The Energy Wiz: When To Lock In

FIGURE 1. Wholesale forward energy pricing may be cheaper at some times than at others. When a contract starts could impact its annual cost.

Choosing when to buy natural gas or power from a competitive supplier (i.e., not your local utility) presents unique risks and opportunities. A few lessons from wholesale markets may help.

Many customers set buying patterns based on when they first started purchasing competitive energy, and then just repeat that pattern when they renew their contracts. If the first contract term started in August and ran for 12 months, for example, then the renewed contract would start the next August, and so on. Depending on the type of energy and the regional market, however, there may be more profitable times to purchase energy. Adjusting the length of a new contract so that it ends at such times could then yield savings.

MARKETS ARE REGIONALIZED

Wholesale markets and pricing are defined by geographic boundaries that may be limited by transmission or pipeline networks and the location of the resource. Natural gas prices, for example, vary widely between the Plains states and those on the coasts. Commodity prices for such regional markets are published daily and are available on the Internet. Forward prices (monthly and for several years hence) are available at such sites (e.g., www.nymex.com, www.enerfax.com, www.futuresource.com, www.hessenergy.com). While not free, trade newsletters (e.g.Gas Daily,Power Daily) often provide more detailed pricing data by market and/or zone, and may be good sources for historical pricing data.

PRICING CYCLES OFTEN EXIST

Charting such forward price data over several years may show cycles that indicate better pricing for a 12-month contract may be secured at certain times of the year, e.g., early spring or early fall, than at other times. Wholesale energy prices form the basis for retail energy pricing, so some experienced endusers and consultants use such cycles to guide when they will next seek bids for their loads. In our example, instead of taking another 12-month contract that ends in August, a contract term may be sought that ends in March (if regional forward prices are found to bottom out in that month). While this is by no means an exact science, lower overall pricing may be secured than during months when prices are normally high due to significant demand (e.g., coldest or hottest periods).

In Figure 1, we see forward pricing in one zone as priced in several months. The low point for most forward months was late March, with pricing higher before or after that month.

BUT WHAT ABOUT VOLATILITY AND TRENDS?

Wholesale energy traders depend on the "fundamentals" that drive pricing (supply, demand, weather, etc.) to guide their activities. Over the long run, and for most markets, those factors are generally good predictors of pricing. Superimposed on them, however, may be short-term forces that lead to price "shocks" (such as recently experienced with oil). A gradually tightening margin between supply and demand may also create a trend toward higher average pricing until new supply is found, or demand reduced. Such variations could impact the pricing cycles discussed above. On average, however, using a pricing cycle to determine when to start (or end) a contract often yields lower overall pricing for a 12-month contract even as other factors may (in the long or short term) alter the price floor.

DON'T AIM TOO FAR AHEAD

If (for example) March is found to be a good time to start a 12-month contract, it may pay to wait until that month approaches before locking in pricing. Locking in much earlier could work against you. All else being equal (e.g., no new Katrinas or wars), wholesale markets tend to price more conservatively further into the future. Signing a contract several months before it starts could result in paying more, relative to waiting until the near future is clearer to the market.