Pros & Cons of an Index Product

Pros and Cons of an Index Product

By Michael DeCaluwe

Occasionally I will get asked about what is a better energy solution — fixing energy or selecting an index product.

Answering that question involves both understanding what an index product is and knowing your specific energy needs and risk tolerance.

What is an index product?

On an index product, your energy rate fluctuates with the market and varies month to month. Your monthly electric rate is based on an hourly rate published your regional electric grid operator.

The utility’s meter takes hourly reads of the amount of power consumed,  and the hourly quantities are charged at the grid operator’s hourly rate. This is your indexed power rate.

Index power rates are typically low at night and during the spring and fall. Rates are higher during “peak” usage hours (8AM-5PM) and during summer and winter when energy demand is at its highest (for heating and cooling needs). Your electric invoice is the total of all these hourly costs for the month.

Are you a good fit for an index product?

An index product is a good choice if you can tolerate volatility or if energy makes up a small portion of your operating costs. Over time, index energy costs have historically been lower than fixed costs because there are no supplier risk premiums built in.

You could also benefit from an index product if you can shift your load to off-peak times. You could take advantage of the lower off-peak hourly rates.

Lastly, if you have a pending energy efficiency project or load management upgrade, consider choosing an index product until the project is completed. Then, you can lock the lower rate that could result from the project.

What’s the difference between being on an index product with a supplier and being with the utility?

If you’re not under contract with a third-party supplier, then you are receiving your electricity directly from the utility. Some utilities offer an hourly index supply rate.

However, there are several differences between the utility’s index product and a supplier’s:

  • A supplier’s index rate (Day-Ahead) can be less volatile than the utility’s (Real-Time) based on the types of indices they use. In some hours, this difference can be as high as 20%.
  • The utility could be socializing non-energy costs, which would increase your index rate.
  • The utility must accept all customers into its programs, while a supplier has credit thresholds.
    • In some markets, customers on utility supply may end up paying for receivables from uncollected supply costs.
  • If a company ever wanted to fix a portion of their future load, the process would be easier if they were already on an index product with a supplier.

If none of these issues are a concern, then the utility could be a good option for you.

Is there more or less risk with an index product?

Although an index product for power has historically been less expensive than a fixed product, it is not risk-free.

For example, during the polar vortex in January and February of 2014, utility index rates were as high as 4-5 times the average price of energy for these months.

Can you take the risk of having your energy costs be 30-40% over budget? Most energy buyers say they can’t take that risk, which is why they typically select a fixed product.

Also, an index product doesn’t give you the ability to budget for energy expenses. For budget-conscious organizations, an index product is not a good choice.

Index at your own risk.

Index energy solutions can be a good fit for some energy consumers. However, you need to know both the benefits and the risks that come with them. The decision to select an index product should be part of a long-term strategy rather than a short-term gamble to save on energy costs.

Please comment below with your questions and thoughts, and feel free to contact me directly if you’d like to hear more.

 

About the Author

Michael is the Senior VP of Commercial & Industrial Sales at Nania Energy Advisors, where he as worked since 2007.       He believes that listening to and understanding clients’ energy needs is vital to becoming a thought leader in the industry and forming a mutually beneficial business relationship. In his spare time, Michael enjoys being a dad, staying active, and playing basketball.

Michael can be reached via email at mdecaluwe@naniaenergy.com or via phone at (630) 225-4552. Click here to follow him on LinkedIn.

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