Managing Energy Price Risk
A Fool and His Money are Soon Parted – The original proverb can be traced back to an English rhyme by Thomas Tusser in 1573.
The actual version being: “A foole & his money, be soone at debate, which after with sorow, repents him to late”. This proverb keeps floating into my conscious. Perhaps because I have been in the energy business for long enough to know that the good times rarely stay for long.
America has seen unprecedented quantities of cheap natural gas flood the markets over the last ten years, so much that it is now the marginal price setter for electric power. This cleaner burning fuel has replaced thousands of gigawatts of coal-fired power stations, is being liquefied and exported overseas, yet still, there are decades of supply available from America’s vast shale reserves. If only market fundamentals drove prices – it would be great.
So which companies are going to benefit in the long term from this lull in prices?
Most organizations I speak with are buying energy by fixing prices forward for a few years in the hope prices rise. Others are continuing with one or two-year strategies, block and index, seasonal strips, even index floating.
Not one energy consumer I have spoken to so far in North America applies a process to correctly manage a commodity like energy. Most see low prices as continuing forever. So spending time on improving controls and setting up processes to ensure they have protection from both rising and falling prices – is not worth the effort.
And so it was 350 years ago. It was almost a hundred years after that proverb that the Great Fire of London occurred in 1666. Starting from a fire in a bakery in pudding lane, it decimated London and took five days to put out. The very next year, the world’s first insurance company was born – but by then of course, the horse had already bolted.
The point is, only the smartest energy consumers investigate and start a process before the storm.
Since pioneering energy price risk management for consumers in Europe over 17 years ago, I have seen several large cycles of energy price volatility, but the only organizations who came out the other side better off with their energy procurement were the ones who recognized they needed more than a supplier’s market report or a broker guess to navigate one of the most volatile global commodities.
In US markets, price creep has already started. Natural gas was $1.63 d/th 18 months ago – it is over $3.00 d/th today. A $5m spend on natural gas, just became a $9.2m spend and $4.2m hole to fill in the bottom line. But that probably still doesn’t hurt enough yet. It probably won’t be until the fire has started that energy professionals and their CFO’s come looking for a solution to energy price risk management – by then, much of the damage will have already been done.
Vervantis provides consumers with the same techniques utilized in a bank or supplier.
Value at Risk calculations is run daily to measure and manage risk correctly. Physical supply contracts are negotiated to allow transactions to be made flexibly. A governance process is wrapped around everything and detailed in a risk policy and sourcing strategy. In this way, CFOs can allocate capital to managing energy price risk in the same way they allocate it to other areas of the business – with clarity and certainty.
The best part though is that this insurance policy doesn’t cost a cent more than traditional sourcing processes – so there is nothing foolish about that.