Purchasing Strategies

In recent years, the energy marketplace has been particularly volatile. Prices have been subject to wild fluctuations, doubling in less than a year (back in 2005), and then coming down again. Volatility aside, however, the reality is that for the past 15 years, natural gas and electricity costs have been rising 15% on average. And looking ahead, there is little relief in sight.

“Nothing suggests that the tightness between supply and demand, upward pressure on prices, and volatility are likely to change for the rest of this decade, or even well into the next,” said Dr. Jack Mason, founder and president, Energy-Window, Boulder, Colo., which provides strategic energy management, analysis and Web-based procurement technology for commercial, industrial, institutional and government clients.

With regard to energy prices, Mason and other industry experts emphasize the importance of taking the long-term view.

“Today’s short-term view suggests that prices are going down, but this is deceiving,” he explained. “A review of energy prices for the past four years shows that we are on the back end of the downward slope following the high prices of late 2005, the year of Hurricanes Rita and Katrina. Historical trends over the last 10 years, as well as experts’ outlook for energy demand vs. supply, suggest that prices will start going up again.”

The volatile marketplace has created challenges—and opportunities—for retailers with regard to their energy-purchasing strategies. In the past, many retailers have been reluctant to enter into longer than one-year contracts. Their reluctance to enter into longer contracts was based on a number of factors, including hopes of attaining better prices, and concerns about “stranded costs” if a location should close. At the same time, retailers have not pursued fixed-price contracts, often out of a belief that the market would fluctuate with macro-economic trends.

But the reality of the marketplace is encouraging retailers to take a new approach, and what used to be the norm may no longer be the best strategy for obtaining the lowest energy prices over time.

“A large number of our big-box retail clients are moving a significant portion of their energy spend to longer-term, fixed-price contracts, which enables them to enhance the predictability of their operational expenses related to energy,” Mason said.

According to Mason, only about 20% to 40% of a retailer’s total energy spend can be controlled through contracts, as they can be done only in competitive markets and only for supply costs (delivery costs remain regulated).

“That said, having a significant portion of the energy spend in a long-term contract—for as long as four- to five-year timeframes—is a good safeguard or hedge against the extreme price volatility of the market,” he added. “Making long-term commitments in terms of energy supply can help stabilize costs.”

Mason said that retailers should consider fixed, rather than floating, contracts for energy as this, too, can enhance predictability and save money over time when prices go up.

“Limit the amount of energy spend that is indexed or floating,” he suggested. “Indexed contract prices not only float, they are capable of sudden and dramatic movement.”

One consideration to keep in mind with regard to fixed-price contracts is not to put them in place when prices are high.

“Buying energy is a lot like buying stock,” Mason said. “You want to buy when wholesale and retail prices are relatively low compared to the overall trends. And that is the situation the market is now in. This is a favorable time to take action and implement a strategy in competitive markets whereby you put a good part of your spend in long-term, fixed-price contracts.”

Mason advised that it’s always important for a company to have a very clear understanding of how its total energy spend is distributed in terms of suppliers, and in terms of fixed price vs. floating or index price. Aim for diversity.

“Also, there should be some diversity in terms of when contracts end, or when the fixed-price terms in contracts end,” he said. “There also should be diversification in that you should have more than one or two suppliers.”