Meat processors face the same challenges that many industries do: the need to reduce energy costs in order to remain competitive. Although a daunting task, strategic energy-management practices ease this burden and mitigate risk associated with the volatile energy market.
When assessing the energy-management needs of meat processors, there are three main areas that need to be addressed: energy buying, procurement and delivery. Here are several energy-management best practices relating to these areas that can assist meat processors in curbing their energy costs.
Develop a risk-management plan
An important aspect of managing energy budgets is to have a risk-management plan that is coordinated with the budgeting process. The first step for implementing a risk-management plan is to identify usage by month and by season, as well as the variability of the cost components involved with obtaining energy. This helps meat processors identify pricing objectives and create a risk profile. Businesses need to assess their tolerance to energy price fluctuation and identify whether they can operate if energy prices would happen to double. If a company cannot afford to stay in business if prices spike drastically, then it is a good idea to hedge.
Set price targets and stick to them
While it is important to set price targets and objectives in a risk-management plan, it is even more critical to follow those objectives. Some meat processors will not hedge when prices are low because they want to wait for the lowest possible price, but this plan can backfire if a company waits too long to hedge. On the other hand, when prices are rising, businesses will lock in high prices because of fear that prices will continue to rise. Having price points in place in your risk-management plan and adhering to them lessens the risk of market movements having a negative impact on energy budgets.
When considering hedging, evaluate your company’s objectives. If the plant is budget- and margin-oriented and/or it has forward-sold its product, hedges should be executed when natural gas and electric prices fit their budget or margin targets. Hedging at this point makes sense, regardless of where the prices are, because their objective is to manage margins and budgets.
Meat processors need to consider how their energy costs fit into their budget requirements. There is no magic time to hedge energy; companies hedge at different times because they have differentiating objectives and processes related to managing their own cost exposure. Some companies will implement forward hedges every month or quarter. Others tend to hedge opportunistically when the market presents perceived value. There is risk associated with being an opportunistic hedger: if you miss a drop in prices, you may end up paying a high price for energy in the future.
Make procurement process competitve
An effective risk-management plan should implement an aggressive energy-procurement process that makes suppliers systematically compete for business based on cost and quality. In addressing the process of buying natural gas, two aspects need to be considered: underlying market volatility and physically obtaining the molecules that make up natural gas. Hedging natural gas on the exchange does not give a meat processor any actual product; it only provides price protection. Companies need to procure physical volumes, and there can be a significant difference in price from one supplier to another. As you get closer to the point of consumption, there is less transparency and pricing information. When procuring energy, there is a search process that needs to take place. Often times, meat processors rely on third-party energy-management providers to undertake this process on their behalf. In this case, an energy-management company will structure systematic procurements that meet both the physical and financial needs of a company.
An energy-management provider can offer valuable assistance in creating competition between suppliers. They break down the process of buying natural gas based on the three components of service: commodity supply, long-haul transportation and local distribution. By focusing on each component separately, energy-management companies are able to provide meat processors with the lowest possible prices.
When dealing with the suppliers, energy-management providers arrange contracts and credit with three to five suppliers. This allows them to see the prices each supplier is offering and choose the lowest price. Since most energy-management companies only deal with suppliers that offer a quality product, price is much more of an issue that the product itself.
Once the natural gas is purchased, it needs to move through the interstate pipeline. Energy-management companies work with meat processors to determine their flexibility in procuring energy. If a meat processor can tolerate some interruptions, they will be able to pay a much lower price for the interstate transport and distribution services. On the contrary, if a meat processor has an extremely high reliability level that needs to be met, then the energy-management company will find a more reliable service.
The last step of the process is working with the local distribution company. Generally, companies take the posted price, but there are some situations where energy-management companies can work with local providers to get a discount on natural gas distribution services. For example, if a client is located near an interstate pipeline, it can perhaps tie directly into the pipeline and bypass the local distribution company or get a discount from the utility in exchange for not bypassing.
Along with market activity, determining delivery costs is another important variable to consider. Specifically, plant managers should examine the cost of moving energy from the commodity point to the consumption point. In the case of natural gas, plants should compare what they are paying to the Henry Hub, a point on the natural gas system in Louisiana that is used as the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX).
If a plant transports natural gas from Henry Hub, then it simply needs to look at the cost of moving the natural gas through the interstate pipeline. However, most plants are not physically served with gas from Henry Hub, in which case there is a basis differential that represents a combination of the value difference between Henry Hub and other liquid pricing points and the transport costs in getting natural gas to the delivery point.
For example, a plant that obtains most of its natural gas from the Mid-Continent area or Canada should closely examine the value of gas coming from both sources and the transport costs. The objective should be to manage price volatility in the supply basin and work to push down transport costs to the lowest extent possible.
In addition to the three main focus areas for energy management discussed above, another issue that meat-processing plants are beginning to address is carbon management. While there are no comprehensive federal carbon regulations in place, it is an emerging issue of which plants must be aware.
Federal legislation mandating carbon emissions tracking and reductions is likely in the near future and meat processors should have an idea of how potential â€” but sweeping â€” regulations may affect them.
Being aware of the essential issues involved with energy management is important, but equally as critical is implementing processes that can help meat processors optimize their energy budgets.
By implementing an energy-management plan that is aligned with the corporate goals, meat-processing companies can overcome market volatility and even take advantage of market movements to optimize the money spent on powering their plants.