Our colleague Felipe Gracia in La Vanguardia

Felipe Gracia, who is responsible for E&C’s recent rapid growth in the Iberian market, was interviewed by Spanish daily La Vanguardia last week. Below you can find the text of the interview (in English translation, original Spanish version below).

“The traditional way of buying energy is no longer appropriate”

 

The consultant analyses the evolution of the sector in the past year with events such as Fukushima.

 

Economy / 09/01/2012 / 00:10h

 

Judith Martinez

Barcelona

 

Felipe Gracia is an energy consultant and co-owner of the European group E&C consultants, with operations in 17 European countries and offices in Belgium, the Netherlands, Spain, Germany and the UK. Specialized in financial markets, Gracia analysis how their variations affect the costs of these companies for buying energy, gas as well as electricity. He says that due to the volatility, their price suffers significant variations at different moments in the year and that the choice of the moment at which you buy is crucial.

 

Where is the energy that we consume coming from?

 

Some two thirds of the gas that is consumed in Spain comes from external producing countries and arrives in our country by LNG-ship. This gas is regasified in terminals in the ports and can be injected into the system or loaded on trucks so that it arrives at clients that don’t have access to gas pipelines (this is what we know as liquid gas). The rest arrives by pipeline, principally from Algeria. By contrast, (almost all) electricity is generated locally by different technologies: wind, hydro, solar, nuclear, gas-fired, coal-fired, oil-fired or other renewable sources.

 

How is its production regulated?

 

In the case of electricity, through the system operator REE. It has to manage it by complying with the law of demand and offer that settles its price. However, this is not easy, as you have technologies that cannot be controlled 100%. We do not now when the wind will blow, when it will rain, when the sun shines …

 

And who is commercializing it?

 

At the moment we have enough companies that offer gas and power, since production, distribution and commercialization are separated. In liberalized and mature markets, you have a lot of companies that commercialize energy according to the following flow: go to the market, pay the wholesale price, put on a small premium and sell it to the final clients. Energy is a commodity.

 

Which companies consume large quantities of energy?

 

The majority is to be found in the industrial sector, occassonally also in the services sector: a chain of hotels or shops, for example, has an aggregated consumption that can be larger than that of an industrial plant. We consider a company to be a large consumer of energy, when its expenses are superior to 500k EUR per year, in gas as well as electricity.

 

How do they approach this type of purchase?

 

In Spain, the large companies are comparable to the rest of Europe, as the purchasing of energy is not only a technical theme, of installation and consumption. They have understood that the factor that most affects their cost has to do with the financial aspects, especially the moment of buying.

 

Don’t say that it depends on exchanges …

 

The Spanish exchange for power derivatives is OMIP while for gas at this moment it is the Brent and the euro/dollar exchange rate. However, this is changing, as you have inititatives, promoted by the Basque and Catalan governments to set up a Spanish gas Hub.

 

What do you mean by hub?

 

It’s a market where this commodity is sold and bought and where its price is ruled by the law of offer and demand and not by speculative movements around the Brent – at the moment 85% of the Brent purchases are speculative, have no physical delivery.

 

Does buying energy demand a level of sophistication?

 

Yes it does. It’s good to mention the change that we have seen this year in the sort of contracts that the commercializers are offering to their clients, with the possibility of managing the risk associated with the volatility of the financial markets.

 

Is the price usually fluctuating a lot?

 

As markets are global, the economic and political impact of the different countries affects the energy price. Even if the Iberian market isn’t totally liberalized yet, what happens in the rest of Europe and the world affects the prices that our clients pay, for gas as well as for electricity.

 

On the other hand, the more markets are liberalized and mature, the larger the fluctuations they suffer and as such the cost that companies have to pay for the energy that they consume.

 

So buying energy should be approached on a strategic level?

 

This is our big challenge: explain our clients that the traditional way of buying energy is no longer valid and that they have to think about diversifying the risk. It is key to elaborate a buying strategy that is adapted to the business of every client. It’s the same concept that applies to other raw materials.

