What Is the Long Term Trend in Utility Prices?
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Source: EIA (2013 and 2014 numbers from EIA Monthly through Sep 2013 and 2014, respectively)

Periodically our Soluxe team likes to step back and test prevailing wisdom.  And what is more commonly assumed than that electricity prices are constantly increasing?

A study of end user pricing going back to 1990 reveals a surprising fact: The common assumption is wrong. Utility prices have barely moved and have actually declined on an inflation-adjusted basis. Commercial prices on average in New York have increased only 2.3% per year, less than the average rate of inflation according to CPI data.

This research – covering industrial, commercial and residential pricing — has enormous implications for large electricity consumers who wish to protect themselves from future price shocks. If you wish, you can skip the summary of the research and go directly to “Implications” below.

Research

The US Government’s Energy Information Agency has published a history of average electricity tariffs by end-user for New York.

  • Industrial. In 1990 commodity prices were a shade under $.06/kwh; 23 years later they were barely a penny higher, without adjusting for inflation, a difference of .84% or less than .006% per year.
  • Commercial. From 1990 to 2014, commercial prices rose 56% or only 2.3% per year.
  • Residential. From 1990 to 2014, residential prices rose 77% or 3% per year.

When one looks at commercial utility tariffs in National Grid New York’s territory (formerly New York State Electric & Gas) from 2004 through 2014, delivered rates to customers (including municipalities) increased from $.123/kwh to $.144/kwh, an increase of less than 1.7% per year on average. Between 2006 and 2014 the increase was negligible, from 2007 to 2014 the rate actually decreased by 6.5%.

The rate of change is also noteworthy in National Grid’s commercial rates. While two years showed increases in excess of 10% (13% in 2012-13 and 19% in 2013-14), 2011-12 showed a decline of 13% and 2008-09 showed a decline of 21%.

Data from ConEdison’s New York commercial customers drives similar conclusions: Prices have been moderate, within a range, and sharp decreases are just as likely as increases.

Implications

Our research carries several important lessons for large electricity consumers:

  • Beware of suppliers urging long term hedges. Theoretically hedging protects the buyer from unanticipated spikes in prices.   Budgets, particularly for governmental entities, are set a year to a year-and-a-half in advance. Most munis do not have the luxury of adjusting their budgets and running a deficit. If costs exceed those in the budget, sacrifices must be made elsewhere to offset the shortfall.Hedges protect budgets. But they do not guarantee savings. Many buyers confuse hedging with savings, and many suppliers compound the confusion by talking about ever-increasing utility costs. As the research shows, those costs are not predictable.A buyer of long term supply incurs two risks: First, long term hedges carry a premium which is the price extracted by the supplier for (i) foregoing higher price markets later if the supplier has unlimited supply, and (ii) buying higher price supply in the market to cover the supplier’s obligations if its supply is limited.The second risk is opportunity cost. If utility prices decline – and we can see that over the past ten years they declined on National Grid by 21% in one year alone – the hedge will cost more money.We will discuss below in “Strategies” the way in which a smart consumer can avoid these two risks while at the same time protecting itself from higher prices.
  • Market timing is a crapshoot. Much ink is spilled each year by commodity market analysts projecting future price trends. We would like a dollar for every analyst over the past year who predicted that crude oil prices would stay over $100 per barrel for the foreseeable future. Recently crude oil inched below $70 per barrel. In 2008 crude oil touched $40 per barrel.The price trends analyzed in our research show that energy markets are impossible to predict. Electricity prices, particularly in the Northeastern United States, are volatile because of the fine supply and demand balance for natural gas, the principal fuel for electricity generation. Natural gas prices, in turn, are affected by several factors, all of which are unpredictable:
    • Availability and cost of supply – This factor can be influenced by pipeline capacity, time of year, weather in western Canada as well as in the Gulf of Mexico, etc.
    • Weather in the consumption area –
    • Cost of competing generation fuels such as coal
    • Dispatch of other generating plants such as nuclear, other natural gas plants down for maintenance, etc.
    • Regulatory restrictions on CO2 emissions by industrial fuel oil consumers, coal generators, etc.
    • Over the next couple years, demand for Liquified Natural Gas which will soon be exported to markets in Europe and Asia where natural gas prices are much higher
    • Availability of storage gas which is useful in the winter to meet weather demand but becomes less useful toward February and March when pressures in the storage field drop and it becomes harder to withdraw supply.

    Accordingly, be wary when energy supply analysts pronounce such advice as “buy in the summer before the winter heating season, when prices are low” or “buy now because prices are sure to rise.”   History shows that there are no crystal balls.

  • Let’s face it: To Save Money You Must Reduce Consumption. The only effective way to save money on energy supply is to reduce consumptions.Hedging can protect from higher prices; if prices go up, hedging will save money. Likewise, from time to time supply may be available at prices below utility prices. At such times a short term purchase of variable price electricity might generate short term savings. (The principal risk here arises when utility prices drop; there is often a 2-3 month delay to change suppliers so a buyer could find themselves locked in to a high price while the utility transfer process grinds on.)Accordingly, relying on energy supply contracts alone will not provide reliable savings for consumers. The best approach will include a combination of hedges, described further below, and energy efficiency solutions.

Strategies

In view of energy price volatility, large consumers should examine several practical strategies that can meet their goals of reducing price risk.

  • Short term hedging. Hedges should be placed for periods no greater than one year to 18 months, except in the cases described below. One year hedges carry a low risk premium. Many suppliers offer one year hedges and so competition and liquidity keep pricing tight and fair. Moreover, a term of one year to 18 months will help span structural changes in the market that can provide benefits if prices decline.Three situations might justify putting on longer term hedges: (i) a planned expansion (e.g., adding a new shift or anticipating new customers), (ii) a long term budget, or (iii) an energy efficiency upgrade the value of which will turn on energy costs (e.g., natural gas for a furnace conversion project or electricity for a geothermal project).
  • Staggered Purchasing. Consumers should rarely buy 100% of their forward energy requirements at the same time. A better approach is to follow what utilities themselves do, namely, purchase 50% or less of their total volumes in staggered intervals. Thus, a consumer using 10,000 mwh per year could buy 5,000 mwh for one year terms every six months. In this way, 100% of the volume would be hedged but the hedge prices would be the average of the independent hedges.Staggered hedging can also help consumers that may have variations in volumetric needs, e.g., because customer orders are variable or weather can impact volumetric needs. One example: A sports stadium that cannot anticipate whether it will be in a playoff season would benefit from hedging only part of its volumes.
  • Integrate Solar and EE Solutions. Consumers that are reviewing potential solar or energy efficiency projects will want to buy only their base load, i.e., the volumes they need irrespective of whether they go forward with the conservation project.

 

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