LuthINformed- Issue 4, Indexed Price & Hybrid Product…

Published to LuthINformed, Issue 4 (June 3, 2016)

To continue with our discussion of power supply options we will review an indexed price agreement and hybrid product. Furthermore, we will evaluate the risk associated with these options.


Indexed Price…

An Indexed Price agreement is a contract that ties your cost of power to a market index. Such a structure provides some level of risk mitigation since cost components such as capacity and ancillaries are typically fixed. An ESCO in New York can offer an energy price based upon any of these market price mechanisms; the Day Ahead, Hour Ahead and Real Time Markets. For example, the Day Ahead Market discloses on Monday what the electric prices will be for any given hour on Tuesday. Some ESCOs offer an Index product tied to a utility rate as well. One of the advantages of an Index product is that it allows the buyer to float with the current market until a decision can be reached regarding long term trends.

These deals, if structured correctly, should allow you to move into a Fixed Price contract should market prices decline. It is important that you negotiate into your supply contract the ability to convert to a fixed price deal. Obviously, an Index agreement has more risk than a Fixed Price deal because, should market conditions trend upwards, your price increases. The flexibility of getting out of an upward cycle by locking in a fixed price can control this risk.

Hybrid Product…

An increasingly utilized supply option is a Hybrid Product. This structure provides some of the components of both the Fixed and Index contracts. Customers and their energy providers or consultants will identify some level of a base load which can be fixed in the market. The base load is a block of electric power that will always be used by your facility during any given time. Implementing an energy block hedging approach is a proven strategy that mitigates the risks associated with market timing and eliminates the premiums associated with less transparent structures.

By employing this strategy, customers manage price risk by 1) paying a fixed price for a base load “around-the-clock” block and 2) paying hourly market prices for the power consumed above the block. Generally speaking, customers with high load factors fare best under hourly pricing because they use more power during off peak periods when prices are lowest. Energy blocks can be shaped either seasonally or based upon On/Off Peak times to mitigate risk exposure. A block supply strategy produces good results because the buyer gains price transparency and avoids the risk premiums associated with conventional fixed price supply structures.

This strategy also allows an organization to take advantage of downward price trends for that portion of their load that is not on the fixed price. Contractually, the customer should also be able to convert this structure to a fixed price should the market price increases.
Any customer considering either Index or Hybrid supply should insist the ESCO supply a Value At Risk (VAR) analysis that can be developed to show their best/worst case scenarios using historical prices.

More…

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Supply Contracts and Risk…

The assignment and transfer of risk is the basic function of any supply contract. If the energy supplier’s risk is reduced – while your risk increases – the supplier should charge a lower premium. Experience has taught us the myriad ways in which contract language plays a major role in a customers’ final energy cost. Know what your agreement really says..

Next time we will continue or discussion with load factor calculation and demand response programs…


DISCLAIMER

Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

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LuthINformed- Issue 4, Power Supply Options & Fixed Price Supply Agreement

Published to LuthINformed, Issue 4 (June 3, 2016)

This is the last of four issues in which we present a broad overview of power and natural gas markets and deal structures. Going forward, we will delve much deeper into the nuances of the energy issues affecting us all. We hope to provide our readers with guidance and actionable information that will be both valuable and useful. As always, your feedback is welcome…


Power Supply Options…

As you probably know, deregulation has not provided price stability. Many retail energy customers are exposed to market fluctuations. For example, any Con Edison full-service customer with a demand over 500kW is subject to Mandatory Hourly Pricing, or MHP (NYISO Day Ahead hourly pricing). So retail customers seeking price protection, or budget certainty, turn to an Energy Supply Company (ESCO) that can offer some form of “price insurance”. Generally speaking, the less risk, the higher the premium. And while ESCOs typically offer many various supply options, the three most common structures our clients use are Fixed Price, Indexed Price, or a Hybrid of the two.

Supply agreements are initially presented as “boilerplates”, but should be negotiated to meet your specific requirements. Be sure to understand any scenarios under which your supplier may be allowed “pass throughs”, since these will affect your final cost. Also, the more complex the structure, the more “active management’ and monitoring is required. An analysis of your Load Profile and Load Factor (below) is essential to determining the product most likely to minimize risk and maximize savings. Load analysis can also be used to apply your historical, hourly profile to historical index prices to establish a cost baseline and benchmark against future performance.

Fixed Price Supply Agreement…

The simplest, and most common, supply agreement is a Fixed Price contract. In this type of agreement, the customer agrees to a fixed price per KWh for an agreed period of time – typically one to three years. This product best suits a customer with a low tolerance for risk because it places most of the risk on the supplier. It also satisfies an organization’s need for budget certainty. However, most fixed price supply contracts carry a certain level of “load risk” since they typically contain usage bandwidths. These bandwidths can be thought of as “buffer zones” which provide a cushion for unexpected usage variations. For example, if your contract allows suppliers to pass on weather related fluctuations, extremely hot weather may push usage outside the buffer, allowing the supplier to charge market prices for the differential – often at a time when prices are highest. A Fixed Price offers protection from upward price swings – but it will also keep you from fully participating in any downward price movement. The benefit of a sustained downward price trend can be partially realized for Fixed Price contracts through a “Blend and Extend” process.

A Blend and Extend agreement is a contract that most suppliers will offer to their clients. If the market moves lower, after you have already agreed to a higher fixed price, the supplier may extend your contract out another year or two allowing you to take advantage of the lower prices. To accomplish this, the ESCO blends the cheaper future rates with your current rate for a new contract that reflects an overall lower price.

Next time we will continue our discussion of supply options with an Indexed Price agreement and Hybrid Product.


DISCLAIMER

Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.