When it comes to managing risk in volatile energy markets, every position within a company has a unique goal. Procurement managers have objectives based on target prices. They are highly budget focused and eager to hedge long term as soon as prices are favorable. Finance directors seek the lowest price possible to keep a competitive edge. They are market driven and keep watch for the market’s elusive bottom. Same company, different goals, vastly different approaches.
This internal divergence is not uncommon. Without clear communication and an agreed-upon risk strategy, companies often fail to achieve consistency across silos. And without consistency, energy budget certainty is beyond an organization’s reach.
As Sun Tzu said, “The general who wins the battle makes many calculations in his temple before the battle is fought. The general who loses makes but few calculations beforehand.”
Of course, plotting those calculations when it comes to buying energy may take companies down separate paths; each approach has its own unique tactical opportunities. So let’s evaluate the two most common risk strategies, and the reasons organizations choose one or the other.
Let it Ride
The most hands-off energy budget strategy is the “let it ride” approach. This strategy relies on the expectation that, over time, short-term prices are favorable to forward hedges. In a falling or flat market, this is often the case. Even with occasional spikes during periods of heavy demand or unforeseen supply outages, the spot market usually trends lower.
The downside to this strategy (as every strategy has a weakness), is that prices can always go higher and stay there. Companies need to accept that periods of high volatility come with the prospect of increased costs. Certain organizations, however, can pass on unexpected price spikes onto their customers and these industries often see success when they let it ride.
The opposite of the spot market is the “long-distance hedge.” For some businesses, costs need to be locked down as far in advance as possible to price goods or services appropriately and competitively. The long-distance hedge has an obvious disadvantage, though: the knowledge and reassurance that a polar vortex or other unforeseen event that can upend energy markets won’t send a company’s spend into the stratosphere often comes with an up-front premium. Other reasons companies choose this approach include an illiquid market and limited access to actionable market intelligence.
There are myriad schemes that lie somewhere in between, such as “do what competitors do” to minimize competitive risk rather than energy market exposure.
As Master Sun said, “What is of supreme importance in war is to attack your enemy’s strategy.”
No matter which way an organization goes, one thing is universal: There’s always a little uncertainty in the pursuit of energy budget certainty. But by setting an organization-wide strategy — and following that approach thoroughly and consistently — a company puts itself in the best position for success.
To learn more, contact one of our energy market experts.