 

In what measure can a good energy buying strategy affect these costs for a company?

 

In 2011 the power market had a variation of some 10 EUR per MWh. That means that on a consumption of 1.000.000 kWh, the price difference is 10.000 EUR. Realizing a cost reduction of 10 EUR per MWh by consumption planning is very, very difficult. Therefore, it is important to take into account the effect of volatility and propose strategies that permit to control the budget in advance.

 

If we look at the daily market OMEL, fluctuations have been much larger, so you have to think carefully about your purchasing model.

 

Could you be more explicit?

 

If we think about the traditional model for buying at many companies that negotiated once a year, mostly at the end of the running year, we see that in December, many of them have faced this 10 euro per MWh increase in their power cost. If we think about a client consuming 100 GWh that normally pays 80 EUR per MWh, passing on to 90 EUR per MWh means a total impact of a 1 million euro increase, or 12,5%. For us, this is the risk of not managing the markets.

 

And what variations have gas prices displayed?

 

The price differential in 2011 compared to 2010 is some 8 EUR per MWh, a vital variation for companies that have important gas expenses. For some companies we are talking about a rising cost that is heading the most important costs in the balance sheet.  For these, it is very important to be well advised.

 

Due to Fukushima?

 

It is one of the many causes that have affedted the energy price in 2011. The nuclear disaster in Japan provoked a 3 EUR per MWh increase of the gas price in less than 2 weeks (+12%). Moreover, the decision by Germany to stop eight nuclear power stations (equivalent to the total amount in our territory) has provoked much tension in the gas market.

 

You really have to be an expert.

 

The users and those responsible for the purchasing in the companies still lack a lot of training and information regarding the different components and prices of energy. Even though we meet with highly professionalized purchasing departments, they normally don’t dispose of experts in the different commodities that they buy, and energy is certainly one of them.

 

Who should manage the procurement of energy in a company?

 

Historically, it was done by technicians from maintenance or engineering, but when the companies understand that their price depends on financial factors, it becomes the responsibility of the purchasing or financial managers, who take the buying decisions together with the general manager in relation to the strategy that the company has defined.

 

Any advice to take into account when making decisions?

 

The future of the energy price cannot be predicted (like we experienced before and after the 11^th of March, with Fukushima). Which doesn’t mean that a company shouldn’t define its energy buying plan in a form that is adapted to its business (this is what we call strategy), and apply it by monitoring the markets. This second step is where consultants deliver a major help to companies. We help them to buy in the best circumstances possible.

 

As far as private or residential consumption is concerned. What should we take into account regarding this matter?

 

On a private level, contracts are still largely regulated and there is little we can do to obtain a better price, as all the options are very similar.

 

When will we approach the rest of Europe in terms of buying energy?

 

It is certain that the European markets are more mature and have sufficient liquidity to be able to buy energy far in advance of consumption.  Nevertheless, we have to admit that the large national companies have made a great effort this year, they have rethought their models and invented and brought to the market products (contracts) that approach those of the neighboring countries.

 

On the other hand, as consumers, we need to get used to control the risk and as such, our energy budget, so that it is adapted to our business.

 

We need to diversify the risk.

 

Occassionally, national consumers think that buying equal quantities in the energy market so that the risk is distributed is speculative, whereas in reality, the opposite happens. Waiting until the end of the year to negotiate a contract, thinking that prices will get better, that is speculative. Moreover, as has been demonstrated this year, nothing is certain.

 

What is the lookout for the energy markets?

 

It is very probable that in the coming year we will see large volatility in the markets and that the risk for the companies will rise ever more.  The more notable is the fact that, in line with the rest of Europe, buying energy will be very difficult and will demand great specialization.

