Is It an Optimal Time to Fix Your Electricity Price?

January 2013

• While the total cost of the electricity bill has been increasing, the actual cost of the energy commodity is quite low. Is it a good idea to lock in that commodity portion?
• Cost increases come from an increasing number of contracts offering generators guaranteed revenue.
• By far the largest part of the increases in electricity costs do not come from the portion of the cost that can be hedged.

Electricity costs are constantly in the headlines these days. Reports warn us of double-digit increases to our electricity bills in the coming years. And yet, when you look at the wholesale price of electricity in Ontario today, electricity looks cheap. The average spot price for Ontario electricity in 2013 was about $26/MWh, about half of what it was 10 years ago. If costs are projected to increase significantly and current spot prices are low, is now the time to fix your electricity price?

The flaw in this logic is exposed when the commodity cost we pay for electricity is broken down into its constituent components:  the Hourly Ontario Energy Price (HOEP) and the Global Adjustment (GA). The HOEP is the spot price for the energy itself. The GA is the per MWh impact of the money paid to generators as revenue guarantees (as well as some costs related to conservation and other programs).

For an energy contract, a generator is guaranteed a fixed rate for each unit of electricity produced up to the contract capacity. Generators earn the HOEP on the electricity they produce and sell in the market; however, at today’s low HOEP, this price is generally significantly less than the guaranteed rate in the generator’s contract. The Ontario Power Authority (OPA)makes up the difference by issuing the generator a cheque, and it recovers the cost of those payments through the GA. Lower HOEP results in bigger cheques to generators and a bigger GA tab for consumers. Conversely, higher HOEP lowers the GA burden on consumers.

For a capacity contract, a generator is guaranteed a fixed amount of net revenue each month – called Net Revenue Requirement (NRR). At the end of each month the OPA calculates the revenue that a generator ought to have earned by operating in hours where the HOEP exceeds their contracted marginal cost of production, subject to some nuances. This difference between their NRR and imputed revenue is made up with funds from the GA. In a month when HOEP is low, the generator will not be expected to earn much revenue in the market and will be issued a bigger cheque out of the GA. If the HOEP increases, the generator would be expected to earn more revenue from the market and the resulting GA charge decreases. Again, higher HOEP means lower GA, and vice versa.

As explained in more detail elsewhere, increasing costs for electricity are coming largely from increases in the GA component of our commodity costs. This cost component on its own has been rising faster than the total cost of energy has risen. Offsetting the rise in GA has been the decline in the HOEP. As more and more generation is added in Ontario, the cost of revenue guarantees to those generators increases, but the greater and greater capacity has created surplus electricity and pushed the market value of that electricity lower. The HOEP represents the marginal cost of production for a generator, independent from the costs guaranteed to generators. Aside from periods where there is unseasonably frigid winter weather or unseasonably hot summer weather, the HOEP has been low. Demand is flat and supply is increasing.

For the most part, retailers offering fixed price electricity are offering to fix the HOEP part of the cost. But that is not the cost component that is rising. It has in fact been falling, or at least stable. And its fall has partially offset the increase in the GA. The last thing a consumer wants to do is fix the HOEP piece and prevent it from falling. Doing so would eliminate the tendency for changes in HOEP to mitigate changes in the GA, and would expose the consumer to higher swings in energy costs than they see while unhedged.

In fact, the interaction between HOEP and GA makes the total commodity cost relatively predictable for those who understand the mechanics of these contracts and the minor impact external factors may have. This predictability helps analysts like Aegent know with a high degree of certainty that electricity costs will be increasing significantly. Unfortunately, the component that is driving the increase is the component that cannot be hedged.

With HOEP remaining low and the cost increases stemming from a growing number of government contracts guaranteeing revenue to generators, it is clear most of this increase will be in the unfixable GA.

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