As an energy consultant I'm asked a variety of questions about how to best manage energy costs, but none more frequently than "is it a good time to lock-in my supply price?"  Inevitably the more volatile energy prices become, the more I am asked the question as people become less assured of their economic welfare.  While most people believe that the answer to this question is best determined by my sharing some prophetic insight into the future market conditions (i.e. will future market prices increase or drop), I believe the answer is best determined by not having an answer at all.

Knowing what you know, and what you don't know... While I pride myself on being a very experienced energy consultant, the fact of the matter is that I don't possess anymore insight into the future outcome of events than anyone else.  What I do possess is 1) the ability to know what I don't know, 2) if that gap can be bridged through learning, and 3) if not [as is the case with predicting the future] how to prepare for the unknown.  Predicting future energy prices equals predicting the weather, economics, politics, law, human behavior, and every other element of life across a variety of nations that impact the price of a barrel of crude oil.  The combination of events is overwhelming to the point that I would suggest no fortune teller or computer model is capable of getting it right without some element of luck.

Basing decisions on guesswork [no matter how intellectually based or statistically driven] is like telling time using a broken clock...your only guarantee is being correct two minutes of every day.  Given this disposition, I'd recommend addressing the future for every possible outcome it might bring rather than the outcome I think or assume it will bring.  Preparing for the possible is typically more prudent than planning for the probable...or even worse, predicting the future; particularly when facing complex market environments such as fuel prices.

Supply and Demand vs. Speculative Supply and Speculative Demand... Retail energy prices are driven by wholesale trading, which in turn is driven by the amount of buying and selling on either the present [spot] or future [futures] markets.  While the daily spot market is very much a traditional here and now "supply and demand" transaction between buyers and sellers, the futures markets [i.e. NYMEX] are based upon what buyers and sellers "believe" the supply and demand reality of the marketplace will be at some point in the future. 

Further differentiating the two markets is the role of the buyer.  With the exception of storable fuels such as coal and oil [and to a limited degree natural gas on a wholesale basis] spot market buyers are typically consumers of energy as the value of the commodity perishes if it is not burned on the spot (i.e. electricity purchased for a specific hour of the day does not carry any future value as it can't be stored, so its only value is the value of its use).  However on the futures market the buyer purchases both the value of the commodity's use and the value of time as the commodity's worth varies based on speculative supply and speculative demand and does not expire until the designated futures month.  Hence, in the futures market the buyer can also be a seller.  This phenomenon expands the buy-side of the marketplace from consumers to speculators, and also expands the forces affecting prices from actual supply and actual demand to speculative supply and speculative demand.  While the former can be ascertained by measuring market fundamentals such as the amount of exploration, harvesting, refining, distribution capacity, consuming demand, etc. the latter is based on a more human interpretation of the future and all the respective fear and greed associated with human behavior. 

When in doubt, pick both... Considering that 1) the future market is speculative [not yet factual], and 2) the present market is [factual and] independent from the future, each market's risks and rewards naturally offset each other.  While the future is unpredictable, it can be determined by buying the future at any time [and locking in the cost].  Inversely, while the present is more predictable, it can not be determined until you're in the present (i.e. the day or hour of use).  Applying opposite market positions to neutralize the effect of the other is referred to as a "hedge".  Hedges can be accomplished either through offsetting physical supply contract positions ["physical hedge"] or through financial instruments such as options ["financial hedge"].  Energy consumers typically can satisfy their hedging objectives via physical hedges by structuring offsetting contract positions across multiple fuels or offsetting price positions within one contract.  In addition, electric and natural gas utility distribution and transmission costs [which are often non-negotiable] typically satisfy a quasi-fixed price position to further stabilize the fixed-variable supply hedge within the fuel portfolio.

A hedged approach to fuel cost management is the only proven means to satisfy both price certainty and price opportunity concurrently; effectively removing the guesswork from determining when to fix or float supply pricing as each position is accomplishing what the other is not.

Thinking percentages rather than prices... Fixing or floating energy prices for a future period simply because you think the price tag is good or that the market will...is not a strategy, it's a guess.  Good, better, best are all relative and relativity changes with expanding market dynamics.  With the advent of energy deregulation, oil, natural gas and electricity supply cost structures are becoming more closely linked to each other.  This link in market price behavior across the three commodities should be taken into consideration, particularly when making future purchases as electricity prices will become increasingly more dependent on oil and natural gas market fundamentals than in years past.  For instance, what may have been an average electricity price for the past five or ten years may not likely be the average for the next five or ten years.  Accordingly, history alone is not an adequate basis for future decisions.  Given the constant and rapidly changing market price benchmarks, diversification of cost allocation becomes critical in maintaining control over budget certainty while still participating in market opportunity.

Similar to financial planning, long-term energy cost objectives must be defined by budget [and cash flow] needs as well as risk tolerance [or aversion].  Understanding such needs is prerequisite to defining a goal and the appropriate portfolio management strategy to get you there.  By matching the percentage of desired budget certainty and/or risk with percentages of budget dollars, buying energy becomes a process of mathematics rather than a futile process of prediction.  When structured properly and actively managed throughout the year, a hedge of any fixed-to-variable ratio will deliver the intended economic result regardless of market conditions.  It's an all-weather strategy that you will find indispensable amidst growing market uncertainty!