 

 

“La forma tradicional de comprar energía ya no es válida” El consultor analiza la evolución que ha sufrido el sector en el último año con sucesos como el de Fukushima Economía | 09/01/2012 – 00:10h Judith Martínez

Barcelona Felipe Gracia es consultor energético y socio del grupo europeo E&C Consultants, con operaciones en 17 países europeos y oficinas en Bélgica, Holanda, España, Alemania y Reino Unido. Especializado en los mercados financieros, Gracia analiza cómo las variaciones de estos afectan al coste que supone para las empresas la compra de energía, tanto de gas como de electricidad. Dicha volatilidad hace que su precio sufra variaciones significativas en diferentes momentos del año, y que la elección del momento de la compra sea crucial. ¿De dónde proviene la energía que consumimos? Unas dos terceras partes del gas que se consume en España provienen de países productores extranjeros y llega a nuestro país mediante barcos metaneros. Este se regasifica en las terminales de los puertos y puede inyectarse en el sistema o cargarse en camiones para que les llegue a los clientes que no tienen acceso a la tubería de gas (es lo que conocemos como gas natural licuado). El resto, nos llega en tubería, principalmente desde Argelia. Por el contrario, la electricidad se genera (en casi su totalidad) de forma local mediante diferentes tecnologías: eólica, hidráulica, solar, nuclear, ciclos de gas, carbón, combustible fósil y otros tipos de renovables. ¿Cómo se regula su producción? En el caso de la electricidad, a través del gestor del sistema REE. Este debe regularla para cumplir con la ley de demanda y oferta, que arrojará el precio de la misma. Pero no es fácil, ya que hay tecnologías que no se pueden controlar al 100%. No sabemos cuándo soplará el viento, lloverá, hará sol… ¿Y quién la comercializa? Actualmente hay bastantes compañías que ofertan gas y electricidad, ya que los negocios de generación, distribución y comercialización están separados. En mercados liberalizados y maduros, hay muchas empresas que comercializan las componentes energéticas y el mecanismo de

adquisición es el corriente: ir al mercado, pagar el precio mayorista, colocar una pequeña prima y venderla a los clientes finales. La energía es una commodity. ¿Qué empresas consumen grandes cantidades de energía? La mayoría son del sector Industrial, pero en ocasiones también las de servicios; una cadena de hoteles o de tiendas, por ejemplo, tienen un consumo agregado que puede ser mayor que el de una planta industrial. Consideramos que una empresa es gran consumidora de energía cuando su gasto es superior a 500K€ anuales, tanto en gas como en electricidad.

¿Cómo abordan este tipo de compra? En España, las grandes empresas están equiparándose al resto de Europa, donde la compra de energía no es solo un tema técnico, tanto de instalación como de consumo. Están entendiendo que el factor que más afecta al coste de la misma tiene que ver con los aspectos financieros, en especial el momento de la compra. Habrá que estar pendiente de la bolsa… La bolsa ibérica para los derivados de la electricidad es el OMIP, mientras que para el gas hasta ahora era el Brent y el cambio €/$. Pero esto está cambiando, y ya hay iniciativas, promovidas por el gobierno vasco y catalán, de configurar un hub de gas español. ¿En qué consiste un hub? Es un mercado donde se compra y se vende esta commodity y cuyo precio se rige por la ley de

oferta y demanda y no por movimientos especulativos en torno al Brent – actualmente el 85% de la compra de Brent es especulativa, es decir no tiene entrega física. ¿La compra de energía se está sofisticando? Así es. Es digno de mencionar el cambio que hemos visto este año en la tipología de contratos que las comercializadoras están ofertando a sus clientes, con la posibilidad de gestionar el riesgo asociado a la volatilidad de los mercados financieros. ¿Suele fluctuar mucho el precio? En la medida en que los mercados son globales, el impacto económico y político de los distintos países afecta al precio de la energía. Por eso, a pesar de que el mercado Ibérico todavía no está plenamente liberalizado, lo que sucede en el resto de Europa y del mundo afecta a los precios que nuestros clientes pagan tanto por gas como por electricidad. Por otro lado, a medida en que los mercados se encuentran más liberalizados y maduros, mayores son las fluctuaciones y por tanto el coste que las empresas deben pagar por la energía que consumen. Entonces ¿la compra de energía debe estar sujeta a una estrategia? Este es nuestro gran reto: explicar a los clientes que la forma tradicional de comprar energía ya no es válida y que deben pensar en diversificar el riesgo. Elaborar una estrategia de compra, que se adapte al negocio de cada cliente, es clave. Es el mismo concepto que se aplica a otras materias primas. ¿En qué medida puede afectar una buena estrategia de compra de energía en los costes de una empresa?

