Setting up Your Energy Derivatives Policy

Abstract

If you buy or sell energy, at some point you will be at risk, so it makes sense to hedge. We are not talking about the kind of hedging that defends against volatility, because the single biggest fact of energy markets is that prices fluctuate wildly, and unexpectedly, particularly since the deregulation of markets. In order to monitor the effectiveness of energy derivatives properly and also to control their use within your organization it is important to set up a clear energy derivatives policy. Company shareholders are usually very demanding: on the one hand, they don’t want companies to hedge away any of their upside profit potential, and on the other, they hate to see too much downside potential loss exposure. An energy consumer that implements a bad hedging strategy may end up paying high fixed prices for energy while its competitors pay lower spot prices. So how does a company choose the correct hedging strategy?