Energy cost management: How different can supplier contracts be? What can those differences cost my business?

This is the third article in a series in which we discuss how to evaluate the major differences between suppliers when you make an energy purchase. It is noteworthy that we have observed meaningful (+/-10%) differences between supplier prices on any given day, so these differences are well worth understanding.

In this article, we will review the key contract language that you need to understand to ensure that your suppliers are providing you with what we are calling an “apples-to-apples” offer. We are using electricity products as an example, although most of these same terms and conditions can impact gas contracts as well. In this article, we will highlight the contract language, describe the intention of that language, its potential impact on you, the customer, and explain the best outcome for you.

Make sure that all supplier products are apples-to-apples comparisons

Product definition. If you are unclear as to what an electricity product is, take a look at this article titled “Energy Cost Management: What is a product?”

The first place to look for a difference between suppliers is to review the product definition. The supplier will have a clause that defines the product and explains what is included in the price that they provide you. If you’re buying a fixed price product, you are paying a premium for your supplier to take on all cost risk. Make sure that the contract that you sign includes a product definition that specifies all the risk that you expect the supplier to take on for the full duration of the contract. In other words, if you are buying a fixed price contract make sure that the product is defined as follows:

The Contract Fixed Electricity Price includes all components of electricity cost including energy, capacity, and ancillary services (for an understanding of these components, see the Resources section of The Megawatt Hour website, here). The Contract Fixed Electricity Price also includes transmission and distribution losses, supplier margin and all risk premiums for providing a fixed rate. Fixed prices are generally quoted exclusive of gross receipts and sales taxes, which will be added on to your invoice separately. Delivery charges are not included in the Contract Fixed Electricity Price.

Some suppliers will only fix certain components of your costs for part of the contract term, but may not bring that to your attention when quoting prices. Make sure you read the language carefully and ask the following simple question: Is the supplier fixing all components of costs that I want them to fix for the entire term of the contract? If one supplier decides to pass through distribution losses, for example, then make sure that all suppliers are doing so.

Here is an example of how this might impact you. The capacity charge component of your costs (see the definition of capacity here) changes each year in New York State in the Spring. Some suppliers will pass on changes in capacity to customers if the capacity tag changes during the term of the contract. Other suppliers will accept the risk of any capacity changes (although they will likely price that risk in to your contract).

If you are comfortable taking some price risk, and it results in a lower contract cost, be aware of it. And, if you care to, negotiate ask that the supplier pass along any reductions in capacity tag to you. If they have the right to pass along cost increases, then you should receive any benefits from lower capacity tags. This concession may be difficult to negotiate (because the supplier has paid for capacity up to a year in advance), but you should be able to get some concession since capacity tags are published before the supplier has to commit to a purchase. If you want to discuss this detail further, contact us. 

What cost impact might this kind of supplier product difference have on my quoted price? The answer is, it depends on which product cost component is being fixed and for what period of time. We have observed that some suppliers will pass through any change in capacity costs after the first year; others will promise to provide you a fixed price at a given rate no matter how your capacity tag changes next year. What you care most about is that all suppliers are managing this risk more or less the same way. While it is not entirely clear how different suppliers manage the risk of changing capacity tags, we have seen pricing differences of $0.001/kWh to $0.003/kWh depending on how a supplier handles capacity risk.

Non-product costs—taxes, add-on costs (like New York’s Clean Energy Standard). Make sure that all suppliers are treating add-on, non-product costs, the same way. Either all the suppliers are passing through the same costs or they are all fixing the same costs, but make sure they’re treating these add-ons the same way. Why? Because if one supplier is passing through the Clean Energy Standard and another supplier is fixing that cost, you won’t be able to compare the pricing accurately.

Here are all the component costs that we recommend you take as a pass through:

Line losses. What are line losses? The electric distribution system requires retail suppliers to purchase a bit more power in the wholesale market than the power measured at your meter. These losses are fairly small (2% to 10%) but can be quite volatile since they are dependent on hour-to-hour load and temperature. The retail supplier must estimate and incorporate the distribution loss factor in to their cost calculations, or agree to pass them through to you as they are charged to the supplier.

Renewable energy standard or, in the case of New York State, the Clean Energy Standard. In general, we recommend that customers ask for these charges as a pass through. They should be transparent costs that are basically the same for every customer. (In other words, there is no magic to setting a price for these costs.) Also, in the case of NY’s Clean Energy Standard, there may be legal challenges to this program, so you do not want to commit to a set price for any future period because the costs may get adjusted, and the implementation schedule may change. In short, there is uncertainty related to these costs.

Taxes. There is no way for a supplier to assist you in managing taxes on energy, so they should pass through these costs transparently.

Bandwidth or Change in Usage– When a supplier quotes a customer a full requirements fixed price, they typically have to account for any major change in usage. If actual usage is more than a certain percentage above or below the supplier forecast (based on your business’ historical usage), then the supplier typically has the ability to recoup the costs that the supplier has incurred to provide you with that supply. This clause is standard in the industry. The so-called industry-standard “bandwidth” has typically been +/- 10% although that has changed recently, with some suppliers offering 100% bandwidth. You should be aware of the bandwidth that the supplier has used for pricing purposes. Big differences in bandwidth from supplier to supplier should show up in the price that is quoted to you. Suppliers who will take on more of the risk of future usage variances deserve to get paid to take that on risk. You should see those differences in the prices quoted to you.

Change in Law/ Government Regulation – This clause is meant to allow suppliers to pass along unforeseen costs to you, the customer, when regulators impose those costs on suppliers. Supplier margins are thin (usually $0.001-$0.003/kWh in the case of electricity). This clause states that any new regulation that impacts supplier costs and arises while a customer is under contract can be passed through to a customer. This is meant to protect a supplier from losing money on a customer contract thanks to regulatory changes.

Check to see if all supplier contracts contain this clause and that regulatory changes are clearly defined. If the supplier does not include a regulatory change or change in law clause, then the supplier will not have the right to pass new costs on to you. If the contract does include this clause, then make sure that the supplier has the obligation in the contract to notify you of the change, allows you to accept the change (and understand its impact on you), and that the supplier provides you with clear, explicit information on your invoice that shows this new charge.

Bottom line for energy buyers and finance professionals. Make sure that the prices quoted to you can easily be compared between and across suppliers. All charges that are fixed should be fixed and included in all product quotes from all suppliers. Anything that is outside the supplier’s control (taxes, renewable energy standards, etc.) should not be fixed— if the supplier can’t help you manage that risk, then you should not be paying them to accept that risk.