Benchmarks

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In the wake of recent power and gas market volatility and retail deregulation , large end-users have suddenly realized that they are now . To control their energy budgets in this environment, corporate energy managers (CEMs) must quickly become familiar with markets in which they are inexperienced participants. Moreover, they must become accustomed to sophisticated risk management tools in order to protect their companies' bottom-line.

Energy end-users are generally risk averse and are typically the least knowledgeable energy market participants. Due, in large measure, to a long-standing reliance on their gas and electric utilities to shelter them from true market volatility, many end-users are being forced to learn about and implement energy risk management techniques. Prior to the catastrophic energy market events on the West Coast coupled with tremendous natural gas volatility and the market upheaval created by Enron's failure, most energy end-users had never thought much about managing energy price and counter-party risk.

During the recent Energy Managers Roundtable sponsored by Platts Research & Consulting/E Source, about 30 Fortune 500 CEMs were surveyed relative to their expectations for future energy prices. 56 percent of the respondents expected to pay the same price for electricity in three years as they are today, and 44 percent expected to be paying more. This compares to just three years ago when 90 percent expected to be paying less as a result of deregulation. The lesson that deregulation does not always equal low prices came as a jolt to most end-users. Also, because of concerns related to volatile energy prices, the polled CEMs expect to develop and utilize energy risk management practices in a more structured and deliberate manner.

The practice of hedging risk has long been used by the agricultural, financial, and other commodity markets to control exposure to adverse market events. Hedging, in its purest form, is the practice of locking in an acceptable price as protection against volatility. Hedging tools may limit the user's upside, but are primarily used to control downside risk. The focus is to protect bottom-line profitability. Such risk management is accomplished through the exchange of commodity futures contracts and options, as well as through the combining of such instruments into more sophisticated derivative products, including straddles, collars, and spreads that accomplish specific risk mitigation goals. Trading counter-parties, such as an energy service provider, can also provide swap opportunities that can assist both parties in optimizing their unique risk exposure profile.

CEMs are beginning to develop hedging strategies that include switching from the previous month-to-month supply contracts to a combination of forward contracts, swaps, and local transportation agreements. For one large aircraft manufacturer, these actions provided savings of over $5 million of their $180 million annual energy bill, and reduced the variability and risk in their energy budgeting. Others are looking to develop strategic relationships with energy management firms that will provide these services under an outsourced arrangement on either a fixed fee or shared savings basis.

Energy risk management is becoming an increasingly important facet of today's business and is essential to the stabilization of a company's