What to look for in an index product… how not to get taken

• The Megawatt Hour recently analyzed index pricing and billing for a client who is on an index rate from a local ESCO.
• It is difficult to know what you’re paying on an index rate, and even more difficult to validate the accuracy of your billing as there is usually no transparency from your ESCO about how your bill is calculated.
• This post provides a detailed description of a proper index rate, and what information you should ask for from your supplier to verify invoices.

When to buy an index

• An index product is a good option when markets are high and you are not interested in locking in a high fixed price rate. Of course, that approach assumes that one’s view is that markets are likely to decline.
• If you’re not budget sensitive and would prefer to track the utility rate, then buying an index rate makes sense. If forward markets are high relative to historical prices, and there is significant forward price volatility at a given point-in-time, then it may make sense to buy an index rate and then opt to transition to a fixed rate when there is a buying opportunity.

Don’t purchase an index rate with the expectation of “saving” money on electricity. You are most likely to track a utility tariff on the index, at least over a 12 month term, but it is unlikely that you will “save” relative to almost any benchmark.

Background

Let’s use NY State as an example. The utility default rates in NY State, the rate that you will pay if you do NOT choose an ESCO, are based on the day ahead price of electricity as recorded in the NY ISO Zone in which you’re located (LINK TO ISO). Each utility in NY calculates the default rate tariff a little bit differently.

The two important points to bear in mind are:

• If you’re on an index rate, you should be paying the day-ahead energy rate + the capacity clearing price (both verifiable from public data at the NY ISO) + ancillary rates (also verifiable by the NY ISO).
  • Over a 12-18 month period, your index invoice should total very close to the utility default rate.
• The industry standard for an index product in NY State tends to be energy billed at an index and everything else – capacity, ancillaries, losses, and any risk premiums (as well as ESCO margin) added into a fixed adder. The adder on an index product was, for several years, priced at around $0.01 per kWh. Now that capacity prices have increased in all NY Zones, you should expect to pay an adder rate closer to $0.02-.03/kWh depending on your facility’s usage and capacity profile.
  • If you’re interested in a fully indexed rate, you should request a full pass through of all electricity cost components. Suppliers may resist offering you this product because of the complexity of billing and the necessity of a corrected (true-up) bill about two months after the meter read and initial bill.
  • Be certain that your fully indexed contract specifies which auction rate you will be charged for installed capacity.

Defining an index product

The following section is technical, but essential to properly defining your index contract with your supplier.

If you’re not yet at the stage where you are ready to negotiate a contract, skip to the next section, “What to Watch For”, for tips on how to make sure you’re making a good decision for your business.

Here’s the language you should ask for in your index rate contract:

Detail and definitions:

The cost for commodity services billed under this contract shall be calculated for each account as follows: ( Hourly Metered Energy * Hourly Zonal Day Ahead LMP) + (Hourly Metered Energy * Contract Fixed Adder Rate).

If the index contract uses the term “Loss Adjusted Hourly Energy” to mean the applicable Hourly Metered Energy volume for the Account(s) grossed up by the applicable distribution losses as defined by the Utility, be certain that the contract specifies the public source of the loss multipliers. (The old rate-case loss factors from days of regulated utility tariffs have no real meaning in today’s deregulated market.)

“Hourly Metered Energy” shall mean the energy volume for each hour ending period as defined either by the interval meter data, if available, or as calculated from the monthly meter read using the distribution utility load profile for the Account(s). (If your account does not have an interval recording meter, be aware that your energy cost will reflect the load pattern of a typical customer in your rate class – not your specific load pattern.)

The prices do not include Taxes or delivery charges. Taxes will be itemized on the invoice. Delivery charges will be billed separately by the Utility.

What to watch for:

• Make sure your contract defines how you will be billed. Smaller ESCOs, or ones that bill through the utility, seem to be making billing errors and seem to be billing rates that do not track any verifiable rate. The only way to ensure that you are even able to verify your bill calculation is to have a well-defined product in your signed contract.
• Make sure your energy costs and losses are calculated correctly and follow the formulas we describe, above.
• Review your last 12 months of index bills—do the energy charges match the utility tariff? Do energy charges track the day-ahead ISO clearing price?

The bottom line for businesses: Right now review your rationale for choosing an index rate. Wholesale energy prices are low and suggest that if you were ever to consider a fixed or block rate, now is the time. If an index product is right for your business, make sure you take control of the process with these tips.

if you want to discuss this—we can do all of these validations automatically.