En 2011 el mercado eléctrico ha tenido una variación de casi 10€/Mwh. Es decir que sobre un consumo de 1.000.000 Kwh, la diferencia en precio es de 10.000€. Conseguir bajar el coste en 10€/MWh mediante la planificación del consumo es muy, pero que muy difícil. Por eso es importante tener en cuenta el efecto de la volatilidad y plantear estrategias que permitan controlar el presupuesto con antelación. Si miramos al mercado diario OMEL, estas fluctuaciones han sido mucho mayores, por lo que hay que pensar muy bien a la hora de decidir el modelo de compra.

¿Podría ser más explícito? Si pensamos en el modelo tradicional de compra de muchas empresas donde se negocia una vez al año, y habitualmente al final de este, vemos que en diciembre muchas de ellas se están enfrentando a este incremento del 10€/Mhh en el coste de su electricidad. Si pensamos en un cliente con 100GWh que normalmente paga unos 80€/MWh, pasará a pagar 90€/Mwh, con un impacto total de un incremento de 1M€, o un 12,5%. Para nosotros este es el riesgo de no gestionar los mercados. ¿Y cómo ha variado el precio del gas? La diferencia de precio en 2011 respecto al 2010 es de unos 8€/Mwh, una variación vital para las empresas cuyo gasto en gas es importante. Según la empresa, estamos hablando de importes muy elevados, encabezando los mayores importes en su cuenta de resultados. Por esto es tan importante estar bien asesorados

¿Debido a Fukushima? Es una de las muchas causas que en 2011 ha afectado el precio de la energía. El desastre nuclear ocurrido en Japón provocó un incremento del precio del gas de 3 €/MWh en menos de 2 semanas (+12%). Además, la decisión de Alemania de parar ocho centrales (equivalente al total de las que disponemos en nuestro territorio) provocó más tensión en el mercado de gas. Realmente hay que ser un experto. A los usuarios y responsables de compras de las empresas todavía les falta mucha formación e información acerca de los diferentes componentes y precios energéticos. Aunque nos encontramos con departamentos de compras muy profesionalizados, normalmente no disponen de expertos en las diferentes commodities que adquieren, y la energía es sin duda una de ellas. ¿Quién debería gestionar la compra energética en una empresa? Históricamente lo hacían responsables técnicos de mantenimiento o ingeniería, pero cuando las empresas comprenden que su precio depende de factores financieros, pasa a ser responsabilidad de los directores de compras y financieros, que junto con el director general toman las decisiones de compra en relación a la definición de la estrategia de la compañía. ¿Algún consejo a tener en cuenta en la toma de decisiones? El futuro del precio de la energía no se puede predecir (ya lo vimos antes y después del 11 de marzo, con Fukushima). Eso no significa que cada empresa debe definir su plan de compra de energía de forma que se adapte a su negocio (es lo que nosotros llamamos estrategia) y aplicarla de acuerdo a la monitorización de los mercados. En este segundo paso, es donde los consultores prestamos una mayor ayuda a las empresas. Les ayudamos a que compren en las mejores condiciones posibles. A nivel de consumo privado o familiar, ¿qué deberíamos tener en cuenta sobre esta materia?

A nivel particular, la contratación se encuentra bastante regulada y poco podemos hacer para obtener un precio mejor, pues casi todas las opciones son muy parecidas. ¿Cuándo nos acercaremos al resto de Europa en la forma de comprar energía? Es cierto que los mercados europeos son más maduros y hay liquidez suficiente para poder comprar energía con mucha antelación. Sin embargo, hay que reconocer el gran esfuerzo realizado en este año por la mayoría de empresas nacionales, que a base de romper moldes están innovando y sacando al mercado productos (contratos) que se acercan a los de sus vecinos.

