07 Nov To Buy Or Not To Buy? That is the Question
My colleagues and I were the first group of brokers to sell deregulated natural gas in Pennsylvania. Electricity would deregulate many years later in 2010 and 2011 with rate cap expirations. Many years and many grey hairs later, the number one question we get remains the same. Should I lock in a fixed price or float with the market? While there is no absolute answer, there is generally a best answer for each individual account. The difficulty lies in whether the right questions are being asked and whether business owners are properly evaluating their risks and rewards.
Energy trading has and always will be a pure supply and demand marketplace. Regardless of the most extreme conditions to either side of that equation, – whether a polar vortex increasing demand or a major hurricane impacting supply – the markets will inevitably go up and down. These extreme conditions only increase volatility. They do not change the up and down nature of trading.
When Katrina and Rita hit in 2005, the energy markets took a tremendous spike upwards, even more dramatic than the stock market fall in 2008. There was a general panic in the business community, especially for those customers who had not budgeted properly and or evaluated their risk. In the years following, we encountered many deals that were locked in 4-5 years because that long-term pricing provided a discount over a one-year deal. When the polar vortex hit in 2014, the same panic hit the marketplace again and business owners were locking in longer term deals to avoid paying the incredibly high prices for 2014. In neither case did the technical factors support the market staying up for multiple years. However, the general panic over blowing up this year’s budget caused bad decision-making that would impact the bottom line for years to come.
The most simplistic way to react to market changes is to take a position based on your tolerance for risk. Decide whether you are willing to assume a price that can spike 100% or more based on one bad event, like the two mentioned above which occurred in the past 12 years. The benefit from the market falling is usually a 10-20% decrease from normal trading, so under average conditions, there is more upside liability than downside potential. Make sure you understand the risks of being exposed to the market and don’t panic if a temporary spike works against you – history will be on your side that markets reset shortly thereafter.
By taking extreme conditions out of the equation, what is a business to do with the markets up and downs? Talk to your broker or supplier about when to lock in and create enough security that you can operate your business with peace of mind. If the market falls from where you locked in, you will always need to buy more energy in outer years and start averaging down. If the market rises from where you locked in, sit back and enjoy the savings, until the market provides another window.
It is important to use the market financial tools to your advantage, but don’t act like you are an energy trader and try to beat the market. Make sure you are asking pertinent questions to evaluate risk and ensure that your energy costs are working for your business and not creating an open liability.