___________________________________The Utilities Exchange Ltd – UX Energy Services
What is speculation?
According to the Oxford English Dictionary,
speculation is defined as “the forming of a
theory or conjecture without firm evidence” or
“investment in stocks, property, etc. in the
hope of gain but with the risk of loss”. At face
value, these definitions highlight the challenges
facing energy buyers in today’s market: the
need for sound information on which to base
decisions, and also the risk-reward scenario
that is at the heart of the dilemma between
seeking budget certainty while also looking to
buy at the lowest cost possible.
Of course, speculation in the context of energy
purchasing has become exclusively synonymous
with certain aspects of flexible purchasing. This
is a viewpoint that is flawed because purchasing
gas and electricity through either fixed or
flexible contracting involves speculation – the
challenge is in assessing and managing the risk
associated with that speculation.
Alastair Harris – Director of Risk Management
Looking at fixed price contracting, this has commonly been seen as a low-risk
approach as it is one that sees a price agreed for the duration of the contract.
Can this be seen as speculating? The answer is “Yes”, because even if the
purchasing decision is based upon informed market intelligence in line with the
first definition above, you are still taking the risk that the day on which you go to
market to fix your price is the optimal one for your organisation. The risk is
therefore that you bind the organisation to what turns out to be an unfavourable
even uncompetitive cost. Unhelpful in business when margins are so tight.
At the same time, your price is only fixed for the duration of the contract that you
sign – be it one year, two years or more – thereby leaving you exposed to market
volatility beyond that point. Is this speculating? Again, the answer is “Yes”
because you are implicitly taking a view on the market price beyond your contract
timescale – whether this is determined by your internal structures, budgeting
requirements and timescales, or any other factor.
Moving to flexible contracting, and we can see that the same applies. Tranche
purchasing is commonly applied by end users that purchase a specific percentage
of their energy for a given period at a pre-defined point in time – largely
determined by their budgeting requirements or the fact that it has traditionally
been bought at certain points in the calendar year. Again, this is a speculative
approach: by not purchasing all of your volume, you are implicitly speculating
that the market price is going to fall before you have to buy the rest of your
volume.
Flexible contracting with refloats is also accused of being speculative, but it is a
way of procuring energy that – when appropriately managed and implemented –
which to not only lessen the emotional drain when energy purchasing, but most
importantly facilitates optimal risk control, or perhaps better expression might be
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UX Energy Services – Your Risk, Managed 1
___________________________________The Utilities Exchange Ltd – UX Energy Services
it facilitates improved balance. A flexible contract can be operated as a fixed price
agreement by locking all of the required volume if considered appropriate, while
refloats can be undertaken in line with agreed policies and when justified by
market analysis. The net effect is to change simply change the timing at which
purchases are effected. Whether purchasing Day Ahead or in tranches or through
refloating control, the buyer is necessarily choosing a time to purchase and the
fact that one method is discounted in favour of another, the fact remains that the
time for purchasing is under the control of the buyer, more options to “change”
your mind does not inherently make the decision making more speculative.
Indeed when considered objectively, it can be readily argued fixed price
procurement is the most speculative punt of them all.
Given that speculation of one form or another, and to different degrees, is
inevitable, the main issue is the ability to take a step back, accept that whatever
procurement approach you take is speculative to one extent or another and will
have risks associated with it, and from there start to consider the best way in
which to manage the risk profile generated. This can be broken down into three
stages.
Firstly, what do you want to do? You have to determine a strategy regarding your
procurement and establish what options are out there. Secondly, how do you
want to do it? Answering this question needs you to define what contract
structure to use and why, and also to define individual and collective
responsibilities through a risk policy – along with the parameters for operating
that policy. Thirdly, what are the objectives you want to achieve through your
energy procurement? Key among these should be understanding the risk
associated with the chosen option and how this should be managed.
Probably the most important point to note is that just because energy has
historically been procured using a certain approach, this does not necessarily
mean that this particular approach is the optimal one for your organisation, or
indeed it is a low risk approach, or is the optimal approach for your organisation
going forward. There are more tools out there to allow purchasing efficiency to be
raised and risk to be managed. It requires more effort, more time, more
understanding, all of which are challenging for any purchasing entity today. The
question is, have you got the balance right and your risk under control? You may
need to challenge preconceived conclusions!
Alastair Harris – Director of Risk Management
The Utilities Exchange Ltd – UX Energy Services
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