Beyond Procurement
By Chris Bowden
THE WORLD OF ENERGY is no longer confined to the back pages of lying energy price risk. Many have
the Sunday business section. Whether it’s a potential winter gas woken up to the fact that around 70%
shortage that’s dominating the headlines, or stories about compa- the final end user price is the cost of
nies adopting a more environmentally aware attitude to their ener- energy (the rest made being made up
gy consumption, it has been difficult for even the most disinterested of fixed costs). Energy procurement is
to avoid the issue. increasingly seen as a risk manage-
The growing awareness of energy-related issues means that energy ment process, rather than a contract
buying can no longer be a behind-the-scenes business function. In the buying process.
glare of the spotlight, the energy department’s activities have moved Hence the rise of flexible contracts,
centre-stage as commercial and industrial users endeavour to meet where tranches of energy can be
the multiple demands of cost, consumption and carbon reduction. bought throughout the year from the
supplier that offers the most advanta-
A Change in Procurement geous price. Flexible contracts enable
As result, the energy buying function is going through a period of companies to take advantage of the
dramatic and unprecedented change. The era of straightforward market peaks and troughs and keep
once-a-year procurement processes is over. those prices as close to the wholesale
The wider energy market is a complex place that requires skillful markets as possible – the key success
management and a far wider range of activities, knowledge, under- factor in any buying strategy.
standing and skill-sets than ever before. What’s more, the purchas-
ing and consumption of energy has as much a financial remit as an
... the purchasing and consumption of
engineering one and is increasingly the purview of the treasury energy has as much a financial
department. These changes can be summed up as a shift in focus
remit as an engineering one
from fixed to flexible mechanisms – although the process is not as
straightforward as this simple statement may imply. Taking a physical or financial position
According to a survey of FTSE 250 companies carried out for Utilyx in any market is an inherently risky
in 2006, 74%of organisations finalise their contract negotiations process that needs to be managed
within three months of the contract start date, while 60% enter year properly. To adopt flexible contracts
long contracts with their suppliers. successfully, risk management
Although this provides certainty over prices and makes budget fore- becomes a function of the energy buy-
casting simpler during the term of the contract, it does not allow con- ing department. This in turn consoli-
sumers to react to changes in the market. Like millions of homeown- dates its position within the heart of
ers coming to the end of their fixed-rate mortgage periods, many the organisation, since any policies for
organisations have found that fixing an energy contract presents managing energy price risk should be
them with a number of financial headaches when contracts expire. closely aligned with corporate-wide
The other side of the coin is that, should prices fall in the contract operational risk management.
period, organisations with fixed purchase contracts in place will find History shows us that high profile
themselves out-of-the-money. As a result, organisations are com- financial scandals involving trading
pletely at the mercy of external forces and, as the survey also desks are caused by inadequate risk
demonstrated, are suffering losses estimated to be as much as £1 management procedures and ineffec-
billion in the UK alone. tual monitoring of trading activity.
Financial markets are constantly finding new ways to minimise the Adopting a suitable risk management
impact of large trades by breaking them up into smaller fills. The policy is therefore both a question of
same cannot yet be said of the energy buying population. Fixed corporate governance and a matter of
price contracting tends to result in customers buying energy around execution and control.
the same time each year. The two notable contract seasons (in April A risk management policy expresses
and October) impact upon the cost and increase the risk of buying the highest level view. It is, in effect, the
when energy prices are high. part of corporate strategy that should
be defined by the board. At the centre
Managing Risk of risk management policy is the com-
The general trend of rising prices disguises the greater problem – pany’s decision on how much uncertain-
high levels of volatility. Negotiating a fixed contract in this environ- ty to accept in their costs and revenues.
ment is highly risky. In order to reduce their exposure, companies are It provides a framework for the execu-
adopting a strategy that involves the active management of under- tion of purchase contracts and defines
COMMODITIES NOW SEPTEMBER 2007 77
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