Hedge contracts are for large consumers

Last week, we investigated how a pool pass through contract could save you money. We concluded that when market conditions are favourable, your electricity bill will be lower if you take the pool price. That post raised some discussion about what if hedge contracts had been purchased instead.

In this post we investigate how hedging your electricity contract can insure you against the volatility of the market.

Large consumers buy hedge contracts

We’ll analyst the costs for a single large energy consumer. This customer has 40 MW of installed machinery. Example customers of this size (and larger) might be:

• Steelworks;
• An aggregation of supermarkets or shopping centers; and
• Utility water companies

The minimum purchase price for a hedge contract from d-cypha trade is 1 MW. If your peak electricity usage isn’t over 1 MW, purchasing your own hedge contracts wont save you any money. But I’m sure a long talk with your electricity retailer would – we’ve been told that rates for higher using consumers are extremely competitive right now.

MW or MWh, what is the difference [ 1 ] ↓

What is the right amount of peak and base to buy?

Buy hedge contracts to fit your profile [Full Size]

Here is the daily load profile for the industrial consumer. Consumption is low overnight, typically below 14 MW. At 7 am production quickly ramps up to full output (around 38 MW). Then production finishes around 10 PM at night.

Peak contracts cover your usage between 7am to 10pm seven days a week. So if your facility uses more power during these times (like our example large consumer), it will be a good fit for a peak contract. Base contracts cover all hours of the day seven days a week. Base contracts are good for consumption that occurs consistently day and night. Our example consumer’s consumption doesn’t drop below 14 MW.

Buying a 14 MW base contract

The sum of our two contracts cover the peak [Full Size]

The consumption doesn’t drop below 14 MW. Imagine creating a rectangle 14 MW high on the daily profile chart. We’ve drawn it in green. It represents the base contract. Buying a 14 MW base contract means that we have agreed to pay for 14 MW at $X for every half hour in the day. Even if our machines break- down, or we take a vacation and shut down the plant, we still pay for that 14 MW.

Buying a 22 MW peak contract

The consumption between 7am and 10pm rises to between 37 MW and 38 MW. We’ve already purchased 14 MW with the base contract, which leaves 23 MW outside of contract. Buying 23 MW of another base contract would be wasteful in the extreme, because we don’t use that additional 23 MW at night. Instead we’ll purchase a peak contract for 22 MW (leaving 1-2 MW to take on spot market risk). We opted for 22 MW because the usage fluctuates above and below 23 MW, and we couldn’t purchase 22.5 MW because dcypha only trade contract units of 1 MW.

Making and losing money. A tail of two quarters.

We’ll investigate the cost of the hedge contracts over two financial quarters in 2012:

• The first from April to June; and
• The second from July to September.

The following analysis assumes the hedge prices [ 2 ] ↓ :

• base contract: $48 / MWh; and
• peak contract: $54 / MWh.

In the first quarter (April to June 2012). The total energy costs (both hedges and spot market rates for the energy outside of contract) were $3.28M. The equivalent if all energy was purchased from the spot market was $2.18M.

The second quarter (July to September 2012). The total energy costs were $3.44M. The equivalent if all energy was purchased from the spot market was $4.18M.

Contract Period	Spot market	With hedging
April - June 2012	$2.18M	$3.26M
July - September 2012	$4.18M	$3.44M

Paying for predictable pricing

A set of hedge contracts that fit your load profile can save money when the market becomes volatile. However when markets produce stable prices it is best to buy directly from the pool.

The trouble is, who knows how to predict whether the next quarter will be volatile or stable? If you can predict the volatility of future quarters, give us a call, we’d love to talk :)

You must purchase contracts that fit the shape of your load (or perhaps change the shape of your load to fit the contracts). Because once you are contracted for 14 MW, you must pay for those 14 MW whether you used them or not. An ill-fitting contract shape can cost you more than the volatility it protects you against.

Finally, if your consumption doesn’t rise above 1 MW for at least the peak hours, then it isn’t worthwhile purchasing a hedge contract yourself. This is what retailers are for. They pool all of their customers together and purchase large hedge contracts.

If you have some ideas for further investigation let us know in the comments

Footnotes

MW or MWh, what is the difference? [ 1 ] ↑

A MW (Mega-watt, 1 million watts) is an amount of energy consumed per second. Often pumps and generators have a nameplate with the MW rating written on it. Light bulbs are rated by their power consumption too. 20W to 100W being common around the family home.

A MWh (Mega-watt hour) is the standard measure of energy in the electricity market. Running a 1 MW pump for 1 whole hour will consume 1 MWh, running for half an hour will consume 0.5 MWh. And running a 100W light bulb for an hour will consume 0.0001 MWh.

I normally talk in terms of MW when giving the size of a facility, because it aligns with the ratings given for large equipment. Your electricity bill is for energy consumed (MWh) not your instantaneous power (MW).

Why $48 / MWh and $54 / MWh? [ 2 ] ↑

We estimated that contracts in Victoria could have been purchased at these values for the 2012 year. To understand how the contract price has been changing we read through some of the “market wrap” reports written by d-cypha trade.

The second quarter was volatile notably because of the introduced carbon price. But we used the same contract prices assuming that they had been purchased well in advance, you can’t get such low prices on hedge contracts any more.