How Does Having a Portfolio of Suppliers Save Money?

August 2010

• Attempting to reduce energy costs through buying at the "bottom of the market" cannot guarantee consistent savings against market prices.
• However, having a portfolio of suppliers can guarantee competitive pricing and in many cases, demonstrated savings.

Aegent has long emphasized to clients that locking in energy prices is a strategy for price risk management, not a strategy for cost minimization. Attempting to reduce energy costs through buying at the "bottom of the market" cannot guarantee consistent savings against market prices. However, having a portfolio of suppliers can guarantee that you'll receive competitive pricing and in many cases, demonstrated savings.

So how can money be saved through having a portfolio of suppliers?

In most cases, a portfolio of suppliers will result in energy cost savings. We need to realize that sustainable savings are not achieved against the market, but against the prices available from a number of competing suppliers. The table that follows demonstrates how a portfolio of competing suppliers can lead to cost savings.

		Prices ($/GJ)
	Quantity (GJ/d)	Supplier 1	Supplier 2	Supplier 3	Hedge Savings vs Next Best Price
Winter 2009/10	500	9.26	9.16	9.32	$7,550

The prices shown in the table are actual prices for the 2009/10 winter block that were gathered from three natural gas suppliers. Having the option to choose a price from any of the three offers provided a clear opportunity for savings. The $7,550 in the table represents the savings achieved by going with the price from Supplier 2 rather than the next best price offered by Supplier 1. It is the difference in the two prices applied against the quantity of 500 GJ/day over the 151 days in the winter period.

Why are there different prices being offered?

When a supplier offers a fixed price, they need to consider a multitude of factors including their current position, the credit risk of the buyer and their competition. A supplier who has a large supply of natural gas (a long position) may be willing to offer a more competitive price if they're trying to reduce their position. Depending on the credit rating of the buyer, suppliers often apply a credit risk premium to their price. Each supplier may have a different view of the credit risk of the buyer and so will apply a different risk premium. Suppliers will also add a profit margin to their price. In a situation where the supplier perceives there is no competition for their offer because the buyer does not have a portfolio of suppliers, an opportunity exists to add a bit more margin.

While this is not an exhaustive list of the factors that influence the price offered by suppliers, it helps to illustrate the supplier's process that goes into determining the price that is offered to a buyer.

As consumers, we're conditioned to want to achieve the best value for our dollar. For products like natural gas and electricity, for which quality is not a negotiated item, we look for other methods for determining whether or not we're getting value for our dollar. The main value of hedging is achieved through avoiding the risk associated with fluctuating market prices. The value in using a portfolio of suppliers is competitive pricing.

5 Simple Steps to Effective Energy Buying Read more »

Buying to Control Price Risk Read more »