Risk management is defined as being concerned with measuring, investigating and forecasting the risk a business faces including market risk, credit risk, operation risk and legal/regulatory risk. You can apply risk management policies to all energy types.
When addressing market risk, there are three things to consider.
||Assess current market prices.
|•||Define your predictions for what the future may hold.
||Set targets, or decide what price you would be comfortable with in
securing some of your energy requirements. Remember, you may complete
this process often during a growing season or fiscal year.
|A set of high pressure natural gas pipes at a compressor station.
|A natural gas processing plant on a pipeline.
There are various sources available to assist with the assessment of current markets. You may locate daily information from the various trading centres available (NYMEX, Orion Futures, etc.), check out the business sections of your local newspaper, or take advantage of energy experts, as some will have their own market commentary and summaries they create and distribute on a daily, weekly or monthly basis.
Exploration of current market conditions and recent pricing also provides the ability to forecast what the future might hold. Today’s market holds record storage levels of natural gas, an economy that continues to deliver increased unemployment throughout the world, and production levels that are constantly being cut.
The amount in storage fluctuates with “demand-and-supply” dynamics, and as winter months come to an end levels are traditionally low. There are expectations that this year the storage levels will end up unusually high, above the five-year average amount. This is in part due to a decreased demand stimulated by a weak economy in Canada and in the United States of America.
On Jan. 26, 2009, or “Black Monday,” 45,000 jobs were lost with the prediction of more to come. As demand decreases, so does the production output for the natural gas producers needed for energy use. For example, the number of natural gas rigs decreased by 26 per cent from September 2008 to January 2009, and production output in the United States was down approximately 17 per cent in December 2008 when compared to December 2007.
Even as production continues to decrease, it is possible that demand will increase in and around early summer this year due to additional gas-fired electricity generation. This is when a purchasing strategy becomes a really important tool to manage your risk. It will ensure that you do not keep all of your eggs in one basket or expose too many at one time.
SETTING TARGETS REMOVES EMOTION FROM DECISION-MAKING
You need to determine how your energy needs could be satisfied through different prices and for varying terms. It’s important to set targets by volume in small increments that may allow for continued opportunities in a declining market. Setting targets removes the emotion that can misguide buyers in an ever-changing market. Once you have secured some volumes at your target price, you have reduced your exposure to the risk in current or index pricing where prices change quickly without notice.
Keep in mind this strategy is not solely for one energy type. To take advantage of the opportunities that alternative fuel sources provide, you can use pricing strategies and set targets for multiple commodity types to maximize your flexi-bility. A sound risk management policy allows for two fuels to be used at a greenhouse. From now until early summer, we see an accommodating market for the natural gas and possibly the oil components of your energy strategy.
Don’t fall into the trap of waiting to execute your purchasing strategy based on the chance that markets may fall lower. Instead, pick a price that fits into your operating budget and grab it. Markets generally rise much faster than they fall and waiting too long could end up sabotaging your risk management strategy.
In the next issue we will focus on Energy Efficiency – easy fixes and what you need to know before committing to the next step in planning for a successful project.