Procurement in volatile markets: a playbook for buying through uncertainty

 Various scenarios detailing how the business may cope with uncertainty should be considered to guide procurement decisions, based on regional factors, potential pricing, potential industry demand, and any sustainability or geopolitical factors. 

Key stakeholders in the business will often have their own business agendas that procurement needs to feed into, so providing clarity on how a company may react during times of uncertainty can be a good way to offer communication guidance for CFO/board alignment.

The key benefit of preparing for uncertainty is that it equips procurement specialists for the reality of today’s markets: uncertainty is the norm, and procurement must adapt.

Why volatility changes procurement rules

Volatility equals uncertainty, and in usual procurement, strategy is based on recurring scenarios that can be built on. Uncertainty removes these predictable patterns, making predictions more difficult.

Timing risk dominates in shocks

Risk can present itself in different ways in energy procurement, with varying timing affecting pricing. Geopolitical risks can have an almost immediate impact on pricing, while the ongoing risk of price spikes and drops can affect procurement decisions more frequently. Layered purchasing, in which buyers can procure energy in different parcels at different times, helps mitigate some of this risk. 

Liquidity moves and supplier risk re-pricing

When energy prices are volatile, a business needs more collateral to ride out price hikes, which can affect everyday operations that may require funds. But it can also affect suppliers, potentially causing them to reassess pricing, add extra charges, or amend contract terms. Making sure robust contract terms are in place before an energy procurement contract commences can safeguard both parties against unexpected value reductions. Alternatively, introducing more flexible terms that benefit either party may reduce risk for one participant or the other. Still, both parties must understand the increased risk if this flexibility leaves them vulnerable to pricing impacts.

Recognising volatility regimes early

The ability to recognise signs of market volatility early could mitigate the impact of price changes on a business’s procurement strategy.

Early indicators

While locking in future prices to avoid price increases can be a good move to stabilise long-term energy pricing, it's only effective if supported by research and considered as part of a long-term strategy. Making rash decisions and fixing overpriced energy as part of uniform long-term contracts is what’s known as forward curve panic. Looking for widening spreads involves identifying an increasing gap between the price procurers are willing to pay for energy and the price generators are willing to sell it for. Early indicators could also include disruptions such as geopolitical pressures, distribution issues, or power outages from a single supplier on which the procuring business is overly reliant: these are known as outage clusters.

Fuel/carbon shock translation to power

When a procurement strategy heavily relies on fossil fuels, value can be affected by what’s known as a fuel shock. When the cost of producing fossil fuels increases, it can impact the overall wholesale market pricing structure. Changes to carbon pricing, which the government imposes as a penalty for generating carbon emissions, can also affect the marginal cost of generation, leading to higher prices.

Tactical moves: staging, hedging bands, deferrals

Some of the crucial best practices in procuring in unreliable energy markets are to mitigate risk. We take a look at some of the best ways to do this. 

Tranche buying in stress markets

A key strategy for reducing risk in volatile markets, tranche buying or layered buying, involves purchasing smaller sections of energy at different times rather than large amounts at once. This avoids locking in overpriced energy for an extended period and instead takes advantage of the more minor, incremental price changes over time. 

Creating certainty bands

Another strategy used to limit price exposure in energy procurement is certainty bands, which allow minimum and maximum pricing to be introduced, called a ceiling and a floor. Your energy price floats between these two metrics, giving you flexibility to benefit from price drops while being partially protected from price hikes. 

When to defer vs. lock in

Knowing when to lock in versus when to delay buying energy is a key element of any successful procurement plan. As a rule, buying when prices are lower than expected is the best course of action for nimble businesses that can react to short-term market changes. Locking in prices, on the other hand, may be preferable when your company has clear growth or transformation plans for the near future, as it allows budgeting to be forecasted on a long-term pricing structure, even if you aren’t receiving the very best energy pricing at that time.

Communicating strategy to stakeholders

Stakeholders will often be concerned with two key elements of energy procurement: value and risk. Making sure these elements, as well as how the business might fare if the calculations differ from expected scenarios, are clearly communicated will make your procurement plan seem more robust and earn trust from key stakeholders. Aligning internal expectations with a realistic procurement plan is also key: what are your stakeholders’ key drivers, value, risks, geopolitical factors, sustainability, or brand reputation? 

You should also make clear the impact of uncertainty on the business and explain that good outcomes are more realistic metrics than perfect timing for energy buying. In volatile markets, it’s important to remember that the best procurement outcome is robust, not heroic.