Do businesses benefit by purchasing energy through trade association buying groups? In many cases “no.” How can that be?
First, some background. The term “load profile” refers to the variation of an electricity user’s electrical load versus time. Load profiles vary by customer categories (residential, commercial and industrial) and by individual customer within those categories. Customer’s individual load profiles are used to estimate their electric supply requirements and determine their individual pricing. The two main drivers of pricing are demand charges and energy charges. Demand charges are based on a customer’s peak load as measured in kilowatts (kW). This is the customer’s highest rate of electricity usage during a given time period. Energy charges are a function of how much actual electricity a customer uses over a given time period (month, year), measured in kilowatt-hours (kWh).
When customers with individual load profiles are aggregated, an economic benefit to the overall group may result. Whether or not an economic benefit results depends largely on whether or not the aggregated group of customers have non-coincident peaks. When combined, customers who have variation in their individual peaks may have a more attractive overall load profile and this can lead to improved pricing for the group. Where does the benefit go?
The value of any economic benefit resulting from forming an aggregation group can be shared with the customers, kept by the supplier, or a combination of the two. Customers will rarely ever know if there is a benefit and what comes of it. The only way customers could possibly tell is to have the supplier price each load individually, price the group as a whole and then compare the two sets of prices.
There are also costs associated with participating in trade association buying groups, many of which are hidden. Such costs include:
When making offers, many trade associations and their supplier will keep the offer price open for a period of time. This may be a few days, a week or even longer. Holding a price open is risky for suppliers. If, during the offer period, customers sign up and, at the same time, the wholesale market for electricity rises, the supplier can lose margin or even end up “upside down” having to purchase supply at a price that is higher than the price they have held open and committed to sell at to customers. In order to protect themselves from this possibility, suppliers will add a risk premium to their offer price. This can be expensive and drives up the offer price. [Alternatively, suppliers may “pre-purchase” supply in anticipation of making an offer. In this case, the risk works in reverse. If during the offer period the wholesale markets decline, customers who sign up will pay an above market price for their electricity.]
Expensive Embedded Option
Some trade associations promote that their contracts call for no penalties to be paid by the customer if the customer breaks their contract because they sell their property before the end of the contract term. This is an option and options have value. In exchange for including this feature in a contract, suppliers add a premium to protect themselves in case customers exercise this option and break their contracts because of the sale of a property. The customer pays this option premium whether they exercise the option or not. And what is the customer paying for? This option is only of value to the customer when two conditions are simultaneously true; (1) they sell their property during the contract term, and (2) prices in the wholesale market are lower at the time the contract is broken compared to when the contract was entered into. Most customers do not expect to sell their properties during the term of their electricity supply contracts. And, what is the likelihood that prices will fall further below today’s already low levels? In summary, customers end up paying for an option feature that has little chance of being of value to them.
Trade Association Fees
In order to entice a trade organization to promote the supplier’s offer to the trade association’s members, suppliers often will agree to make payments to the association itself. These payments are rolled into the price they offer the trade association members and they can be substantial. You may really like your trade association and may be happy they can make a buck or two, but you should be aware that they are being paid and that you are footing the bill.
Suppliers seek trade association relationships because it is a way to exclude competition. By gaining the trade association’s endorsement, the supplier no longer has to compete with other suppliers. While the trade associations may conduct some sort of due diligence during a selection process, what matters is the pricing the suppler offers the trade association’s members during the offer period. And, by this point, there is no competition.
Winner and Losers
When forming an aggregation group, there are times when some members of the group will benefit and others will not. As an extreme example, imagine an aggregation group consisting of a large hospital and several small sandwich stores. The hospital, with its attractive load profile, may end up with a slightly higher price. The sandwich stores, with their much less attractive load profiles, would each most certainly benefit immensely. Sometimes some members of an aggregation group are subsidizing other members of the group.
So, what can be done?
If you are considering participating in an aggregation group, it is to your benefit to seek other quotes. You cannot lose. Either you will confirm that the aggregation group is economically better for you or you will elsewhere find better pricing, terms and conditions.
Copyright 2011 by Avalon Energy Services, LLC.