How will you decide to buy in 2007?
August 2nd 2007 Summer is an ideal time to review policies and strategies ahead of the winter. A lot of guidance can be found in National Grid’s Winter Consultation Report, with the latest update in June warning that while gas and electricity supply has improved there is still no room for complacency this winter.
Then there is the climate factor. New government policies and initiatives to address climate change are continuously being announced, but do you wait for mandatory regulation to address climate issues or do you take voluntary actions now?
Assessing your risk - evaluate the alternatives
The buying strategy employed will largely depend on the risk culture of the organisation. A risk-averse company will usually find comfort with a fixed price approach, while companies with a greater appetite for risk, and the larger rewards that can be accrued, may take a more flexible approach to buying. The success of this flexible approach will be based on the ability of the company to forecast price movements and buy (and sell) accordingly to maximise value.
Around 85% of the industrial and commercial market renew annual electricity contracts for either an October or a November start date. As such there is greatest buying demand in this two-month time window, which can lead to appreciable market upside as October and November contract renewals approach. So come October, the prices being quoted will not necessarily represent a fair valuation of the underlying costs and fundamentals. If this is the case, why do so many customers find themselves trying to renew annual contracts during the months of July, August and September every year?
There are alternative times to buy annual contracts. Companies can lock in contracts now before prices start to rise or can even negotiate an extension of the existing contract. The contract decisions taken will be guided by the risk-reward approach of the company. For example a company may decide to lock in a supply deal for two or three years, rater than review on an annual basis, but the risk here is that the company will suffer an opportunity loss if contract prices fall over the maturity of the two/three year contract.
The conventional rule within risk management is that taking on market risk brings with it the possibility of reward. Taking on specific risk will not be rewarded as specific risk can be diversified away, and the market does not reward unnecessary risks. In the energy markets over the last few years there has been little ability to manage away the market risk, due to its volatile and unpredictable nature, but we have developed alternatives to the traditional fixed and flexible approaches to energy procurement.
Guaranteed Fund performs well in its first year
The Guaranteed Fund was launched in 2006 and can be regarded as a sort of hybrid between a fixed and a flexible contract. It is a product which allows you to eliminate the risk of securing your entire power requirement at the height of the market, whilst ensuring that complete budgetary certainty operates from contract start to contract end. The Guarantee Fund spreads the risk of making a poor purchasing decision from a timing perspective. (In the financial markets few fund managers try and gamble on the timing of a purchase - this is too risky; rather they will buy multiple products, instruments and investments to ensure that specific risk is avoided and the position is hedged.) The guaranteed fund is based upon two key objectives: firstly to ensure budgetary certainty prior to the start of an annual contract; and secondly to hedge against the specific risk of buying against the height of the market. In effect it guarantees the buyer that he will get average or better than average pricing. EnergyQuote’s Guaranteed Fund customers have been delighted with the results that our Trading desk has achieved.
Why swap to funds?
Changing the way your business purchases its energy is not a decision that should be taken lightly. However, it is sometimes necessary to move away form the traditional approach for a myriad of factors; whether it is to gain a competitive edge, to purchase in line with your corporate policy (after an acquisition or merger), or simply stay up to date with market developments.
We understand that every business has its own attitude and appetite for risk when procuring energy, which is why our ‘Funds’ offer varying degrees of flexibility and can be tailored to your own individual requirements. ‘Fund’ members immediately benefit from increased economies of scale as physical volume constraints are removed which allows smaller energy users to access buying methods normally reserved for organisations typically spending in excess of £5mn on energy per annum. The benefit of these more efficient and flexible methods is access to better pricing and improved risk management.
EnergyQuote has developed a suite of Fund products that operate according to a company’s appetite for risk. While there are several different Funds to choose from, the Guaranteed Fund is proving to be very popular as it is based on the concept of a low risk strategy; one that minimises the risk to an annual budget that can be involved in purchasing on a near-term flexible basis, whilst still allowing more responsiveness to market movements and a more comprehensive diversification strategy than any fixed term contract thereby removing any speculation from one’s buying rationale. EnergyQuote’s Guaranteed Power Fund has previously out performed the market curve by over 12%.
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