Energize Profits: Hedging Strategies for Power Generation Suppliers

4 min read
26 June, 2023

Adding new strategies to your current business plans can be a great way to maintain profitability without using the same old tactics. One way you can do this is by including hedging strategies in your energy business. Hedging can reduce risk during a continuously fluctuating market, making it an extremely valuable strategy. Knowing how to use hedging to keep your business positive can give you the upper hand against competitors. Hedging can help you retain customers and acquire new ones in a volatile market, making it an essential strategy for every power generation supplier. Keep reading to learn more about the different types of hedging and what makes them unique. 

Understand Power Generation Price Volatility

The term price volatility can be used in a wide variety of industries. It refers to how quickly or widely prices can change; most of the time, they change quite rapidly. In the energy industry, this term is used when electricity or natural gas prices are not consistent with consumer demand. There are several different reasons why a market could be volatile. Some of these reasons are supply and demand inconsistencies, political tensions in other regions, and harsh weather conditions.

When any of these factors are in play, it can greatly affect the industry’s supply and pricing. Power generation suppliers cannot rely on consistent and predictable energy prices to remain profitable and encourage growth. Understanding how quickly circumstances can change and how that impacts your pricing is essential for all energy suppliers.   

Effective Hedging Strategies for Power Generation Suppliers

Power generation suppliers are exposed to numerous risks when the market changes suddenly. To help manage risk, energy suppliers can implement hedging strategies to ensure profitability in an unfavorable market. These are calculated ways of purchasing energy that providers in deregulated regions offer. By building a future contract in small increments over time, you can create hedges around your pricing. These hedges protect your contract from any changes in the market. To help you understand this tactic better, let’s look at four hedging strategies that you can utilize in your business. 

Delta Hedging

One of the most effective and easy hedging strategies is delta hedging. This system is generally utilized in forward trading or future-based contracts. In this strategy, transactions must have equal but opposite delta exposures. The goal is to make the transactions delta neutral, meaning that the delta equals zero. If fluctuating prices are a huge concern, this strategy will be a great option for eliminating any risk associated with price changes. However, one thing to note is that delta hedging.

Market-based Valuation

Power generation suppliers can implement market-based valuation to help with both pricing and risk management. While this process can be intricate, it can help you price energy competitively based on how other companies’ pricing. To determine the energy’s valuation, or how much it is worth, you will need to consider electricity to be the variable. Then, you will need to add the variables together with a discounting factor. This helps you know if you are overpricing or underpricing energy compared to your competitors

Dynamic Hedging

While there is more activity in the short-term market, dynamic hedging approaches the market with long flexibility to protect your contracts from future changes. Dynamic hedging can help you reduce risk in the change that the market fluctuates while helping you make more money. These risks can be issues with future production, so a dynamic hedge can keep your contracts secure if any problems arise. By creating a stable environment for future contracts, you can hedge against price movements and continue to see profits in a highly volatile market. 

Long and Short Hedges in Future Contracts

To manage risk and give your customers a sense of certainty in a volatile market, long and short hedges can be utilized. A short hedge protects the inventory’s value while a long hedge protects against a potential price increase in the future. Short hedges can lock in the inventory value since the storage or transit commodity value is already known. Lo hedges are conducted by someone who wants to buy in the cash market. Both short and long-term hedges can help manage risk and provide security in an uncertain market. 

Leverage Technology For Better Hedging

As technology advances, more and more tools are available for energy suppliers. Finding software, like Risk360, that can help automate tasks can eliminate the number of repetitive tasks in your daily or weekly process, thus decreasing your to-do list. Automating your processes can help you delegate different portions of your job to your team. As you are able to relinquish control and divvy out tasks, you can spend more time focusing on becoming the optimal hedge fund manager. The more time you can devote to this role, the more you will be able to improve collaboration among your team and foster investor relationships. If volatility is causing your margins to shrink, it is time you focus on risk management and see how implementing hedge strategies can keep you on the right track.     

Balance Strategies with Sustainability Goals

Climate change is a huge factor affecting every business in the energy industry. Having sustainability goals that will help combat this crisis is important, but they should also be realistic. When your goals become too large, you can have trouble accomplishing them. You must first choose an obtainable goal, put strategies into place that can help you achieve your goals, and then build upon this foundation as you have the resources. Keeping your goals in mind while creating your business strategy is essential. If you can map out both in a way that will benefit the other, you will be on the right track toward success. 

Beat Market Volatility While Remaining Profitable 

Market volatility is never a fun situation. It can leave customers confused and concerned while energy suppliers are left to figure out how to remain profitable. While it can be difficult at first, with the right hedge strategies, you can find a way to remain profitable, meet your goals, and maintain customer satisfaction. If you are looking for more ways to keep your business profitable while maintaining competitive pricing, download our free guide that covers everything you need to know to keep your business out of the red and deep in the black. 

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