Electricity Procurement 2013: How “Doing Nothing” Becomes A “Net Short” Trading Position.

Today, every business enterprise uses electricity in one form or another to manufacture their product or deliver their service. Whether they “buy, transform and sell” or “buy, add value and deliver” they need to be equally good at all three aspects if the business is going to be successful. Resources are needed at one end of the business just as much as customers are needed at the other as long as your facilities are operating.

Despite significant challenges and economic pressures to improve performance, many organizations still seem satisfied if their electricity procurement efforts simply deliver value through cost savings. But with the recent doubling of natural gas prices from 10- year lows, there will no longer be an opportunity to reduce electric costs and save money.

It’s been my experience lately that most buyers are simply not willing to commit to higher priced contracts (and lock in higher budgets), denying the organization the opportunity to minimize future cost increases.

Today, most energy buyers I contact are so focused on managing the day to day procurement needs in front of them that they fail to realize (or fail to accept ) what’s going on behind them in their energy supply chain. With greater and greater frequency I hear the response: “Thank you, but we’re happy with our current contract, try back in a year”. Unfortunately, that response addresses none of the organization’s future needs. Entering into an electricity contract only satisfies the need for the term of the contract and until your facilities permanently close you’ll always be in need of electricity. But the time period after  the contract expires is just as important to manage since that’s where your budget risks really lie.

Based on the information presented below I’ll attempt to show how the risk of doing nothing today is far greater than risk of being wrong tomorrow.  Ignoring the current opportunity to secure future energy needs at near all-time lows could be putting the entire business at a competitive disadvantage if your competitors seize the chance. In fact, put another way, those organizations that do not lock in future electricity costs are unconsciously taking a “net short” position in the most volatile commodity on the planet. Is your procurement strategy really a trading strategy? Is that officially authorized?  Electricity is the world’s only commodity that is manufactured, transmitted, distributed and consumed all within the same second. Considering that most organizations don’t have an energy expert in the procurement position, that’s the business equivalent of  “playing with fire”.

Measuring the Risk vs. Reward of “Doing Nothing”.

 Today, the price of natural gas directly affects the production cost and offer prices of gas generators in the wholesale electricity market.  Because natural gas-fired generators are the price-setting suppliers in most hours, the price of natural gas strongly affects the market-clearing price for electricity. The chart below shows recent Texas electricity prices and natural gas prices, demonstrating the close relationship between natural gas and electricity prices.

Gas Price Risks of “Doing Nothing” 

Today, although Natural Gas prices are trading just over $4.00, they’re still about $9.00 below the 2008 high and just $2.00 above the all-time low. Despite the recent surge in prices, natural gas is still close to the $4.00 estimate that S&P believes would cover the discovery, development, and production cost of natural gas. Are you willing to risk your energy budget to get a lower gas price given that the odds are so low against it?  Do you know something the Gas Industry doesn't ? Given the greater odds of higher vs lower prices what are you waiting for?

Electricity Price Risk of “Doing Nothing”

Today, a generator’s basic requirement is that they can expect future revenues to be high enough, often enough, to cover the costs of building and operating a plant, including a return on capital commensurate with risk. The August heat wave of  2011 (shown as the blue spike in the top chart) led to the use of energy emergency procedures 6 times and 19 hours of prices at the $3,000 price cap. While this year’s cap is now set at $5,000 (2014 is $7,000 and 2015 is $9,000) Higher prices are needed to encourage companies to build more power plants to keep up with the expected population growth in Texas. Industry experts say generation companies that operate the state’s power plants are losing money because prices are too low for most of the year and they only make money during the hottest summer and coldest winter months.  According to The Electric Reliability Council of Texas, which oversees the wholesale real-time market in Texas, prices for electricity in the region have averaged only $25 a megawatt (wholesale) hour since the beginning of the year.

Most generators have commented that 2013 and 2014 futures are probably under-priced relative to what actual spot prices will be. Further, they believe the futures market may not fully reflect new rules whose implications for prices are difficult to model.  When measured against recent price history (shown above), is the limited reward of prices moving slightly lower worth the unlimited risk of  prices moving  increasingly higher?  Better yet, is the right person in your organization making the call?

In closing, the opinions expressed above are strictly my own based on over 25 years of   trading experience in the wholesale energy market, which includes managing trading on behalf of TXU. Unlike most brokers and consultants who prefer to stay neutral in order to “never be wrong”, I believe that clients need more than just “numbers and choices”. Anybody can supply that. Has your current broker called and offered such information and advice? Why’s that?  Are you simply going to call them now and ask them for quotes? Have they earned your business? Probably not.

If you want somebody with the industry experience and trading expertise to help you act on the risks and rewards of today’s electricity market, contact us today. We’re waiting for your call.