Electricity prices vary throughout the day

We investigate the raw cost of electricity. How much profit does a retailer make in selling us electricity?

Not everyone will find this article interesting. Because not everyone has a huge electricity bill or works in the electricity industry. If your electricity usage is greater than 50000 kWh / year (the equivalent usage of ten small families) then this is for you.

For those not reading on: Conclusion, A pool pass through contract could save 24% on your annual electricity bill. But by doing so you take on wholesale market risk instead of your retailer, and we note that in recent months it may have been more profitable to be on a fixed contract due to the large spike in volatility after the carbon price introduction.

The wholesale price for electricity varies every half hour

For a period during the 2000s I worked for the Australian National Electricity Market operator (then called NEMMCO now AEMO) and became fascinated with the wholesale electricity market. In most countries now, there exists a market based system for pricing electricity. In Australia that wholesale price changes every half an hour.

But most retail electricity contracts have a flat rate price per kWh used. Your retailer is buying electricity at the varying wholesale rates, and selling to you at a fixed flat rate. Your retailer takes the risk and they don’t take risks out of the kindness of their heart. The risks are carefully evaluated and priced into the flat rate. Your flat rate covers:

• The raw price of electricity
• The wholesale market risk
• Administration and overhead; and
• Retailer profits

A pool pass through exposes you to the wholesale electricity market

The pool pass through contract is the name of a deal you can make with your retailer where you pay the varying wholesale rates, instead of the guaranteed $0.24 / kWh.

Those wholesale prices vary from negative $1 / kWh, where you get paid to use more electricity – up to $12.50 / kWh. The price normally hovers between $0.04 / kWh and $0.06 / kWh.

These pool pass through deals were not popular for a very long time. Businesses were more interested in a flat predictable electricity bill than one which can be higher in summer and lower in winter. But all of that is changing and businesses are beginning to ask for pool pass through contracts.

Businesses may be moving away from pool pass through contracts

There has been a surge of volatility with the introduction of the recent carbon price in the Australian market (see All you need to analyse the electricity market pt 1) The general trend for the last two years was that businesses were asking for a pool pass through contract. Contrast this with the last few months, some businesses have regretted that decision. The recent volatility made the fixed price plans offered to the highest volume customer cheaper than riding the wholesale market.

Throughout the analysis bear in mind that a very large consumer (one spending hundreds of thousands on electricity per year) would be offered much better rates than $0.24 / kWh. Accepting wholesale market risk might work well in the years with low volatility, but could be an unacceptable burden for your short term cash flow when volatile periods happen.

Meet the worst kind of customer

We’ll run some calculations to see what the raw cost of the underlying electricity is on a pool pass through contract. But to do that we need an example customer. Meet Jill, the worst kind of customer. Jill uses the most electricity during the middle of the day when the prices are at their highest. Can Jill save money on a pool pass through contract? Yes. Read on to find out how much.

Jill’s usage profile on a typical weekday [Larger Size]

Here is Jill’s electricity usage profile. She uses 5000 kWh per year and is a smaller sized business. Her cost per year is $1245 including a generous 10% off discount from Origin energy. Jill’s company is a small design firm, and the electricity is mostly made up of the office computers, lights and cooling.

A saving of 24%

We calculated the base wholesale electricity cost had she been on a pool pass through contract for the last financial year (ending 30 June 2012) and made the following adjustments:

• Added $0.023 / kWh to account for the price of carbon which was introduced since July 2012.
• Added a $0.80 / day electricity supply charge

The raw cost of electricity then is:

$562

This raw electricity price doesn’t account for the costs incurred by your retailer in serving you electricity. The type of costs might be market fees, administration and business overhead. We weren’t sure how to calculate these costs. Instead we assumed that they could be around 50% of the total cost. Adding in that 50% brings the total to:

$943

This is a reduction of around 24% on the already discounted retail price of $1245.

What are the risks?

A pool pass through contract comes with very serious risks. In fact, the saved money is due to you taking on risk that your retailer previously faced. Here are the risks that our example business will face:

• The electricity price could reach $12.5 / kWh. Our example businesses would lose $3.60 for every hour that they ran under such high priced conditions.
• A disaster could cause the wholesale price could unexpectedly remain high for a long time.
• You could end up paying more in total for your electricity than if you were on a flat rate

Ride the wholesale ups and downs

By riding the market ups and downs you (on average) will save money across the year. And that saving will be equal to the price of risk that retailers charge to you (and profited from).

If you are a large business paying $200,000 / year, your savings would be less than the figures quoted here. The competition for very large businesses is fierce right now. Retailer margins are extremely low, and they look to make up their profit with volume.

Have a talk to your retailer and ask about their pool pass through plans. Here are some questions to ask them:

• How much energy must I consume to be eligible for a pool pass through contract;
• What are your fixed charges (administration fees); and
• Does any portion of your costs vary with consumption (e.g. market fees)?

Do you know something we don’t about pool pass through contracts? Have you tried them in the past, how did it work out for you?

If you’d like a copy of the data we used or want to comment about pool pass through contracts call us on (03) 8644 8163.