Fixed, index and block-and-index: what you are actually choosing

Fixed

A fixed price contract sets the supply rate for the term. The supplier takes on the risk that wholesale prices move against it, and prices that risk into the rate.

What you get is budget certainty. What you pay for it is a risk premium — the amount by which the fixed price exceeds what the supplier expects the energy to actually cost. That premium is real and it is generally larger for longer terms and for more volatile markets.

A fixed contract is not a bet that prices will rise. It is the purchase of certainty, and it is worth what certainty is worth to your particular business.

Index

An index contract passes wholesale prices through as they occur, usually with a defined adder for the supplier's costs and margin. There is no risk premium because the supplier is taking no price risk.

What you get is the absence of a premium and full participation if prices fall. What you accept is full exposure if they rise, including during the kind of extreme events that periodically occur in wholesale power markets.

Index is appropriate for organisations that genuinely can absorb a volatile month and that have someone paying attention. It is inappropriate for a business whose margins cannot survive a bad quarter, regardless of what the long-run average might be.

Block and index

A hybrid: a fixed block covers a defined portion of expected consumption, with the balance indexed. The proportions are negotiable.

This suits accounts with a predictable base load and a variable increment — which describes a great many commercial operations. The base is hedged, the variable part is not, and the premium is paid only on the hedged portion.

The questions that actually decide it

Not "where do you think prices are going", which nobody reliably knows. These:

• What does a bad month do to you? If a doubled energy cost for one month is survivable, index is on the table. If it is not, it is not, whatever the expected value calculation says.
• Do you need to budget a number? Some organisations genuinely must commit to a figure. That is worth a premium and there is no shame in it.
• Who will watch it? An index contract with nobody monitoring it is an unmanaged exposure rather than a strategy.
• How predictable is your consumption? This determines whether a block structure makes sense and how large the block should be.
• What is your risk tolerance as an organisation, as opposed to the risk tolerance of whoever is signing?

What to check in either structure

The headline structure tells you less than the terms beneath it. In particular, examine the pass-through clauses: even a contract described as fixed commonly passes through certain components, and which ones are fixed versus passed through varies substantially between suppliers.

Also check the bandwidth or swing terms, which define what happens if your consumption differs from the contracted volume, and the conditions under which the supplier may reprice.

Common questions

Is a fixed or variable electricity contract better for a business?

Neither is universally better. A fixed contract buys budget certainty at the cost of a risk premium. An index contract avoids the premium but carries full price exposure. The right choice depends on what a bad month would do to the business and whether anyone will monitor the position.

What is a block and index electricity contract?

A hybrid structure where a fixed block covers a defined portion of expected consumption and the balance is priced at index. It suits accounts with a predictable base load and a variable increment.

Does a fixed electricity contract fix my whole bill?

No. It fixes a defined portion of the supply rate. Delivery, demand and fixed charges remain regulated, and many fixed contracts still pass through certain supply components. The pass-through clauses determine what is actually fixed.

Related