Whether it’s electricity or natural gas, the right purchasing strategy for your business is dependent on a multitude of factors.
These include your business’s energy usage, operations, risk tolerance, and budget needs. Without a tailored and intelligent strategy, you could end up missing opportunities to capture market lows as well as force your business into paying volatile, spiking market prices for the entire length of your energy contracts!
As you know from our previous posts, your electricity and natural gas supply prices are made up of multiple components and each one requires an intelligent purchasing strategy to maximize the full cost avoidance potential of it. One of the components that can benefit the most from a refined strategy is the actual electricity and gas commodity.
Before embarking on your electricity and natural gas procurement journey, it is vital to understand the 3 basic types of purchasing strategies that underpin the customization of your energy contracts: Fixed, Index and Blended.
With a fixed price, the most common type of purchasing strategy, you set and secure a price per kWh at a point in time during your contract term for 100% of your contract.
There are many benefits with using fixed pricing strategies as they are relatively simple to manage, they provide cost stability to protect your budget from spiking market fluctuations, and they allow for budget predictability. As with any purchasing strategy, we use our well-informed market timing techniques with a fixed pricing strategy to help you identify both advantageous and inopportune times to purchase pieces of your contracts.
While fixed pricing is one of the ‘safest’ purchasing strategies due to substantial protection from price volatility, it is not without its own risks. The danger with this type of purchasing strategy comes with missing out on capturing low prices in declining markets, future rate changes based on variations in your usage patterns, and a multitude of other factors, all of which could lead to higher overall costs.
With an index pricing strategy, you float certain components on the market and pay a varying monthly settlement cost.
The polar opposite of fixed pricing, the benefits of an index pricing strategy are that it provides you the flexibility to take advantage of opportunistic market conditions as well as affords you the potential to capture significant market lows from the monthly settlements. Because you’re automatically capturing low prices while the market fluctuates, there is a lot of cost avoidance potential with index pricing.
There are also more cost avoidance opportunities for businesses who use energy off-peak hours and those who can adjust their energy consumption to better take advantage of market dips. Businesses who have loads that suppliers deem as ‘risky’ also frequently employ this type of pricing.
Because the market is constantly changing, there is the potential for higher price volatility with index pricing. For example, the market could swing upwards and sustain that trend, which would increase the monthly settlement cost.
A blended pricing strategy is a combination of both fixed and index pricing in which part of your contract cost is fixed per kWh and part is floated on the market paying the monthly settlement price. With this type of strategy, you could lock-in as little as 1% of a price component for your entire contract. The percentage you decide to fix or float is dependent on our guidance informed by refined market predictions as well as the risk tolerance of your business.
For example, if the market hits a year or all-time low, it would be a good time to fix or lock-in a solid portion of your electricity or natural gas commodity contract. If the market hits a decent low, but we predict it will fall more in the coming weeks or months, we would suggest fixing a smaller piece of your contract and indexing another percentage to ride the predicted lows. This would allow you to leave more of your contract open to capture even lower prices in the future. If the market looks to be on the rise, we would tell you to wait on purchasing the open position of your contract until the market starts to drop again.
With blended strategies you can actually accomplish a fixed rate as the end result by locking in or hedging different proportions of your contract until you’ve fixed all of it. Like the example above, you would do this by timing the market and hedging portions when it dips.
This type of pricing provides the best of both types of strategies as it affords the protection of cost stability and predictability for your budget while allowing the flexibility to capitalize on market changes.
The risks for blended pricing are the same volatility risks that come with index and fixed pricing, albeit on a smaller scale as the fixed portion of your contract is open to fixed pricing risks and the indexed portion of your contract is open to the risks of index pricing.
The Opportunities of Blended Pricing
As this type of strategy offers the best of both worlds, there is a great deal of opportunity when customizing it to your business’s needs. For instance, you could fix/hedge a portion of your load during the day and index at night to leverage your daily consumption patterns as well as take advantage of the market being less unstable at nighttime.
One type of customization we commonly do with blended pricing is a seasonal purchasing strategy referred to as the New Englander. With this strategy, you would fix/hedge a good price for the volatile winter & summer months and index your price during the spring and fall to take advantage of market lows as prices during those times are significantly less erratic. We dubbed this strategy the New Englander as winter prices in New England are some of the most uncertain and inconsistent throughout the entire country!
When it comes to purchasing electricity or natural gas, there is no one-size-fits-all approach as every business requires a customized strategy adhered to their operations, budget goals, and KPIs.
Many brokers simply recommend 100% fixed price contracts to their customers because they don’t require a lot of hands-on work. Brokers who operate in this transactional way have one goal: churn out as many contracts as humanly possible. Although 100% fixed contracts are suitable for many businesses with strict budget rules, they are not a match for all businesses as this is a very antiquated way of purchasing that does not yield as many cost avoidance benefits as tailored strategies.
We do things differently as our Energy Advisors work closely with you to gain a comprehensive understanding of the operations and requirements of your business, educate you on the different approaches to purchasing electricity and natural gas, and then customize a strategy to your business and budget needs. Our goal is to ensure that you are buying energy in an intelligent way and have a customized purchasing strategy that maximizes the value and cost avoidance potential of your contracts.
While vitally important, choosing the right purchasing strategy is just the first step. To discover more about what goes into our meticulous contract design process, check out our blog post on our process for designing a client’s contract.