A French energy-intensive industrial company has been paying high costs for its power and gas consumption. With a few suppliers, it has entered fixed price bilateral contracts which offer some volume flexibility.
Due to market illiquidity, proxy hedging leads to
Critical questions and factors
Depending on the company’s risk appetite, it can adopt one of these strategic energy procurement approaches which then can be tailored to its specific situation:
When certainty is priority, this strategy is designed to fix procurement costs upfront so that any movement in energy market prices will not impact the price the company pays for commodities.
When budget protection is priority, this strategy is designed to allow for protection against rising markets enabling the company to work to a budget, while still capturing downside price movements.
Dynamic Price Optimization
When cost optimization is priority, or the company has a variable consumption profile, this strategy allows partial cost protection, in exchange for potential profit from volatile spot markets.
In a price locking strategy, the total energy requirement is bought in a single transaction, prior to the start of the processing period. However, it is important to have the right timing for purchase in order to achieve a competitive price.
In order to strike an optimum time for price locking, we:
With a price capping strategy the company is able to optimize the price right up to the point of delivery. At the same time, it is protected against any price increases that are above the ceiling level.
Unlike a Lock-in Price strategy, the company does not have to buy all of the energy at once, which means that risk is spread over a longer period.
Benefiting from both the cap and risk management techniques, this strategy is effective in either a rising or a falling market.
Similarly to the price capping strategy, the company is able to optimize the purchase price for a proportion of the volume up to the point of delivery and leave the rest to be purchased on the spot market.
The spot market can outperform the forward market by 10% or more due to the absence of forward risk premia, thereby offering cheap buying opportunities. However, there are occasions when the spot price volatility can wipe out any cost saving.
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