How companies can cope with energy price risks
As profit margins are often thin and many sectors are energy-intensive, firms have to closely follow oil, gas and power prices. There are several strategies that companies can follow to mitigate price fluctuations. All of them have their pros and cons and most companies make use of a combination of these strategies. Therefore, we should point out that the exposure, risk appetite and market situation for every single company is different:
Minimise energy use: By using energy-efficient production processes, the amount of energy will be diminished and the vulnerability to energy price hikes will diminish. Air carriers can for instance invest in more energy-efficient aeroplanes. This strategy however takes time and is less suitable to accommodate the immediate impact of high energy prices.
Use a price escalation clause: This makes it possible for firms to pass on energy price increases to the customer. This is mainly done in B2B markets. Price clauses with private consumers (B2C) are more difficult to achieve and therefore not common.
Directly procure inputs: Firms can directly procure oil, gas or power at the moment a sales deal is closed. This secures the calculated energy price at the moment of closing the deal. They can do this in two ways. First, they can agree on the price with a supplier and ensure delivery of the fuel at the moment needed in the production process. However, it must be said that suppliers are sometimes reluctant to lock in such long term contracts as the price risk is handed over to them. Second, firms can buy the needed energy directly, have it delivered directly and stored until needed. Yet, this results in (high) storage costs and a decrease in working capital.
Commodity futures: If the above strategies are not possible, a hedge with a commodity future is an option. However, futures are complicated financial products which have to be fully understood and constantly monitored.