Nowadays instead of having one choice, commercial and industrial consumers of electricity now face an increasing array of power purchase possibilities. With this increase in availability comes the increased scope for negotiation.
Whilst large consumers of energy may consider novel ways of acquiring power such as installing their own combined heat and power plants or purchasing or availing of a district heating system, they may still need to purchase electricity from a third party provider. This paper will focus on purchasing electricity form outside electricity suppliers. Many of the comments will also apply to the purchase of other forms of power.
Electricity power purchase contracts
Since February 2005 all electricity customers have been entitled to switch electricity supplier. This can be done through the Change of Supplier process handled directly between ESB Networks and the relevant electricity suppliers without disruption and at no direct cost to customers.
Current suppliers in the market place are: Airtricity, Bord Gais Eireann trading as Bord Gais Energy Supply, Energia, ESB Customer Supply, ESB Independent Energy and Vayu Limited.
It is proposed below to give a whistle stop tour of the do's and don'ts of negotiating the best possible electricity power purchase agreement for you and your company. It is impossible to give a definitive list of points to which a consumer should give attention in negotiating any contract. Each contract is likely to be slightly different, and each consumer will have different concerns. However, the following fundamental principles must be borne in mind:
The price being paid for the supply must be fully understood.
- As with every commercial contract, the consumer must be fully aware of the practical implications of each clause.
- The greater the demand for electricity of the consumer the stronger it will be in trying to renegotiate standard terms.
If it has a choice, the consumer will buy electricity from the cheapest source. Before accepting a price and when looking at the price provisions in the contract, the following points should be borne in mind:
Basis of calculation. To avoid paying more than the market price, buyers should try to benchmark contract prices to other sources of information. It may be difficult to calculate whether or not the prices offered by one supplier are in fact cheaper than those of other suppliers. While it is possible to request quotations from any number of suppliers, these may not be easy to compare. For instance, one supplier may quote a fixed unit price for energy plus a charge based on the maximum demand taken in the coldest month of the year, plus a fixed administration charge. As mentioned above, it will also pass on to the consumer all use of system charges that it is required to pay in respect of the supply. Another supplier, on the other hand, might levy a unit charge, a monthly standing charge, an availability charge calculated by reference to the maximum capacity of the connection point, and a demand charge related to the maximum demand related to the maximum demand in each month. To compare such different quotations is not easy and what initially appears to be an attractive unit price may in fact not reflect the true cost of the supply.
Fixed or variable. The consumer may be offered a fixed price contract or a variable price contract. The price at which suppliers purchase electricity from the pool can vary each half hour of each day throughout the year but by entering into contracts for differences with generating companies suppliers can effectively buy power at fixed prices. At times, pool prices may be much lower than fixed prices quoted by suppliers, and at other times may be significantly higher. If the consumer accepts a contract price related to pool prices, it takes the risk that its electricity prices will fluctuate and perhaps be much higher than it anticipated.
Demand profile. The consumer should ensure that the price quoted by the supplier is appropriate to its "demand profile". Electricity is generally cheap at times of low demand, for instance during the summer months, at weekends and at nights, and if the consumer can manage its demand so that it is high during these periods and low at other periods, it should seek a contract price which reflects this rather than a fixed price for all periods. Alternatively, this can be achieved by taking a pool price related contract. For example, the ESB offers Winter Demand Reduction Incentives.
Escalation/Indices. Where a fixed price contract is entered into for a period longer than a year, the fixed price will usually be subject to escalation in accordance with specified indices. Escalation formulae are very complicated and therefore it is not uncommon for them to be incorrect. Since a small drafting error can result in much higher price increases than were intended, they should be checked particularly carefully.
The indices are intended to protect suppliers from increases in the costs of generating electricity (for instance oil and gas price rises) over the term of the contract. If the indices show a fall in costs, the consumer should insist that its price should be reduced accordingly.
Consideration needs to be given to the indices themselves. The elements which comprise any index should be checked to ensure that they are relevant to the generation cost of electricity. Further, the indices should not be an internal index produced by the supplier, unless it is audited by its accountants and made available to the consumer.
Payment terms. The terms for payment should be considered in conjunction with the prices quoted. The terms offered vary from contract to contract, some providing for payment within 14 days of the due date with interest at 4 per cent above base in the event of late payment. Generally, a 30 day payment period with interest at 2 per cent above base is reasonable, but suppliers often argue that the more generous the payment terms, the higher the unit price that they will charge.
Price review. A final point to note is that if there is provision for prices to be increased during the period of the contract (other than by indexation), the consumer should be given sufficient notice of the proposed rise so that it can, if it wishes, terminate the contract and find an alternative supplier before the price rise takes effect.
In view of the importance to the consumer of its electrical supply, it needs to be fully aware of the terms on which it is made available and the requirements that it must, in practice, comply with if the supply is to continue. Among the practical problems which commonly arise are:
Consumer's equipment. In the connection agreement there are often restrictions or conditions on the operation of the consumer's equipment, for instance, the power factor must remain within certain limits, use of the equipment must not cause interference with other customers of the supplier and the specific maximum capacity must not be exceeded. The consumer, however, may not know when it is in breach of such restrictions - a serious matter when the penalty for breach is often stated to be de-energisation of the connection with the consumer being responsible for any resulting costs, damages and expenses incurred by the supplier.
The consumer should ensure that its equipment is designed to meet the specified requirements and it should require the supplier to give notice as soon as it becomes aware that the equipment is not complying with them. De-energisation and liability to pay for damage caused should then only arise if the failure is not rectified as soon as practicable after the notification.
