Creating an Energy Strategy Focused on Mitigating Risk

In a volatile energy market, it’s especially important that businesses have a strategy designed to meet the organization’s unique needs. In fact, for businesses seeking an effective way to manage operating costs, a tailored energy strategy is an effective tool to meet enterprise goals.

While energy markets are naturally cyclical, it has been several years since we have experienced volatility and price fluctuations like we have in recent months. This volatility is due to a few major factors:

• The U.S. energy market is increasingly driven by global energy demands.
• The U.S. energy grid is in the middle of a massive transition, from coal to natural gas to renewable energy sources. As older power plants retire and new, more efficient energy plants come online, we are shifting to a state where the grid no longer has excess energy supply.
• We continue to increase demand for electricity through the electrification of technologies that historically ran on fossil fuels, such as electric vehicles and heat pumps.

For decision-makers hoping to better manage costs amid this volatility, there are some key considerations.

When the market is more volatile, the timing of contract execution with an energy supplier becomes even more critical, as prices can swing higher and lower throughout the day. It’s also important to note that how much this market volatility will affect a business depends on how much risk the company is willing to take on when signing a commodity supply agreement.

The first step toward developing an energy strategy that meets objectives and mitigates risk is to assess an organization’s risk appetite. Risk managers and energy decision-makers need to consider the energy strategy and solution that suits their organization’s risk appetite and examine their business’s sensitivity to price fluctuations.

There are two common strategies businesses use to buy their energy: a fixed-price, point-in-time strategy, and a flexible buying strategy. When analyzing strategies, it’s important to consider whether the right approach is to lock in the various cost components or ride the market. In other words, decision-makers need to decide if they want to fix, float, or choose a combination of the two.

A fixed energy price contract helps offset the hourly variability in energy prices. Ultimately, this option favors cost certainty by locking in several years’ worth of energy at the current price for the length of the contract. When a business makes a purchase when rates are low, they benefit from that lower rate for the entire term. The monthly bill still varies, based on consumption, but the rate paid stays constant regardless of what happens in the market. If a business is more risk-averse, they can manage that risk with this type of contract. However, it’s important to note that timing is everything: It’s critical to lock-in when rates are low and flat, or falling for the period you’re considering. Long-term price certainty may come with a price premium.

A time-of-use contract directly passes on wholesale prices to consumers. When choosing this type of product, it’s important to understand how the energy market has been developed, as well as the fundamentals that affect these rates. For example, in deregulated energy markets, an hourly energy auction takes place, during which generators bid to participate. Rates are influenced by the demand for generation typically driven by weather, generators’ efficiency, and the cost of fuel. Power markets can be volatile, so it is important to continuously monitor market conditions, just as you would with the financial markets, and make adjustments as necessary to stay ahead of changes.

The next strategic step is to create a baseline for a company’s energy usage. It’s important to monitor and understand current energy usage and how that data affects energy spend. Remember: Energy efficiency is something you can control even when markets are volatile. Putting energy efficiency practices in place can positively affect overall energy usage and spend. It also can effectively lower carbon impact and help you accurately report carbon-reduction efforts to meet an organization’s ESG standards. Once a business is tracking their usage, an experienced supplier can help them better understand when their energy usage is costing you more. There are peak times of the day during which energy is more expensive due to higher demand.

For organizations considering sustainability efforts but unsure where to start, energy efficiency upgrades like LED lighting are a great first step. If your business is further along its efficiency journey, leveraging clean energy can also help you control your energy costs especially as fossil fuel costs climb. In the last decade, solar and wind costs have dropped steadily, with commercial rooftop photovoltaic (PV) costs dropping by nearly 70 percent, according to the National Renewable Energy Laboratory. Be sure to discuss your questions with your supplier as there are several sustainable options that carry a smaller cost impact than might be expected.