We all want to enter into a contract knowing exactly what to expect, right? The perception is often that a “fixed-price” contract equals predictable pricing. The truth is when you contract for a fixed electricity price you are locking in the majority of price exposure, but real price risk still exists. It’s important to understand the unpredictable components of your commercial energy contract.
Your Energy Contract Pricing is Comprised of These Components
The largest part of your electricity supply price is the energy cost which is largely driven by the cost of generation fuels like natural gas. Fortunately, it’s relatively straightforward for a supplier to hedge the energy costs.
The big issue for a supplier is to hedge the right amount of electricity given what you are predicted to use over the contract term. Suppliers will manage this risk by building in a premium to cover usage variations, and by limiting how much variation they will allow you to have. This is called a ‘swing provision’ in your supply contract. One way for you to get charges that exceed your fixed contract price, is to use more energy than is covered in your contact swing provision. If the supplier is forced to buy higher-priced electricity to serve your needs outside of your swing, then the supplier may end up passing that higher cost on to you.
How to Calculate Swing Provisions in Energy Pricing
- Your facility’s contracted electricity usage: 10,000,000 kWh
- Contract Swing Provision: 10%
- Your facility’s allowed maximum electricity usage: 11,000,000
Watch for Pass-through Charges
To manage the risk of other price components, suppliers will use pass-through language in their contracts. Here are two ways they may do this:
- They may look to pass through the actual cost to you from the start by leaving the specific component out of the fixed price.
- They may make the best estimate of what they believe the cost will be and include it in the fixed price, but contractually allow the pass-through of costs in excess of the estimate.
Each supplier handles these issues differently through contractual provisions, such as ‘change in law’, ‘material adverse change’, and ‘price component adjustments’, etc. Not understanding your contract can leave you with unwanted surprises from pass-through and price adjustments.
How to Avoid Surprises in Your Energy Bill
- Compare contract provisions from supplier to supplier before signing
- Pay attention to your bills and any notices you get from suppliers
- Hold suppliers accountable for explaining the rationale for increases
- Understand your contractual rights and your options
Many end-users don’t have the time or expertise to adequately do these things. As a client of Premier Power Solutions, we do these for you. If you are not a client yet, and you suspect you are getting adjustments to your price, contact us and we will review your contracts, identify areas of concern and make recommendations to mitigate the current risk and avoid future pitfalls.
Energy market pricing is continually fluctuating. While energy prices do trend higher or lower based on market fundamentals, they also fluctuate within a longer-term trend. These intra-trend market movements can be potential buying opportunities.
Consider a Block and Index Strategy
Rather than trying to time the market to fix an energy price all at once, it may make sense to execute a procurement plan that allows you to take advantage of future buying opportunities without fully exposing your organization to price risk.
This procurement strategy is typically referred to as a ‘block and index’ or a ‘managed’ product. Purchasing portions of energy over time will mitigate energy price fluctuations that come from being “all in” with a 100% fixed supply contract or a 100% index contract. This strategy strikes a balance between establishing budget certainty and managing energy purchases to drive energy cost reduction.
Key Features of Hedging Strategies:
- Transparency of energy costs
- Take advantage of market dips while limiting budget risk
- Conversion to a fixed price at any time
Is a Hedging Strategy Right for My Organization?
As a Premier Power Solutions client in an active hedging contract, our advisors can work with you to develop a procurement plan based on your specific risk tolerance and budget objectives. We would then monitor the market for you to ensure hedging decisions were made at the appropriate times and volumes.
There are many approaches to buying energy, and each organization’s energy needs and sustainability goals are unique. To learn more about energy procurement strategies, click here.
To determine which energy pricing strategy is right for your business, please contact us. Our experienced energy analysts and advisors can help you develop a customized corporate energy strategy that’s right for your business.