Por otro lado, como consumidores debemos acostumbrarnos a controlar el riesgo y por tanto nuestro presupuesto energético, de forma que este se adapte a nuestro negocio.

Debemos diversificar el riesgo.

En ocasiones, los consumidores nacionales piensan que hacer compras parciales en el mercado energético de forma que se distribuya el riesgo es especular, cuando en realidad sucede lo contrario. Dejar la negociación de un contrato a final de año, pensando que los precios serán mejores, eso sí es especular. Además, que como se ha demostrado estos años, no es cierto.

¿Cómo ve el futuro del mercado de las energéticas?

Es muy probable que en los próximos años veamos gran volatilidad en los mercados y que el riesgo para las compañías se incremente todavía más. Lo más destacable es el hecho de que, en la línea del resto de Europa, comprar energía será más dificil y requerirá gran especialización.

Filed under: Spain

Spain: catching up with liberalization

Europe is running at different speeds when it comes down to implementing EU directives. This certainly holds for the directives regarding energy market liberalization. The UK and Scandinavian countries started to reform their energy markets towards competitive models in the 1990′s. By implementation of the EU directives written in the late nineties, most other countries followed in 2000 – 2003. But some countries lagged behind. And these are not only countries that have only recently acquired EU membership. In the French electricity market, almost every consumer is still buying energy in a regulated market. The EU is struggling with the French government to force them to embrace energy market liberalization. In Germany, the government waited until 2007 before passing a law that organized third party access to the grids by regulating the grid fees.

I have spent the past week in our office in Spain, another country that was slow in implementing energy market liberalization. For years the Spanish energy legislation entailed a double system where regulated tariffs co-existed with open market prices. When the tariff was lower than the open market price, consumers switched to the regulated market, when the open market was dropping below the regulated level, they switched to those lower open market prices. The result was that the regulated tariff acted as some sort of upper level above which open market prices never rose much. Spanish power consumers spent a comfortable time under this umbrella and didn’t have to develop the sort of purchasing practices that became common in other countries, such as buying electricity in tranches.

In 2008 the Spanish government (forced by the EU) banned the regulated tariff system. Until now, the Spanish power prices haven’t shown the sort of volatility that other countries have seen in the past year. The economic crisis, which hit this country particularly hard, is of course an important reason for that. Power demand in 2009 is down 5% compared to 2008. But it is not the only reason. The large Spanish utilities seem to be still in the process of fully implementing the approaches that utilities in any other open market embrace, namely:

1. In the wholesale market: marginal cost pricing. With 55% of all electricity produced in conventional thermal power stations, you would expect the prices of coal and gas to have much more impact on Spanish power prices than we currently observe.

2. In the retail market: back-to-back pricing, i.e. daily adjusting the fixed price quotes to the level of the wholesale market prices. There is a parameter for the Iberian wholesale power market, namely the Omip futures exchange (http://www.omip.pt), but liquidity at this exchange is still very low. And what is worrying is that prices often don’t show any changes at all for many days in a row. The traditional suppliers often claim that they still set their fixed prices independently of the Omip price level and that they are based on the underlying total cost structure of their production assets. In reality, this is not completely true. Retail fixed prices for Spanish power are now cheaper than a few months ago, which is in line with the Omip evolution. If we compare the fixed price quotes that we get to Omip price levels over a longer term, we see a good consistency. It is therefore safe to say that the Omip, even if trading on it is very thin, is already acting as a sufficiently reliable benchmark of Spanish power prices. But still, the Spanish suppliers are not (yet) daily adapting their retail prices to the wholesale market. If the Omip price goes up by 5 euro in a month, you will see that the fixed price quotes go up by about the same amount. But is not like in many other countries where any 1 ct change of wholesale power prices is immediately reflected in the retail prices offered to industrial consumers.