As a general point, wherever liability to pay for damage arises under the contract, liability should be restricted to paying for reasonable costs and expenses incurred. No indemnities should be given. Normally a consumer will not be able to sue for consequential loss.
It should also be noted that connection charges may be levied by reference to the specified maximum capacity of the equipment at the connection site. If this is much higher than the consumer's likely maximum demand, it will be paying a much higher charge than it need. There may however be contractual restrictions on the consumer's ability to reduce the specified maximum capacity.
Supplier's equipment. For contracts requiring that the seller add assets to serve the buyer, such as new generating or other capacity, buyers should expect to sign long-term agreements in which prices cover the seller's long-run marginal cost. Sellers are not likely to speculate in, or get financing for, large investments in new assets without long-term contracts to purchase power output. Alternatively, the term of the contract should be set to expire before the date of expected capacity additions.
Suppliers' right to inspect and maintain its equipment. The consumer will be required to give the supplier access to its premises to read meters and to maintain equipment located on its premises. These rights of access are generally very widely drawn and should be restricted to those areas of the premises to which access is strictly necessary for this purpose. In certain circumstances, it may be necessary to provide that the consumer's site rules will be complied with.
Insurances/Liability. The consumer may be responsible for any damage done to any of the supplier's equipment situated on its premises. If so, it should check that the equipment is insured under the terms of its insurance policy.
As a general point, wherever liability to pay for damage arises under the contract, liability will be restricted to paying for reasonable costs and expenses incurred. No indemnities should be given by either party. Normally a consumer will not be able to sue for consequential loss.
Force majeure. Contracts will provide for suspension of supply for reasons outside the party's control, a consumer will want to see the Supplier mitigate the effect of such events and to take steps to reinstate supply as soon as possible.
Disconnection and termination. The contract may specify that in certain circumstances the supplier is permitted not to make a supply and to de-energise or disconnect the consumer's premises. For instance, if the supplier loses its supply licence, or the consumer becomes insolvent or is in breach of either the supply agreement or connection agreement. In all such cases the consumer should request as much notice as possible of the impending cessation in supply. Where the supply or connection may be terminated due to breach, the consumer must be given an opportunity to remedy the breach of contract before any cessation in supply is affected.
The consumer should consider how it will obtain a supply if that supply agreement is terminated or the secondary supplier is temporarily unable to make a supply. It may have agreed with a primary supplier, such as the ESB, to provide a stand-by supply but that supply may be unavailable for technical reasons. The only way that a consumer can be confident of a supply at all times is by installing a stand-by generator.
Level of service. To get a lower price, consider lower level of service. If a consumer is seeking the lowest possible price, he or she could opt for interruptible service, perhaps with limitations on the frequency and duration of interruptions. The decrease in quality must not jeopardize the buyer's business. Some industries in the US, such as scrap steel recyclers or copper smelters, organise their production around interruptible service to attain lower operating costs. An alternate approach is to allow the buyer to accept or reject electric service at a given time depending on the price at that hour.
Expect sellers to avoid adverse impacts on their other customers. Such as externalities on their generating or transmission systems. Consumers may create adverse externalities on the transmission system through voltage fluctuations or other problems that adversely affect other consumers or generators. In such cases, buyers and sellers should be prepared to deal with quality management, using electronic equipment to limit externalities on the transmission system and imposing penalties, including cancellation of the contract, if protective measures are not properly activated by the buyer.
Retain flexibility in light of uncertain demand. Buyers sometimes get themselves into a pickle by committing to excessive purchases through overly optimistic business projections or through delegation of contractual negotiations to a department that has little understanding of the fluctuations of the business. Flexibility in electricity use can be important to the buyer to accommodate changes in his or her business, such as increases or decreases in sales, changes in input costs or changes in output prices.
One form of flexibility is in the amount of electricity to be consumed. A contract can allow the buyer to increase or decrease consumption within limits. The limits would be required by the seller to reduce his opportunity costs associated with devoting resources to customer A (who may not use them) and thus foregoing an alternative contract with customer B. Another form of flexibility is to purchase from several sellers. For example, the consumer's relatively constant base load demand may be supplied by one source (e. g., self-generation) and additional, but less certain and perhaps more expensive, demand may be supplied by a different source that is better able to accommodate ups and downs in demand (e.g., a utility). Flexibility may also be achieved through price flexibility. For example, it may be possible for a buyer to tie the unit cost of electricity under the contract to his own production costs.
Anticipate unreliable supply in a competitive environment. For example, a supplier might be delayed in starting service if he has to build a new self-generation facility at the consumer's site or if he has to build a new power plant at a remote site to meet his contractual obligations. Penalties for poor performance may be used in such situations, and the contract may allow the buyer to cancel the deal if performance is poor.
Beware the moral hazard in using a buyer's agent. If a consumer employs an agent to plan electric energy services for the consumer, the agent may be motivated to pursue his or her own ends, not the electricity consumer's. For instance, if an engineer hired by the consumer specializes in designing cogeneration systems, the engineer may be motivated to propose that the consumer purchase a cogeneration system from him or her, though another energy service option would be more cost effective for the consumer. To protect against this "moral hazard," the buyer can review other alternatives or tie his payments to the supplier to an independent price index.
Don't buy what you don't need. The consumer may be wasting electricity, and energy efficiency may be a better deal than more kilowatt-hours. Conservation allows the consumer to reduce his or her energy service bill over the long run by investing inefficiency improvements for lighting, motors, space cooling, and so forth
A continuous supply of electricity is of fundamental importance to consumers and, as contracts for the connection and supply of electricity contain many pitfalls for the unwary, consumers should draw on all the expertise available to them in their negotiation. As time passes and energy prices continue to rise, the negotiation of these types of contract will become even more important.