Understanding Your Energy Contract When Faced with the Unexpected
As we all navigate personal and business impacts with the COVID-19 pandemic, it can be difficult to think about anything else. For those whose job it is to focus on energy, layering on this “new” world of social distancing, business shutdowns and overall economic adversity has added more uncertainty and challenges that likely require a heightened level of energy management evaluation and navigation.
Here’s the good news: We have faced uncertain times before and have a number of lessons learned that we can leverage. In 2008, we experienced an energy bubble resulting in extremely high natural gas and power prices followed by the financial credit crisis, which led to a number of failed businesses and industries. During the 2014 polar vortex, we saw a winter period of abnormally elevated demand for energy across the country and resulting in extremely high prices.
Both circumstances highlighted the importance of evaluating your energy supplier on its merits, including financial strength, risk-management expertise and favorable customer policies. The 2020 pandemic brings us lower electric demand in the commercial and industrial sector and related uncertainty about when businesses will be able to resume normal operations, an unprecedented drop in oil prices, and an oil and natural gas production industry fighting for survival.
What should customers understand about the impacts on power suppliers who serve customers with a fixed-price, full requirements contract?
First, most commercial and industrial customer usage is down, which has implications on a number of supply charges.
Suppliers typically calculate a fixed price for a customer’s full requirements contract using some expectation or forecast of the customer’s use. If the actual use deviates from this forecast, the cost to supply that customer may increase (or decrease). In the current economic environment, energy suppliers may be faced with excess supply in a low-priced market, impacting the suppliers’ bottom line.
Secondly, fixed prices are usually a combination of use-based and demand-based pricing components. When suppliers sell less, they may also struggle to recover the fixed costs associated with demand-based components.
In many power markets, a fully-fixed energy price includes capacity and/or transmission costs that are based on a customer’s peak demand (i.e., demand-based costs). While usage measures the amount a customer consumes, peak demand is a measurement of consumption when usage is at its highest; this measure is used to calculate the cost for reliable energy supply.
These demand-based costs are essentially fixed costs (for a period) that are then unitized to a $/kWh price by a supplier for a fully-fixed price contract. If a customer’s actual use is less than expectations (e.g., if the customer uses fewer kilowatt hours), then the supplier may not recover all of the demand-based charges. As an example, $100 over 100 units = $1/unit, but if a customer uses 75 units rather than the expected 100 units, then the supplier will only collect $75 toward a $100 bill for the demand-based costs.
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Successful suppliers manage usage variations and demand costs through advanced analytics and appropriately assessed risk premiums. In some cases, suppliers pass through risks and costs associated with usage deviations to customers as allowed by material change clauses or usage bandwidth restrictions in their customer agreements. There can be a correlation between lower risk premiums and thereby lower fixed prices and an increase in the use of contractual provisions, like material change or bandwidth restrictions, that allow the pass-through of associated costs.
It’s important for customers to understand who bears the risk of usage variations and how it’s accounted for in their contract.
Understanding Material Change & Bandwidth Provisions
Material Change Provision
Does your fixed price contract include a material change (aka material adverse change or ‘MAC’) provision? If so, it likely allows the supplier to pass through costs associated with a material change in use. It’s important to understand what a supplier defines as “material change;” for example, it may be something similar to usage changes ‘in excess of 25% of historical monthly use for two or more successive months’ or it could be defined differently, or not at all. Review your contract to become familiar with any applicable material change clause.
If your fixed price contract includes a bandwidth provision, it’s important to understand that your contract likely includes a pre-determined contracted “band” around a stated use, outside of which additional costs may be incurred. Generally, the stated use is consistent with the customer’s historical use, but that is a data point that should be reviewed and understood. Often the band is wide enough to cover ordinary weather variations (for example, no additional costs incurred as long as usage is within 10% of historical monthly volumes).
With widespread reduction in energy consumption, it’s increasingly important for customers to review their contract terms to understand if/how they might be impacted as a result of usage changes.
These observations are not intended to be legal advice. Constellation recommends that end-users seek legal counsel to understand their agreements fully. It is also Constellation’s desire to empower customers to make good energy decisions. In that spirit, Constellation encourages all end users to read their contracts thoroughly to understand the implications of a material change provision and/or a bandwidth provision, and to ask questions about their applicability. Learn more from our previous blog about reading and reviewing your energy contract like a professional Learn more about reading and reviewing your energy contract like a professional.
The goal of Constellation’s business model is to ensure long-term stability and withstand the effects of short-term economic volatility.
- We are committed to being a leading supplier of energy and energy services for the long run.
- We will continue to offer a suite of products to help customers meet various budgetary and risk management needs.
- We will continue to provide clear and understandable terms with contracts that are transparent and empower you to manage your energy budget.
Get in touch with your Constellation sales representative if you have any questions. Learn more about Constellation’s fixed natural gas solution and more about Constellation’s fixed electricity solution.