Reducing energy costs to remain competitive is a challenge that businesses across industries are being forced to undertake. Strategic energy management practices can ease this daunting task and mitigate risk associated with an uncertain energy market.
When assessing the energy management needs of an organization, several key areas must be addressed. This article provides energy management best practices in three key areas to assist businesses with curbing their energy costs.
1. Establish a Risk Management Plan
A significant aspect of managing energy costs is to have a risk management plan that is coordinated with the budgeting process to ensure all energy expenses are taken into account. To establish this plan, a company should first identify usage by month and by season, as well as the variability of the cost components involved with obtaining energy. This information will then help identify pricing objectives and create a risk profile, which assesses a company’s tolerance of energy price fluctuation and helps the company identify whether it can operate if energy prices were to spike. If a company cannot afford to stay in business if prices rise drastically, then it is a good idea to hedge.
While it is important to set price targets and objectives in a risk management plan, it is even more critical to actually follow those objectives. Some businesses will not hedge when prices are low because they want to wait for the lowest possible price. This plan can backfire if a company waits too long. On the other hand, when prices are rising, businesses sometimes will lock in high prices out of fear that prices will continue to rise. Having price points in place in your risk management plan and adhering to them lessens the risk that market movements could have a negative impact on energy budgets.
When considering hedging, it’s imperative to evaluate your company’s objectives. If the company is budget- and margin-oriented and/or it has “future sold” its product, hedges should be executed when natural gas and electric prices fit its budget or margin targets. Hedging at this point makes sense, regardless of where the prices are, because its objective is to manage margins and budgets.
Companies need to consider how their energy costs fit into their budget requirements. There is no magic time to hedge energy; companies hedge at different times because they have differentiating objectives and processes related to managing their own cost exposure. Some companies will implement forward hedges every month or quarter, while others tend to hedge opportunistically when the market presents perceived value. There is risk associated with being an opportunistic hedger: if you miss a drop in prices, you may end up paying a high price for energy in the future.
2. Implement an Aggressive Energy Procurement and Delivery Process
A successful risk management plan should drive an aggressive energy procurement process that forces suppliers to systematically compete for business based on cost and quality. When addressing the natural gas buying process, there are two aspects that need to be considered: underlying market volatility and physically obtaining the molecules that make up natural gas.
Hedging natural gas on the New York Mercantile Exchange (NYMEX) does not give a business any actual natural gas; it only provides price protection. Companies need to procure physical volumes, and there can be a significant difference in price from one supplier to another. As you get closer to the point of consumption, there is less transparency and pricing information.
When procuring energy, there is a search process that needs to take place. Often times, companies rely on third-party energy management providers to undertake this process on their behalf. In this case, an energy management firm will structure systematic procurements that meet both the physical and financial needs of a company.