Volume risk, hedging, and renewables: What is the way forward?
In the rapidly evolving energy landscape, clients are increasingly seeking to align their power procurement strategies with decarbonisation goals.
However, traditional hedging strategies are being challenged as the energy mix shifts towards renewables.
The answer lies in adopting a portfolio-level approach to risk management that considers the interplay between all sourcing strategies—driving decisions that mitigate risks holistically across financial, operational, and environmental dimensions.
Traditional hedging: The ladder approach
Energy users have traditionally relied on suppliers to manage risk through hedging. One common method is the ladder hedge approach, where businesses gradually hedge their future energy demand over time. This incremental purchasing helps to average out price fluctuations, smoothing out price rises and falls. For example, a business might start buying energy for a specific future quarter-years in advance, resulting in a final block price that reflects a more stable cost by the time the quarter arrives. Combined with suppliers managing deviations in demand close to delivery, this approach has historically provided businesses with reliable and predictable energy costs under normal market conditions.
The shift towards renewables
As you work to reduce your business’s carbon footprint and meet decarbonisation targets, you might have thought to incorporate renewable energy sources into your energy procurement strategies through contracts like Power Purchase Agreements (PPAs) or investments in onsite generation. However, integrating these renewable sources with traditional hedged products introduces new complexities.
Renewable energy’s intermittent nature, due to its dependency on weather conditions, creates volume risk due to variability in output. This can lead to both over- and under-production relative to forecasted volumes, exposing businesses to financial risks:
- Under-production: If renewable output falls short, businesses may need to purchase additional energy from the market. If market prices are lower than the contracted hedge or PPA price, this could result in financial gains.
- Over-production: Excess energy may need to be sold back to the market. If the market price at the time of sale is lower than the original procurement price, this generates additional costs.
Outside of financial risks, environmental considerations also require careful attention. A portfolio heavily weighted toward certain renewable sources—such as solar, which primarily generates during summer daytime—can have further implications:
- Operational challenges: Variability in renewable generation affects hedging strategies and introduces risks associated with volume mismatches.
- Greenhouse gas (GHG) emissions risks: With evolving standards, such as potential changes to the GHG Protocol requiring hourly matching of green certificates instead of annual aggregation, portfolios that are not carefully balanced could result in higher reported emissions
A portfolio-level solution: Addressing risks and emissions holistically
To navigate the complexities of modern energy procurement, a portfolio-level approach that optimises sourcing strategies while effectively managing both financial and environmental risks is the most effective option. Key principles for a successful strategy include:
- Integrated portfolio design:
Developing a balanced mix of PPAs, onsite generation, and market-based hedging to ensure flexibility and risk management. For example:- PPAs provide long-term price certainty and green credentials but require flexibility to manage over- or under-supply.
- Hedged products stabilise a portion of demand, leaving room to adjust for renewable variability.
- Onsite generation reduces market exposure but must account for surplus energy handling.
- Risk-driven decision-making:
Assessing risks from both a financial and emissions compliance perspective. An unbalanced portfolio could lead to higher scope 2 emissions if standards change, such as moving to hourly matching. Businesses should evaluate the cost implications of over- or under-hedging in various market conditions and carefully consider how renewable integration impacts overall portfolio cost structures. - Enhanced hedging strategies:
Adjusting traditional hedging methods to accommodate renewable variability, provide the flexibility needed to effectively manage the volatility of renewable energy within the portfolio. - Investment in storage and flexibility:
Incorporating storage solutions, such as batteries, to mitigate volume risk and better align renewable output with demand shape. - Supplier collaboration:
Partnering with suppliers familiar with renewable challenges enables flexible contract structures, such as sleeved PPAs or hybrid agreements, that optimise costs and manage unexpected variations.
The way forward: Resilient, decarbonised portfolios
The path to decarbonisation may be complex, but it is achievable with the right strategy. Adopting a portfolio-level approach that integrates risk management across both financial and environmental factors allows businesses to make informed decisions such as selecting the right PPAs, structuring contracts effectively, and managing both costs and emissions efficiently.
This holistic approach mitigates both financial and GHG risks, ensuring that portfolios remain resilient as regulations and standards evolve. A well-structured portfolio empowers businesses to confidently progress toward sustainability goals while maintaining cost stability.
As part of a comprehensive power procurement strategy—incorporating PPAs, onsite generation, and hedging—it’s crucial to continuously adapt to the dynamic landscape of modern energy sourcing. A strategically designed approach, supported by the right tools, allows businesses to manage their power position effectively and achieve the optimal balance between hedged and renewable-sourced power, mitigating risks while meeting sustainability targets.
Learn more about how we can help you structure and manage your energy portfolio, get in touch.