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The Role of Market Timing in Energy Procurement

Posted by SJI Energy Advisors on Jul 2, 2020 3:31:00 PM

The rules of market timing are simple:

  1. Buy when the market is low and go long. Buying long-term contracts in down markets ensures advantageous rates, along with budget certainty and protection against significant upward market swings.
  2. If you must buy when the market is high, go short to ride out market volatility.
  3. Don’t wait until the last minute, or you’ll severely limit your options. Start pricing your next contract 12-18 months before your current contract expires.

The trick is in the execution. You have to watch the market every day; you must study and understand the long-term market trends; and you must be ready to go to market immediately. That’s what our clients pay us for, so that they can focus on running their business.

Learning from History

We recently conducted a 5-year review of all our energy contracts, seeking to confirm that we have been practicing what we preach. As background, please take a look at the market graph below showing both wholesale electricity and natural gas market prices since July 2013. The middle blue line is electricity and the dotted black line is natural gas.

Prior to the polar vortex of 2014, both natural gas and electricity markets were historically low and stable, providing solid buying opportunities for 24 and 36-month contracts. The companies that followed our advice did just that, sheltering themselves from extreme highs between December 2013 and January 2015. This is reflected in the table, to the right, where we see that the average length of the contracts we wrote in 2013 was almost three years.

On the other hand, those who had to sign contracts immediately after the Polar Vortex incurred much higher costs. All we could do to mitigate the problem was to keep the contract length short with the expectation of buying at more normal rates in the future. Our average contract length dropped to roughly two years in 2014 and 2015, and our clients were once again able to buy at more attractive rates as the price of electricity and natural gas began to decline in the fall of 2015.

Applying the Lesson Now

Once again, we are currently enjoying very favorable market conditions, and – heeding our advice – our clients are once again securing longer-term contracts, currently averaging almost three years in length.

As you can see in the market graph, electricity prices have been holding at 5-year lows since May 2017 with a short but intense price spike in the winter of 2018. Natural Gas has also been holding at 3-year lows since the market bottomed out in the spring of 2016.