Flex it or fix it? It depends on your appetite for energy risk

Ben Archer, Head of Risk Management, Gazprom Energy

Given the recent volatility of wholesale energy costs, it’s important that organisations choosing a new energy contract reconsider what type of deal is right for them. Figures from ICIS Energy found that gas prices ranged from over 80 pence per therm in 2013 to just over 30 pence per therm in 2016. As customers feel the impact of these price fluctuations it raises the question of whether to take a risk averse approach with a fixed rate contract, or alternatively consider a more closely managed flexible contract approach.

Choosing a fixed contract means keeping your energy costs static and predictable for the contract duration – typically one to five years – regardless of what happens to market prices. On the other hand, a flexible contract means buying gas based on your demand or when the price suits you. With a flexible contract you can forward buy (hedge), or simply let a published market index determine your price, which allows you to make the most of low current and future energy prices if they occur. In comparison, fixed contracts mean being able to budget for energy with certainty, knowing for sure how much you’re paying from one month to the next.

Both approached offer opportunities and benefits for the customer whether that be cost certainty or a savings opportunity. What’s important is to consider your business model and risk profile to make an informed judgement on which route to go down.

For instance, would it be able to pass the costs to customers to maintain profitability? The benefits of taking a risk should be considered too, such as the opportunity to save costs by strategically buying energy under flexible terms.

The finance or procurement manager can establish how the organisation would fare should the price of energy go up or down by the amount it has fluctuated previously. A business with strict budget controls when it comes to energy may not have a business model that could support such a price rise. A fish and chip shop owner, for example, may simply not be able to cope with energy prices higher than their current value, and opt for a fixed deal. Price certainty and peace of mind could be just what some businesses are satisfied with, even if energy prices drop. However, if an organisation is prepared and able to buy in line with changing market prices to get cheaper energy than it perhaps would with a fixed contract, it might find a flexible contract a worthwhile option. Although more risky, it could save money in the long-term.

Risk appetite isn’t the only factor involved in choosing an energy contract; the human resource available to manage energy buying should come into it too. Other than checking that energy bills are accurate and based on contracted rates, fixed contracts require minimal input or resource. However, managing flexible contracts is a strategic purchasing activity. With a flexible contract, energy buying needs to be planned around market rates and trading conditions that best suit the organisation. This can be carried out in-house, but only with an in-depth understanding of the market. An internal procurement department may have the necessary knowledge, in which case you might not require additional personnel. But to reap the full benefits of a flexible energy contract, organisations might choose to take on a dedicated energy manager, or consult with an independent energy specialist or the procurement desk within their energy supplier. These people specialise in tracking the market and buying energy accordingly.

Whether they select a fixed or a flexible energy contract, organisations can use the market to their advantage. But it is important to decide which approach to take by considering the business model, resources and financial position before deciding. It’s also key to establish whether budget certainty is more important, or if the ability to utilise a dip in prices is a priority for energy buying. Only then can a confident decision be made about which option is most suitable.

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