Purchasing Options for Purchasing Options for Energy Buyers Energy - - PowerPoint PPT Presentation

Purchasing Options for Purchasing Options for Energy Buyers Energy Buyers

6th June 2006

The Risk Management Way

Mark Dickinson Encore - Managing Director

2

Overview Overview

Encore’s view on 4 of the imperfections in the UK

energy markets and why you need new ways of procurement and portfolio optimisation

Show how energy buyers that risk manage differ

from the many who don’t!

Explain how you can buy your energy flexibly and

safely and optimise your portfolio from the day you set your budget to the day you consume the energy

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Market Imperfection No. 1 Market Imperfection No. 1

• The supply demand

imbalance in 2005 was not materially different to the supply and demand imbalance in 2004

• We actually had more gas

in store going into the period than we had in the previous year

• We don’t believe the high

price were caused by the a shortage of gas supplies

• 40
• 30
• 20
• 10

10 20 30 40 50 Jan-05 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06

Supply Demand Imbalance (million therms/day)

• 1,200
• 900
• 600
• 300

300 600 900 1,200 1,500

Gas in Store (million therms) 2004 Storage 2004 Supply/Demand Imbalance 2005 Supply/Demand Imbalance 2005 Storage

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Market Imperfection No. 2 Market Imperfection No. 2

• Generally the UK energy

market is not physically constrained, it is financially constrained

• Typically, the people who

could deliver additional capacity to the UK wholesale market collect revenue from the UK consumer

• So why would they want to

supply marginal energy to the UK which would lower the market price in the UK and consequently the sale price

Avg Sale Price 45 to 55 p/therm

Avg Sale Price 55 to 65 p/therm Avg Purchase Price 54 to 64 p/therm Avg Purchase Price 54 to 64 p/therm Avg Purchase Price 40 to 50 p/therm Avg Purchase Price 40 to 50 p/therm Avg Purchase Price 40 to 50 p/therm

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Market Imperfection No. 3 Market Imperfection No. 3

• Large Consumers on flexible contracts

have bought very little energy for Winter-06, 2007,2008,2009

• The Suppliers, Traders and Banks

have bought lots of energy, and they have bought all of the storage

• There are 182 days in the winter and

the UK has 90 days of storage. Every time there are more days of the winter left than there is gas in store the market has the potential to be cornered

• The market was cornered in Q4 2005

and will be in Q4 2006 and each year until enough large consumers buy energy forward

• In previous years this was not a

problem as enough large consumers had fixed prices and as such the suppliers, traders and banks had to balance the system amongst

• themselves. Now they can balance

against all of the large consumers

25.00 50.00 75.00 100.00 125.00 150.00 175.00 200.00 3 / 1 / 5 1 / 1 / 5 1 7 / 1 / 5 2 4 / 1 / 5 3 1 / 1 / 5 7 / 1 1 / 5 1 4 / 1 1 / 5 2 1 / 1 1 / 5 2 8 / 1 1 / 5 5 / 1 2 / 5 1 2 / 1 2 / 5 1 9 / 1 2 / 5 2 6 / 1 2 / 5 2 / 1 / 6 9 / 1 / 6 1 6 / 1 / 6 2 3 / 1 / 6 3 / 1 / 6 6 / 2 / 6 1 3 / 2 / 6 2 / 2 / 6 2 7 / 2 / 6 6 / 3 / 6 1 3 / 3 / 6 2 / 3 / 6 2 7 / 3 / 6 3 / 4 / 6 1 / 4 / 6 1 7 / 4 / 6 2 4 / 4 / 6 1 / 5 / 6

p/therm

Day Ahead Dec-05 Jan-06 Feb-06 Mar-06

Ukraine / Russia Gas Dispute Cold Weather in Moscow Rough Storage Failure

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Market Imperfection No. 4 Market Imperfection No. 4

• The current Interruptible

transportation contracts in the market allow for demand side respond in times of extremely high demand – this is an enforced response from people with alternative fuels

• We have not had a sustained

period of enforced mass demand side response since 1995

• However just because there is

not an enforced demand side response does not mean that there should not be a commercial demand side response

• However at the moment Large

Consumers do not necessarily see the value of it

70.00 80.00 90.00 100.00 110.00 120.00 130.00 140.00 150.00 160.00 170.00 180.00 190.00 200.00 1 / 1 1 / 2 5 8 / 1 1 / 2 5 1 5 / 1 1 / 2 5 2 2 / 1 1 / 2 5 2 9 / 1 1 / 2 5 6 / 1 2 / 2 5 1 3 / 1 2 / 2 5 2 / 1 2 / 2 5 2 7 / 1 2 / 2 5 3 / 1 / 2 6 1 / 1 / 2 6 1 7 / 1 / 2 6 2 4 / 1 / 2 6 3 1 / 1 / 2 6 7 / 2 / 2 6 1 4 / 2 / 2 6 2 1 / 2 / 2 6 2 8 / 2 / 2 6 7 / 3 / 2 6 1 4 / 3 / 2 6 2 1 / 3 / 2 6 2 8 / 3 / 2 6

p/therm

Day Ahead Working Days Next Week

Gas Oil 2 Gas Oil 1 Fuel Oil 1

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What can we do about the What can we do about the Imperfections? Imperfections?

• Restructure the European Energy Markets - it’s in hand but

might take some time – 2008?

