Mitigating Risk in a Volatile Energy Market
In a complex world, no-one can be an expert in everything. Knowing when you’re not, can be the difference between success and failure.
In this webinar, Rob Gorby speaks with one of our energy market experts, Ruari Cairns, about the options businesses have to mitigate risk when procuring energy.
Transcript:
Rob:
My name is Robert Gorby. I'm the Chief Commercial Officer with True Powered by Open Energy Market and I'm delighted to say I'm joined today by Ruari Cairns.
Ruari:
Thank you very much. Looking forward to the chat, excellent.
Rob:
So today we're going to talk about mitigating risk in a volatile energy market and in particular look at the different purchasing options that are out there for businesses to make the most of their energy buying strategy and to again mitigate risk reduce costs. So looking forward to getting into this in a bit of detail with Ruari.
Ruari, can we start by explaining a little bit about what the fund and flex purchasing is for businesses who may not be too familiar with those terms?
Ruari:
Yeah, absolutely. And I think probably the best place to start is to explain the fundamental differences between the type of contract which I think most customers are already familiar with, which is a fixed price contract and a flexible style arrangement.
So, with a fixed price contract, effectively what customers are doing is they're taking a contract on a particular day, and energy trades much the same way the equity markets, foreign exchange and currency markets do, with the price changing on a minute by minute basis.
So when you're putting in place a fixed price contract, effectively what you're doing is you're negotiating a price to start from the start date of your contract, so let's say from October 2024 for either a 12, 24 or 36 month period. And when you lock in that price and effectively all of your volume, so your whole requirement of volume between the start date and the end date of that contract is bought at that price. So regardless of what happens to market prices following the decision to put that fixed price contract in place and is irrelevant to you as a business, if market prices start to spike dramatically, your fixed price contract looks very good because you're protected from those significant price increases. And if prices start to collapse through the floor, your contract doesn't look quite so good because you're locked in at that rate and you're getting no benefit from that falling market. I think that's the type of contract that most of our customers and prospects would be familiar with.
And when we start to speak about flexible type arrangements, I think there's often quite a few misconceptions about how they work, what it is and the general processes that sit around it because flexible contracts are typically spoken as if they are one thing, while in reality, a flexible contract, can mean many, many different things. And because unlike with a fixed price contract where at the point in time when you're negotiating that contract, you're buying 100% of your energy, when you put in place a flexible contract, you're not actually buying any energy at that point in time and you're putting in place a framework with a supplier. So most of the same suppliers that offer fixed price contracts also offer flexible contracts. And so when you put that flexible contract in place and what you're doing is you're negotiating the cost of the management fee. So how much money the supplier is making, how much margin they're making and all of the various different pass through charges which make up your commodity bill. And but you haven't actually committed to buying any of the energy itself.
Now how you buy that energy itself, you can do in many, many different ways which brings me back to why I was saying that Flexible contracts always being spoken about as one thing is not really the best way to look to look at it. Because at one end of the spectrum you have customers who put in place a flexible contract and do something very similar to what people within fixed price contracts do, which is upon signing that flexible contract see that where market prices are that they like. They like the look of where market current market prices are and decide to buy 100% of their energy requirement in one chunk.
Similar to what they would do within a fixed price contract. But they're just doing that within the constraints of that flexible agreement. And at the other end of the spectrum, you have businesses who take much more innovative and much more sophisticated strategies where rather than buying all of their energy in one block, they start to buy different chunks of different seasons, months, quarters, seasons, even floating some volume onto the spot market and some customers decide to buy and sell positions. It can get really quite complicated at that end of the spectrum.
So I think the first important thing to make clear is that a flexible contract isn't just one thing, it's many different things and it can be many different options.
So with that sort of brief synopsis of what a flexible contract is, obviously we also spoke about fund contracts and what a fund style contract is. So the reason that we've developed the Open Performance Fund, our fund products, is because in order for customers to purchase on the flexible markets, as I described, depending on how you would like to be able to do that and there are certain volumetric restrictions. So in order to be able to purchase flexibly, you need to have a certain amount of volume. And now we tend to look at that as being around 10 GW hours of consumption. Pretty similar for gas or power. If you've got plus 10 GW hours of power or gas, you can start to look at flexible contracts. If you're any less than that then your options are either a fixed price contract or fund type buying.
