The world energy market is highly unpredictable. Everything from global weather, to the financial markets and geopolitical pressures impacts on prices. There are sharp drops in prices - and sharp rises too.
Forward buying your energy
To avoid this unpredictability affecting your bills, we buy the energy we supply to our customers in advance – sometimes a few years ahead. It’s called forward buying – also known as ‘hedging’ – and it’s why the price you pay for your energy doesn’t go down immediately when world energy prices fall.
It’s also why, when prices spike, your bills don’t increase as quickly or by as much either. Just as a fixed rate mortgage avoids fluctuations in interest rates, forward buying makes sure that we don’t have constantly to change the price you pay for your energy.
The type of instability we’re seeing in Ukraine can give the energy markets the jitters and send prices upwards. But by buying energy in advance, we limit the effects of that volatile pricing – shielding our customers from the need to increase our prices suddenly.
It’s a financial risk that we take as the supplier, on behalf of our customers. In order to buy energy in advance, we enter into contracts with large suppliers and purchase energy on ‘forward markets.’ With forward markets, we’re able to guarantee a price for delivery up to four years before that energy is needed. Every month, a small proportion of the total energy we think we’ll need for the year ahead is purchased.
So - to give a theoretical example - if we were buying energy over 10 months, we’d buy 10% of what we needed every month. This reduces the need to buy during extreme price spikes, and means what households pay closely tracks the price we paid for the energy.
Smoothing out the price changes
Because we buy over an extended period, prices are smoothed out, so retail prices aren’t exposed to volatile wholesale price movements - whether up or down. Protecting our customers against sudden price increases on the wholesale market also means that when the wholesale cost of gas falls (as it has during 2014 to 2015), we aren’t able to pass on all of that reduction immediately -- simply because we bought the gas customers are burning today quite a long time ago, and at a higher price.
As our overall costs come down, we pass these reductions on to our customers: just like we did in January 2015. We’re continually looking for opportunities to pass on any savings. But with nine million households depending on us to heat their homes, we also believe it’s necessary and right to buy energy for customers in advance, rather than take a big gamble on where wholesale prices will be.