Procurement in a volatile market: Hedging strategies that work 

Whether you seek budget certainty or control over your costs, all energy procurement decisions are made against an instantaneous market landscape. 

Energy is one of the most volatile commodity markets in the word. Events on the other side of the globe – such as the weather, geopolitical issues and supply chain disruptions – can have an instantaneous impact on electricity and gas prices in the UK.  

In the last five years alone, we have witnessed energy prices reach historical heights and lows alike: COVID brought instant energy demand destruction, and prices plummeted. While the Ukraine-Russia conflict threatened the very security and future reliability of Europe’s gas supply network, energy rates skyrocketed in the process. 

Resultingly, the need for us to purchase our energy in a timely, appropriate fashion has never been more important.  

One of the solutions organisations can leverage to mitigate the risk of adverse price movements is hedging. 

What is hedging?

Essentially, hedging means negotiating a contract with a supplier which sets the price level for a portion of your electricity use for a selected time frame. This involves using financial instruments like futures contracts to mitigate the risk of adverse price movements.  

Many energy purchasers continue to procure fixed contracts to secure their energy. However, the main limitation of this buying approach is that you are required to determine the price of your energy for your chosen contract duration on one set day/price point in time.  

This can be secured at a low price point in time, but equally at a high price point, and we can determine that outcome only retrospectively.  

However, businesses are increasingly utilising flexible contracts, which allow the buyer to spread that purchasing decision into multiple chunks (hedges) across time, thus reducing the likelihood of a high price outcome. 

Why should I consider hedging?

Opting for flexible purchasing over fixed term buying can carry many key benefits, including:  

• Hedging through flexible contracts allows us to diversify our purchasing points through time, rather than the fixed option of one point in time. This often leads to more attractive price outcomes. 
• In addition to spreading our purchase choices, and differently to fixed buying, flexible purchasing allows the buyer to hedge volume within the delivery year of the contract, where we often find the cheapest available market prices. 
• Price outcomes tend to be smoother year-to-year as smaller regular purchases work to dilute the volatility in the market. Fixed-term buyers sometimes struggle from a budgetary perspective with the huge percentage shifts in rates/cost year-to-year due to ongoing extreme market volatility. 

How can Inspired help you?

We work with you to understand the buying needs of your business through a risk management strategy scoping session. 

Following that, we would look to identify and implement an appropriate buying approach for your hedging moving forward. Example approaches could be: 

• Hedging timetable – A purchasing template which ensures we purchase small amounts of volume across time, thus achieving a typical/normalised price outcome. 
• Capital at risk – working to an agreed upper price/cost boundary, we will allow the position to move lower in a falling market to achieve lower prices.
• Price trigger – an approach which can set multiple price targets/limits at make hedges at different price levels.
• Day-ahead or Month-ahead – we can leave our purchasing requirements to a point very close to delivery, as this is where best prices can often be found.

A longer contract duration is also crucial, as we can focus our buying into future years where we have tended to see a lower priced and lower volatility market across the last half decade.

Each procurement option comes with considerations, advantages and disadvantages and is dependent on your organisation’s appetite for risk.

Regardless of market conditions, working with an expert partner allows you to make informed decisions about the best energy procurement strategy for your organisation.

With a strong track record of working with some of the UK’s largest and most complex energy users, Inspired has the experience and expertise to support you.

Whether your goal is to protect your budget, generate savings or support your wider sustainability efforts, our experts can tailor a risk management strategy to suit your requirements.