• You could make sure you have the correct supply contract,

without the limitations, and a considered process for using it

• You could create a process where you’re able to purchase

future energy requirements now, without risking being stuck with high price energy when market prices fall.

• You can make sure you are ready to do things such as load

management when the time is correct

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Energy Procurement vs. Energy Risk Energy Procurement vs. Energy Risk Management Management

Features of Energy Procurement Features of Energy Risk Management Buying fixed price contracts or Flexible contracts with a price fixing only option Some companies have entered into contracts with price unfixing but often it is restricted Recognises that a flexible contract is always better than a fixed contract because you can create exactly the same effect as a fixed price contract but you retain choices Recognises that because prices go up and down a flexible contract needs the ability not only the ability to fix prices but also to unfix prices in order to avoid speculation Recognises that prices move up and down without restriction and that the tools that you need to manage your energy risk are also need to unfettered by restrictions Budgets are set and the performance against the budget is only looked at periodically If measurement is done only the value of the portfolio is measured and not the risk of it Recognises that the value and the risk of your energy portfolio need to be measured every day as energy price don’t double in one day - a risk manager can see it coming The senior management of the company don’t set clear objectives for the procurement team The senior management want you to have fixed your price and perform well against budget if prices have risen by the end of the year The senior management want you to have a market based price if prices have fallen by the end of the year They want to judge this using 20/20 hindsight with little reference to what happens in between Recognises that large consumers of energy have conflicting objectives in terms of performance against budget and performance against market Creates a Corporate Risk Policy that is signed of by senior management and sets out the broad boundaries that the procurement team shall work to in terms of fixing and unfixing energy that are consistent with the large consumer achieving their corporate objectives Creates a process for quickly changing the Corporate Risk Policy as the business objectives change Possibly outsources the procurement of energy to a consortium group or to a traditional procurement advisor The conversation focuses around a fixed proportion of the portfolio that should be on a fixed price and a proportion that should be on a floating price Recognises that you should not give your portfolio to a third party to be gambled Recognises that no-one can predict the markets, if they could they would be out there doing it and keeping it a secret, rather than being paid by large consumers to try and do it with your money Recognises that you do need a risk measurement and control process to allow the proportion

• f the portfolio for which the price is fixed to be adjusted to match changes in the market

conditions and in your business strategy Recognises that over an above this control structure you might over weight or under weight some decisions based on market information and commercial opinion Consider implementing a demand side response at times of high price spikes but generally either has not bought the energy to be able to sell it back Even if energy has been bought the organisation internally has not set a strategy for price levels at which the energy can be sold and the alternative fuel bought or production ramped down to allow supply from stocks Recognises that simply by having a predetermined capability to load manage you can

• ptimise your commercial position

Sells energy forward when spikes occur using the fact that they can load manage to make it a risk free transaction. Buys back the energy when the panic is over and in many cases never ends up actually interrupting anyway

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Results of Energy Risk Management Results of Energy Risk Management

20.00 25.00 30.00 35.00 40.00 45.00 50.00 55.00 60.00 65.00 70.00 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Date p/therm

Fixed Price Market Price Avg Risk Managed Price Best Risk Manageme

2004 Avg Benefit 10% Benfit for Long Term Risk Managers 12% 2005 Avg Benefit 18% Benfit for Long Term Risk Managers 40% 2006 Avg Benefit 27% Benfit for Long Term Risk Managers 45% 2007 Avg Benefit 27% Benfit for Long Term Risk Managers 40% 2008 Avg Benefit 10% Benfit for Long Term Risk Managers 40%

• Reduced Risk
• Reduced Cost
• Controlled
• Simplified
• Adaptable
• Optimised to the needs of

your business

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Optimsing until the day of delivery Optimsing until the day of delivery

• Once you have a risk

management environment you can continue the optimisation process until the day of delivery

• You can monetise the options

the options in your portfolio even without actually using them

• For example:
• 21st November sell Day Ahead

switch to Oil

• 22nd November sell Day Ahead

switch to Oil

• 23rd November sell Day Ahead

switch to Oil

• 23rd November Sell Working

Days Next Week

• 28th November buy back the

balance of the week

70.00 80.00 90.00 100.00 110.00 120.00 130.00 140.00 150.00 160.00 170.00 180.00 190.00 200.00 01/11/2005 08/11/2005 15/11/2005 22/11/2005 29/11/2005 06/12/2005 13/12/2005 20/12/2005 27/12/2005 03/01/2006 10/01/2006 17/01/2006 24/01/2006 31/01/2006 07/02/2006 14/02/2006 21/02/2006 28/02/2006 07/03/2006 14/03/2006 21/03/2006 28/03/2006

p/therm

Day Ahead Working Days Next Week

Gas Oil 2 Gas Oil 1 Fuel Oil 1

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How do you do it? How do you do it?

• First set up a clear risk policy which allows you to match your

company’s objectives to your energy procurement position

• Second ensure you have a contractual relationship that allows

decisions to be taken flexibly – without limitations

• Third set a budget and a limit to the amount of risk your

business is prepared to take. Review and change this as the needs of your business change

• Fourth measure the changing value of your portfolio and its

risk every day

• Five use this information with your procurement strategy and

market expertise to optimise decisions

• Don’t gamble or let other people gamble on your behalf

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What Happens when you do What Happens when you do it? it?

• You transform a horrible discussion with your FD
• Into amazing performance

VALUE AT RISK (£)

Capital at Risk = £30,000

VALUE AT RISK (£)

Capital at Risk = £30,000