Firstly, lets state the obvious: in business, money is everything. You want to keep your costs, including those of business energy deals, as low as possible. You may have heard of the mysterious concept of ‘hedging’ used by energy suppliers and, like any savvy business(wo)man, are wondering how it affects your energy costs. This guide explains what exactly ‘hedging’ is, and why you do not need to be sceptical.
In a nutshell, hedging is a way for energy suppliers to purchase their energy in a way that minimises their vulnerability to the high volatility of the wholesale energy market.
As is typical in commerce, energy suppliers are looking to keep their costs low, and sell their energy at a profit. The energy market is exceedingly volatile, influenced by political, social and climate-related factors, as well as simple supply and demand.
If energy suppliers were to buy their ‘stock’ of energy in one go, this would be tricky, since they would have to try and time their purchase perfectly, at a point when there is a fall in the wholesale energy market, but when it is not expected to fall anymore. Short of clairvoyance, this is practically impossible. If the market continued to fall, and a competitor bought their supply at this time, the supplier will have no hope of selling their stock at a profit. In comparison, the competitor would be able to sell their stock with ample profits, and still be cheaper than the first, unlucky supplier. This is just the point – if suppliers were to purchase energy like this, their financial success would depend on pot luck.
This is where ‘hedging’ comes in. It is essentially a strategy to avoid this gamble. Instead of purchasing their energy stock all at once, suppliers buy smaller quantities intermittently, to ‘top up’ their supply whenever they can afford the current cost. This way, the fluctuating prices should average out over a long-term period, allowing suppliers to offer contracts at a fixed rate.
Businesses have recognised that at times when the energy wholesale market is particularly low, they, as energy customers, do not see this reflected in the prices they pay. This is as a result of hedging, since the energy they are currently paying for will have been purchased months, or even years ago. When they are told this is because of ‘hedging’, people are often confused, or suspicious. In their minds, if the market is in a ‘fall’ period, they should see it reflected in their business energy costs.
However, ultimately hedging should be seen as a good thing. Without this strategy, ‘fixed term, fixed price’ contracts would not be on offer, and it is likely that your business depends on these for its budgeting security – you know exactly how much you will be paying for your energy for the length of your contract. Without hedging, you would also have to pay additional risk premiums on your energy costs, which would inevitably be sizeable to account for the incredibly volatile market.
Therefore, while hedging means that you will not see falls in the energy market ‘passed through’ to customers in real-time, in the long term it allows business energy costs to be as low as possible.
In summary, the hedging strategy benefits both suppliers and their customers in most instances. You can be confident that your energy costs, though probably not reflecting the state of the wholesale energy market as it is at that very moment, are not unnecessarily inflated.