Balancing Upside and Downside Price Risk….
For those customers unable to benefit from a flexible contract, you are left trying to “time” the market, selecting an opportune time to commit to your fixed price contract. In the ever-fluctuating energy market, timing is critical when committing to an energy contract. Having a “I will only sign at the market low” sounds impressive but lacks any kind of risk management. There are way too many unforeseen reasons for prices to spike or surge to only focus on market lows and not consider market highs. In an ideal world, everyone would conclude their contract at market low, but in a realistic world full of unpredictable circumstances, we balance the need for a competitive price with the need minimise risk exposure. The delicate balance between upside price risk and downside price risk requires strategic decision-making.
Understanding Upside and Downside Price Risk
Upside Price Risk:
- Definition: The potential for energy prices to increase significantly.
- Scenario: Factors like geopolitical tensions, supply shortages, or surging demand can drive prices upward.
- Consideration: If you anticipate rising prices, locking in a contract early may be advantageous.
Downside Price Risk:
- Definition: The possibility of energy prices declining.
- Scenario: Economic downturns, oversupply, can lead to price decreases.
- Consideration: If you expect falling prices, delaying contract conclusion might be prudent.
Price Spread:
- Definition: The difference between market low and market high price. The spread between these two extremes is the price spread.
- Scenario: If prices are currently trading near the lower range, it is a good time to secure a contract, as there is more upside price risk than downside, and vice-versa.
- Consideration: Understanding this spread helps customers make informed decisions, manage risk, and effectively time the signing of their contracts. It also highlights the appeal and importance of flexibility and risk mitigation for customers fortunate enough to qualify for a flexible style contract.
Factors Influencing Timing
Market Trends:
- At Direct Power we will help you to analyse historical price trends and forecasts.
- Consider expert opinions on future price movements.
Business Needs:
- Assess your energy consumption patterns.
- Align contract duration with your operational and budgeting requirements.
Risk Appetite:
- Evaluate your risk tolerance.
- Decide whether to prioritise stability or potential cost savings.
Case Study: A Manufacturer’s Contract decision
- Scenario: A manufacturing company faces volatile energy prices.
- Observation: The company observes prices at the upper level of the price spread with a bearish market trend (downside risk).
- Action: They delay contract conclusion, waiting for more favourable prices.
- Result: Prices drop further, and the company secures a cost-effective contract.
Case Study: A Data Centre’s Contract decision
- Scenario: A Data Centre company faces volatile energy prices.
- Observation: The company observes prices at the lower level of the price spread with a bullish market trend (upside risk).
- Action: They conclude their contract, locking in prices whilst they are competitive.
- Result: Competitive prices, peace of mind and no risk exposure.
Winning Strategies for the volatile energy landscape
- Demand Reduction: The cheapest kWh of energy is one you don’t use, so invest in energy efficiency.
- Renewable generation: When prices are high, investing in self-generation becomes more appealing.
- Become a net exporter: secure an Export PPA, so you are paid for anything exported to the grid.
- Secure long term fixed contracts at price spread lows: When prices are close to market spread lows, lock in longer term contacts to minimise exposure to market fluctuations and reduce price risk, achieve a competitive advantage against your peers.
- Secure Flexible or shorter-term contracts at price spread highs: When prices are high, you can delay contract decision in a bearish market, or opt for a shorter term or flexible contract in a bullish market.
- Demand Side Flexibility: participate in schemes that help you get paid for turning down your consumption during periods of peak demand.
Conclusion
Timing an energy contract involves weighing risks and rewards. While upside potential exists, downside risk can significantly impact profitability. Regularly monitor market conditions, stay informed, and collaborate with Direct Power to make informed decisions. Remember, timing matters, and more than ever customers are encouraged to balance the potential price outcome against the potential risk exposure.
Contact Direct Power for a wholistic approach to navigating the increasingly volatile energy market. With improved efficiency, monitoring, advanced contract style we can help you not just survive but thrive in the new energy landscape.
