On-site Solar Generation: Protect against increasing Price Volatility

The true cost of energy price volatility comes from having to report lower than expected profits to shareholders and owners which results in reduced trust and ultimately a lower share price. Verdia’s Thimo Mueller explains that while on-site solar generation can lower your energy costs, it can also help to deliver more predictable returns for your business.

Uncertainty around future energy policy and the ongoing transformation of the electricity system are at the heart of current public debate. At the same time there have been large increases to wholesale electricity prices across Australia. In fact, NSW wholesale prices have doubled over the past four years, while Victoria and South Australia have seen a staggering three-fold increase.

It is no surprise that these increases have captured the attention of energy users across the Commercial and Industrial sector, many acting to mitigate spiraling operating costs.

There are multiple factors which have contributed to this development:

– tripling of natural gas prices

– changes to the supply & demand balance in the National Electricity Market (esp. exit of coal)

– weather-related events (such as heatwaves and droughts)

The reason for a reduction of wholesale electricity prices in Queensland from FY17 to FY18 is due to the State Government intervening at the end of FY2017 by directing state-owned generators to adapt their bidding practises to drive down power prices. However, this direction ended on 30 June 2019.

Many companies have reacted to increased electricity costs by investing in or entering into a PPA (Power Purchase Agreement) for on-site solar generation. This trend is likely to accelerate since the business case remains highly compelling for most sectors and solar PV system costs are expected to decrease further.

While electricity cost savings are often the main economic benefit from on-site solar generation, there is an additional, less highlighted benefit that is gaining importance: reduced exposure to volatile electricity prices. Wholesale electricity prices in the National Energy Market have become more volatile over the recent years in all markets.

In the chart below, ‘volatility’ is displayed as a standard deviation of quarterly volume weighted average spot prices. A high standard deviation indicates that quarterly prices have been very volatile within a year – demonstrating uncertainty around future electricity prices.

Source: Verdia, based on AER data, measured as standard deviation of quarterly volume weighted average spot prices

The highest level of volatility across all markets was observed over the last three Financial Years (SA, VIC in FY19; NSW and QLD in FY17). This is mostly due to an increased production from variable renewable electricity generators, such as solar & wind – as well as the thinner capacity reserve margin in the system resulting from the planned phase-out of firm capacity and unplanned outages of ageing thermal power plants.

The cost of volatility is reflected in the energy rates charged by the electricity retailer (increased hedging costs that are passed through). However, the true cost for business is higher and comes in the form of a lower EBITDA and greater unpredictability of a major operating expense (electricity).

Over the last 18-24 months, many companies were hit cold by a massive increase in energy costs that could not be counteracted. Consequently, these companies had to report a lower than expected result to their shareholders and owners. A second hit came in the form of reduced trust from shareholders and ultimately lower share prices as the company failed to deliver results according to expectations. Predictability has a value – uncertainty leads to a higher discount factor for the future cash flows of a company in an enterprise valuation.

On-site solar generation delivers a predictable output and shields 20-40% of electricity consumption from unwanted cost increases. It is therefore an essential part of a balanced energy strategy.

Thimo Mueller

Thimo Mueller is General Manager Strategy & Commercial at Verdia. He has 15 years of experience in the global energy industry in strategy & transformation leadership. Before joining Verdia, Thimo worked for RWE/Innogy (one of Europe’s largest energy utilities) in Europe and Dubai, and for The World Bank in Australia.

The information which is summarised herein is not intended to reflect any recommendation or financial advice. To the extent that this material contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs, and because of this, you should, before acting on it, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs.   
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