Contracts - Watch the Fine Print
In retail energy transactions, even minor changes in contract language can mean all the difference in terms of ultimate costs. Suppliers of retail natural gas and electricity earn stark margins and face a great deal of potential risk. Fuel costs are on the rise and expected to continue in that vein. This, plus the prospect of widespread and fundamental change in wholesale and retail power market structure due to the need to create better incentives for timely construction of generation, transmission and pipeline capacity mean it is imperative for both buyers and suppliers to understand what is and is not included in a given contract and to make informed decisions about what is acceptable risk and what is not. Three important elements to be aware of in this context are bandwidth, balancing language and change in law provisions.
Bandwidth - All retail energy suppliers estimate their costs based on historical usage and expect to provide roughly the same amount in the future. If they have to serve more than that, they need to buy the additional amount at current prices. If they serve less, they have to sell the excess into the current market. Thus, suppliers will typically stipulate a 'bandwidth' or percentage of the estimated usage within which they will stick to the contract price. This can be as little as 0% to as much as 100%, with a more common range being 10% to 25%. Typically, the higher the bandwidth, the higher the price premium - but also the higher the protection for the end user. Usage variations for commercial buyers are driven mainly by weather, and a bandwidth of 15% to 25% should offer adequate protection. If a supplier is willing to weather-adjust the bandwidth, then a 10% to 15% bandwidth is adequate protection for most circumstances.
Balancing - Balancing is what happens when a bandwidth is exceeded or not met. Though not commonly invoked except in the most extreme circumstances, the intention of balancing in terms of a retail energy contract is to make the supplier whole for any additional costs or losses they incur. A common way to calculate this is to use the total usage (kWh) in a given month for all accounts at a single delivery point compared to the historical usage year before and to charge the buyer for any energy costs above the assumed costs in their contract price for overages. Underusage is accounted for by multiplying the volume of usage beneath the bandwidth by the difference between the price they realized by liquidating the energy and the original energy costs. This sounds easy, but is actually a complex process open to much interpretation, and is not typically well-defined in most contracts. Electricity and natural gas charges include much more than the commodity, so care must be taken to understand how the other elements are to be treated, with the idea being to make sure that they are included in both the buyer and supplier sides of the calculation. Some suppliers balance using both energy (kWh) and demand (kW). While not unfair, this will tend to result in more variations, more often than with just kWh. Some suppliers are willing to credit back any benefit they get from liquidating energy in higher markets - a good thing.
Change in Law - Issues such as new capacity constructs in New England and PJM, the advent of a nodal market system in Texas and changing attitudes on the part of FERC on how to incentivize infrastructure construction mean there are going to be a slew of changes in the laws and regulations governing energy markets in the coming years. As more and more end users opt to take longer-term positions, the question of how these changes will be handled is important. Suppliers need to be able to adjust for changes in market structure or regulations that change their costs. These adjustments should be 'passed through' to the buyer at no additional cost or mark-up. However, many suppliers use the term 'interpretation' in their list of items that comprise a change in law. Buyers should be sure that only legitimate changes in law or other regulations that have the force of law by a governing body could result in additional costs. Also, if increases can be passed through, credits for lower costs should likewise be given to buyers.
Simplifying Contract Review and Acceptance - With all the complexities noted above, contract review (especially by legal) is more important - and potentially more time-consuming than ever. Adopting standardized contract language is a logical way to help reviewers zero in on the most important aspects of the contract, as well as to streamline the review process so that the delay between auction closure and contract closure is as brief as possible. In February, NAESB introduced the Base Contract for Retail Sale and Purchase of Natural Gas or Electricity (see March Elerts at the top of the page). This standard contract is structured in distinct sections, including basic terms for the contract, a section for special provisions that allows the buyer and seller to negotiate terms specific to their situations and company requirements, and a section that serves as a transaction confirmation, covering actual price, billing, delivery point, and the volume. Assuming that the master terms have been set up front, this standard contract can reduce the transaction time to a matter of an hour or less - saving both time and costs associated with legal review. Most importantly, the accelerated contract closure enables end users to maximize savings by securing the best possible pricing before market conditions change.
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