Now how fund type buying works is by taking lots of smaller to medium sized customers, the businesses that normally wouldn't have access to the flexible purchasing markets and pull them all together into a basket or into a fund and allow those businesses access to that flexible contract marketplace.
Rob:
OK. And in terms of the fund itself, so is it is it as black and white as if it's above 10 gig or below 10 gig? Are there other variables that might determine whether or not fund would work for your business versus fully flexible for example?
Ruari:
Yeah, that's a really good question because the answer, and this is fairly common within the energy industry, is that it's very rarely black or white. Unfortunately it's very rare that there are any questions where we say if you're this then you go in this way and if you're not then you go in that way.
There is a little bit more nuance to the question and the reason why it's a little bit more nuanced specifically with regards to flexible and fund purchasing is some customers meet the threshold to be able to purchase flexibly. So say you were a customer who had 10 GW hours of power or gas and that would meet the threshold where you could put a flexible contract into place. But businesses of that size and larger still often choose to go into a fund style contract. The reason being is that even though you may meet the threshold, the minimum threshold to be able to purchase within those markets and the flexibility that you would have to be able to operate within that contract is much more limited than it would be within a fund.
Our funds have hundreds of GigaWatt hours of volume within them in both the gas and power funds that we that we manage. And that allows businesses to be a lot more strategic with how they purchase volume. Because if you are going in there with just the minimum amount of volume that you have, say sort of around 10 GW hour level, and perhaps you only have maybe one or two bites at the cherry. So if you were looking to buy some volume for winter 24 which starts in October of 24 and ends in March 2025 and at that level you would really only have two bites at the cherry. So your options are you can either buy nothing, you can buy 50% or you can buy 100% of your volume.
And now that's OK for some, some businesses. Some businesses are happy with that approach, decide to go down that route, and other businesses look at it and say, well, actually I would prefer to be a little bit more strategic with this. And by entering into the fund, your options are, because of the size of the volume within the fund, you have a lot more flexibility and to be able to purchase in much smaller tranches. So within the fund, we're often purchasing 5%, 10% of volume at a time, which wouldn't otherwise normally be available to the customers who simply meet that minimum threshold.
Rob:
Yeah, OK, interesting. So I mean, how would you advise the customers decide on which approach is best for them? What are the sort of other factors that might determine the approach they should take?
Ruari:
Yeah, that's a really good question.
So I think that the first thing it comes down to is understanding what a customer’s risk appetite is. As I say, there is no one-size-fits-all solution. It's not a case where we can start speaking to a single customer and then immediately be able to say, well, this is what the best option for you is.
The first thing that we need to do is understand a little bit more about the specifics of that customer, what the risk appetite is exactly, what it is that they want to achieve with regards to their energy procurement objectives. And we do have an online risk assessment which we can take our businesses through and looking to understand what is the best fit for each business.
And the fund is a very attractive proposition for businesses at the moment simply because, as with the title of the of the webinar today, the markets are exceptionally volatile at the moment. And you know, I've been working in energy now for somehow close to 20 years. I'm not quite sure how that's managed to happen, but somehow close to 20 years of experience within the energy markets and the last two years have been more volatile by far than at any other point in which I've been working in the energy industry.
So, when the markets are as volatile as they are at the moment, really you need to be making sure that you do have a strategy that works for you irrespective of whether market prices are rising or whether market prices are falling. And so that's why it's really important to go through that process with customers, understand what their risk appetite is before we can start to direct them in terms of what type of product would be best, there would be best for them.
And just as a sort of final note on there and the sort of overarching objective that we have within the fund is slightly different from what we have within flexible contracts. So flexible contracts always are tailored specifically to each customer's risk appetite. So this is specifically for those customers who are sort of 10 GW hours plus. On the fund the overarching objective is to beat the market average and so the 12 months before the start of that delivery and the fund is tasked with being able to beat the market average during that 12 months.
And it's been very successful in doing so over the last number of years and very transparent with how we report on the performance of the fund. All of that information is available online through our website. It is actually and on that point it's really unbelievable how consistently strong that fund has performed and it doesn't matter whether it's been a rising or a falling market.
