systems operator in the market is National Grid Gas plc, and it is responsible for making sure that gas supplies match demand on a daily basis.
Wholesale energy prices forecast
Prices for wholesale energy can rise and fall dramatically. Highlighting this, Ofgem figures show significant fluctuations in the price of wholesale electricity between 2010 and the start of 2020. Bear in mind that because of the high volumes of electricity traded on the wholesale market, you are unlikely to see these figures expressed as wholesale electricity price per kWh. Instead, the measurement used is generally a megawatt hour (MWh) – which is equivalent to 1,000 kWh. According to Ofgem, the wholesale price for next working day delivery at a constant baseload rate was at its highest during this 10-year period in September 2018 at £67.69 per MWh. It had fallen to £35.93 per MWh in January 2020.
The way in which prices fluctuate makes it very difficult to forecast future UK wholesale electricity prices and gas prices with any degree of certainty or accuracy. A whole range of variables come into play when predicting how prices may change, including available supply, environmental disasters, geopolitics and consumer demand. The COVID-19 pandemic is causing particular uncertainty at present. This global event has had a strong impact on energy markets, contributing to a collapse in oil prices and falls in the prices of other fossil fuels. Statistics provided by the European Parliament reveal a drop in the price of Brent crude of two-thirds from US$69 a barrel on 6 January 2020 to under US$23 on 30-31 March 2020.
According to the European Parliament, the pandemic will carry on affecting global energy markets, but the precise implications will depend on the nature and speed of the economic recovery, as well as decisions made by policymakers. It notes that a fast recovery and a return to business as usual in international trade could lead to a recovery in fossil fuel prices, while a more muted recovery with reduced global trade could result in more sustained low prices – as well as structural changes in the energy market.
How to buy electricity wholesale
Some companies, usually large, industrial businesses that use very high levels of energy, purchase electricity on the wholesale market, but this is rare – and it is a phenomenon that has only emerged recently. In the vast majority of cases, businesses purchase energy through the retail market, meaning they deal with suppliers rather than directly with generators.
So, when you are searching for the right deal for business energy, it is important to know how to navigate the retail rather than the wholesale market. With so many suppliers and tariffs on offer, it can be difficult knowing where to start when you’re looking for a competitive deal for your business. However, there are simple steps you can take to help ensure you get the right contract for your business.
At Utility Bidder, we are a business energy comparison and switching specialist and can search the market on your behalf. Whether you operate industrial premises, warehouses, shops, offices or any other type of business, and regardless of the size of your company, we can help you to find a contract that offers impressive value for money.
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