Why Today's Energy Supply Contracts Carry More Risk
This article is a revised excerpt from our whitepaper, Finding the Risk Hidden in Your Energy Contract: 10 Terms & Conditions You Need to Know.
In the past decade or so, a number of developments in the energy industry have introduced more risk to the energy market.
Ten years ago, energy price components were predictable and stable, or at least manageable through financial instruments. As a result, retail suppliers offered "fixed for floating trades," taking on wholesale market risk in exchange for a premium.
In that agreement, a retail supplier’s ability to stand behind a fixed-price contract hinged on its ability to manage the hedge through risk management and market insight.
However, thanks to a number of changes in the industry, that reality has changed. Here is an overview of the key developments that have driven up risk in the energy market—risk that suppliers often pass onto their customers through manipulation of the terms and conditions in their contracts.
Increased Competition Leads to Smaller Margins for Suppliers
A significant rise in the number of competitive retail suppliers, coupled with a growing broker and consultant market share, has driven down supplier margins considerably. In the last five years alone, the number of retail suppliers and brokers/consultants has grown more than 50% in most markets.
With smaller margins available to protect their hedges, suppliers generally self-insure their positions through conditional premiums, or they manage them through various “contract-outs” in the terms and conditions of their customer agreements.
Market and Regulatory Changes Lead to Higher Costs for Suppliers
As the retail supply market tightened, rapid and significant changes to the energy generation mix, transmission, and distribution networks gave rise to a growing assortment of new cost components: transmission and capacity charges, renewable portfolio standards, balancing charges, and ancillaries.
While some changes may support commodity prices, and others may depress them, they all cost money for energy providers, which ultimately leads to an increasing collection of pass-through charges in your energy supply contract. For many customers, pass-through charges actually outweigh the energy prices themselves.
The rise in the amount and complexity of pass-through costs has been driven by a variety of factors, including:
- Technology advancements: The rapid growth of distributed energy resources (DERs) like combined heat and power (CHP), on-site solar photovoltaics (PV), and behind-the-meter energy storage is forcing utilities to adapt to a more decentralized system. The emerging multi-directional network is a fundamental shift in transmission and delivery structure, and it creates new costs for grid operators.
- Regulatory pressure: The emergence of climate-focused regulations and incentive programs have helped intermittent renewable sources like wind and solar earn a significant share in the generation mix. This intermittency requires operators to make additional investment in grid stability and reliability, which they recoup through new balancing and capacity charges passed through to customers. State-level regulations further add to new costs on end-user supply contracts through renewable portfolio standards.
- Infrastructure needs: According to the US Energy Information Administration (EIA), nearly 70% of the United States’ transmission lines and power transformers are 25 years old or more. This aging infrastructure requires expensive updates and maintenance. In addition, integrating power from renewable generation located far from urban demand centers requires investment in new long-distance, high-voltage direct current transmission lines.
As a result of these developments, today’s energy contracts contain more risk. For large energy users, then, the questions at hand are who’s wearing that risk, and at what cost?
Our new whitepaper, Finding the Risk Hidden in Your Energy Contract: 10 Terms & Conditions You Need to Know, explains how suppliers use 10 common terms and conditions to shift the burden of this risk onto customers, and how energy users can exert leverage and negotiate their contracts during the energy procurement process.