Rob:
Could you just explain a little bit about you know how the fund team, the traders, go about beating the market average in a falling market for example, what enables them to do that which is where our customers really benefit as well.
Ruari:
Yeah, absolutely, because that has been the big challenge over the over the last 14 or 15 months. And because you know if we look back at the the fund performance for the periods of sort of Winter 22, Winter 23 when prices were on a very steady upward trajectory. You know we saw prices peak after the Russian invasion of Ukraine; ended up peaking around August, September of 2022 and the fund performed very, very well during that.
Because we got into the market early, we didn't have a crystal ball, we certainly didn't predict that prices would get quite as high as they as they did. But using the tools and the strategies employed by the very experienced trading team where there is just a huge wealth of experience right the way throughout that team.
You know Gregory our Head of Trading's been working in the energy industry now for 25 years. I think he's been saying 25 years for the last five years…
Rob:
He won’t thank you for saying that.
Ruari:
He's got a huge amount of experience as does Christian and Victoria and our trading team who are both working around sort of 10 years and trading energy within the European market. So hugely experienced in the tools and the techniques in terms of how to be able to manage contracts in a rising market. But one of the, sort of I guess, the push back that we were having at that time from prospects were saying well we can see that you've done well while prices are rising, but what happens if we start to see a dramatically falling market. How is your product going to be able to operate when you have a falling market. And as you'll see and as if everyone can see with the with the performance that we publish on the fund and we've continually managed to do that in both a rising and a falling market. And I don't want to get too much caught up into the technicalities of how that's done. But there are tools and techniques to be able to ensure that the strategy within the fund meets those two overarching objectives which businesses have, which is protection against rising prices and participation in falling markets. Because really, irrespective of what businesses risk appetite is, those are the two key objectives that everyone really needs to meet is protection against rising prices and participation in falling markets.
Rob:
Interesting. So I guess what would you say to customers where there may be a temptation now where they see the markets are falling and the temptation is to jump into a fixed contract on the basis that is falling from current levels, what do we say to those customers?
Ruari:
Yeah, I mean, so for some customers that is the right approach to take it certainly wouldn't want if there's some businesses who are looking at it and looking at where current market prices are and are comfortable with the fact that prices might continue to fall further. Because you know if we were to get into the discussion of where the markets are currently trading, the fundamentals of the market still look very, very healthy right now, which is quite a surprise when you consider the amount of geopolitical tension, that you'll see whenever you turn on the news at the moment. Fundamentally the markets are very well supplied at the moment. We have significant amounts of liquid natural gas coming into the markets and gas storage levels remain at all time record highs for the time of the year. And fundamentally the markets look very good right now.
So even though the prices have come off and there is the potential for that downward trend to continue and certainly the trading team at the moment remains bearish for the rest of the year. So fixed price contracts for some businesses, you know might be the best fit. We wouldn't want to talk any business out who was comfortable where prices are.
Our job is just to really make them aware that actually there is the potential for prices to fall further. And it's really important and I'd say now more important than it's ever been before that the strategy that you do employ works well irrespective of which way the market price is trading. A fixed price contract only works for you if market prices start to rise from here. If market basically start to rise dramatically, dramatically from here, your fixed price contract will look good. And there is no guarantee at the moment that prices are going to start rising from here.
There's upside risk for sure, and I think everyone's familiar with the upside risk coming from not just from Russia and Ukraine but from trouble within the Middle East and you know potential interruptions to supply of gas coming into Europe from various means. There is significant upside risk within the market, but we've got to balance that against the fundamentals.
So when you've got that uncertainty and that volatility like we do right now, it's just really important to make sure that the strategy that you're putting in place and the contract that you're putting in place will work for you regardless of whether the market prices are rising or whether the market prices are falling.
Rob:
Brilliant. Thanks, Ruari. Some great insights there actually, having some really good observations and advice for businesses.
So look, if your business is interested in finding out more about the fund or if you'd like to book a call to speak with us about how we can support your business through managing your energy in a volatile energy market, please do visit our website TrueZero.tech and get in touch with us there. You'll also be able to find out a lot more about the fund and also take the fund challenge.
So thank you very much for your time and look forward to seeing our next webinar.
Thank you.
Ruari:
Thanks everyone.