16 Dec Debunking the Myths About Long-Term Fixed Pricing of Power
By Jack Doueck
Debunking Myth #1: Long-Term Fixed Pricing is the Lowest Cost Option
Over the last few years in de-regulated states, there has a been a widespread notion that long-term fixed pricing is the best path to the lowest cost for electricity. This is especially true among large commercial customers and real estate owners across the country.
A slew of recent studies, however, have shown that over the past six years, fixed pricing was more expensive than index (variable) pricing in virtually every market. Let me say that again: Whenever you fixed the rate since 2014, (any day or month you chose to do this), for 12 months or more, you paid more for power over the next twelve months than had you simply rode the index for real time energy. This analysis includes some of the most volatile power markets in recent memory – and, still, floating was cheaper than fixing for 12 months or more.
The chart below compares the forward 12-month fixed block price for energy in New York City for a given month versus the average index real time energy cost for the same period. Overall, long-term fixed pricing has been on average, 33% more expensive than index.
Looking at the actual monthly (index) energy costs in New York City Zone J since January 2014, the average year of year change in energy prices in the summer months was -1%, the average for the winter months was -11% and the average for the shoulder months was -12%. The results are the same. Pretty much any time a customer bought a fixed block of power since January 2014 – they overpaid.
The absolute optimal time to buy a 12-month fixed price block was December 2013, just before the January 2014 polar vortex. However, even with that superb hindsight vision and perfect timing, the savings for that period over the index was only 2%.
The reality is that electricity rates have been on the decline since about 2008 in virtually all markets. And the trend is continuing. In the PSEG territory, the average first quarter 2021 rate is lower than any rate since 2015. It is the same in New York.
If one tracks this trend over the last few years, he will notice that there has seemingly never been a ‘bad time’ to lock in rates! When rates increase, customers are told that rates are rising and will continue to rise, so they should “lock in now before it gets worse!” When rates decline, customers are advised to “lock in now at historic lows.” “This may be the bottom”, they say, “so lock in now” before rates start to rise!” Despite the reality of prices, the obvious conflict of interest from energy brokers pitching long-term fixed pricing suggests why customers have been so hard pressed to adopt it.
Debunking Myth #2: Long -Term Fixed Pricing Gives us “Budget Certainty”
The second, and more persistent, myth is that long-term fixed pricing provides “Budget Certainty.”
Why don’t long-term fixed rates provide the coveted ‘budget certainty’?
First, approximately half the electricity cost of a building is made up of “T&D” (Transmission and Distribution) charges that are billed by the local utility, and they are always variable. Second, as we have seen the hard way in 2020, the actual usage or load varies based on occupancy. So, two out of three variables are never fixed. Even if customers have a fixed rate for supply, when the T&D charges go up or down, and when the actual usage changes, their budgets are anything but ‘certain’.
Any effective energy consultant can assist with budgeting and forecasting (using forward curves and historical usage) even if the rate for supply is variable.
Perhaps what customers really mean when they say they want ‘budget certainty’ is price spike protection. This can easier be achieved with a more effective procurement strategy that we will discuss below.
Debunking Myth #3: Long-Term Fixed Pricing Provides a True Apples-to-Apples Cost Comparison
Essential to every customer’s long-term fixed price evaluation is the creation of a ‘beauty contest’ (a reverse auction) so that an ‘apples-to-apples’ comparison between vendors can be made to find the lowest cost. Customers are presented with this comparison and assured that this is the only way to obtain the lowest cost.
However, is that true?
No. The ‘beauty contest’ approach followed by long-term fixed pricing does not generate the guaranteed lowest cost.
Why? First, because four or five bids in an RFP does not properly represent the hundreds of choices. Second, an RFP is an arbitrary snapshot in time and not a true cost comparison. (An RFP done on Monday will miss a rate reduction on Tuesday). Third, Long-term fixed rates are not ‘risk-free’. Long-term fixed pricing comes with a lock-up and onerous ETFs. Fourth, with long-term fixed pricing, changes in energy demand, capacity or “ICAP tags” cannot benefit the building because the price may have been fixed at a (falsely) higher capacity cost. Finally, long-term fixed pricing bring customer expectations that costs wont increase, but energy suppliers will charge the customer more than the fixed rate if anything changes such as the ICAP tag or any other regulatory charge (ZECS, TOTS, RPS etc).
Unfortunately, long-term fixed pricing always benefits energy companies without always benefitting customers.
Debunking Myth #4: All the Big Landlords Buy Long-Term Fixed Price
Surprisingly, although, based on the previous points, not surprisingly at all, more and more of the biggest names in commercial real estate have not procured via long-term fixed price contracts since they were burned by it (any year since 2008).
Which energy procurement strategy do they use? One that avoids the pitfalls of long-term fixed pricing.
It is called “Block and Index”. The commercial customer buys short-term fixed priced blocks of power specifically and only for the months with historical price risk thereby protecting from spikes only for those specific months in which the building has price-spike risk. (This is usually the peak of summer and winter). The rest of the year the building obtains the true lowest cost by buying in the day-ahead wholesale market – in other words, variable index pricing. With Block and Index strategy, customers can obtain the true lowest cost, because the procurement strategy itself resembles buying energy with scalpel instead of a sledgehammer – a much more effective pricing strategy is the result.
We have numerous case studies of large C&I assets that used the Block and Index procurement strategy over the last few years. It accomplishes everything that customers want: It protects against rate increases; it buys power at the cheapest price during the shoulder months, and it is just as easy to budget for.
These customers request that energy suppliers submit bids for a Block and Index strategy and to bid transparently on the gross margin, or the ‘adder’. Then, to see if they really saved money, customers may retroactively compare the actual cost incurred to what the local utility would have charged. That is the only true apples-to-apples comparison, and the only way to evaluate if buying from an energy supplier has actually saved them any money.
We are aware of more than one billion square feet of commercial real estate that utilize an effective Block and Index procurement strategy.
For long-term fixed pricing, touted as the ideal way to reduce cost, the disadvantages to this outdated strategy outweigh any seeming benefit. Long-term fixed pricing does not produce the lowest cost. It does not provide customers with ‘budget certainty’. The ‘apples-to-apples’ comparison is prejudiced and fraught with risks. Thankfully, many if not most large commercial landlords are realizing the fallacies of the methodology and moving to a more intelligent process. With a Block and Index strategy and full wholesale cost transparency, customers are finally able to achieve their goals for reduced cost, protection from price spikes and onerous ETFs. These large, successful commercial real estate companies buy energy with scalpel instead of a sledgehammer.
Jack Doueck is a Founder and Principal of Advanced Energy Capital, as well as Energy Marketing Conferences and LED Plus. He can be reached at JD@AdvancedEnergyCap.com.