Choosing an Electric Supplier: A Primer

Eighteen states have opted for electric utility deregulation, induding most of the states in the northeast from Virginia to Maine, and all of the mid-Atlantic.

Reasons for doing so are multifaceted, but range from lowering rates to, in the case of Maryland, not wanting to be surrounded by Pennsylvania, Delaware and Virginia, which have all deregulated. States refusing to dereg­ulate would thus be at a competitive disad­vantage when competing for businesses relo­cating in the mid-Atlantic region.

Although many states enacted deregulation several years ago because of market conditions and transitional charges, customer choice is only now becoming a reality. With choice, however, comes both complications and po­tential benefits, which must be viewed against a backdrop of rapidly escalating energy costs. As with any open market, there will be win­ners and losers, and the winners will be those who best understand the game and its rules. Although in-house counsel frequently review and negotiate contracts, electric contracts pose several unique issues. Understanding those is­sues in advance could make the difference be-. tween a successful transaction and one that will haunt the company for some time to come.

Deregulation History

Electric deregulation grew out of the recog­nition that electricity really involves three types of businessess. First was the obvious elec­tric generation - the actual production of the kilowatt hours that consumers consume. Second was the transmission of that power to local networks. Third was the distribution of that power to individual users.

Only the second and third of these three components have what economists would call natural monopolies - there can be only so many power lines into a community or home. Generation could be supplied by competitive suppliers. Conceptually, deregulation of the electricity supply market is similar to the deregulation many years ago in the long-dis­tance telephone service market.

Electric choice involves several basic questions. First, should you purchase power indi­vidually or through a group? They do offer advantages in terms of market power (buy­ing "in bulk") and convenience (someone else does the legwork).

However, there is frequently an adminis­trative fee to cover the costs of running the group, and members often get a deal that is average for the entire group - thus some members may have done better individually. If you are purchasing individually - and are running a sizeable business-do you want to hire a consultant? Consultants cost money, but they can help in at least two ways. First, they can so­licit competitive bids from multiple suppliers. Second, a good consultant can suggest ways to reconfigure power use to get a better price. Suppliers in the local grid must assure that they have enough power to meet peak hour demands, meaning they must have enough generating capacity to meet demand during the peak hour of the hottest summer heat wave. During much of the rest of the year, a portion of that capacity will be idle.

Consequently, suppliers value customers who are able to reduce capacity during peak times, or at least do not increase consumption during those periods. By reducing demand, or at least maintaining a level "load profile," you will get a better deal.

Similarly, because sup­pliers value customers who can make use of otherwise idle power supplies during non-peak periods, by shifting usage away from the peak afternoon periods, you may get a better price. A good consultant will examine your load profile and discuss possible ways to improve it.

Business Goals

Beyond load profiles, there are also various ways to buy electricity depending on your business goals. Market price of electricity varies on hourly as well as seasonal basis, sometimes dramatically.

However, if you require certainty in pricing and budget forecasts, you may chose to pay a premium fora traditional fixed price contract. Alternatively, if you are willing to tolerate some swings in the market price, you may choose a cheaper indexed price and try to cut back on consumption during market highs.

You could also choose a hybrid, which allows fixed prices for a block of power and indexing for additional, optional, power requirements. All of these are issues to discuss with a consultant.

If your supplier fails to deliver, then you are automatically put on "default service" by the utility, an expensive proposition, especially dur­ing peak use periods. Therefore customers must examine the credit-worthiness of the supplier.

The power contract must also have accept­able terms. For example, under what circum­stances or conditions can the supplier termi­nate? Contracts have been offered allowing the supplier to terminate simply because the supplier decided to withdraw from a particular state's market.

If the supplier exercises that option during a heat wave, can you afford to pay the peak hourly prices on the spot market? Does the contract obligate the supplier to supply all of the power that you request?

Contractual Issues

What does the contract provide about changes in your business? Remember that the supplier must reserve sufficient capacity to meet the peak load as shown by your historic load profile. Understandably, the supplier takes a risk that it will be paying for idle capacity if you reduce consumption - for example, by a closing a location.

Some contracts obligate the consumer to provide advance notice to the supplier of anticipated changes in consumption, limiting your future flexibility.

You must solve these issues in advance, because suppliers quote based on market conditions.  Especially for large contracts, suppliers often quote prices that are only good for 24 or 48 hours.

If you delay your decision, there is often a hidden premium buried in the price to compensate for the risk of market changes while you are decided. This is especially difficult for companies where final decision on expensive power contracts is centered on level of management that is not normally involved in evaluating these issues. 

It is a risky, complicated game, but there are opportunities for those who play it well.

This article was published in the October 2005 print issue of Atlantic Coast In-House.