Fixed vs. Indexed Electricity Pricing
- June 21, 2018
With a variety of different pricing strategies to be considered, there isn’t a blanket “right” or “wrong” choice when evaluating fixed vs. indexed pricing strategies. The market spectrum for pricing options ranges from fully fixed electricity pricing (with all components locked for the contract term) to fully indexed electricity pricing (with all components passed through at market rates). While there are options that blend elements of fixed and indexed pricing (e.g. hedge energy, pass through capacity), understanding both ends of the spectrum is crucial to identifying which plan will work best for your building and/or portfolio. When making this decision, it is important to consider your company’s budget, tolerance for energy risk, peak load management strategies, and operational plans (e.g. leasing/occupancy expectations, efficiency projects, etc.).
Fixed Electricity Pricing
In a fully fixed electricity pricing plan, the customer is locked into a set price lasting the duration of the contract, which can be long-term (e.g. as long as 3-5 years) or short-term (e.g. as short as 1 month). Regardless of market fluctuations, the price per kilowatt hour stays the same over the term (subject to adjustments due to changes in law, new legislation, or passed through regulatory components). Customers typically choose a fixed pricing plan to provide budget certainty and mitigate the monthly regional price risk (e.g. due to weather, pipeline constraints, generation retirements, etc.). It is especially beneficial in a market where prices are expected to continue rising. However, if the market prices fall during the term of your contract, you remain locked into your higher price and do not benefit from the lower market rates. The risk is buying at the top of the market when prices have been increasing (and you expect them to continue increasing), only to see the market sell off and prices decrease (but you’re stuck paying a higher fixed rate for the rest of your contract term).
Indexed Electricity Pricing
A fully indexed electricity pricing plan is on the opposite end of the spectrum vs. fully fixed. While all components are locked at a fixed rate in a fully fixed price, indexed pricing components are passed through to the customer at the market settlement prices (download Electricity Markets Explained to review the various pricing components in your territory). Depending on the timing and duration, index pricing tends to outperform fixed pricing (on a weighted $/kWh basis), but at the risk of blowing budgets due to pricing volatility (see Polar Vortex 2014 and early 2018) and subjecting the customer to potentially wild swings in pricing month-to-month.
Block and Index
Between both ends of the spectrum is the “block and index” strategy, which combines elements of fixed pricing with index pricing. Fixed price “blocks” (i.e. hedges) are strategically placed during the contract term to hedge against (typically) volatile time periods (e.g. Jan/Feb in the northeast, on-peak hours in the summer in hot climates). Various sized blocks can be structured for on-peak, off-peak, or around-the-clock time frames so you can hedge as much or as little as you’d like. Hedges can also be layered in over time (similar to dollar cost averaging) until you eventually arrive at a 100% fixed price (while reducing the risk associated with single point in time purchasing). Some suppliers offer the ability to place hedges based on percentages of expected load (e.g. 25% of January’s load, rather than a 1.5MW block), also referred to load following block and index, which makes it easier to understand and implement from the client perspective.
While each supplier typically has their own “brand name” for their blended purchasing strategy, usually with market intelligence and recommendations (Engie = EasyFlex, Direct Energy = PowerPortfolio, Calpine = PowerFolio3D, Constellation = Flexible Index Solutions), they’re all essentially the same strategy (with differences in implementation, billing, reporting capability, how certain pricing components are treated, etc.).
Which is the right electricity pricing plan for you?
Unfortunately, there is no textbook formula to decide which electricity pricing plan will best fit your energy procurement needs. Multiple external factors, such as property specific capacity payments and market drivers influence the price you ultimately see on your electricity bill. Often times choosing a blended procurement plan, like the block and index pricing model, can provide the most benefit because it takes advantage of both ends of the market spectrum, but ultimately performance depends on timing, market activity, and your benchmark for performance evaluation (rate $/kWh vs. cost $, performance vs. market or utility default, performance vs. budget, etc.) .
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