Matt Brakey, president of energy consulting firm Brakey Energy, wrote a guest column in Crain’s Cleveland Business last week about three energy procurement tactics employed by energy brokerages that he believes amount to little more than “smoke and mirrors.” Below is a summary of Brakey’s opinion on these three tactics. Note this is a single person’s opinion, and customers seeking energy brokerage services may still want to consider these tools.
Under this model, the energy brokerage solicits bids from energy suppliers in an auction format where bids start high and decline as suppliers offer increasingly aggressive prices. Customers typically define how much energy they need to procure.
First, according to Brakey, some suppliers refuse to participate. More importantly, auctions only differentiate suppliers based on price, which he likens to a buying a house with no consideration whatsoever of the condition of the house. “Contract terms, counterparty risk, customer service, and past business dealings” are also very important factors as well.
A 2013 blog post on The Megawatt Hour notes there is no evidence of the benefit of these auctions. Furthermore, participants pay for the auction service through an adder of 0.5 to 1.0 percent of supply costs.
Heat Rate Products
Under this contract format, customers sign contracts with suppliers based on the operational efficiency or “heat rate” of a power plant. This is a form of variable rate product that links retail prices to wholesale natural gas costs rather than electricity costs, as Amerex Energy Services explains. Brakey points out that natural gas prices are already highly correlated with electricity in competitive electricity markets, and therefore linking prices to natural gas is somewhat of a gimmick.
Having said that, the correlation is not perfect. Indexing to natural gas prices can eliminate risk tied to other components of generation costs, such as capacity cost.
A “not-to-exceed” or “protected-price-point” contract is sort of a hybrid between a fixed and variable-rate contract. Under this type of arrangement, a broker offers a customer a fixed maximum price for energy. Brakey says the price is usually well above the current market level and therefore offers little protection to the company buying the energy. However, the contract obligates the buyer to use the broker again for its next supply contract.
The broker will buy a call option in the futures market to hedge against rising electricity prices, and the broker agreement includes a premium to pay for both the call option and the broker’s profit margin. If the market price falls, the buyer still pays a price that is below the price ceiling, but also pays for the cost of the call option and the broker’s margin.
Basically, if prices rise, the buyer still pays a higher price for energy—though the deal should protect against extreme increases. If prices fall, the buyer takes advantage of lower pricing, but pays more than under a traditional variable-price contract due to the cost of the call option and broker fee. Either way, the broker benefits, and the customer pays the transaction costs. Although the column does not state this explicitly, the logical conclusion is that customers should either choose a fixed-rate contract to protect against price increases or a variable-rate contract to benefit from falling prices, but not to pay for both.