Are you paying too much for energy?
July 24th 2008 WARNING: It is essential that anyone considering implementing any of the principles contained herein has first implemented an approved risk management policy and a robust risk measurement and control process.
Another 20% has been added to Industrial and Commercial consumer prices in both gas and electricity. The forward curve for energy is now higher than the record highs witnessed in the summer of 2006!
If you have been managing your risk effectively you would have fully fixed your position some months ago for the next three years, as it is unlikely that many organisations authorised a 120% gamble on the energy markets since last October.
However the reality is that many of you will not be in this position, either because you don’t measure or manage your risk or because you have an energy advisor which has been advocating reliance on their ‘expert’ opinion rather than a rational risk management process.
Advisors that have convinced you to under hedge your position during the recent price rises have now clearly demonstrated that they may be far from ‘expert’ because if you are not fully fixed for the next 3 years and if that did not happen some time before Christmas then your position has not been properly managed.
Whilst this performance is in a tragic way not without irony you now need to be careful of the latest advice rumoured to be emanating from some of the market advisors that you may be using.
In a move that is Norman Wisdomesque in its comic genius, the same advisors that have advised you to sit and watch whilst your energy costs doubled are now allegedly advising you to fully fix your position for the next 3 years or even 4 years!
Whilst prices may indeed rise further, we know that spot prices are currently at record levels. In 2005 when they out turned at lower levels there was demand destruction, so if the spot price really out turns at the levels currently quoted in market forward curves there will be significantly more demand destruction and at some stage prices over the next 2 years should fall on a fundamental basis. Even if this is not true and the spot prices out turn at the levels predicted in the forward curves we will be living in an economy that is suffering from hyper inflation and the management of your business will need to be very different from the current management in a low inflation economy; so unilaterally fixing your price forward for many years now, simply makes no sense.
Setting a risk limit and risk managing your position now, does make sense.
If you reflect and find that your advisor has placed you in this position, then you need to consider changing your advisor.
FOR THE UPCOMING PERIOD OUR DO’S AND DON’TS FOR CONSIDERATION CAN BE SUMMARISED AS:
DO... |
DON'T... |
Look at your portfolio - if you are not fully fixed for the next three years by now - there is an issue with the way your organisation procures energy.
You need to change this.
Create a risk management process that will dynamically hedge your portfolio and allow you to limit cost increases without preventing participation in market price falls.
Critically appraise your energy procurement process – you should be 40% ahead of the current market.
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Go and panic and fix your prices for the next 2 or 3 years.
If you bore all of the pain so far it makes no sense to over react – it does make sense to manage your risk.
Give an advisor the benefit of the doubt for your position.
This is not an exceptional circumstance and it could have been managed. You need to consider the appropriateness of the process used to manage it.
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