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Energy risk management for businesses

Energy is one of the few major business costs that you can’t fully control. Wholesale price volatility, rising non-commodity costs and badly timed renewals can turn a manageable bill into a budget crisis.

This guide explains the energy risks businesses face and how to manage them. Here’s what we cover:

• What is energy risk management?
• Why is energy risk management important for businesses?
• What are the main types of energy risk?
• How does the energy risk management process work?
• How to create an energy risk management strategy and policy
• How do fixed, flexible and blended contracts hedge energy risk?

What is energy risk management?

Energy risk management is the process a business uses to keep its gas and electricity costs under control. It means spotting where prices, contracts or supply could hit your finances, working out how big that hit could be, and putting a plan in place to limit it.

For a lot of businesses, energy is a high and volatile cost that can severely affect profit margins and cash flow. The aim of energy risk management is not to “beat the market” but to make energy costs predictable and affordable, at a level of risk the business is comfortable with.

Energy risk management covers four areas:

• Buying energy: Choosing the right contract type, deciding when and how to buy, and avoiding costly out-of-contract rates.
• Managing contracts and suppliers: Understanding terms, charges and supplier stability, and making sure bills are correct.
• Controlling consumption: Reducing how much energy you use and changing when you use it, through efficiency measures, peak shaving and on-site generation.
• Planning: Setting budgets, measuring and reporting on energy costs, and keeping up to date with market and policy changes.

The approach will vary depending on the size of the business. A small business might simply fix its prices at the right time and track its usage. A large energy user might buy energy in stages on the wholesale market under formal hedging rules.

The difference between energy risk management and energy procurement

Business energy procurement is simply how you buy your gas and electricity, by agreeing contracts with suppliers. It’s just one of the ways businesses manage their energy risk.

Energy risk management is the wider strategy that sits behind those buying decisions. Alongside when and how you buy, it also looks at how much energy you use in the first place, through efficiency measures and generating your own power on site.

Why is energy risk management important for businesses?

Energy is vital to the running of most businesses, but it is a high cost and can be volatile if it is not managed.

Managing this energy risk well brings the following key benefits:

• Budget certainty: Predictable energy costs make it easier to set prices, plan investment and protect margins.
• Protection from price shocks: A clear buying strategy lowers the chance of locking in prices at a market peak or being caught on expensive out-of-contract rates.
• Better cash flow: Fewer surprise bills, deposits and penalties mean less pressure on working capital.
• Resilience: Good planning helps a business cope with disruptions to its energy supply, such as power cuts.

What are the main types of energy risk?

This section explains the main types of energy risk that British businesses are exposed to.

Energy price and wholesale market risk

Wholesale market risk is exposure to changes in prices on the British wholesale electricity market or wholesale gas markets.

Prices on these markets are affected by geopolitical events that disrupt global supplies of natural gas, such as the restriction of shipping through the Strait of Hormuz in 2026.

Business energy suppliers buy gas and electricity on these markets, so they pass on any rising costs through the tariffs they offer to customers.

Purchase timing risk

The most common way businesses reduce energy price risk is by signing a fixed contract with their supplier, which locks in the unit rate you pay per kWh for a set number of years.

The catch comes when that contract ends. This is known as purchase timing risk, and it’s your exposure to whatever the market is doing when you need to renew.

If wholesale prices have climbed a lot since you last signed, the rates on offer will be noticeably higher than what you were paying before. Even using a business energy comparison service won’t get you back to your old prices if the whole market has moved up.

Volume and consumption risk

Volume risk is the potential for additional charges if your consumption differs significantly from what your contract assumed.

The risk depends on the type of contract:

• Flexible energy contracts: Any difference between the energy purchased and the energy consumed is settled on the wholesale market, which exposes your business to short-term price changes.
• Some fixed contracts: These have a tolerance band for expected annual consumption, so using significantly more or less energy than expected can lead to penalties.

Load shape risk

Load shape risk relates to when you use energy rather than how much you use. It applies to businesses with half-hourly electricity meters.

Wholesale electricity costs vary throughout the day, so the costs your supplier incurs depend on when your business uses energy.

