The Value of Layering Your Energy Procurement

With so many options for energy procurement, managing energy for your business can be daunting. Because energy prices are constantly in flux, a good rate today might not be there tomorrow – or even in 15 minutes in some cases. A misstep while locking in energy rates can end up costing thousands of dollars, now and over the long term.

Whether you opt to risk it on an index price or lock in to the best fixed rate of the moment, large energy consumers are almost certainly at a disadvantage. That’s why savvy commercial and industrial businesses turn to layered energy strategies.

What is a layered energy strategy?

With a layered energy strategy, customers lock in a fixed rate for only a portion of their energy load. The amount that’s fixed is known as a “hedge” or “layer.” The remaining portion continues to float at the market rate. Customers can continue locking in additional fixed hedges of varying sizes and prices over the course of days, weeks, months or even years, enjoying the benefits of a blended price, and sometimes ultimately becoming 100 percent fixed.

The primary benefit of a hedging strategy is that it gives the consumer maximum control over their energy procurement and risk – down to each kilowatt-hour. Businesses need not put all of their proverbial eggs in one basket – either fixed or index. You can instead enjoy low market prices while simultaneously building a fixed hedge to protect your budget should prices spike. The more layers you add, the less dependent you’ll be on market-based prices.

How do businesses procure layers?

To successfully hedge your energy supply, it’s crucial to understand the energy market and work with a supplier who is experienced in procuring hedges. Retail suppliers like Direct Energy Business offer customers a team of experts who analyze historical data and current market conditions, develop a procurement strategy based on goals of the business and help customers execute each hedge over the course of time.

“With a managed product, you don’t have to be an energy expert,” says Hans Rottmann, Strategic Sales Manager at Direct Energy Business. “When we start on these products, we meet with the customer to discuss all of their sore points and develop a strategy from there that works for them. Our team of energy strategists will then be available for regular calls to help decide the best time to make purchases.”

It is imperative to be proactive when there’s a price opportunity in the energy market. Hesitating to lock in a rate at an ideal time can be a very costly mistake for businesses of any size.

To get a better idea of how a proactive hedging strategy can save your business’s bottom line, let’s look at two national restaurant chains with layered purchasing strategies, but radically different outcomes.

A tale of two restaurants

Restaurants A and B both use PowerPortfolio^® - our premier layered procurement solution. However, only Restaurant A succeeded in meeting their goal of hedging nearly 100 percent of their energy load within their budget target.

During the initial meeting with Restaurant A, our energy strategists learned that their goals was to find year-over-year savings.

“They wanted certainty,” Rottmann explains, “and did not want to leave themselves open to any extreme rate spikes, even if that meant missing out on the lowest prices.”

As most restaurants have fixed, year-round hours, they didn’t have the option to shut down appliances and turn off the power if energy prices were high. They’d be using energy no matter what. And that meant their energy budget would be at risk if they floated on market-based pricing for very long.

Through constant market monitoring and a regular strategy meeting, Restaurant A gradually locked in layers of their load over time, as low market prices were available. The strategy paid off and Restaurant A saw annual price declines of 3 to 5 percent – an average of $1,000 in savings per year – for each restaurant site.

When the polar vortex hit in 2014 and caused market rates to spike, the impact was negligible. Eighty percent of Restaurant A’s energy load had already been fixed in layers purchased earlier in the year when prices were favorable.

On the other hand, Restaurant B initially decided to aim for the lowest rate possible. They hesitated locking in a hedge for any portion of their load unless the rate was very low, despite their similarly low tolerance for risk as Restaurant A.

As a result, Restaurant B’s load settled at the market price throughout the year. While they did save money during months when rates were low, they had no protection when the polar vortex hit in the winter. As temperatures dropped, energy rates spiked and Restaurant B was hit with an incredibly high bill.

Panicked by the severe market change and eager to avoid further increases if the cold temperatures continued, Restaurant B made a fast decision and locked in a rate for nearly all of their energy load. However, because of the market conditions at the time, the rate was a $30 per megawatt-hour increase over the previous year – resulting in a $12,000 increase in cost for each restaurant site.

How Restaurant B could have avoided rate spikes

Hedging portions of their energy procurement during times when the rate was low would have insulated Restaurant B from the spike Restaurant A successfully avoided. But because they had not hedged any of their energy load, instead waiting for an even better price, Restaurant B was completely uninsulated and took a major hit on their energy spending.

While it makes sense to want the best rate possible, the longer you wait for a better price also leaves you vulnerable to market volatility.

The unique value of PowerPortfolio is that it enables customers to enjoy good market rates and some hedged insulation with customizable, gradual-layers. Restaurant B could have reduced their budget risk by locking in a fixed rate for part of their energy load when prices were low – even if it wasn’t as low as they hoped. Then, if market rates dropped further at a later date, they’d continue enjoying the flexibility to buy another hedge.

“If they didn’t like the price, they could have at least locked in some portion to protect from a rate spike,” Rottmann says.

Extreme weather events have a direct impact on the energy market and must be taken into consideration in most energy plans.

“Markets trade throughout the day as weather reports come in,” says Beau Gjerdingen, Senior Meteorologist at Direct Energy Business. “And since we purchase our energy ahead of time, there’s a significant value in knowing the risk of a weather event, like a polar vortex, that would impact pricing.”

Because there are so many factors that can affect the cost of energy, Rottmann says that the expertise and customization that comes with a managed solution like PowerPortfolio may yield the best results for many businesses.

“It’s true that one size doesn’t fit all. Every business has different energy needs,” Rottmann explains. “But through data-fueled strategy, a managed product solution will help find the best fit.”