Hedging vs Fixed-Price Energy Procurement. Which Energy Strategy is Best?

Effective energy procurement is becoming more complex as new laws are issued, new technologies are developed, and renewable energy sources become more accessible. There are multiple approaches to developing an ideal energy strategy and each carries a different type of risk. Whether you are purchasing traditional grid power or incorporating renewable energy sources into your corporate energy mix, your organization would be wise to develop a custom strategy based on your unique energy consumption data, business needs, and sustainability goals.

Fixed Price Energy Procurement

Most commercial energy buyers are familiar with fixed-price energy contracts. You pay fixed-price energy rates for a defined period. This energy procurement strategy works best for businesses that require price certainty and budgetary control. With fixed-price energy contracts, 100% of the supply cost risk is on the supplier. In a fixed-price energy contract, the supplier needs to hedge the right amount of electricity given your predicted energy usage over the contract term. Suppliers manage this risk by building in a premium to cover usage variations, and by limiting how much variation they will allow you to have.

Although fixed price is the more common energy procurement approach, it may not be the best strategy for every situation or organization. When you contract for a fixed electricity price, you are locking in the majority of price exposure, but real price risk still remains.

Hedging Strategies

Energy market pricing fluctuates all the time. While energy prices can trend higher or lower based on changing market fundamentals, pricing also fluctuates within a longer-term trend. These intra-trend market movements provide potential buying opportunities. Rather than trying to time the market for a fixed-price energy contract, you can execute an energy procurement plan that allows you to take advantage of future buying opportunities without fully exposing yourself to price risk.

Purchasing portions of energy over time will mitigate energy price fluctuations that come from being “all in” with a 100% fixed supply contract or a 100% index contract. This strategy strikes a balance between establishing budget certainty and managing energy purchases to drive energy cost reduction.

The key benefits of hedging strategies include:

    • Transparency of energy costs
    • Leveraging market dips while limiting budget risk
    • Converting to a fixed price at any time

Types of Hedging Strategies

Block and Index
This procurement strategy is typically referred to as block and index or a ‘managed product’. With a traditional block and index energy strategy, you can capture a fixed price, or “block”, during the contract term and any energy used above the block is billed at the index market rate. You can execute a block when you secure your initial energy supply contract, or you can be initially billed 100% index and execute blocks in the future. These contracts are best for organizations with a predictable, steady baseload.

Load-Following Block and Index
A load-following block and index energy strategy allows you to hedge a certain percentage of your energy usage despite volumes that fluctuate over time. Best for an organization that does not use a steady baseload of energy year-round. Although you may pay a price premium over a traditional block strategy, you will still be able to fix a portion of your usage while leaving yourself open to market buying opportunities.

Managed Hedging
For the greatest flexibility to react to market events, you can choose an active, managed hedging approach. With this plan, you can establish price and time-based triggers to execute hedges. Managed hedging allows you to lock in varying blocks of energy at different times over the course of multiple years. This is a forward-looking approach, allowing you to build into a fixed price with a more certain budget.

Customizing Your Energy Strategy

Ideally, each organization should have a customized energy procurement strategy based on its own unique energy data which strikes a cost-benefit and carbon offset balance and helps you achieve your business objectives and sustainability goals.

Usource’s proprietary technology, coupled with our deep market expertise, allows us to secure the best pricing and terms available for our wide range of industrial, commercial, and institutional customers. Usource clients receive real-time market intelligence, gathered and interpreted by a dedicated team of experts whose primary focus is to help you execute on the best energy buying strategy for your business.

If you currently have an active hedging contract, our advisors can work with you to develop an energy procurement plan based on your specific risk tolerance and budget objectives. We would then monitor the market for you to ensure hedging decisions were made at the appropriate times and volumes. Find out if an active hedging strategy is right for your business, contact your energy advisor or email us at myadvisor@usourceenergy.com

energy procurementenergy strategy

About the author

Tom Dyer

Tom is the Senior Director of Procurement and Analysis for Usource. Tom has extensive experience in energy markets, developing and implementing unique solutions and innovative energy strategies, for some of the nation’s largest energy users across a variety of sectors and geography.

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