Convergence Point

Introduction: The Procurement Challenge

Imagine you’re responsible for buying electricity for 50,000 households, 2,000 small businesses, and 50 industrial customers. You don’t know exactly how much they’ll consume next year. Some will leave, new ones will join. Consumption depends on weather, economic activity, and individual behavior.

Yet you must buy the energy before you know the final consumption. Buy too much? You’re stuck selling excess at potentially lower prices. Buy too little? You’re forced to buy the shortfall at potentially higher prices.

Welcome to retail procurement—the high-stakes chess game of buying for thousands of customers you can’t perfectly predict.

Back-to-Back vs. Strategic Procurement: The Risk Spectrum

Retail procurement strategies exist on a spectrum from zero risk to high risk:

Back-to-Back Procurement (Zero Price Risk)

How It Works:

1. Sales team signs new industrial customer for 10 MW starting next month
2. Sales immediately notifies procurement team
3. Procurement immediately buys 10 MW for the contract period on wholesale market
4. Open position returns to zero

Characteristics:

• ✓ No price risk (bought at market price the instant it was sold)
• ✗ No price opportunity (can’t benefit from falling prices)
• ✓ Simple to manage (minimal forecasting needed)
• ✗ Margins entirely dependent on sales markup and operational efficiency

Who Uses This:

• Small utilities with low risk appetite
• Retailers entering new markets (learning phase)
• Companies with thin capital reserves

Profit Formula:

Profit = (Sales Price - Purchase Price - Overhead) × Volume

Where Purchase Price ≈ Market Price at contract signing. The only variables you control are sales markup and overhead costs.

Strategic Procurement (Managed Price Risk)

How It Works:

1. Forecast total customer consumption for next year
2. Develop procurement schedule (when to buy)
3. Buy incrementally over time, targeting below-average prices
4. Accept open positions (long or short) within risk limits
5. Flatten positions closer to delivery

Characteristics:

• ✓ Potential to profit from smart timing
• ✗ Risk of buying high (above average)
• ✓ Can optimize procurement across customer portfolio
• ✗ Requires sophisticated forecasting and risk management

Who Uses This:

• Established utilities with risk capital
• Competitive retailers seeking pricing advantage
• Companies with professional portfolio management teams

Profit Formula:

Profit = (Sales Price - Average Purchase Price - Overhead) × Volume

The critical difference: Average Purchase Price can be meaningfully below market average if procurement timing is skillful.

The Risk-Return Spectrum: Four Strategic Positions

Let’s map out the realistic options:

Position 1: All-Inclusive Annual Contract (Outsourced)

What It Is:

• You outsource entire procurement to a larger utility or trading house
• They buy all the energy, handle balancing group, manage risks
• You pay a fixed price per MWh (annual contract)

Pros:

• Zero complexity (one contract, one price)
• No market risk, no overhead
• Predictable costs

Cons:

• Highest cost (outsourcer captures all market opportunities)
• No upside potential
• Dependent on third party

Example Pricing:

• Year-2026 forward market average: €85/MWh
• All-inclusive contract price: €92/MWh
• Cost of simplicity: €7/MWh

Position 2: Load Schedule Delivery (Partial Optimization)

What It Is:

• You provide consumption forecasts by quarter or month
• Procurement partner buys on your behalf following a schedule
• You participate in some price variations but with guardrails

Pros:

• Some exposure to price opportunities (buy low quarters)
• Limited complexity (partner handles execution)
• Reduced overhead vs. in-house

Cons:

• Still paying for service
• Not full control over timing

Example:

• You agree to buy 25% of annual volume per quarter
• Q1 average price: €78/MWh
• Q2 average price: €82/MWh
• Q3 average price: €88/MWh
• Q4 average price: €86/MWh
• Average cost: €83.50/MWh (€1.50 below market average)

Position 3: Full In-House Procurement (High Skill Required)

What It Is:

• Your own trading desk
• Direct market access (EEX, OTC brokers)
• Active position management
• Your balancing group

Pros:

• Full control and flexibility
• Capture all market opportunities
• No middleman fees

Cons:

• High overhead (salaries, systems, licenses)
• Significant risk exposure
• Requires deep expertise

Example Costs:

• Trading platform subscriptions: €200k/year
• 3 portfolio managers: €500k/year total
• Risk management systems: €150k/year
• Balancing group fees: €50k/year
• Total overhead: €900k/year

Break-even: Must save more than €900k/year through better procurement to justify in-house approach.

