𝐖𝐡𝐚𝐭 𝐦𝐚𝐤𝐞𝐬 𝐚 𝐠𝐨𝐨𝐝 𝐭𝐫𝐚𝐝𝐢𝐧𝐠 𝐬𝐭𝐫𝐚𝐭𝐞𝐠𝐲?

In simple terms...buy for less than you sell at; or sell for more than you buy at (depending on which trade happens first). Your net position will be zero at the point of delivery.

Do enough of it to make sufficient profit to pay the cost of capital at risk and leave enough to pay the desk costs and you win.

Positions may be held for seconds or months depending on your capital arrangements, and opinion.

𝐖𝐡𝐚𝐭 𝐦𝐚𝐤𝐞𝐬 𝐚 𝐠𝐨𝐨𝐝 𝐡𝐞𝐝𝐠𝐢𝐧𝐠 𝐬𝐭𝐫𝐚𝐭𝐞𝐠𝐲?

Well, that’s a lot more complicated, and something that the media still doesn’t seem to grasp even after the failures of the last year or so.

Several articles over the weekend looked at suppliers that failed and appeared to suggest that had they bought further forward things would have been OK. Unfortunately, that misses the point again – the length of the hedge is irrelevant, the risk it is hedging is the thing that should determine the hedge duration. In fairness, the CMA throughout its investigation into energy supply failed to understand the purpose and implementation of hedging, and that was after a long investigation – so how are non-professionals supposed to have a clear view.

At the top level a hedge is a risk removal strategy – and should be executed in a way that removes an existing risk. Simple in theory, complex in practice.

Beneath that, it depends on what you’re hedging…

A battery operator may only look a few hours or days into the future and have a combined trading and hedging strategy (even more complex and something for another day); while a battery investor may seek to lock in the value of its asset through allowing a third party to manage it in exchange for a fixed fee years in advance.

A wind farm owner may try to hedge the build cost through a long term PPA of some sort, although for the majority of the current assets the long-term hedge is through the various subsidy schemes in place. In the shorter term a fixed price PPA offers stability of income for a period, either on a volumetric or capacity basis.

An energy supplier may sell fixed term contracts and choose to back to back the term of the contract with an energy hedge.

A large customer may want budget certainty for the coming year to align with its planning and customer pricing cycle – and match this with its energy hedge. Leaving exposure to the short term market may be exciting, but isn’t a hedge.

There is no one size fits all approach, and what works for one business will not work for another. The markets are complicated, adding in misunderstood price exposures can be terminal as has been seen over the last year or so.