Business energy suppliers typically charge higher unit rates to businesses that use more of their energy during expensive peak periods.

Non-commodity cost risk

Business electricity bills in Britain include charges for using energy infrastructure, as well as government-imposed environmental policy costs.

These include:

• Network costs: TNUoS and DUoS charges for using the national and local electricity grids, and the equivalent charges for using gas transmission and distribution networks.
• Environmental levies: Government-imposed levies that fund environmental schemes, including the Renewables Obligation, Contracts for Difference, Green Gas Levy and the Climate Change Levy.

Non-commodity cost risk is the potential for these parts of your bill to increase as a result of regulatory reviews and policy decisions. How exposed you are to these increases depends on whether the contract is fixed or pass-through.

Energy contract risk

Energy contract risk is the potential for additional costs hidden in the small print of business energy contracts.

The most common example for SMEs is an auto-renewal clause that moves the business onto an unfavourable rollover contract if notice is not given.

Supplier and credit risk

Supplier failures in the retail energy market are a natural consequence of a competitive market.

When a supplier goes bust, Ofgem’s supplier of last resort (SoLR) process appoints a new supplier so that customers’ electricity and gas supplies are not interrupted.

One consequence of the SoLR process is that fixed contract rates no longer apply. Businesses are moved onto deemed rates at current market prices instead.

Regulatory risk

Regulatory risk is the potential for a government or Ofgem decision to affect prices on the wholesale energy markets.

One prominent example of regulatory risk is carbon pricing, which affects the cost of electricity generated by gas power stations, a major contributor to the power mix on the national grid.

Operational and security-of-supply risk

Operational and security-of-supply risk is the potential for a disruption to your energy supply to affect your business’s operations. The most common causes are a local power cut, or a network-wide problem caused by the failure of a major power station or a cyber attack.

How does the energy risk management process work?

Here’s how a typical medium-sized business would go about managing its energy risk, step by step.

It’s not a one-off exercise. Think of these steps as a cycle you come back to whenever something changes, whether that’s in your business or in the wider energy market.

1. Understanding energy consumption

To manage energy risk, you first need to understand how and where your business uses electricity and gas.

The best way to understand your consumption profile is through automatic readings from commercial gas meters, business electricity meters and sub-meters installed across your portfolio of properties.

A commercial energy monitoring system can be used to collect and analyse this data.

2. Identify risks

Identify the risks that are most relevant to energy use across your portfolio. In the section above, we’ve listed the most common types of energy risk that SMEs face.

It is usually worth mapping out the contract end dates for your most energy-intensive sites, as these are the points at which your business becomes exposed to current wholesale market conditions.

3. Assess and measure your exposure

For each risk you identify, calculate your potential cost exposure.

For example, you could calculate the overall financial impact of a 20% rise in wholesale prices. Or you could check the out-of-contract rates published by your current suppliers to see what you would pay if one of your tariffs expired.

4. Set your risk appetite and policy

Decide how much price uncertainty your business can tolerate. Some businesses need full price certainty for budgeting, while others can accept some exposure in return for the chance of lower costs.

In the section below, we explain how to create a risk management strategy and policy.

5. Choose your buying strategy

Select contracts and buying methods that match your policy. Below we discussed how energy price risk is managed by different types of contract.

6. Reduce and control demand

Lower your exposure by using less energy or changing when you use it.

Read on to find out how energy efficiency and renewable energy can reduce risk.

7. Put the plan into action

Carry out your strategy. Agree on contracts, make purchases at the planned times, and ensure suppliers, brokers, and internal teams know their roles.

8. Measure, report and adapt

Track your performance against your targets, including:

• Overall energy budget variance.
• The business electricity prices and commercial gas rates per kWh you’ve secured, compared with market benchmarks.
• The percentage of energy for future years that you’ve already bought.
• Reductions in consumption.

Report regularly to the person accountable, such as the owner, finance director, or board. Review your strategy periodically and adapt it in response to significant changes in the market.

How do you create an energy risk management strategy and policy?

An energy risk management strategy sets out how your business will buy and manage energy. The policy is the written document that records the rules, responsibilities and limits that everyone must follow.

