On a napkin
$/MWh Market Block hedge Open / index tail Cap Floor Collar zone $180 $120 $60Energy hedging uses financial and contractual instruments to reduce exposure to electricity price volatility. The goal is not to buy cheap — it's to reduce variance in energy costs relative to budget. A buyer who fixes 80% of their load at $60/MWh and the market falls to $40/MWh hasn't failed; they've successfully reduced budget risk, which was the objective. Mark-to-market regret is the enemy of a disciplined hedging program.
Hedging is risk management, not speculation. A hedge program should be evaluated against its stated objective — budget certainty — not against whether the unhedged position would have been cheaper in hindsight. Organizations that evaluate hedges on the wrong metric end up taking more risk than they intend.
A block purchase is a forward contract to buy a fixed volume of electricity at a fixed price for a specific period — a month, a quarter, or a year. Strips are sequences of monthly or quarterly blocks covering a full year. Most large C&I buyers build hedge portfolios as a series of strips layered over time — adding new forward purchases as the delivery period approaches while maintaining a target hedge ratio. Layering averages entry prices across the forward curve, reducing the risk of locking in at a single high point.
A typical hedge program targets 70–90% fixed for the near year, 40–60% for year 2, and 10–30% for year 3. Outer years carry more uncertainty — holding optionality makes sense until the picture becomes clearer.
A collar combines a purchased price cap (a call option that limits upside price exposure) and a sold price floor (a put option that gives up some downside if prices fall sharply). The floor premium offsets the cap cost, creating a near-zero or zero-cost structure. Within the collar range, the buyer pays market prices. Above the cap, the seller pays the buyer the difference. Below the floor, the buyer pays the seller.
Collars are used by buyers who need to cap worst-case exposure but aren't willing to fully fix prices. They work well when the forward curve is moderately elevated — the buyer wants protection against further upside while retaining benefit if the market falls. The width of the collar (the spread between cap and floor) determines the cost structure and the degree of market participation retained.
Call options give the buyer the right — but not the obligation — to purchase electricity at a fixed strike price if the market rises above it. Buyers pay an upfront premium for this asymmetric protection. Options are most useful when the forward curve is elevated (making a full fix expensive) but catastrophic protection is still needed — for example, a $300/MWh cap on peak-hour exposure for a price-sensitive industrial buyer. Swing options add volume flexibility. A disciplined options program provides a risk ceiling without sacrificing all market upside, at a known cost.
Common questions
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