When utility default service isn’t a good energy procurement strategy

In a down market like the one we have been experiencing over the past few years with mild winters and summers, some clients have asked if they should stay on or go back to the utility’s standard offer service (aka, default service). There are specific situations when it does make sense for a company to get electric supply from the utility. Other than those rare circumstances, it is generally better for a large energy user to purchase energy in the competitive market with a third-party supplier.

Your utility is purchasing electricity from the same suppliers that you have access to in the competitive market,  however, it does this based on the needs of the entire customer base on default service rather than optimizing for your specific needs and usage patterns. Typically, a large energy user’s individual usage pattern (profile) is more favorable to a supplier than the average profile of the utility customer group on default service. Because of this, a large energy user will almost always get a better supply price from the competitive market than from utility default service.

When energy prices are low in the short term compared to longer-term energy prices, fixed-price offers from a supplier can be higher than utility default prices. But before jumping back to utility default service, we strongly recommend you analyze an index-based strategy. Here’s why:

1) Your company may be subsidizing the utility’s default customer group

Utilities use Load Factors to assist in setting the rate they will charge customers. A load factor signifies how consistently a company uses energy. Utilizing most of your power during on-peak hours will result in a low load factor with higher pricing, like a typical residential customer. The load factor is calculated by dividing the average kilowatt-hour demand by the peak demand.

Formula:

kWh’s / (peak kW * # days in billing cycle * 24hrs in a day)

Example: 

Monthly Peak demand= 500kW

Total monthly kWh consumed= 500,000kWh

Load factor= 74.4%

A utility’s average load factor is typically 38-42%. The lower the load factor, the higher the cost per kilowatt-hour. As a large energy user, you probably have a high load factor and are therefore subsidizing those with low load factors.

2) Take advantage of real-time market movements to manage price risk

An indexed approach with strategic hedging allows you to take advantage of market dips in the less volatile months, while protecting your budget against the higher-cost winter (and potentially summer) months. A utility will typically lock in a set rate for a short period of time. Depending on the utility, this can be anywhere from 1 month to 6 months in advance. When you are on Index, you paying an hourly market rate, and Usource can help you selectively hedge at times when price volatility exceeds your risk tolerance.

3) Lower, and even avoid, some of your non-commodity charges

By separating your company from the utility’s customer group, you can leverage your favorable load factor and large annual electricity consumption to lower your non-commodity charges. These charges include capacity, stranded costs, and ancillaries. In some states, like New York, you can avoid paying the monthly merchant function charge on your utility bill when you purchase from a third party supplier.

 

Usource has crafted a variety of index-based energy procurement strategies, taking into account risk tolerance, time commitment available and budget targets. Read about Lindt & Sprungli’s index-based hedging strategy, or how another large manufacturer saved $190,000 with their strategy. Contact an advisor today to discuss how you could be saving over your utility default rate.


About the Author

Tom Dyer is Sr. Director, Procurement & Analysis for Usource. Tom has over 16 years of experience in the energy markets, including working for two of the largest energy suppliers on the East Coast.

View Tom's Bio
Author image

Go to All Posts