As we approach winter, it is a good time to explore a common offering by energy companies, the fixed price contract. I say this a good topic for the approach of winter for two reasons. First, since Michigan is a state that experiences winter weather, it is common for customers to want to lock in a price for the heating season that protects them from the ups and downs of heating prices through the winter season.
Secondly, the approach of winter also indicates the approach of a new year, and many farms and businesses will start to look at their budgets for the coming year. As we explore this topic, I want to look at: WHY customers would want to lock in a price, HOW energy companies can offer a fixed price, and WHAT indicators can a person use to determine WHEN to lock in a price.
WHY customers would want to lock in a price
Energy prices are volatile (they are constantly moving). The prices are moving at multiple locations with a national price that moves independently from regional prices. It is difficult to know what will happen next.
Energy prices are affected by supply and demand and by anything that may affect the perception of supply and demand. Because of that volatility, the primary reason people choose to fix a price is the benefit of knowing that they will be able to stay within a budget for a portion of their energy needs.
Locking in a price can ensure that the unexpected will not keep you from meeting your goals and help you manage your risks. Whether you are delivering a product based on a known cost of energy or you are ensuring that your operational expenses will stay within certain parameters, you can find budget certainty in an uncertain environment.
HOW energy companies can offer a fixed price
I don’t know exactly how all energy companies choose to do this, but the most reliable way for an energy company to offer a fixed price is to do the same for themselves by utilizing fixed price physical contracts or energy market financial products.
A wise energy company is going to protect themselves and you by ensuring that they will have adequate supply to provide the fuel at the price you have chosen to lock in. This does involve some cost and some risk for the energy company.
If you do not take the volume that you indicated, and the energy company fixed the price on that volume, there could be losses sustained. For this reason, often energy companies will insist on a fixed volume contract as well as a fixed price.
Indicators a person can use to determine WHEN to lock in a price
The first and best indicator to use to determine when to lock in a price is whether the price is within your budget goals. If the price is where you need it to be, then it is probably a good time to lock the price in.
Unfortunately, most of us give way to human nature and want to know that we are choosing the BEST time and not just a good time. This mentality often leads to error or even a failure to make a decision.
View the accompanying charts for NYMEX ULSD and Mt Belvieu Propane. In hindsight, it would be easy to choose when you should have purchased each year to get the best price. But you can quickly see that the best time may have been different almost every year.
One way to both meet your budget goals AND give yourself the ability to look for a good price is to split your total purchase into portions and buy it in smaller increments, if that option is offered.
The first time you contract, you lock in a portion of your needs. If the price goes up, you are glad you had that much locked in. If the price goes down, then you are glad that you can lock in the next portion of your needs at a lower cost.
Another way to lock in a price and still look forward to a market decrease after you buy is to utilize a different kind of contract that “caps” your price instead of fixing it. For an upfront cost, usually 10-20 cents per gallon, you can fix the highest price you will pay, but enjoy some of the downside of the market as prices decrease.
These contracts can be costly, but you can always enjoy good news. Either the market is above the price you are paying and you are happy you are paying the lower cost that was fixed as your cap, or the market is moving down and you are happy that you have the ability to move with it. However, the upfront cost makes this type of contract less popular than the fixed price contract.
When dealing with energy markets, it can often be helpful to remove some of the uncertainty from your costs by choosing a contract that will help mitigate the volatility of the prices. Talk to your energy provider to find out what opportunities may be available.
Please remember - Historical and fundamental analysis cannot predict the future of energy markets. This information is provided only as information and is not meant to be a source of investment advice.
Plan ahead for budget certainty. Fuel contracting allows you to lock in a portion of your anticipated fuel needs at a price that works for you. Visit www.forwardfuelpricing.com to get your free quote today!