What is Index Pricing? Is it worth considering?

When most companies contract their electricity, they obtain fixed price contracts to hedge or protect their business from price fluctuations. In essence, they are paying a small premium for price insurance, providing the guarantee that their electricity price will not increase for the entire term of their contract.

But some companies are OK with some risk.  They believe that the energy markets are not likely to increase in price over the near term.  If this is what you believe, you might want to consider a variable or index priced electricity contract.  Your price will change month-to-month, but you will be buying exactly what the market charges.  This post is intended to educate you on a what can be a confusing subject.  Customers of some suppliers of index products might have been mislead by their sales people.  Our goal is to make sure that every customer understands exactly what their options are.

An Index Price Contract is based on the LMP (Locational Marginal Pricing) Index price, which is readily available by viewing the Independent System Operator (ISO) websites.  This is the wholesale price of electricity which changes every fifteen minutes.  Your price for the month will be based on how much electricity you use during every fifteen minute period of every day, times the LMP price for that fifteen minute period.

typical_load_profile

The process may seem complicated at first, but it starts with your Rate Code.  Your Rate Code tells the supplier what your Load Profile looks like.  A Load Profile defines how a customer uses its electricity every hour of the day and every day of the week for 365 days in the year.  Most businesses have the majority of their electricity usage between 8AM and 6PM.  Their weekend and night usage is typically lower.  So their load profile defines this.  A manufacturer running three shifts would have a very different load profile.

Your company may have an Interval Meter, which records your electricity in fifteen minute increments.  This data is used to create your Load Profile.  Most smaller users, with under 1,000,000 kWH/year of usage do not have an Interval Meter, so their load profile is defined as the average for all users in their Rate Code category.

Why is the Load Profile important?  Because with Index Pricing, you will be charged based on the LMP price for every fifteen minute period.
Hourly-LMP-Graph

 

 

This graph on the right shows you what the Real-Time LMP price is, for this particular day in the ISO-NE zone.  The price you pay will be based on this information,

Now to an example:

  1. Assume you use 100,000 kWH in a given month.
  2. Your load profile can be used to determine how many kWH you use every fifteen minutes.
  3. Your kWH usage for that fifteen minute period is multiplied by the LMP price.
  4. A total for all the fifteen minute periods is added up.
  5. Finally, the ancillary charges are calculated and added to the bill.

Index Pricing has risk.  You will experience months with very low price, while other months will have very high prices.  On average, for a one-year period, you will likely save money.  But you must have the emotional comfort to understand that prices could fluctuate widely from month to month.  For this reason, Index Pricing is not usually for the small business customer, unless they really understand how it works.

For large electricity users, a Block and Index contract gives them the best of both worlds: you obtain a fixed price for a specified block of kWH usage and then pay the floating index price for the remainder.  This allows you to limit your risk exposure to rising prices (the block price) while benefiting from possible drops in prices with the index.

Finally, the chart below shows the Real-Time LMP price in MWH.  You divide the number by 1000 to calculate the per kWH price, before adding ancillary fees, which will add roughly $0.02 to the kWH price.  Please contact us if you would like to learn more about electricity and gas pricing option.

FIve-Minute-Real-Time-LMP

Making Sense of the Present Electricity Market

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  • Regional issues are ruling the day, when it comes to understanding today’s electricity market– gas & power correlations remain critical, but we continue to see increased frequency of separation.  There are fundamental factors that are behind this trend:
    • Northeast basis – too much info on this to put in this blog posting, but the short-story is that the region is short gas pipeline capacity and this year’s cold temps and pipeline constraints have caused huge gas spikes to New England (several days in $20-30 range) and to a less extent New York Zone 6 (>$20).  Day-ahead power has moved with gas with some spikes near $200/MWh. This is impacting long-term prices.  Unfortunately, the pipeline constraints are unlikely to be resolved in the near-term.
    • ERCOT Resource Adequacy – this issue is also not going away as ERCOT is expected to remain below is target for reserve margins and the increased offer caps are not expected to resolve the problem.  So do not expect summer premiums to disappear and there will be ongoing discussion on solutions to the problem.  Regulatory news and summer price spikes will both impact forwards.
    • PJM Capacity –the wholesale energy prices in the market remain low, but capacity prices vary greatly within the ISO – rising for most of the West and falling for the East over the next 2 years with certain areaa having exceptional spikes (ATSI).  Note that we have updated capacity charts that clearly illustrate this trend.
    • California Cap & Trade & SONGS outage- ongoing strength in forwards as Cap & Trade has been implemented and there is still tremendous uncertainty regarding SONGS, which has been shut down for almost one year.
  • Customer message:  The overall message is straightforward, but may be difficult for customers to accept since many have had consistent year-over-year price declines since the peak of 2008.
    • Year-over-year declines in gas have stopped with 2012 likely being the bottom.
    • Rangebound gas behavior for the near-term with modestly higher prices possible for 2014.
      • It makes sense that natural gas futures are higher than a year ago, but below long-term averages.  And we expect this to continue.  So don’t count on another spring dip – it is very unlikely to see a repeat of April 2012.
    • Both upside and downside are limited by coal-to-gas, production economics, storage, etc.
    • Regional fundamentals are causing significant regional risks that must be considered.  If you only focus on natural gas, you are exposed to significant regional risks such as New England winter spikes and ERCOT summer spikes.
  • Regional issues may provide a better rationale for customers to contract their electricity now.