Create a Fire Prevention Plan for Energy Buying

January 2009

• In mid-2008, many natural gas buyers were in full fire-fighting mode.
• The drop in energy prices, and the prospect for soft prices for the next while have created the ideal opportunity for organizations to develop a fire prevention plan - an energy price risk management plan.

In the midst of a crisis, we react. The urgency of the situation focuses the mind and motivates action. Faced with a fire, we spring into action and fight the fire.

But it is harder to focus the mind and motivate action when there is no emergency facing us. How often do we "spring into action" to create a fire prevention plan? But in fact, it is usually less costly and more effective to be proactive than reactive.

In mid-2008, many natural gas buyers were in full fire-fighting mode. Forward gas prices had rocketed up 60% in only a few months. Energy consumers who had requirements to buy gas at market prices for the second half of 2008 or for 2009 were straining at the prospect. For a gas consumer buying 2000 GJ per day of gas the rise in prices represented increased gas costs of more than $4 million a year.

No doubt some of those buyers were saying to themselves, "if I get through this, then things are going to change. I won't let this happen to me again."

Then, in a matter of weeks, the fire went out!

Certainly, the upheavals in the general economy that have contributed to the drop in energy prices have themselves created different kinds of fires on different fronts for many organizations. And so attention in those organizations has shifted to fighting those fires. But the drop in energy prices, and the prospect for soft prices for the next while have created the ideal opportunity for organizations to develop their energy price risk management plan.

One thing we know for sure is that energy prices will rise again. And the deeper and the longer the current decline in prices, the sharper and more extreme the price rise is likely to be when the economy - and energy demand - revives. Smart energy buyers will have used this time to prepare.

What can you do to develop your price risk management plan?

• Form a buying team, with representatives from the functional areas of your organization who are affected by energy supply and energy costs.
• Examine the effect energy cost increases in early 2008 had on your business. Which of these effects were you able to absorb, and which threatened your ability to achieve your objectives? This will help you determine the risks that must be managed.
• Examine your past energy buying strategies and decision-making methods. Did they prepare you for what happened to prices? Did they serve you when prices were rising sharply? Did they serve you when the bottom later fell out? Or were you just reacting?

This kind of analysis can identify the strengths and weaknesses of past practices, and prepare you to make the changes necessary to address proactively the next cycle in energy prices.

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