Position 4: Hybrid (Pragmatic Middle Ground)

What It Is:

• Partner handles day-to-day execution and balancing
• You retain strategic decision rights (when to buy)
• Shared risk management

Pros:

• Lower overhead than full in-house
• More control than full outsourcing
• Partner’s expertise on execution

Cons:

• Coordination complexity
• Potential misalignment of incentives

Typical for:

• Medium-sized municipal utilities
• Retailers with 10,000 – 100,000 customers

Dynamic Stop-Loss Strategy: The €256,000 Savings Example

Let’s walk through a real-world procurement strategy that balances risk and opportunity:

Scenario (January 2025):

• Utility serves 30,000 household customers
• Forecasted 2026 consumption: 300 GWh
• Current Year-2026 forward price: €88/MWh
• Historical 5-year average: €84/MWh
• Utility’s assessment: Price is slightly elevated

Strategy:

• Don’t buy all 300 GWh immediately (avoid buying at potential peak)
• Implement graduated procurement with dynamic stop-loss

Procurement Schedule:

Month 1 (January 2025): Buy 15% (45 GWh)

• Price: €88/MWh
• Rationale: Secure baseline, don’t wait too long
• Remaining open: Short 255 GWh

Month 3 (March 2025): Price drops to €85/MWh

• Buy another 20% (60 GWh) at €85/MWh
• Rationale: Price improving, increase purchasing
• Remaining open: Short 195 GWh

Month 5 (May 2025): Price at €82/MWh (below historical average)

• Buy 30% (90 GWh) at €82/MWh
• Rationale: Attractive level, accelerate
• Remaining open: Short 105 GWh

Month 7 (July 2025): Price at €79/MWh (very attractive)

• Buy remaining 35% (105 GWh) at €79/MWh
• Rationale: Excellent entry, complete procurement
• Position: Flat (fully hedged)

Results:

Average Purchase Price = 
(45 GWh × €88 + 60 GWh × €85 + 90 GWh × €82 + 105 GWh × €79) / 300 GWh
= €82.45/MWh

Alternative (Back-to-Back):

• Would have bought all 300 GWh at €88/MWh on Day 1

Savings:

• (€88 – €82.45) × 300 GWh = €1,665,000

But Wait—What If Prices Rose?

Downside Scenario:

• Month 1: €88/MWh → buy 15%
• Month 3: €92/MWh (prices rising, not falling)
• Stop-loss triggers: Buy remaining 85% (255 GWh) at €92/MWh
• Average cost: (45 × €88 + 255 × €92) / 300 = €91.45/MWh
• Incremental cost vs. Day 1: (€91.45 – €88) × 300 GWh = €1,035,000 loss

Risk-Adjusted Assessment:

• Expected value depends on probability of price rise vs. fall
• If 60% chance of falling, 40% chance of rising:
  • EV = 0.6 × €1,665k gain – 0.4 × €1,035k loss = €585k expected gain

Actual Result in Real Example:

• Procurement saved approximately €256,000 through dynamic strategy
• Not the full theoretical upside, but meaningful value creation

Household vs. Industrial Customers: Completely Different Games

The procurement challenge varies dramatically by customer type:

Industrial Customers: Simple and Transparent

Characteristics:

• Fixed contracts: Explicitly specify volume (10 MW for 3 years)
• Predictable load: Aluminum smelters run 24/7 at constant power
• Long commitments: 1-5 year contracts typical
• Direct communication: Sales and procurement coordinate on every deal

Procurement Process:

1. Sales signs contract: 10 MW baseload starting 2026
2. Sales notifies procurement instantly
3. Procurement knows exactly what to buy: 10 MW × 8,760 hours = 87,600 MWh
4. Decision: Buy now or wait? (Timing decision, not volume uncertainty)

