If You Can’t Stand the Heat…

When temperatures hit new heights in the summer of 2003, and the capital's commuters sweltered their way through their daily journeys, the UK experienced a run on electric fans. Hardware shops were besieged by people who had failed to anticipate the heat wave, desperate to find some respite.

In 2006, the mercury is once more rising to record levels. But this time we all seem to be a little more prepared. The desktop fans are firmly in place, the refrigeration units are packed with bottles of water and we're cranking up the air conditioning in an effort to create pleasant and productive working conditions.

INCREASED ENERGY DEMAND

But although we have supplied ourselves with the means of keeping cool this year, many treasurers and energy buyers have, once more, been caught on the hop by the surge in demand – and its impact on profitability. Air-con may prevent our offices from turning into furnaces but it racks up energy bills by as much as 50%.

The impact of our air-con addiction has even wider consequences. Greater demand requires greater supply.

The UK is not the only country to experience the high temperatures, and alternative energy sources from Europe have been temporarily unavailable. So severe is the problem that there have been murmurings about restricted use and power outages – a topic that is usually confined to the fevered speculation surrounding an impending winter cold spell.

PRICE INCREASES

This spike in demand also has a major impact on wholesale prices.

Electricity more than trebled - from around £81 a megawatt hour on Monday 17 July, to an average of £260 24 hours later. Anyone who needed to buy power on Tuesday afternoon would have been seriously out of pocket – caught in a cycle of rising demand and rising prices.

Of course, the temperature – whether abnormally hot or unusually cold – is only one of many issues that affect energy price. The current problem has been made worse because some power stations are out of service thanks to their summer maintenance programme, which has reduced the supply available.

We are also about to enter the most severe phase of the hurricane season - which last year devastated US refining capabilities, causing peak oil prices. Meanwhile, the ongoing crisis in the Middle East has taken its toll on this year's prices.

Any company that has not hedged its energy position is now dangerously exposed to these rapidly rising prices and extreme levels of market volatility. Having just recovered from the shocks of the winter, they are playing the same game once more: desperately trying to keep ahead of fluctuating prices in the face of massive demand.

TODAY'S ENERGY CONTRACTS

The fact is that buying energy is no longer a straightforward once-a-year tendering process.

Traditional fixed-price, fixed-term contracts may reduce operational risks in the short term by guaranteeing budgets over a given period, but they do nothing to protect the organisation in the face of consumption surges and wildly fluctuating wholesale prices – particularly if the contract expiry and a price spike happen to coincide.

Modern market conditions require a much more flexible approach. In-depth knowledge and understanding of the power, oil, carbon and gas markets are essential so that purchases can be made when prices are at their most favourable rather than being tied to when energy is needed.

Many companies face the devastating consequences of a rising and volatile market simply because they lack the specific experience to make these more strategic buying decisions.

The good news is there is no longer any need for ignorance or lack of resources to be a barrier to more effective energy buying.

Retaining the in-house specialists in market analysis and hedging strategies is simply unfeasible for all but the very largest consumers. However, outsourcing can be a cost-effective way to ensure the business isn't exposed to the unnecessary financial risks that come with paying too much for energy.

OUTSOURCING YOUR ENERGY PROCUREMENT

Although there may be some residual reluctance to outsourcing energy procurement to third-party experts, these market professionals use their skills to minimise energy bills by purchasing as close to the wholesale price as possible.

The alternative is to continue buying energy at the wrong time and paying over the odds in a market whose volatility shows no sign of calming down – a far more unpalatable prospect.

That's not to say that blindly entering into an outsourced agreement is without risk in itself. The key to successful outsourcing is to ensure that it is effectively managed.

An outsourced service does not mean you can forget about energy procurement and sit and watch the bills reduce. In fact the reverse is true. With fluctuating prices and an outsourced supplier the purchase of energy needs to be managed even more effectively.

Both the organisation and the professional risk manager need to understand what the appetite for risk is, and how far the company is prepared to go for increased returns.

Watertight risk management policies and procedures are essential and once the policy is in place it is up to the energy buyer to manage it effectively, and ensure that it is adhered to.

Most importantly, dialogue needs to be maintained and all decisions to purchase come back to the client company, who make decisions based on information and recommendations provided by their supplier.

As the heat wave has demonstrated, the markets move rapidly and optimal buying opportunities are often fleeting. Power prices can turn in a matter of days, sometimes even hours.

Selecting and managing a third party effectively provides access to a wealth of valuable insight, understanding and analysis of the market. It ensures that procurement is controlled and costs are reduced. But most importantly, it means that energy ceases to be the financial black hole that it has become of late – whatever the weather.

CASE STUDY: SOMERFIELD TAKES CONTROL OF ENERGY COSTS

Somerfield is rapidly establishing its position among the UK's supermarkets for providing fresh produce and convenient shopping. It has a strong programme of store acquisition and refitting, which has had a significant impact on its energy consumption.

Each refitted store consumes an extra 30% to 50% of power, in part because chiller cabinets, which store both the fresh and convenience foods, consume more electricity than freezer cabinets.

The company had purchased its energy on one-year fixed-term contracts, via a standard tendering process. However, the store realised it could change the way it purchased electricity and gas and make a major contribution to the way the it controlled energy costs.

Somerfield turned to Utilyx, who helped negotiate flexible contracts: instead of buying its energy for the coming year in a single fixed-date transaction, the supermarket hedges against rising costs by buying chunks of the commodity throughout the year.

This ensures Somerfield buys its energy at the best price, and can add or remove sites from the contract without paying the suppliers' risk premiums.

The Utilyx team's in-depth knowledge and analysis of the markets provides information on actual and predicted price moves. To ensure that Somerfield can act on urgent information a dedicated mobile phone line has been set up to enable it to authorise Utilyx to make purchases on Somerfield's behalf.

The service from Utilyx means that Somerfield now has more time and resources to devote to reducing its energy consumption.

"Utilyx has proved to be a valuable outsourced tool. In fact I would say that they are an extension of our department," says Richard Hemmings, head of energy buying. "The energy market is a complex one, and you need experts in place to manage it properly. That's exactly what we get from Utilyx."