Larger Users

Buying processes for larger customers initially developed as they responded to the various opportunities available to them to ensure that a switch of supplier could be undertaken in a timely and orderly manner. Whilst these processes are

complex and can be time consuming, they are generally well understood by participants on both sides of the market and also by the advisors serving the sector. There are, however, tensions and strains within them that have emerged as a result of a discernible trend which we have observed to reprice major user contracts in response to changes in wholesale markets as price volatility has grown.

In 1990, it was a requirement that eligible, over 1 MW, electricity customers had half hourly metering installed, and that notification of switching was registered with the settlements agency four weeks in advance of the contract anniversary date. This starting point tends to mean that the period immediately prior to expiry is typically the time when most customers strike their contracts. With churn rates relatively high in the sector, from the supplier point of view, the scale and nature of their operation serving larger users can change quite

profoundly over this period and between one contract ‘round’ and another. In contrast, sometimes suppliers opt for wider commercial reasons to compete less aggressively in particular rounds, which will have a substantial influence on market shares. In recent times, for example, both Powergen and EDF Energy elected to do this whilst their assimilations of TXU and Seeboard were being concluded.

Partly through the involvement of advisors and brokers, but also as a consequence of central reconciliation and settlement methods that have

developed, a series of processes have developed which are applied, in various different ways, by or on behalf of larger customers. These processes are summarised in the diagram shown in Figure 5:1.

Figure 5:1: Overview of Typical Business Procurement Processes D a ta

c o lle c tio n & ve rific a tio n T e n d e r p re p a ra tio n & d isp a tc h A n a lysis o f re sp o n se s N e g o tia tio n C o n tra c t a w a rd D a ta c o lle c tio n &

ve rific a tio n T e n d e r p re p a ra tio n & d isp a tc h A n a lysis o f re sp o n se s N e g o tia tio n C o n tra c t a w a rd

Differences in the approaches to, and time required for, each of the functions shown in Figure 5:1 arise because of short-term market conditions, the

complexity of the customer’s requirement, and the chosen route to market. As will be discussed in Section 7.2.1.2, this presents a key challenge to buyers

responding to wholesale market conditions, which have become very much more volatile over recent years.

The scale of this challenge is evidenced by Figure 5:2. It shows an example timeline for larger users undertaking a formal tendering process based on the practice which developed in the 1990s. A key driver of the timing is

administration of the supplier change process. In the electricity market, such ‘registration’ can be undertaken within 5 working days, although, to ensure a timely process, 15 working days is the general minimum. In the gas market, 15 working days is required for registration, although a number of suppliers specify that they need longer than this, sometimes as much as twice this time.

Figure 5:2: Example Timeline as Established in the 1990s for a Formal Tendering Process Undertaken by a Larger Energy User

The development of the wholesale electricity and gas markets into commodity markets, and the close links between them and contract supply pricing to non- domestic customers, now mean that many fixed price offers are only valid on the day they are made. Moreover, during periods of extreme wholesale price

volatility, offers can be extremely hard to come by, if at all.

Such time pressures have a significant impact on the negotiation process for larger business customers. They must now be in a position to organise

competing, valid offers, analyse them, and negotiate their supply contracts within very short time-spans, vastly shorter than Figure 5:2 implies. This very important consideration is discussed in more detail later in this Section and has been a major factor in the rise of intermediaries serving the sector.

Data Collection Tender Preparation Tender Despatch Analysis of Responses Negotiation Contract Award

Week 1 Week 4 Week 6 Week 8 Week 8 (to 12) Week 12 (to 15)

W eek 1 3 t o 16 Co ntr act Start Data Collection Data Collection Tender Preparation Tender Preparation Tender Despatch Tender Despatch Analysis of Responses Analysis of Responses Negotiation Negotiation Contract Award Contract Award

Week 1 Week 4 Week 6 Week 8 Week 8 (to 12) Week 12 (to 15)

W eek 1 3 t o 16 Co ntr act Start

5.1.1.1. Electricity

The bulk of medium and large customers now hold supply contracts with a 1 October renewal date. The development of electricity contracting ‘rounds’ was a result of the process of opening the supply market to competition. In the early 1990s, the majority of contracts in the eligible competitive market were

negotiated with a 1 April contract commencement date (reflecting that the

market became competitive on 1 April 1990), and most contracts at this time were for 12 months. This timing meant that most contracting activity was undertaken in the first quarter of the year. However, against a background of sharply rising Pool prices in the early 1990s, some users opted for 18 month fixed price

contracts, commencing on 1 April, as these offered a one-off price advantage compared with an annual arrangement from the same date. This preference arose because such an arrangement incorporates two summers of expected low wholesale costs against one higher priced winter period. Furthermore, in 1993 many larger customers undertook 18 month contracts as a means of avoiding the renewal process in April 1994, when the 100kW to 1MW sector of the market was due to open. This subsequently created the second ‘major’ annual contracting round of the year for 1October contract renewals.

This trend was repeated to a certain extent in the run-up to 1998, when the small business and domestic sectors of the market were due to open to

competition, although slipping from their original implementation month of April to a staggered phase-in.

Now the major negotiation round for business electricity supply contracts is for October renewals, followed by April, with much more limited activity for July and other dates. In the main, customers have tended to continue to opt for 12 month supply arrangements, although longer-term contracts are more common for larger users buying for high numbers of smaller, sub 100kW sites. Longer-term, typically two-year, but some much longer, contracts were also more common across the spectrum of customers at the time of the sharp fall in wholesale electricity prices in 2002. As a result of these developments, in recent years the bulk of negotiation activity has taken place in the third quarter of the year for October contract renewals, and in the first quarter of the year for April contract renewals.

5.1.1.2. Gas

In the gas market, the majority of large user contracts also now have a 1 October contract renewal date, again reflecting general trends in development. There is, though, more variation in contract start dates compared to electricity. This difference largely reflects the longer developed and more mature nature of

the traded wholesale gas market. As a result, non-domestic customers have exercised more flexibility in their gas supply contracting, for example, opting for shorter-term pricing arrangements, and competitively contracting for sites added to their portfolios as and when acquired. Just as in the electricity market,

however, the majority of gas supply contracting activity is undertaken in the third quarter of each year.