What Energy Purchasing Strategy Is Best for Managing Risk?
Whether you’re an investor who buys and sells stocks, or an energy manager who’s responsible for purchasing power for a company, market volatility and unpredictability make it next to impossible to make the correct purchasing calls 100 percent of the time.
Just as a sudden, unforeseen conflict in another country can impact the stock price of a company, an unexpected change in the weather can make electricity demand — and consequently, prices — fluctuate.
In both situations, it’s common to incorrectly time the market; however, the implications on an energy buyer can be greater. A long-term investor who makes an ill-timed purchase has the option to simply wait it out. If he holds long enough, he may still be able to make a profit.
Companies that need to purchase power don’t always have that luxury. An energy manager who tries to time the market and makes an electricity purchase right before the price drops lower can’t just “wait it out” — the company is locked in to that price for the entire contract term.
The good news is that to get the best energy price, you’re not limited to trying to predict the market. There are strategies that companies can use to make smarter purchases — but which approach is best to help manage long-term price risk?
Common approaches to energy procurement
Businesses of all types — commercial and industrial, regional and national — can purchase energy in any number of ways. Here are two common strategies that companies often use:
- Fixed Price Point-in-Time Strategy: Using this strategy, companies can purchase years’ worth of power, locking in the current price for the duration of the contract. This method ensures cost certainty over the life of the contract, which can help with long-term budgeting. And if buyers hit the market at the right time, when prices are at or near the low, they will benefit for that entire contract period. Of course, if prices go even lower after they’ve locked in the price, the contract won’t look quite as attractive in the end.
- Flexible Buying Strategy: Alternatively, businesses can use a flexible buying strategy. With this approach, instead of going to market one time and making one big purchase to fulfill the company’s needs for a period of years, buyers make multiple purchases over time. So, for example, a company’s energy manager could fix the price for 25 percent of its load every six months for two years. This provides the flexibility to respond to market conditions over time, while still achieving budget predictability.
Which strategy helps protect against price volatility?
There are certainly benefits to both energy procurement strategies. Fixed-price contracts provide stability and simplicity, and protect companies from market price changes. Once you make that purchasing decision, you’re locked into that price.
However, fixed-price contracts only achieve budget certainty for the short term. Regardless of the strategy, your company will have to renew at the end of the contract, when prices may be higher than you expect.
A flexible strategy encourages companies to think further into the future. Your company purchases a percentage of load at regular intervals over time, which still provides budget predictability but also allows you to take advantage of market opportunities.
Ultimately, the flexible strategy is designed to offer more risk protection. A company using this approach gets to enjoy the benefits of price declines, as well as the security of knowing that any increases will be mitigated over time.
Every company is unique, but it’s worth considering whether your strategy is helping you achieve your business goals, manage risk and achieve budget certainty. For more information about developing a smarter energy procurement strategy, contact us today.