Volume Risk: Near zero (only risk is customer bankruptcy or plant closure)

Household Customers: Complex and Probabilistic

Characteristics:

• No fixed volumes: Consumption varies by weather, behavior
• Customer churn: People switch suppliers (30-60 day notice)
• New sign-ups: Can’t predict exactly who will join next year
• Weather-dependent: Heating/cooling demand drives massive variations

Procurement Process:

1. Current customers: 48,000 households
2. Forecasted change: -2,000 departures, +3,000 new (net +1,000)
3. Expected 2026 customers: 49,000
4. Average consumption: 4,000 kWh/year per household
5. Expected total: 49,000 × 4,000 kWh = 196 GWh

But:

• Actual customers could be 47,000 – 51,000 (95% confidence)
• Actual consumption could be 3,500 – 4,500 kWh/household (weather)
• Actual volume range: 164 GWh – 230 GWh

Volume Risk: High (up to ±15% variation)

Implications:

• Can’t buy exact amount (don’t know it)
• Must manage expected open position + volume uncertainty
• Use probabilistic forecasting (scenarios, confidence intervals)
• Adjust procurement as year progresses and uncertainty resolves

Volume Uncertainty: The Hidden Killer

Price risk gets all the attention. Volume risk is sneakier and equally dangerous:

Example: The Mild Winter Surprise

Setup (November 2025):

• Utility forecasted winter 2025-26 consumption: 150 GWh
• Bought 150 GWh at average €110/MWh
• Expected costs: €16,500,000

Reality (March 2026):

• Winter was 15% warmer than normal
• Actual consumption: 130 GWh (not 150 GWh)
• Utility is long 20 GWh it doesn’t need
• Must sell excess at current market: €95/MWh

Financial Impact:

• Paid: 20 GWh × €110/MWh = €2,200,000
• Received: 20 GWh × €95/MWh = €1,900,000
• Loss: €300,000

No price risk was taken—utility bought what it expected to need. But volume uncertainty created an unwanted long position that lost money.

Mitigation Strategies:

1. Buy conservatively: Procure 90% of forecast, leave 10% short
2. Use options: Buy call options for upside volume risk
3. Weather derivatives: Hedge against mild winters
4. Dynamic adjustments: Update procurement as forecasts improve

The Make-or-Buy Decision: Three Paths

Every utility must answer: How do we procure?

Path 1: Make (In-House Trading Desk)

Requirements:

• 3-5 traders/portfolio managers
• Professional trading platforms (€200k+/year)
• Risk management systems
• Balancing group registration
• Regulatory licenses

When It Makes Sense:

• Customer base > 100,000 (volume justifies overhead)
• Organizational risk appetite exists
• Access to capital for risk-taking
• Want full strategic control

Example: Large municipal utility serving 500,000 customers, €500M annual revenue

Path 2: Buy (Full Outsourcing)

How It Works:

• Annual all-inclusive contract with larger utility or trader
• They handle everything (procurement, balancing, risk)
• You pay fixed €/MWh

When It Makes Sense:

• Small customer base (< 10,000)
• No risk appetite
• Limited capital
• Focus on sales and service, not trading

Example: Rural electricity cooperative with 5,000 customers

Path 3: Hybrid (Collaborate)

How It Works:

• Partner provides platform, balancing group, execution
• You retain strategic decision-making
• Shared risk management framework

When It Makes Sense:

• Medium-sized (10,000 – 100,000 customers)
• Want some market exposure without full overhead
• Willing to share control

Example: Regional utility with 50,000 customers partnering with larger neighbor

Key Takeaways

✓ Back-to-back procurement = zero price risk, zero price opportunity
✓ Strategic procurement requires forecasting, risk capital, and discipline
✓ Dynamic stop-loss strategies can save millions (€256k example) but need risk limits
✓ Industrial customers are simple (fixed volumes, long contracts)
✓ Household customers are complex (volume uncertainty, churn, weather-dependent)
✓ Volume uncertainty can be as dangerous as price risk
✓ Make-or-buy decision depends on scale, expertise, and risk appetite

Next in Series: Post 6: Generation Assets: Power Plants as Financial Options