If I were a large consumer of electricity in Spain, I wouldn’t bet that this situation will last forever. I know of no fully liberalized electricity market on this planet where wholesale power prices are not set by marginal cost pricing. And if sales departments of utilities sell prices in the retail market below the level that they could get in the wholesale market, they will get into trouble with their superiors sooner or later. I really believe that is just a matter of time for Spanish power consumers to suffer the same amount of volatility as their counterparts in other countries with a well-diversified power production park such as Germany. The peaks might continue to be less high, due to the availability of relatively cheap gas formulas in Spain.

With the products that Spanish power suppliers currently offer, it will be very hard for industrial consumers to protect themselves against that volatility. A year ago, we starting asking Spanish suppliers for tranche model contracts, with the possibility of fixing the electricity price for a yearly volume at different moments so that we could spread the risk of the price fixing decision. They looked at us like we came from another planet. Some of them even argued that Spanish electricity buyers would never buy in such ways. Due to our insistence, a client of ours recently signed such a tranche model contract with a large Spanish utility. And most of the other utilities are starting to offer similar products. So we could say that Spain is catching up, but is still far from where it should be. Price premiums for such products are still high, the service level for fixing the prices for the tranches is not what it should be and other conditions remain a source of much discussion. But at least, the first step is taken, and the fact that there is competition for offering such products, makes us hopeful for the future.

This is also a good thing for the gas consumers in Spain. The Spanish gas market isn’t much different from the gas markets in most other European countries. The gas price is linked with a formula to oil prices. The only difference is that we often run into formulas with lower slopes, meaning that the prices don’t rise so quickly with a rising oil price. But in Spain, like in any other country, the price of the gas will rise if the oil price continues its current uptrend. In those other countries, consumers will be able to hedge that risk by swapping the oil-indexed price for a fixed price. Most European gas suppliers have developed excellent services for such swapping activities. In Spain, up until now, gas suppliers were reluctant to do so. Some Spanish suppliers bluntly answered that we could contact banks to give us hedging services. But we prefer to do the hedging with suppliers for a multitude of reasons, such as accountancy, volume risk, premium issues, credit, etc. In the past year, the discussions that we had with Spanish gas suppliers regarding such hedging services were extremely frustrating. Now that Spanish power suppliers start to develop this part of the energy supply business, we are hopeful that their natural gas branches will follow suit.

E&C’s Barcelona office

Filed under: Energy policy, Energy suppliers, Spain

Is Spain heading for European power prices?

In the past five years, Spanish power consumers enjoyed lower prices then their competitors in many other countries of Europe like Germany, the Benelux, France, UK or Italy. Only Scandinavian countries had lower wholesale power prices most of the time. There is some rationale for Nordic power prices to be lower. Hydropower is so abundant that it produces the marginal megawatthour that sets the price for all energy. And as the fuel cost of hydropower is zero, it is logic that this produces low overall energy prices. But how about Spain? It produces around 50% of its electricity from fossil fuels. Hence, it should be expected that marginal MWh’s are produced with coal-fired power plants during off-peak hours and gas-fired power plants during peak hours. Hence, the prices of coal and gas should set the prices of respectively baseload and peakload power. Spain should therefore have power prices that are similar to those of Germany.

Then why were Spanish power prices systematically lower than German in the past years? I can think of two reasons:

1. Like the French government, the Spanish rulers never embraced power market liberalisation wholeheartedly. Regulated tariffs continued to co-exist along open market prices for a long period. As regulated tariffs are based on the average total cost of power, they remain lower in times that the fossil fuel costs run up. Open market prices had to adapt to these lower regulated tariffs. We see a similar phenomenon in France, where the regulated market prices are also lower than the open market tariffs in periods – like the past five years – when coal and gas prices rise.

2. We have seen gas contracts in the Spanish market with pricing formulas that resulted in prices that were much lower than what gas costs in other countries. I wouldn’t be surprised if Spanish power producers have old long-term contracts for coal and gas which allows them to pay prices that are far below the international market benchmarks used by producers elsewhere in Europe to set power prices.

