Planning Your Energy Budget

February 2008

The annual budgeting process is complex and time consuming for most organizations. Costs central to your business are well understood, however, natural gas and electricity are both commodity products with high levels of price volatility.

Complicated by the fact that the consumption of energy is highly dependent on the weather, establishing an energy budget can be challenging. Unfortunately, for many companies, the consequences of large energy budget variances can be dramatic.  In establishing an energy budget, many organizations incorrectly forecast next year's costs by using last year's expense plus an increment for inflation. Alternatively, many organizations will use a forward price as a price estimate and fail to factor in the volatility of the price over the budget term.

Energy budgets can be established with a degree of certainty but this requires a different methodology than is traditionally used for budget planning. Energy price volatility can be measured, consumption patterns can be forecast and price risk can be managed, all towards the goal of establishing a realistic and achievable energy budget.

Effective use of statistical analysis can help in developing an effective energy budget. This involves a series of steps:

First, the level of budget certainty that the company needs should be determined. For example, a firm that can pass costs on to customers may only need to be 70% certain of achieving their energy budget. Conversely, a firm that must absorb fluctuations in energy costs may need to be 90% certain that they contain their energy costs below a specific budget level.

The second step is to forecast energy consumption. This may be done using historical consumption patterns, or a firm may be able to forecast their production through anticipated sales. Weather often has a substantial impact on consumption and should be considered in the development of a forecast budgeting pattern. Heating degree days and cooling degree days are designed to provide mathematical factors that help adjust consumption patterns to anticipated seasonal weather patterns. Heating and cooling degree day data can be used in conjunction with historical energy consumption to better forecast future energy use.

Once consumption is estimated, the next step is to establish the budget and develop a price risk strategy. Using statistical tools, such as Aegent's RiskSensor™ software, a probability curve of potential energy budget costs can be developed and an energy budget can be determined  with the degree of confidence required by the company. 

With the energy budget established, the final step is establishing an energy purchasing plan to ensure the budget is met.  A key to successfully meeting an energy budget is not in timing the market through a single purchase, but in deliberately working towards a year-end budgeted expenditure. Many buyers of energy get caught trying to beat the market in a single transaction. This often leads to companies being exposed to higher prices while waiting for prices to decline to a level that allows them to meet their budget. In our January newsletter we discussed the parallel between playing poker and buying energy. In that article, we described the key to success as being able to understand the odds and make purchases when it is advantageous to do so. Trying to win a single large pot almost always leads to failure. Rather than waiting for an advantageous price to make a single purchase for the year, purchasing energy to meet a budget often involves periodically purchasing incremental volumes of energy.

If you're interested in better understanding how Aegent Energy Advisors can help you with your budgeting process, please feel free to give us a call at 416-622-9449.

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