How Energy Buyers Can Better Enjoy Their Vacation

May 2009

• For energy buyers, it can be a stressful return from vacation to find that an increase in prices has dashed all chances of meeting the natural gas budget.
• Before leaving the office for a well deserved summer vacation, it's worthwhile for energy buyers to add a review of their company's energy hedges and risk profile to their to-do list.
• Using a tool such as Aegent's RiskSensor© can assist in assessing the risk of price volatility, making for a more carefree holiday.

The pursuit of lower prices often leads companies to leave their natural gas costs floating with hopes that prices will drop and result in savings. However, the pursuit of lower prices requires a trade-off with budget certainty. With the summer vacation season approaching, it might a good time for organizations to examine how their procurement strategy is aligned with their tolerance for risk. It can be a stressful return from vacation to find that an increase in prices has dashed all chances of meeting the natural gas budget.

For example, let's assume that an organization expects to use 850,000 GJ of natural gas in a year and has just established a natural gas budget for the upcoming year of $5.2 million. Meeting the budget is important, but the natural gas buyer has been hesitant to fix the price for the coming year because prices have been declining in the past few weeks. Being in a cost competitive industry, the company wants to capture savings where they can.

While getting ready to leave for holidays, the buyer looks at gas prices for the upcoming budget year. On that day, the current price offered for the year is $6.00/GJ. The buyer assumes the organization will be on track to meet its budget as this current price is below the budgeted price of $6.14/GJ. But what would happen if prices were to change while the buyer is away on holidays? As shown below, a price increase of $0.36/GJ can make for a stressful first day back.

To avoid this scenario the buyer may be tempted to fix the price of natural gas for the budget period before leaving for holidays, to ensure the budget will not be exceeded. However, this eliminates the ability to take advantage of any lower prices that may occur over the remainder of the year.

A more balanced approach may be to fix the price of enough of the organization's natural gas requirements to feel confident the annual budget will be met, but still leave some of the gas open to market prices to take advantage of any potential future price decline. The key is to determine how much gas to purchase at a fixed price, and how much to leave exposed to the market. In other words, how much risk is the company willing to take to pursue lower prices?

If the organization needs to be 90% confident that its costs for natural gas will match that of the budget, the buyer should only hedge enough to meet that level of confidence, leaving the rest of its requirements floating in hopes of enjoying any future price declines.

Using a tool such as Aegent's RiskSensor© to assess the risk associated with price volatility indicates that fixing the price for 1,350 GJ/day, or 58% of the portfolio, at $6.00/GJ will provide the buyer with 90% confidence that the company's gas costs for the budget year will be $5.2 million or less. The remaining 42% of the portfolio will fluctuate with the market providing the opportunity for the company to benefit from potential price declines. With the hedge in place, the buyer can enjoy the week away.

A key first step in developing an energy procurement strategy is understanding the risk profile of your organization. Having a clearly understood approach to risk better enables the development of a procurement strategy designed to meet your energy cost objectives. As part of your preparation to leave the office for a well deserved summer vacation, it's worthwhile to add a review of your company's energy hedges and risk profile to your to-do list.

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