Energy procurement models: fixed, flexible, or hybrid?

Having a good understanding of the different types of procurement strategies can help market participants to make defensible choices on contract structure, with a core procurement decision beyond supplier selection. However, it’s crucial to have foresight into which model is most appropriate and how each performs best and worst in specific scenarios. Procurement models can help buyers design hybrid strategies that balance certainty and upside, so it’s essential to understand how each model works in practice. This practical decision guide will explore fixed, flexible, and hybrid procurement models and how to integrate them into energy-related businesses.

Energy procurement models explained

We take a look at the particulars of the three main procurement models: fixed, flexible, and hybrid.

Fixed price

One of the key benefits of fixed-priced procurement models is the certainty of the contract. It offers a long-term (if selected) energy option at a fixed price, making budgeting much easier for businesses. However, there are often associated costs to factor in, such as premium costs, which a supplier can usually add to fixed agreements to hedge against future risks. Lock-in risks are also mostly unavoidable, as fixed-term contracts, by their nature, are fixed and don’t typically allow for price negotiations once the contract begins. 

Flexible

Flexible contracts provide some breathing room for buyers; for example, index-linked contracts can rise or fall with a market index, such as wholesale pricing movements. Tranche buying allows procurers to acquire energy in smaller increments over a specific period rather than all at once at the outset. Companies can also ask a third party to manage flexible purchasing through managed services.

Hybrid

Sometimes known as a Block or Index Pass-Through contract, hybrid models offer the best of both worlds. They work by layering fixed and flexible components together so that procurers can benefit from price drops without the risk of fully flexible models and full exposure to price hikes.

What drives value in different market conditions

Two key drivers of procurement are risk vs. profit. We take a deeper dive into both. 

Low-volatility vs high-volatility environments

A low-volatility market is stable. Steady returns on investments are expected, and as a result, investor confidence tends to be higher. Smaller profits over a more extended period are usually expected in these markets. High volatility, on the other hand, is an uncertain market. Risk is high, so short-term traders can make larger profits as prices spike and drop. The downside is that it can be unpredictable, and with such high risk, investor confidence is lower. 

How price regime shifts change optimal model choice

Different market conditions, or regime shifts, can drive value in the energy market. Regime switching can be beneficial because traditional methods do not always perform as expected, particularly in volatile markets. In contrast, the latter models can be more adaptable, provide early risk signals, and deliver greater value. 

Before COVID-19, for example, bear markets indicated safety and resiliency; however, post-March 2020, markets were highly volatile and unpredictable, which spurred innovations in remote work and a tech industry boom.

Matching procurement models to risk appetite

Different businesses have different tolerances for risk and the amount of price volatility they can withstand. Procurement models can help to determine these thresholds. 

Defining risk appetite in procurement terms

Risk appetite is a barometer for a business that can influence its decision-making about how price volatility might affect when and how it procures energy. Two different metrics tend to guide these decisions: quantitative statements that address specific sets of data and provide numerical evidence, and qualitative statements that address a business’s attitude to risk.

Budget volatility tolerance and governance alignment

A business’s attitude to budget volatility can differ depending on the type of energy contract it is entering into. For example, a fixed-price contract may indicate a low tolerance for volatility, as the business has selected a stable, steady contract, and its governance and management choices reflect that. In contrast, a flexible contract may signal that a company has a more open-minded approach to budget volatility, with a requirement for market intelligence in governance.

Stakeholder expectations 

Various stakeholders within the business will have differing priorities. For example, CFO operations focus on cost savings and financial risk management. Operations stakeholders are more concerned with ensuring the contract is reliable and stable so that operations can continue as usual. In contrast, sustainability stakeholders examine a business's ability to achieve carbon-reduction targets and meet regulatory requirements.

Hybrid approaches for modern buyers

Laddering can split energy into smaller, more manageable increments, reducing the risk of price spikes on large energy purchases. Collars, on the other hand, set a ceiling and a floor price for wholesale energy, which shifts responsibility between the seller and the buyer depending on the price behaviour. The digital field is revolutionising how the hybrid market operates, leveraging AI, digital channels and virtual interactions to create “certainty bands” while keeping upside.

Common mistakes and decision checklist

While procurement models can allow a degree of risk reduction and certainty for energy procurers, they do come with their own unique challenges, such as over-fixing at peaks and under-hedging during high-stress events, with ignoring the load shape coming at a cost. Operational flexibility is crucial when designing procurement strategies, with a clear “model selection” checklist in place. Finally, it’s worth bearing in mind that procurement success starts with choosing the right model, not just negotiating the best price.