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Electricity Contracts and Business Changes

When selecting a retail energy provider for your business, it is tempting to focus on the electricity rate alone.  This is a reasonable approach if your business uses electricity in a consistent manner and a predictable quantity.  However, if your business is expanding or contracting, adding or deleting locations, or anticipates these types of activities, be sure to pay attention to the electric service agreement.  The usage bandwidth and material change provisions in your retail energy contract can significantly affect your electricity costs.

The electric service agreement goes by many names.   Terms of Service, Commercial Electricity Services Agreement, and Contract for Retail Energy Service are several examples of how these agreements are styled.  An electric service agreement is a risk control document.  The two broad categories of risk addressed in an electric service agreement are legal risks and business risks.  Legal risks are those risks associated with two parties entering into any type of contractual relationship.  Examples of legal risks include identification of the parties, indemnity, confidentiality, force majeure, dispute resolution and notices.  Business risks include items such as remittance, post-term pricing, usage bandwidth and material change.

Electricity Usage Provisions

Usage bandwidth and material change are contract provisions that do not get the attention they deserve.  From the standpoint of the electricity provider, a business customer enters into an agreement to purchase a specific quantity of electricity at specific delivery points and use it in a manner consistent with the past 12 months or so.  Why does this matter?  Any rational energy supplier will hedge its supply obligations to minimize market price risk.  They determine their obligations by forecasting usage for each delivery point based on recent historical usage, if available.  When customers materially deviate from historical usage quantities and patterns, the energy supplier assumes additional risk for which it is unhedged.

Of course, one small business using a little more or less electricity than expected is not going to wreck the hedging strategy of a good-sized retail electric provider.  In fact, electricity usage variations of one customer often net out against the usage variations of other customers.   However, if enough customers vary their usage in the same manner, it can have an adverse impact on the retail electric supplier.  To address this risk, the electric service agreement incorporates usage bandwidths and material change provisions.

Usage bandwidths are typically formulaic approaches to managing the market risk associated with customer usage variations.  Customer usage within a defined bandwidth (typically a percentage of forecast usage) is billed at the contract rate.  Surplus or deficient usage outside of the bandwidth is subject to a surcharge.  The billing calculations surrounding this provision may be complex and, in some cases, not fully transparent to the customer.  Be sure to consider any anticipated changes to your business operations for the term of electric service you are considering.  Increasing or decreasing operating hours, adding additional machinery, or otherwise changing the way your business operates could affect your electricity bill.

Material Change Provisions

A broader material change in conjunction with or in lieu of usage bandwidths is often used.  From a legal standpoint, what constitutes material may be in the eye of the beholder.   In a general definition, material refers to something that is important or “goes to the merits.”  An easy way to look at it in the context of retail electricity would be if the change would have influenced the contract price.  A small business that uses 10,000 kWh per month would probably not be subject to material change provisions if it used ±100 kWh in a given month.  The business would be far more likely trigger material change provisions if it halved or doubled its monthly usage, moved more usage to peak hours, or closed or relocated some of its facilities.  If you know or anticipate changes in your business that could affect electricity usage, how electricity is used, or the number and location of facilities during the contract term, pay close attention to the usage bandwidth and material change provisions in the electricity service agreement.  It is a good practice to discuss these issues with your retail electricity supplier before contracting for electric service.

The electricity rates you are presented assume a certain level of risk for the energy provider.  The usage bandwidths and material change provisions limit variations in electricity consumption from exceeding the risk level factored into the price.  As risk is transferred to the supplier, the electricity rate should be higher because the supplier carries more risk.  Conversely, transferring risk to the customer (e.g., narrow usage bandwidth, strict material change provisions) lowers the electricity rate.  For a true apples-to-apples comparison of commercial electricity rates, be sure to compare the usage bandwidth and material change provisions of the electric service agreements.  Evaluate any anticipated changes in your business and select the plan that offers the best combination of low electricity rates matched with the degree of flexibility you need.

Disclaimer:  The author of this article is not an attorney and nothing therein should be construed as offering legal advice.  Please consult an attorney for questions on contract terms and provisions before entering into a contract.

About: Charlie Hewitt

Charlie Hewitt has more than 25 years of in-depth energy experience having served in executive and managerial roles at some of the largest retail energy providers in North America.His expertise covers a wide range of retail energy disciplines including pricing, contracting, risk management, and credit. He holds an MBA from UT Arlington, MA and BS degrees in geology from UT Austin, and was a TXU environmental research fellow.

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