Shopping for a competitive electricity rate is easier than ever. There are a wide-array of providers and plans from which to choose. Fixed price electricity offers remain are the most popular among businesses and consumers. The provider gives you peace of mind by locking in your rate. In exchange, you agree to stick around until the end of the contract term. For any number of reasons, you might decide to terminate the agreement early. You should always pay attention to the early termination fees when you compare electricity offers.
The rationale behind early termination charges is simple. When you enroll in a fixed price electricity plan, your supplier is on the hook to provide you electricity at the contracted rate. The supplier considered the cost of procuring electricity from the wholesale market when pricing your offer. Following your enrollment, the supplier actually had to purchase the electricity. If you terminate your agreement prior to contract expiration, the supplier is stuck with the unsold electricity.
Purchasing Electricity
How do electricity providers procure your electricity from the wholesale market? The answer varies by supplier. Purchasing your individual electricity needs in the market is unlikely unless you are an extremely large customer.
Suppliers typically combine their sales until they a sufficient quantity to take to the market for hedging. This can be an infrequent task for smaller suppliers compared to larger suppliers who fill their shopping baskets more quickly. Suppliers constantly monitor their customer obligations in relation to what they have purchased in the wholesale market. Risk management policies dictate when they have to go to the market.
Early Termination
If you terminate your electricity agreement prior to the end of the contract, you essentially throw a wrench into the machine. You are no longer receiving electricity from the supplier so their obligation to serve you disappears. What does not disappear is the electricity they procured for your home or business.
What does the supplier do with the unused electricity? It is rare for a supplier to sell electricity back to the wholesale market. It is simply too expensive and cumbersome to do so. Most suppliers use this electricity to offset how much they buy for newly enrolled customers. In other words, they balance out their shopping list with how much unused electricity they have on their hands.
Termination Fees
If the supplier shifts the unused electricity to another customer, why is there an early termination fee? There are two answers to this question.
The first deals with how wholesale electricity prices are always changing. For example, assume electricity prices were 10 cents/kWh when you enrolled and 9 cents/kWh when you terminated the agreement. The supplier now has unsold power priced above the current market. In other words, the supplier takes a financial hit.
Sure, you can flip the example above so that prices are higher when you terminate the agreement than when you enrolled. The supplier would profit in that situation. The problem is that the most common reason for terminating an agreement is the customer finding a lower electricity price. That means that most early terminations result in the supplier taking a loss. Early termination fees offset the financial loss to the electricity supplier.
Termination fees serve as a barrier to you exiting the agreement early. You can switch to another electricity supplier for any number of reasons. Termination fees might cause you to reconsider doing so. The goal of the electricity provider is for you to honor your agreement and give them a chance to renew your business for another term. Finding and retaining good customers is essential to their success. None of this is possible if you leave before the end of the show.
Recommendations
For residential customers, make sure you understand the early termination provisions of the agreement before you enroll. There are two basic approaches to termination fees. One approach charges a fixed amount regardless of when you terminate the agreement. The other prorates the charges based on the number of months remaining in the agreement. The prorated approach is often less punitive than the fixed amount.
Commercial customer early termination provisions are usually more complicated. Small businesses may see approaches similar to that of residential customers. Medium and large commercial customers often have some sort of market-based provision. Calculating actual damages to the electricity supplier ranges from complicated to practically impossible. In most cases, it relies on confidential pricing information and lacks transparency to the customer. The best approach is to make sure you understand the early termination provisions of the electric service agreement. Of course, it is always a good idea to fulfill the term of the agreement if possible.
