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The Procurement Professional’s Guide to Negotiating Energy Supply Agreements Part 4: Usage Bandwidth

If you have been following along with our five-part series on negotiating energy supply agreements, we are now up to part four where we will discuss the issue of “usage bandwidth.” Our final part in the next issue will highlight “material change” language, and we will circle back on how all of these pieces contribute to an energy supply agreement that is either in your favor or in the supplier’s favor.

We talk a lot about “risk” when we negotiate an energy supply agreement, and each of the five key aspects highlighted in this series contributes a different piece to that risk puzzle:

  1. Payment terms
  2. Termination fees
  3. Adding and deleting accounts
  4. Usage bandwidth
  5. Material changes

The risk (and the associated cost) is either shouldered by you, the buyer, or by the supplier. As with all of these aspects, the final negotiation typically falls somewhere in the middle where there is an equal amount of risk borne by both parties. But this requires attention on your part to make sure your contract terms are favorable.

The concept of “usage bandwidth” has to do with the certainty of how much energy you will use (electricity or natural gas) in any given month. The risk taken on by the supplier is that they plan on you using a certain amount of energy. If you use significantly more or less than they anticipated, the supplier must then buy extra energy or sell unused energy back potentially at a loss to them financially. Addressing “usage bandwidth” in your supply contract is the supplier’s way of potentially shifting that risk burden back over to you, the buyer.

So now, let’s take a look at the most common ways “usage bandwidth” is addressed in supply contracts in its full range from language that puts all the risk on you the buyer to language that shifts all the risk back onto the supplier.

Zero Bandwidth

Zero bandwidth (or “swing,” as it’s referred to in some electricity contracts) means that the contract rate you have secured applies specifically to the estimated usage stated in the contract at the time of signing. Many contracts will have an attachment that shows how much energy you are estimated to use in each month of the contract. If you have zero bandwidth, your bill each month will be based on your contract rate applied to the estimated usage for that month.

Since only a clairvoyant would know exactly how much energy you are going to use in the future, you will then have additional line items on the bill to address the actual usage for that month. Any energy use over your estimated quantity is billed at some type of “market rate” reflective of actual market pricing for that month. If you use less energy than estimated, the excess quantity is sold back to the market and you are credited back based on the “market rate” and/or profit/loss of the supplier for that transaction.

The key to this contract language in many cases is how the supplier defines “market rate.” That definition can range all the way from a clearly defined index to a vague number set by the supplier. As a savvy buyer, it is your responsibility to negotiate this language so that you are comfortable with how this would be applied.

Your organization can be helped or hurt from a cost standpoint, depending on what direction the market has moved since securing your fixed contract rate. Unused energy could potentially be credited back to you at a higher rate than what you are paying for the fixed portion. If the market has risen, though, you will end up paying more for excess energy you use. The bottom line is that a zero bandwidth contract puts more risk on the buyer, and makes budget certainty very difficult to achieve.

Bandwidth tends to be one of those areas with significant room for negotiation – it just depends on your comfort level for risk and the amount of budget certainty you seek.

Bandwidth as a Percentage of Usage

A more middle-of-the-road solution to addressing this issue is to have bandwidth defined as a percent of usage in the contract. Commonly, this ranges from 10% – 25%. The same concept applies as in zero bandwidth language, but after applying these percentages. The contract estimates your monthly energy quantities, but if your usage exceeds the percentage level, you are charged a market rate for those quantities exceeding the percentage. The same equation applies if you use less energy than estimated: You are credited for the portion of unused energy that falls below your estimated percentage.

Let’s say you have a 25% bandwidth electricity contract at a fixed rate of $0.05/kWh for an estimated monthly volume of 100,000 kWh. Your actual usage for that month is 135,000 kWh. Based on the 25% usage bandwidth language, the fixed rate of $0.05/kWh applies to 125,000 kWh. The remaining 10,000 kWh is charged at the market rate for that month, which in a rising market could be, say, $0.065/kWh. This approach really splits the risk between the buyer and seller in terms of planning on energy usage and quantities. It also provides more of a stable budget than a zero bandwidth contract.

Unlimited Bandwidth

This approach is the best way to achieve budget certainty with an energy contract. This option places all the risk back on the supplier; therefore, there is typically a higher price attached to this type of contract. Unlimited bandwidth can also be presented as 100% bandwidth. In some cases, contract language will specifically state 100% bandwidth (meaning, technically, you could double your estimated usage with no change in price), or there may be no language at all in the contract – indicating unlimited bandwidth.

This type of contract is as it sounds. You use as much energy or as little energy as you need, and you are still only charged the fixed price for the energy you use. The supplier runs the risk of having to sell back unused energy into the market or buy extra energy, but it gives the buyer the peace of mind that “the price is the price.”

Conclusion

As we’ve learned with all of these terms in negotiating energy supply agreements, price shifts with risk. When a supplier accepts contract language – resulting in them taking on the risks associated with each of these areas, such as “usage bandwidth” – this is typically considered a “premium” from a contracting standpoint. And premiums tend to come at additional cost.

As you negotiate these terms within your contract to be more favorable to you, the contract price for the supply of energy will go up. Conversely, if you accept terms more favorable to the supplier, you can typically secure a lower rate.

All of this must be evaluated together to see what the overall impact will be to you on your price. It is not always the best position to just push all of the risk back on the supplier, if the end result is a much higher price for you. Usage bandwidth tends to be one of those areas with significant room for negotiation – it just depends on your comfort level for risk and the amount of budget certainty you seek.

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