How to Take a Portfolio Approach to Proactive Energy Procurement
Adding value to a business is usually either increasing revenue or decreasing costs. There are a number of business systems, however, that are not as certain. In the case of energy procurement, you’re often trying to minimize your risk against rising costs.
Curago will take a portfolio approach for the right client. Energy prices are very much like the stock market with steady ups and downs. Just like returns on your stock investment can’t be guaranteed, your energy savings cannot be guaranteed. But also like stock investment, there are best practices to minimize your risk and put your business in the best situation to get a good return on your investment.
Defining an Energy Portfolio
The formal definition of an energy portfolio can be described as a range of energy transactions held by a company to manage price and consumption risk inherent to their future energy usage. This is typically used by larger users of energy who have a confident view of where future markets are headed and/or know their future usage will be different than past usage for reasons not related to weather. Let’s look at some examples to clarify what this means.
Scenario #1 – Customer has a strong conviction that prices will come down in the future. They can purchase a percentage (typically around 50%) of forecasted usage on a fixed-price and the remaining energy usage will be priced at a rate posted on a monthly energy-price index such as Nymex. This allows the customer to take advantage of the future price drops. We make sure the contract with the supplier allows for converting the index price to fixed-price at the customers discretion. There is risk that prices will go up, so we advise the customer to identify a price above current prices where they will buy to stop (buy stop) prices from going above where it would be acceptable to their internal financial forecasts. With this plan, they benefit from dropping prices but prevent skyrocketing costs if prices go up.
Scenario #2 – Customer likes the current fixed-prices but has a project in the works that will decrease future usage putting a fixed-price contract in jeopardy. The customer will need to work with their project team to determine the estimate for this reduction. Once known, the customer can contract for a fixed-price to cover forecasted usage – including the reduction created by the project. All volume above the forecasted usage can be priced at an agreed upon index. If the reduction is not substantial (20% or less) Curago would ask suppliers to provide pricing for 100% of forecasted usage with pricing based on forecasted usage – plus or minus 20%. There will be a premium for this but will protect against project and price risk. Very large users of energy may also have the ability to use energy options as an alternative way to manage this project’s energy reduction and associated risks.
Real-world Energy Procurement Example
Curago Energy met with the Director in charge of energy procurement and other functional areas at a private liberal arts university. As most people in an oversight position, energy procurement is a very small piece of their job and typically not an area of expertise.
Although, the Director was very knowledgeable of the fundamentals that impact electricity and natural gas prices, he understood that his busy schedule demanded he work with outside energy procurement experts. During our initial discussions we learned that he and his current supplier had been bearish (think prices will go down) on energy prices when they signed a two-year index natural gas contract. This was an excellent decision!
Natural gas prices trended downward for the entire first year of the contract. In that fiscal year, the university paid about $1.30/Mcf less than the prior fiscal year and almost $2.60/Mcf below fiscal year before that. The decision to float the Nymex price had certainly paid-off. Unfortunately, prices soon increased by almost $1.00/Mcf mostly due to the hot summer weather.
The university had missed the opportunity to convert to a fixed-price for all or some of their usage at the historically lows earlier that year. The Director had been very happy with the performance of the contract up to that time and was very busy with his daily duties. The supplier, unfortunately, also did not suggest he take advantage of the low pricing.
When the Director decided to work with Curago Energy, we sought to manage the university’s natural gas spend more proactively. The first thing we did was sign a new index contract with the Nymex being the index point. We took advantage of a weak basis (cost difference between customer’s facility and Nymex) market. The new three-year deal reduced the university’s basis cost by fifty-percent compared to the prior two-year deal.
Curago Energy’s experts continue to hold quarterly meetings to keep the Director informed and to make educated proactive energy procurement decisions. During these meetings our experts report on how the current contract pricing has performed against the market, provide market insights and make suggestions regarding future pricing opportunities.
During one of those quarterly meetings, the Director followed our suggestion to take advantage of a late winter dip in pricing. We converted sixty-percent of the university’s estimated usage to a fixed-price. This new fixed-price, while higher than the extremely low price the university had seen recently, it was significantly lower than several prior fiscal years. The portfolio remained at sixty-percent fixed and forty-percent index until we took advantage of even lower pricing in spring of last year.
At that point, the university fixed the remaining forty-percent of their usage estimate reducing their cost by another six-percent. Additionally, because of the significant price decreases, we decided to look at pricing out beyond the current contract end dates. Pricing for the time period, two to four years out, provided the university the opportunity to lock-in fixed pricing in the $2.70 to $2.80 range. This was only slightly above the lowest prices they saw previously.
The decision was made to continue taking a portfolio approach and place eighty-percent of forecasted usage into a fixed-price with the remaining on the Nymex index. By proactively managing the university’s pricing utilizing a portfolio approach we have managed to take advantage of several price dips and reduce the university’s overall cost back down to pricing close to the lowest levels they paid.
That’s a powerful benefit to working with energy procurement professionals who have a history of doing things “the right way.”