With so many options for energy procurement, energy management 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 for a more flexible index price or lock into the best fixed rate of the moment, large energy consumers have many options to consider. That’s why savvy commercial and industrial businesses turn to layered energy strategies.
What is a layered energy strategy?
With a layered energy strategy, business 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% fixed.
The primary benefit of a hedging strategy is that it gives the consumer maximum control over their energy procurement and risk management — down to each kilowatt-hour. Businesses need not put all their proverbial eggs in one basket — either fixed or indexed. You can instead enjoy favorable market prices while simultaneously building a fixed hedge to help 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 that is experienced in procuring hedges. Retail energy suppliers like NRG offer customers a team of experts who analyze historical data and current market conditions, develop a procurement strategy based on the goals of the business, and help customers execute each hedge over time.
“With a managed product, you don’t have to be an energy expert,” says Hans Rottmann, Senior Manager of Technical Sales at NRG. “We meet with our customers to discuss sore points and develop a strategy that works for them. Then our team of energy strategists is 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’ bottom line, let’s look at two national restaurant chains with layered purchasing strategies, but radically different outcomes.
A tale of two restaurants’ layered purchasing strategies
Restaurants A and B both use a layered procurement solution. However, only Restaurant A succeeded in meeting its goal of hedging nearly 100% of their energy load within their budget target.
During the initial meeting with Restaurant A, our energy strategists learned that their goal 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, so their energy budget would be at risk if they floated on market-based pricing.
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 3-5 % — an average of $1,000 in savings per year — for each restaurant site.
When extreme weather caused market rates to spike, the layered hedges previously procured worked as intended, limiting the impact.
On the other hand, Restaurant B initially decided to aim for the lowest rate possible. They hesitated to lock 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 a polar vortex hit in the winter. As temperatures dropped, energy rates spiked, and Restaurant B was hit with a high bill.
Concerned 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
Working with a trusted energy advisor to hedge parts of their energy procurement when rates were low could have helped insulate Restaurant B from the spike Restaurant A 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, waiting longer for a better price also leaves you vulnerable to market volatility.
The unique value of a layered approach 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 later, 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 Jon deJong, Senior Meteorologist at NRG. “And since we purchase our energy ahead of time, there’s a significant value in knowing the risk of a weather event, like an extreme winter storm, 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 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 a data-fueled strategy, a managed product solution will help find the best fit.”
Interested in locking in low energy rates while still maintaining flexibility? At NRG, we understand uncertain energy market conditions and we’re here to assist you. Talk to our energy experts and see if a layered energy approach is right for your business.
