We are regularly asked: Should I lock in electricity prices as a data center, or not? What will the energy market look like two years from now? I read in the media that prices are going up—should I fix my prices? A word of caution: in this piece we’ll dive deeper into electricity; for gas, different factors are at play.
So what is the smartest purchasing strategy in the long run: dynamic pricing or fixed contracts?
To answer that, it’s important to clarify what exactly is being compared. Suppose you follow the spot market, where you buy every hour exactly what you need at the prevailing rate, versus the 1-year ahead market, where you fix your volume in the forward market. Consulting firm Roland Berger conducted an interesting study on this in 2016.
Now, let’s imagine repeating that study for the past three years: following the spot market versus fixing prices on the 1-year ahead market. And let’s assume we didn’t fix at the best possible moment, nor at the worst, but exactly in between. That gives us the following differences:
The interesting thing about the example above is that it covers a three-year period that includes the steepest rise in energy prices in two decades. One would expect that in such a situation, everyone exposed to the spot market would end up paying significantly more. Yet, the opposite is true.
Even more interesting: this case essentially raises the question of what works better in the long run—tracking an index or actively making decisions in an attempt to outperform it. It is often assumed that fixing prices provides certainty, but in reality this also carries risk. In doing so, you are essentially speculating against the market. So the real question is: can you consistently outperform the index over the long term by fixing prices actively?
This brings us neatly to the stock market, another market that operates on an underlying exchange. Over the past years, extensive research has been carried out to determine what works better: active or passive investing. The findings are striking.
Some key insights:
A comprehensive study from 2000 to 2006, covering 9 million transactions by 68,000 individual investors, shows that 90% of all investors achieved returns well below the market average. (Research from Maastricht University – Rob Bauer, Mathijs Cosemans & Piet Eichholtz).
In the United States, countless studies of this kind have been conducted. For example, The Journal of Finance(April 2000), Barber & Odean, found that between 1991 and 1996 active investors underperformed the market by 18%. The study concluded there is no statistically significant evidence that active investing outperforms passive investing.
Fifty years of independent (scientific) research and real-world experience convincingly demonstrate that following the index, rather than active investing, delivers the best investment results.
Another widely proven strategy from the world of equities is the Dollar-Cost Averaging (DCA) method. Instead of concentrating investment in a few moments of choice, contributions are spread evenly over time. In the spot market, this principle is applied down to the hour—buying exactly what is needed at that moment. With a fixed price, this principle cannot be applied.
The above provides plenty of food for thought. If it is demonstrably unlikely to beat the market, why not simply follow it by linking to it? Combine this insight with the current situation in the Netherlands: grid congestion. In practice, this means our electricity network—our market platform—is at full capacity. Some 14,000 companies are waiting in line to add demand, but will have to wait until 2032 before they can do so, because the grid is simply not large enough. Meanwhile, half the country has covered its rooftops with solar panels, creating a major oversupply on that same grid. In short: pressure on electricity prices is not likely to disappear anytime soon.
In conclusion: a dynamic purchasing strategy appears to be the best choice, both from a scientific perspective and in light of the specific situation in the Netherlands.
Written by: Albert Munneke