Together, they ensure that energy decisions are consistent, accountable and in line with business goals, rather than being made under pressure when a contract is about to end.

What should an energy risk management strategy and policy document include?

An energy risk management strategy and policy document will include the following sections:

• Objectives: What the policy is designed to achieve.
• Scope: Which sites, fuels and contracts it covers.
• Roles and responsibilities: Who sets the strategy, who approves purchases and who carries them out.
• Risk appetite and limits: How much energy must be secured in advance, by when, and the maximum exposure allowed.
• Buying rules: Approved contract types, purchasing triggers and stop-loss controls (see the explanation below).
• Supplier and counterparty criteria: How suppliers and brokers are chosen and checked.
• Approval and escalation: Who can sign contracts and what happens when limits are breached.
• Performance measures: How success will be measured, such as budget variance or performance against market benchmarks.
• Reporting: What is reported, who it is sent to and how often.
• Review process: When and how the policy will be updated.

What are purchasing triggers?

Purchasing triggers are pre-agreed conditions that prompt a business to buy some or all of its future energy. They are usually set out in a written energy risk policy.

Common types include:

• Target price triggers: Buying when market prices fall to or below a level that fits the budget.
• Time-based triggers: Buying on set dates or at set intervals, so that the business builds up cover in stages, whatever the market does.
• Cover deadlines: Making sure a minimum share of energy is secured by a set point before it is needed.

Triggers help businesses take advantage of favourable prices while making steady progress towards their cover targets.

What are stop-loss controls?

A stop-loss control limits how much a business could lose if prices rise. If the market moves above a pre-agreed level, the business must buy a fixed share of its remaining energy straight away to limit its exposure to any further price rises.

Stop-losses are written into energy risk policies, as they help protect budgets from sharp price rises.

How do fixed, flexible and blended contracts hedge energy risk?

You can partly reduce energy price risk by choosing the right type of energy contract. No contract removes risk completely, and each option strikes a different balance between certainty and flexibility.

Here’s how each of these common contract types hedges energy price risk:

Fixed energy contracts

With a fixed energy contract, the unit rates per kWh for electricity or gas are locked in for an agreed period, typically between 1 and 3 years.

In a fixed tariff, your commercial electricity or business gas supplier takes on the energy price risk.

However, fixed contracts introduce purchase timing risk, because businesses need to find a new contract when their current one ends.

Our free, no-obligation business electricity comparison and business gas comparison services can help you find the best fixed prices for your business today.

Flexible energy contracts

With a flexible contract, you buy your energy in portions (“tranches”) over time at wholesale prices, instead of all at once.

This approach reduces the timing risk that comes with fixed contracts, because spreading purchases over time averages out price movements.

Flexible contracts are generally only available to large business energy customers. Find out more in our guide to flexible energy contracts.

Blended purchasing strategy

A blended purchasing strategy means buying energy through a mix of contract types and other supply options. This variety allows a business to offset the specific risks that come with each type of contract.

It usually takes one or more of these forms:

• Holding a portfolio of fixed contracts with staggered start dates to spread timing risk.
• Mixing contract lengths across a portfolio to reduce exposure to price rises.
• Combining these contracts with on-site generation or private-wire power purchase agreements.

How can energy efficiency and renewable energy reduce risk?

Most of a business’s energy costs come from the unit rates charged for each kWh of energy it uses.

Businesses can reduce their exposure to these unit rates by cutting the amount of energy they buy from their supplier. Two common ways to do this are:

• Improving business energy efficiency: Taking steps such as replacing older equipment so that the same operations can be carried out using less energy.
• Generating renewable energy: Using commercial solar panels to generate electricity on site, which reduces the amount of power drawn from the grid.

Who is responsible for energy risk management?

Who is responsible for energy risk management depends on the size of the organisation. These are the roles that typically share responsibility:

• Board or owners: They are ultimately accountable. They set how much risk the business will accept, approve the energy buying strategy and sign off budgets.
• Energy, procurement or facilities manager: They carry out the strategy, manage contracts and suppliers, and monitor consumption.
• Risk or energy committee (in larger organisations): It approves the hedging policy, buying limits and trading decisions that affect energy procurement.

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