Markets: Energy Sector
Hedging Electricity Costs
Solutions to Manage Power Volatility
Eighth in a Continuing Series
First, a little history - What today is Constellation NewEnergy can trace roots back to beginnings as a company founded by Michael R. Peevey, former Southern California Edison president and current president of the California Public Utilities Commission. Formed in 1995 as New Energy Ventures, the company grew to open offices in New York, Los Angeles, Walnut Creek (Calif.), Boston and Philadelphia in 1997. Then New Energy Ventures was purchased in 1999 by AES for $90 million and changed to AES NewEnergy. More regional offices opened across the U.S. and revenues increased until parent company AES experienced credit issues. AES NewEnergy was purchased in 2002 by Constellation Energy Group for $260 million and changed to Constellation NewEnergy. Constellation Energy (NYSE: CEG) is a leading competitive supplier of electricity, natural gas and energy-related services throughout North America (Canada and the United States). Based in Baltimore, the firm serves more than 14,000 commercial and industrial customers throughout 37 states and five Canadian provinces representing nearly 17,000 megawatts of peak load and more than 350 billion cubic feet of annual natural gas consumption.
By Bruce Sher
Bruce Sher, regional vice president, Constellation NewEnergy New England.The concept of hedging financial investments receives a lot of attention, but hedging can be a useful strategy for approaching price risk of all types. For businesses, large asset investments bear the greatest risk associated with price. With energy costs increasingly becoming a significant portion of company budgets, and world events adding to the volatility of underlying fuels, electricity is precisely the type of asset that should be proactively managed.
Since the beginning of the competitive electricity markets, Constellation NewEnergy has worked with businesses to manage energy as a strategic asset. One successful strategy that many customers have turned to is buying pieces or blocks of electricity to hedge against future increases in electricity costs, which is an approach that can have payoffs in the long run.
Through competitive markets, multiple electricity solutions are available to business customers with different options and accompanying agreements. By aligning electricity agreements with their financial objectives, customers have opportunities to strategically shape the delivered price of energy. Although there are many options available on the market, some examples of the diverse solutions and agreements available to businesses are long-term, fixed-price power that allows companies to lock in a price that can be depended upon for future budgeting; medium-term, forward-price products that allow more flexibility; and short-term products with higher risks but increased upside opportunities.
By employing these multiple approaches, which are similar to managing retirement or mutual funds, Constellation NewEnergy has successfully worked with customers of all sizes to customize products including the option to flatten out rates and take advantage of lower prices in the market.
Constellation NewEnergy has provided long-term fixed-price agreements to many Connecticut customers, including the state’s largest manufacturing trade association. Recognizing the electricity market volatility faced by many of its members, the Manufacturing Alliance of Connecticut (MAC) partnered with Constellation NewEnergy to offer members price stability. Similar in the way that many companies and investors turn to financial experts to help determine their investment strategies, we were able to offer our energy expertise to help MAC develop a customized product to meet the needs of its members. The enthusiastic response from MAC members underscores the need for budget certainty and better energy management among large electricity users across the state.
By leveraging our position to purchase blocks of electricity, Constellation NewEnergy is able to secure the most competitive prices for our customers in the market. These blocks of electricity can come in different shapes and sizes to match the customer’s usage pattern. The benefit is that we buy a customer’s power on the wholesale market today so that businesses can pay the agreed-upon price for the entire term of an agreement, regardless of market conditions.
It is also important to note that hedging options are not one-size-fits-all. Several customers have included features such as green power in their deals, or load response to promote energy efficiency and conservation in the region. The environmental benefits that green power and energy conservation provide are well established; however, the associated financial benefits as a hedging tool often get overlooked. Since green power fuel sources (such as wind, solar and biomass) are sustainable and a constant, renewable energy can both eliminate the volatility of fuel supply and be used as an effective tool to manage the risks associated with energy costs.
Investment managers specialize in different sectors and investment vehicles, each suited to the specific needs and risk appetite of their customers. Managing energy risks should be thought of in the same way. Constellation NewEnergy and other competitive suppliers (the companies that buy wholesale power from generators and sell it retail to companies and individuals) are the experts who can build the right strategy that accurately meets the needs of each individual customer. In a specialized area such as purchasing power, smart companies will know when it is necessary to consult the experts.
The best hedge a business can make is against risks to its largest asset investments. With today’s historical increases in energy prices, it’s worth a look at the variety of product options available through the many competitive providers that are already serving more than a thousand businesses and organizations throughout Connecticut.
Bruce Sher is regional vice president for Constellation NewEnergy New England, one of the region’s leading competitive electricity suppliers. E-mail bruce.sher@constellation.com.
