Tips for Creating an Effective Energy Risk Mitigation Strategy
For more insights from IGS Energy, visit our Energy Resource Center.
In a volatile energy market, having a strategy designed to meet your organization’s unique needs is essential for managing risk. In fact, for businesses seeking an effective way to manage operating costs, a tailored energy strategy is an effective tool to meet your 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 your energy supplier becomes even more critical, as prices can swing higher and lower throughout the day. It is also important to note that just how much this market volatility will affect your business depends on how much risk your company is willing to take on when signing a commodity supply agreement. To help you and your business get started on developing an energy strategy that meets your needs and mitigates risk, consider the following:
Assess your risk appetite when choosing an energy contract. As a risk manager for your business, you will need to consider the energy strategy and solution that suits your organization’s risk appetite and examine your 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 for your business, it is important to consider whether you want to lock in the various cost components or ride the market. In other words, you need to decide if you 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, you are choosing cost certainty by locking in several years’ worth of energy at the current price for the length of your contract. If you make your purchase when rates are low, you will benefit from that lower rate for your entire term. Your monthly bill still varies, based on your consumption, but the rate you pay stays constant regardless of what happens in the market. If your business is more risk-averse, you can help manage that risk with this type of contract. However, it is important to note that timing is everything: You want to lock in when rates are low and flat or falling for the period you are 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 is 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.
Create a baseline for your company’s energy usage. It is important to monitor and understand your organization’s energy usage and how that data affects your costs.
This is key, as 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 your carbon impact and help you accurately report your carbon-reduction efforts to meet your organization’s ESG standards. Once you are tracking your usage, an experienced supplier can help your business better understand when your 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%, 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.