Larger Electricity Consumers Better Off Outside the Regulated Price Plan

January 2009

• Larger electricity consumers currently on the Regulated Price Plan (RPP) should be happy they will no longer be eligible for the RPP as of May 1, 2009.
• Their cost of electricity will come down and their risk will be no higher than it would be if they were still on the RPP
• These consumers should consider their risk exposure and risk tolerance and if required, take steps to control their risk.

Effective May 1, 2009, Ontario's "designated" electricity consumers (including municipalities, universities, schools and hospitals) will no longer be eligible for the Regulated Price Plan.

Some larger consumers currently on the RPP and who will come off it on May 1 may be concerned, believing that something the government puts in place for them is a good thing, and that if it ends, they will be worse off.

In this case, the reverse is true - larger consumers currently on the RPP should be happy they will no longer be included in the RPP as of May 1. From the perspective of two key parameters - cost and risk - these consumers will be better off, not worse off.

Lower cost by avoiding RPP cross-subsidy

Larger consumers that are eligible for but have been off the RPP have benefited by avoiding the cross-subsidy inherent in the RPP. Larger consumers that are currently on the RPP will realize the same benefit when they come off.

Consumers on the RPP pay for electricity at the lower tier 1 and higher tier 2 prices. During each RPP period, the plan has a target revenue that falls between these two prices. Larger RPP consumers purchase the vast majority of their electricity at the tier 2 price and so notionally, they pay that price. Smaller RPP consumers purchase their electricity at a mix of the tier 1 and tier 2 prices and so pay a price that falls between the tier 1 and target revenue prices.

The current RPP prices of $59 and $65/MWh (5.9 and 6.5 cents/kWh) were set with a view to collect $60.30/MWh or 6.03 cents/kWh. The intuitive cross-subsidy paid by large RPP consumers is therefore the difference between the tier 2 price and the target revenue price; that is, $4.70/MWh or 0.470 cents/kWh. For the RPP period from April 1, 2005 to December 31, 2008, the average cross-subsidy was $4.76/MWh or 0.476 cents/kWh.

A more detailed analysis comparing off-RPP costs (energy price + Provincial Benefit + OPG Rebate) to on-RPP costs (tier 2 price + final settlement factor) over the same period yields an average cost savings of $5.08/MWh or 0.508 cents/kWh.

Same risk via same cost structure - on or off RPP

The RPP is like a business, with revenues and expenses. Revenues come from electricity paid for at the tier 1 and tier 2 prices. On the expense side, the RPP pays the spot market price and is also subject to the Provincial Benefit (credit or, more lately, a debit) and the OPG Rebate (a credit). Any excess/shortfall of revenues relative to expenses is accounted for in the RPP variance account. Any variance benefit or liability is "settled" with an RPP consumer when they leave the RPP. The key differentiator is that larger RPP consumers pay proportionately more of the revenue than do smaller RPP consumers.

The RPP's expense items are the same items off-RPP consumers pay or receive. Because they pay the true cost in real time, there is never any variance to settle.

It follows then that if consumers on and off the RPP have the same cost structure (except for the cross-subsidy), they also have the same effective exposure to fluctuating spot prices. This means that a larger consumer currently off the RPP or who will come off the RPP on May 1 faces no more risk than does a consumer on the RPP.

Hedge to control risk

Some electricity retailers are telling larger consumers currently on the RPP that they will face higher costs and increased risk when they come off the plan.

The points above prove these statements to be false. Consumers coming off the RPP should therefore not rush into a retail deal.

The purpose of hedging (entering into a fixed-price agreement such as a retail deal for some portion of your energy supply) is to control risk. So before giving consideration to a retail deal, it's best to understand one's exposure to spot market prices, determine one's risk tolerance and then the resulting fixed-price quantity that will bring your exposure in line with your risk tolerance. The last step is to purchase the proper quantity of electricity at a competitive price, by executing a competitive supply acquisition process that includes at least two and preferably three or more suppliers

So if your organization is coming off the RPP, don't be alarmed. Know that your cost of electricity will come down and that your risk will be no higher than it would be if you were still on the RPP. Consider your risk exposure and your risk tolerance and if required, take steps to control your risk.

An item that will affect consumers on and off the RPP is the OPG Rebate, the topic of Aegent's second newsletter article.

OPG rebate to end April 30, 2009. How will consumers be affected? Read more »

Are you ready to leave the Regulated Price Plan? Read more »

Don't get harpooned in a retail power deal Read more »