Both advantages are dissapearing. Coming under intense pressure from the EU, the Spanish government had to abandon the regulated tariffs last year. We see how the market is starting to function like a full-scale open market. During a discussion that we had with an important Spanish power producer, we heard them say that internally more and more questions are being asked why they should sell power from a coal- or gas-fired plant if the price they get for the power is insufficient for buying the fuel. This means, Spanish power suppliers are wondering why they are not applying marginal cost economics like their colleagues in other European countries. From their perspective, this is perfectly understandable. Moreover, all over the world old long-term commodity contracts resulting in prices that are below world market levels, are being put into question by the producers of those commodities. The most famous example of that is the gas price row between Russia and Ukraine. I can imagine that similar discussions are going on between Spanish power producers and their suppliers.

We always expected that the Spanish power market would have a price level and development similar to what happens in the German- French – Benelux market. And as you can see from the graph below: the Spanish wholesale power price is indeed moving closer to wholesale power prices in those countries. For the Spanish power consumers, this will have the following consequences:

1. In times of high coal and/or natural gas prices, higher power prices will be noticed,

2. The volatility will increase, marginal pricing results in larger price differentials than average total cost pricing,

3. Power prices will be more unpredictable, as they depend on what happens in the international coal, oil and natural gas markets.

As the retail power markets in Spain stand today, the Spanish power consumers will be hardly shielded from the risks of these new markets. We find many Spanish power suppliers reluctant to supply the products and services to deal effectively with this increased risk. A multi-click contract, common in most European countries, is regarded as an exotic product. Those suppliers argue that they are not asked for such contracts by clients. Until now, this was probably the case. But as market volatility and unpredictability increase, many Spanish clients will learn the hard way how risky it is to fix power prices in one moment. Moreover, we can see how our Spanish client base is rapidly expanding. This means that Spanish companies feel the need for energy market risk management so hard that they hire us as consultants despite the severe economic downturn that they are currently subject to (together with Ireland, Spain is extremely hard hit). Which makes me happy that we decided one year ago to do business in that country. We will most certainly be extremely helpful to our clients there.

Filed under: Energy policy, Energy suppliers, Spain

Solar thermal: the energy of the future?

I’ve read an article in last week’s Economist on solar thermal power production. This is not the same as photovoltaics. With PV-cells you use electrochemical processes to produce electricity. Solar thermal uses the sun’s heating power to produce steam that drives a turbine. You need to concentrate the sun heat for that of course, so you need mirrors.

This makes me think of my childhood days. Together with my cousin, I used a looking glass to let small pieces of wood burn. In the heat of a summer’s day we would sit behind my grandfathers shed and then we took a piece of wood and kept the looking glass over it. After a few minutes some smoke came out of the wood, it started to color black and the air started to smell burned. Unfortunately, my grandfather caught the smell and severely scolded us for playing with fire. I should have answered, ‘we are experimenting with the energy supply of the future’.

Large-scale solar thermal plants were constructed in Spain and California right after the first oil crisis. Isn’t one of them the background of a scene in a James Bond movie? Anyway, as energy prices sank, investment in solar thermal was abandoned for two decades. With recent new oil price spikes and the climate change policies, interest in this renewable way of producing energy has reignited (yes, I know it is a word game). New plants are up for construction.

What strikes me about these plants is their size. A company called Brightsource Energy, based in California, plans to build 14 solar thermal power plants with a joint capacity of 2.600 MW. It takes a lot of PV-panels or windmills to achieve such a capacity! Another interesting feature of this technology is that you can create hybrids. You can link them to gas-fired power plants, using gas only when the sun isn’t shining. This brings us to a first downside of the technology. It only works when the sun shines. Therefore, it will mainly be implemented in sunny, warm countries. But the idea of desserts that produce electricity that is transported to industrialized areas is getting a bit closer again.

With such potential, and taking into account the simplicity of the basic technological idea, it is surprising that this technology hasn’t been implemented on a larger scale. The article says nothing about it, but I guess investment costs have something to do with it. But with current prices and politicians’ willingness to subsidize renewable energy, this should be a less important obstacle. So if you live in Spain or New Mexico, I guess it is more than probable that you will soon tap electricity from the sun’s heat. Isn’t it beautiful that we are returning to such simple and old energy producing technologies as using the power from the wind or the heat of the sun?

