Fixed Price versus Variable Price Energy Supply Contracts

When purchasing energy, there is a price/risk continuum between fixed price contracts and variable price contracts.

Fixed price contracts allow you to minimize your exposure to price risk by transferring this risk to a supplier.

With a variable price contract, you are accepting the risk associated with changes in the market price of electricity. This is not an insignificant risk as electricity prices are highly volatile. And, electricity price risk is asymmetric, meaning there is much greater potential for upward movement than there is for downward movement (prices are bound by zero on the downside but are not bound on the upside). With variable price contracts, suppliers transfer electricity price risk to you. In exchange, pricing to you should be at a discount.

Most variable price contracts will base changes in the contractprice to changes in an index. Here in the Mid-Atlantic, the grid operator, PJM, tracks hourly prices by zone. These hourly prices are referred to as “LMP” which stands for “locational marginal price.” These LMP prices are a transparent index, meaning PJM makes them available.

Most suppliers who sell variable price contracts will price them as “LMP plus a fixed adder” and they will tell you their “adder”. LMP is passed through to you dollar-for-dollar and the “adder” is their margin on top of LMP. With the same LMP as a basis, you can then compare what “adders” different suppliers are offering. This approach is transparent.

Some suppliers who sell variable price contracts base their prices on indices that are proprietary and vague. There is no place you can go to see the index. Further, they often don’t disclose what their margin is on top of the index and they don’t commit to keeping the margin fixed. This allows them great flexibility in what they charge you each month. You are left vulnerable and there are no checks and balances.

If your are currently purchasing from a suppler under a variable price contract that does not have a transparent index and does not have a fixed “adder” we recommend that you review your contract and examine all of the suppliers monthly invoices to see if you have been getting the benefit of an “index” product.

Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us

Copyright 2010 by Avalon Energy Services, LLC.