Energy Rate – Fix It or Float It

You may not know it but you don’t have to lock into your electricity rate, you can choose a variable rate or even a blend of both, depending on how much electricity you consume. The advantages of each pricing strategies really depends on what the market is doing at the moment you make your decision and your appetite for price volatility. Let’s first look at the variable rate to see how that works.

 PJM, the transmission grid operator in Ohio, utilizes a huge algorithm to determine electricity prices every five minutes for a given geographic location. There are hundreds of these locations called pricing nodes in Ohio, each one taking into account the cost to generate power, the cost to move the power and the amount of load demanded by the consumers. The algorithm instantaneously analyzes these inputs and spits out a value for electricity for each pricing node every five minutes. These five minute prices are averaged across the hour to then arrive at the hourly price.

 A variable product offered by suppliers uses these hourly prices as the main pricing component. In addition to the hourly price, the supplier will include an “adder” which is comprised of all the other costs necessary to get the power to you according to the PJM market rules. For billing purposes, the supplier will apply the hourly price to how much you consumed for that given hour. This is done for every hour during the monthly billing cycle to come up with the weighted average price for the month. Rather than showing you all the hourly detail, suppliers will typically just include this weighted average price on your bill.

 So, are there benefits to floating on the hourly electricity rate versus locking in a rate from the supplier? The benefit of a variable product is that it has lower cost premiums from suppliers as they are not taking any price risks in serving your load. They are merely passing through the hourly rates charged by PJM. The downside to a variable rate is that the pricing can be quite volatile and many budgets can’t handle those ups and downs.

 Given where the market is today, what makes sense? Since the crystal balls are all used up for those playing the lottery, we have to use historic data as a proxy for future pricing. Over the past three years the hourly market has averaged $0.038/kWh in Ohio with a high of $0.088/kWh (set during the 2014 polar vortex) and a low of $0.028/kWh. Compare that to the wholesale forward electricity market for the next three years now trading at around $0.038/kWh.

 Since the future wholesale prices are trading at the same price as the historic hourly rates there seems to be little benefit to taking on the price volatility of the hourly market.  The forward market continues to be just a few percentage points above the all-time lows which further indicates that locking in a rate at these prices is likely a good bet.  These markets constantly change so it is prudent to have this type of analysis refreshed prior to making a decision on pricing products for future supply agreements. If you need help at any time please reach out to us via the OMA.