Filed under: Climate change, Energy history, Energy technology, Spain, US

How to recognize a trend reversal

Last week’s upbeat mood in many markets was not sufficient to convince most commentators. This weeks’ Economist for example, referred to the Japanese stock exchanges in the 1990′s, which saw several upticks only to see prices fall even lower afterwards. They also point at the dangers that are still looming ahead of us. With the US consumers facing a massive pile of debt, it looks like they are not going to plunge into the kind of debt-fuelled spending binge that they lived on in the past ten years. With the Americans probably consuming less in the next few years, an important motor for economic growth is missing. Moreover, for many industrial companies, the crisis is still getting worse and worse. As we hear from many of our clients, most factories are still struggling to cut costs at an equally rapid pace as the decline they see in sales volumes. The round of lay-offs is still going on and with so many people losing their jobs, the overall purchasing power is not improving.

On the other side, for the first time in many months we see positive signals. 1: as we have learned from the stress tests for US banks of last week, the risk of banks toppling because of the credit crisis is now much smaller than a few months ago. The fact that many banks report better than expected first quarter results is supporting this image of a recovering bank sector.  2: with much lower raw material prices some manufacturing companies are currently producing at much higher margins than what they saw during the commodity price boom. This might be just temporary, as the prices of their products will also come under pressure as consumer demand falls. But at this moment, many companies are doing much better than they dare admit. 3: many economic indicators such as US purchase managers’ confidence have stopped falling and some are even turning positive. 4: The engines of the boom of the past years, countries like China and India seem to be doing relatively well. China, for example, claims that the production volumes are picking up again, as the excess storage of goods has been emptied.

The big difference with a few months ago is that back then every single indicator was bearish. Today we can hear the first bullish signals. Only time will tell whether these signals really marked the beginning of the turnaround or whether they were premature. What will be the consequences of massive unemployment in the Western economies? What if the credit crisis would flare up again? What if a huge company such a General Motors would really fail? But then again, such things might not happen and we might see next month that things are a bit better again, and the next month again, and again, and again. If that happens, it is highly probable that energy prices will climb along. Therefore, why take the risk? Why gamble that it is all just an uptick and therefore nothing should be done, just wait for prices that will certainly fall again?

Nevertheless, we have witnessed in the past week that many people were ill-advised regarding the risk of not doing anything. Sometimes, I am stupified by the sort of arguments that are put forward (and accepted) to support such advice. We heard from some people last week that were advised not to do anything as the stress tests would certainly show that banks were still in big trouble. One supplier told clients not to do anything before Friday, because on Friday prices always fall (Hello? Where are the statistics that support this? Why did prices rise on this Friday?)

Many people were also confused with data on fundamentals. Yes indeed, demand for energy at this moment is still lower than supply. But the trouble with such reasoning is double. First of all, data on energy demand and supply is hazy. Secondly, the price of energy futures doesn’t wait for demand to rise over supply before it starts rising. This is only true for spot prices. Futures prices are based on expected future evolutions. If they rise today, it is because of the expectation that the economy will (slowly) recover in the next quarters. If you do not lock in some volume on these futures prices today (which are still just a little bit more than half their value of six months ago) you are gambling that these expectations get it wrong and that the spot prices will remain low.

The ambiguity of today’s market situation is once more a strong argument in favor of contracts that allow you to lock in futures prices for parts of your volume. Anyone that says today that he is convinced that the market will either go up or down, is saying that he is capable of grasping the total status of the world’s economy. And that he sees exactly where it is going in the next few months. Nobody can do that. That is why forecasting is always gambling. Don’t gamble, don’t speculate. Fix forward energy prices in tiny portions and you are not commiting to the market going either way, up or down. You protect yourself against another bull run and at the same time, you keep open some volume to grasp the opportunity of another bear crash. This makes it all the more surprising that in countries such as Spain, it remains difficult to convince suppliers that they should offer these type of contracts and hedging services to their clients.

Filed under: Forecasting, Spain, The market today