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It pays to pass-through – why not fixing every energy component could benefit you

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The more energy you manage, the more complex it is. In this ever-changing economic environment, it’s important to reconsider conventional energy buying wisdom and reevaluate your energy procurement options. 

The price for a tank of gas includes more than the fuel – it also includes taxes and costs to refine and transport the fuel. Energy costs are similar with supply and non-supply costs that vary over time. Supply used to be 70 percent or more of your energy bill; today, it might only account for 50 percent of your bill. The other half includes demand components and mandatory fees. These non-commodity costs can be up to 55 percent  of the bill. However, many businesses don’t pay attention to these charges and miss a major opportunity to lower total costs. 
 
Savvy business leaders need visibility into and control over their energy spending. To choose the best electricity offer, it’s essential to understand the line items that constitute your price. 

Electricity rates include these cost components.

Supply Components

  • Energy: The cost of the commodity itself. This is usually calculated by a supplier as the cost to purchase the amount of power you need in the wholesale market for the specific length of time (term or delivery period) you are seeking.
  • Losses: Charges covering the electricity lost between the point of generation and delivery to your organization. 
  • Ancillaries: Charges for the services that support and maintain reliable operation of the electric grid.
  • Renewable Portfolio Standards (RPS): If your state mandates participation in a renewable energy program, your supplier is required to procure a portion of your power from renewable sources.

Demand Components

  • Capacity: These charges are based on your energy use on peak demand days. This utility fee ensures that the amount of energy you need from the grid will be there when you need it. And for many businesses, capacity costs can account for 25 percent or more of the monthly bill. It’s often the highest single line item on your bill following the cost of the actual power supply. 
  • Transmission: The cost to transport electricity from the generating station to your local distribution company. It can be billed by either your supplier or your local utility, depending on your state and the type of solution.
  • Reliability-Must-Run (RMR): Cost for system-wide reliability shared by all market participants.

 

How to compare electricity rates.  

Choosing the lowest rate on paper doesn’t always mean paying less in the long run. When pieces of the price vary, it’s difficult to make a true rate comparison. By understanding the various costs within your rate, you can better determine when to pass components through instead of fixing them.

 

What’s the difference between fixed and pass-through solutions?

Characteristics of more fixed solutions Characteristics of more pass-through solutions
A fixed rate solution contains all of the above components wrapped into one rate – your price. For a fixed contract, all elements are set for the length of the contract term.

Maximum price protection
A fixed rate includes a premium to cover cost components that may vary over the duration of your service. This premium protects a supplier, who must estimate all the changing cost components to deliver a standard rate for your desired term.

Usually businesses with less risk tolerance choose a fixed solution — even if it means paying a higher rate to do so.
A pass-through solution includes both fixed rate components and pass-through charges. These demand charges are floating costs based on the energy market.

Savings opportunities
A pass-through solution provides tools for managing usage patterns to save money. It ensures you pay for your direct charges at a market cost and no premiums are added. If market costs fall, you can lower your total energy spend to benefit your business.

A rate that does not include every supply and demand charge will be lower. Sometimes this can be good if your business can benefit from certain components being passed through at cost each month.

 

On the surface, a fixed price means that you’ll pay the same rate for electricity each month. But it may be harder to discern what that fixed rate includes.

In some cases, non-supply components may be included as part of the price. Essentially, the supplier estimates the cost of these changing components and provides you with an all-inclusive fixed price for your term. The problem with this solution for many large businesses, is that they forfeit the opportunity to manage these costs and benefit from year-over-year savings. 

Why consider a combination procurement strategy?

Traditionally, and somewhat intuitively, a fixed rate solution might be the logical choice for navigating economic instability. Fixed rate options are easy to understand and plan a budget around. However, while fixed rates present price certainty to customers, market developments and the impacts of COVID-19 are making many businesses rethink their energy approach. 

Over the last decade, transmission and capacity costs have increased due to failing energy infrastructure and increasing demand. This means it costs more to transport and store electricity, and utilities are investing billions of dollars to improve the grid. Such costs for electricity grid improvements are usually passed on to customers. Not surprisingly, energy consumers have seen their non-supply fees surge in response. 

 

Major components of the U.S. average price of electricity, 2019

Electricity Pricing Components
The COVID-19 pandemic further exacerbates existing issues, especially capacity costs. According to the International Energy Agency (IEA), energy demand will never be the same. Based on 100 days of research, the IEA found that global energy demand has plummeted six percent during the COVID-19 pandemic, which is five times larger than the decline during the 2008 financial crisis. Looking ahead, the IEA forecasts that U.S. energy demand will drop by nine percent in 2020.

Under current market conditions, the central issue with all-in-fixed rate solutions is that they include transmission and capacity costs that are based on historical usage from the previous year. COVID-19 and other market developments have turned past forecasts on their head, and future load is now uncertain. Since these costs are often unitized and based on past usage, some customers in certain markets may be locked into paying more than their fair share of system costs. 

Your organization could pay less for electricity and create long term savings with a combination pass-through solution. Then you can maximize the value of market costs by balancing risk and opportunity. We recommend starting to build your pass-through strategy with capacity because it represents approximately 25 percent of your total cost, or more, depending on your market. 

Ultimately, there is no “one-size-fits-all” energy strategy and flexibility is paramount. Our energy experts can partner with you to compare the cost implications of all pass-through components based on your needs. We’re committed to finding the right solution for your business, whether it is a fixed rate, market-based rate or a strategic combination of both

 

Posted: August 12, 2020

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