Energy Suppliers – Hedging Explained

You may have seen or heard various discussions about how UK energy suppliers use hedging.   

What is Hedging?

Energy hedging can pay handsome dividends for energy suppliers. However, it could plunge companies into financial turmoil!

Fundamentally, energy prices are unpredictable and fluctuate with supply and demand, politics, natural disasters, or even unforeseen circumstances such as the recent fire at a National Grid site in Kent.

Energy suppliers buy energy in advance (known as hedging) to match the demand of their customers. Similar to that of airlines, who hedge future fuel consumption to avoid spikes in oil prices.

There are risks to hedging

Energy hedging can protect suppliers against unexpected price surges. However, if they buy too little, they must buy on the spot market, energy sold at real-time prices, to ‘top-up’. This is expensive and volatile. If they purchase too much, they must sell off their excess energy and this can be a lottery.

The current energy crisis has shown that larger companies, or those with more financial clout, are able to afford to hedge more. Unfortunately, smaller companies are unable to do the same. Ultimately, suppliers purchasing energy on the current spot market results in them selling energy at a loss. Hence the current energy climate.

Energy suppliers are at low, moderate, or high risk, depending on storage, hedging, engagement in the spot market and financial backing. Recently, Dale Vince, founder of ecotricity, explained how they are currently in as good a position as possible due to hedging.

Will there be Government intervention?

It is important to understand that a household’s energy supply remains constant if their supplier ceases trading.

In the event of a supplier going out of business, Ofgem appoints a Supplier of Last Resort (SoLR), a process that this week, saw British Gas inherit 350,000 customers from People’s Energy.

It is highly unlikely that energy suppliers have hedged for this extra usage, which has resulted in the suggestion is that the government will offer emergency loans to support these big businesses.

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