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Unforeseen Electricity Fees and Price Increases Can Be Avoided with Strategic Planning and Management

Recently, several large competitive energy supply companies have decided to pass through additional costs to businesses through a common mechanism in their contract language known as a “change in law” clause. This has left many of our clients wondering where the charges are coming from, why they occurred, and how to prevent an event like this from impacting their budget on the next contract.

Suppliers offer products that have the appearance of a “fully-fixed” price because they include all of the known energy components at their current cost levels. However, nearly all suppliers have contract language that allows them to pass through any new costs or increases to existing costs that are unforeseen at the time the contract was signed. These increases can be the result of legal, regulatory, retail market structure, or wholesale market structure changes.  The mechanism that suppliers rely on in many of these instances is the “change in law” provision.  This provision that is in nearly all supplier contracts, permits suppliers to pass through increased or new charges or costs that they incur as a result of changes in law or governmental regulations.  In many cases, this extends to costs resulting from wholesale or retail market changes, as these are put into effect by either governmental bodies or federally-regulated entities called Regional Transmission Organizations (RTOs).

An RTO’s function (ISO-NE in New England) is to manage the electricity grid, ensure that electric supply meets demand.  They determine the compensation that generators and transmission owners receive to achieve that goal.  This compensation, determined on a per-customer basis, is that customer’s Capacity Cost, and is independent of the charges for the actual electricity commodity and other components of the electricity rate.

In this most recent round of pass throughs, the cost component being passed through to clients has been described as being related to “reserve margin.” Reserve Margin is set by the RTO, but what is it? And why did it change? And what impact did it have?

A client’s Capacity Cost essentially consists of the product of 3 variables. Reserve margin is one of those variables. Here is the simplified formula for Capacity Cost:

 

Capacity Cost = Capacity Tag [A] X Capacity Price [B] X Reserve Margin [C]

Capacity Tag [A]
Is a mechanism designed to assign a ratable share of the total capacity costs associated with each capacity year to every electricity account. This tag is set every summer during the peak hour of the peak day (coincident peak) and goes into effect on June 1st of the following year. That tag will then remain in effect through May 31st of the following year until the next capacity tag takes its place. Each individual capacity tag as well as the aggregate of all the capacity tags is also known as a Peak Load Contribution or PLC.

Capacity Price [B]
This price is a rate set by the RTO (the grid operator—in New England, ISO-NE) at an auction three years in advance of when the rate actually comes into effect. There are some factors that can impact this price up until the capacity commitment period, but historically there is a fair amount of price certainty here.

Reserve Margin [C]
A mechanism that is used to tie up the Capacity Tags to the Capacity Supply Obligation. Since, the Peak Load Contributions can’t be perfectly estimated, the RTO needs to procure a larger amount of capacity that statistically fulfills their reliability criteria. Reserve Margin can be calculated by dividing the Capacity Supply Obligation by the sum of all of the Peak Load Contributions.

Since the Peak Load Contributions can vary year over year, that reserve margin ratio can change. This year, the Capacity Supply Obligation was determined similarly to what it was in past years, but because the Peak Load Contribution was lower than what was projected (due to load curtailment, demand response efforts, efficiency measures, and renewable power) the difference between the peak load contributions and the capacity supply obligation was greater than where it had historically been. This created a larger Reserve Margin.  If the Reserve Margin is larger, all other things being equal, the Capacity Cost will rise. Those costs were passed on to utilities and competitive suppliers.

In contracts signed before the Reserve Margin changed, suppliers could not anticipate the higher Capacity Cost and incorporate it into their rates.  As this is the type of increase covered by the “change in law” provision, many suppliers decided to pass these increases on to their customers using that provision in their contract.  Which means an unexpected increase to a supposedly “fixed” supply rate.

 

Navigating Complex Markets

As electricity markets become more complex, and suppliers seek to ensure that their risks and costs are mitigated, what can our clients do to hedge their risk against unforeseen electricity expenditures?

  • Understand how capacity and its components are becoming the largest drivers of the retail electricity price in the northeast and the risk factors associated with those cost drivers.
  • What price risk tolerance do you have, keeping in mind that “fixed prices” already contain a premium to hedge suppliers’ risks associated with capacity and energy? Would you rather pay the actual costs of capacity (capacity pass-through) and other bill components, avoiding the built-in risk premiums?
  • Can you lower your exposure to capacity cost by reducing your capacity tag? Are there efficiency or other demand reduction strategies that can lower your costs going forward?  Are those strategies compatible with your current supplier contract (or next supplier contract) so that you do not incur charges for material changes in use?

To answer those questions in your situation, contact your Patriot Energy representative. Patriot Energy is not just a typical broker, only focusing on supply contracts, but we manage our clients’ energy spend over time and can work with you so that you can decide what combination of strategies will help you mitigate or avoid unexpected electricity costs.