Should I be concerned about high electricity spot prices?

April 2014

• Despite the recent sharp rise in the Hourly Ontario Energy Price, there are no fundamentals supporting a sustainably high HOEP.
• As the government and its agencies enter into more and more fixed price electricity contracts, consumers’ exposure to HOEP is diminished.
• Since the Global Adjustment offsets the HOEP, the total commodity cost (HOEP + Global Adjustment) is a more stable value than either component on its own.  So if a consumer were to fix HOEP, then the offsetting balance of the two components is broken and the consumer faces highly volatile electricity costs.

Retailers are alerting electricity consumers to the recent sharp rise in the Hourly Ontario Energy Price (HOEP), encouraging them to enroll in fixed-price electricity contracts and promising price stability. The weighted average HOEP has increased from $16.08/MWh in November 2013 to $81.83/MWh in February 2014 and $80.41/MWh in March.

While purveyors of fixed-priced HOEP products see this as a marketing opportunity, Aegent encourages consumers to take a closer look at what a spike in HOEP really means by challenging three key assumptions: higher prices are here to stay, higher HOEP means higher electricity bills, and fixed-price contracts ensure cost certainty.

Are higher prices the new normal?

The HOEP is a measure of the marginal cost of production in Ontario’s electricity system and represents the additional cost a generator incurs to produce another megawatt-hour of electricity. During high demand hours the price is generally set by a thermal resource and occasionally set by a peaking hydroelectric resource. For example, a natural gas-fired generator will bid into the market at something close to:

Gas Price x Heat Rate + Marginal Maintenance Cost

The marginal maintenance cost may grow gradually over time due to inflationary pressure. Heat rate – an efficiency measure of how much fuel is required to generate electricity – may degrade slightly as equipment ages, but rarely changes substantially. The volatile component here is the gas price.

Most Ontario generators – non-utility generators being a big exception – will use the Dawn Day-Ahead Index as the gas price in this calculation. Higher gas demand for space heating and depleted storage inventory led to very high gas prices at Dawn in February and early March and a commensurate increase to the marginal cost of electricity production. While this dynamic is the primary cause of the recent HOEP increase, there are several other factors exacerbating this increase in HOEP: closure of cheap marginal cost coal resources, nuclear plants out of service for planned maintenance, and cold weather increasing heating demand.

With the arrival of spring, Dawn prices have moderated substantially below recent spot prices and forward markets show expectations for lower prices ahead. With new electricity supply coming online, and stagnant power demand forecasts, there are no fundamentals supporting a sustainably high HOEP. The spring freshet – historically the lowest priced time of year – will be placing downward pressure on HOEP in the near future.

Does higher HOEP mean higher electricity costs?

It may seem natural to assume that if HOEP increases, a consumer’s electricity bill will increase. But there is nothing natural about pricing in Ontario’s electricity market. As the government and its agencies enter into more and more fixed price electricity contracts, consumers’ exposure to HOEP is diminished. Class B consumers often enjoy lower priced electricity in high demand months. In 2013, the highest total electricity commodity price – defined as the sum of the HOEP and Global Adjustment – was in November when HOEP hit its annual low.

In that month, HOEP averaged 1.61 cents per kWh, and the Global Adjustment was 7.86 cents per kWh. The sum of the two would be a total commodity cost to the consumer of 9.47 cents per kWh.

In February 2014, HOEP averaged 8.18 cents per kWh, the highest ever February HOEP. But the Global Adjustment averaged 1.33 cents per kWh. The sum of the two was 9.51 cents per kWh, virtually the same as “low-priced” November!

Does fixing HOEP ensure cost certainty?

Differences in guaranteed contract prices and the HOEP are recaptured through the Global Adjustment. If the HOEP is high in any month, the Global Adjustment will be somewhat commensurably lower and potentially even negative to offset revenue earned in the market. Since the Global Adjustment offsets the HOEP, the total commodity cost (Global Adjustment + HOEP) is a more stable value than either component on its own. If a consumer were to fix the HOEP then this off-setting balance is broken and the consumer now faces highly volatile electricity costs. That’s adding electricity price risk, not hedging it away.

In 2013, the Global Adjustment ranged from $48 to $79/MWh and the total electricity commodity price ranged from about $77 to $93/MWh. A customer that did not fix their HOEP in 2013 would have experienced a month-to-month variance of $16/MWh in total commodity price, while a customer that did fix their HOEP would have experienced nearly double the variance at $31/MWh. With the Global Adjustment starting 2014 off at $12.61/MWh, customers that entered into fixed price contracts will experience highly volatile month-to-month total commodity costs this year.

While this analysis focuses on Class B customers, there does remain some exposure to HOEP for certain Class A consumers. Before any customer enters into a fixed-price electricity contract, they should clearly understand the implications or consult an objective, independent advisor.

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