As business has become increasingly competitive, the importance of controlling costs wherever possible has increased as well. In various parts of the country, one area of potential cost control involves energy procurement. While the opportunity to control energy costs exists, understanding this opportunity and capitalizing on it requires careful analysis and planning.
How to capitalize on the option to procure energy
For those clients with the opportunity to procure energy in deregulated markets, the goal should not always be selecting the lowest price proposal. While this sounds counter-intuitive, a much better strategy is one that evaluates the whole value proposition in terms of price, risk management, contract terms, and overall cost. Therefore, a sourcing strategy will examine energy procurement decisions through the lens of risk management rather than locking the lowest price. This is not to say, however, that the lowest price is not a critical consideration, as the benefit of deregulation is giving the business user a choice in how they control their costs.
Areas of consideration
When implementing an effective energy risk management strategy, there are multiple areas that should be considered. Some of these include:
- Selecting the Right Product: While this sounds simple, the question is more complex since a business needs to understand their risk tolerance before selecting a product. For instance, a Fixed Price product provides budget certainty, but may not produce the lowest cost. Conversely, an Index Price product may produce lower costs, but will involve significant budget uncertainty with the variable price for electricity. Therefore, the question is what is the goal sought by the client—budget certainty versus potentially lower costs.
- Negotiating Energy Terms and Conditions. While price is obviously an important consideration, it is easy to overlook the importance of the terms and conditions and commercial language of the contract under which the energy will be delivered. Arguably, this is just as important as the actual price paid as it can also significantly impact the bottom line. Watching for terms and conditions that could impact operational decisions, such as increases or decreases in usage, or the impact of relocation or expansion, can alter the perceived benefit of the financial bargain contained in an energy contract. From a risk management standpoint, careful consideration needs to be given to these contractual issues.
- Energy Contract Duration. Another critical consideration is the term of any given energy contract. There are a myriad of factors that can impact the duration of a contract. These could include the business’s outlook on where it will be in the next 1-5 years and the outlook of the business on future energy market conditions. In evaluating energy risk management strategies, these factors, and especially the forward view on natural gas and electricity markets, will have a significant impact on the selection of the appropriate contract duration.
Conclusion
Deregulated energy markets offer end users an unprecedented ability to control energy costs, which can be one of their largest single costs. While the ability to manage this cost provides benefits, it also comes with risk. In order to minimize this risk, clients need to evaluate a variety of different factors. Among these considerations are price, contract terms and conditions and the duration of the proposed contract. A sound energy risk management strategy will evaluate and balance all of these considerations based on the needs of the end user in light of future business plans and the risk tolerance of a particular client. Contact your energy advisor to help you tailor a risk management strategy to control and perhaps reduce your energy spend.
