Have you ever wondered why electricity rates seem unpredictable, or vary significantly between suppliers? Or why these suppliers offer different types of contracts, both in terms of duration and price?
In essence, this largely depends on when and how electricity suppliers buy electricity on the wholesale market. As profit-oriented market actors, they have mechanisms in place to protect themselves from sudden changes in market prices. Understanding this can help you make more informed choices and potentially save money.
Why electricity rates vary between suppliers
Electricity suppliers can choose to buy electricity on the wholesale market at short notice, over the long-term, or through a mix of both.
Think of it like shopping for groceries: prices can vary daily if you buy only what you need, much like electricity on the wholesale spot markets. Alternatively, you can plan ahead and buy in bulk at fixed prices when you deem them interesting, similar to long-term wholesale electricity contracts.
In electricity terms, buying short-term can be risky because prices vary throughout the day and are affected by factors like the weather or demand from industry. Buying long-term means suppliers lock in prices for a longer period – for months, a year, or even longer. This approach provides stability and allows suppliers to offer customers more predictable retail electricity rates. Although, it also means they need to forecast wholesale market trends accurately to avoid overpaying for electricity.
An electricity supplier defines its commercial strategy based on the mix of households and businesses it serves, and on its business goals. In turn, this affects the retail prices and contract types offered to consumers.
Hedging: keeping prices predictable
Electricity suppliers also use a strategy called ‘hedging’ to protect themselves against sudden increases in prices in the markets where they buy electricity. Through hedging, they can lock in the price for a share, or the totality, of their electricity purchases in advance, using financial tools such as futures and options.
For electricity suppliers, hedging functions as a form of insurance against price volatility, helping them maintain predictable costs and offer more stable rates to consumers. It also protects them from major financial losses and the risk of bankruptcy.
However, like any insurance, this protection comes at a cost. Suppliers pay a premium to reduce their exposure to price fluctuations, and this cost is typically reflected in fixed-price contracts. As a result, fixed-price contracts are generally more expensive than dynamic contracts, which pass market price fluctuations directly on to consumers.
Diverse contract offerings
Based on their commercial strategy, electricity suppliers offer different types of retail electricity rates and contracts.
Fixed-price contracts include ‘flat-price’ contracts, which offer consumers a stable and predictable rate for electricity over a set period. This provides a safe option for those who are cautious of unpredictable price rises, but it also means that they cannot benefit from short-term drops in electricity costs. This is particularly relevant for consumers who own electric vehicles or heat pumps, and who can shift or adapt their electricity consumption in response to short-term electricity price changes.
Fixed-rate contracts also include ‘time-of-use’ contracts, where electricity rates are higher during periods of high demand, such as during the day, and lower during periods of low demand, like nights or weekends.
By contrast, variable contracts link retail electricity rates more closely to wholesale market prices, usually on a monthly or quarterly basis.
Some suppliers now offer dynamic price contracts, where the electricity price changes frequently, for example hourly or every 15 minutes, depending directly on the conditions of the wholesale electricity market. To reduce bills, households can monitor their consumption and prices through a smart meter and use electricity during lower-priced ‘off-peak hours’. However, the overall benefits of dynamic pricing depend on consumers’ ability to shift their electricity consumption to times when prices are cheaper.
Making the best choice
Electricity bills have 3 main elements: the cost of the electricity you consume, network charges and taxes and levies.
Choosing the right electricity contract can have a significant impact on your monthly bill. That’s why the most recent change in EU electricity rules introduced measures to encourage the uptake of long-term contracts and the use of sufficient hedging strategies for electricity suppliers, ensuring greater predictability and clarity for consumers.
Using national independent comparison tools can help you find a competitive electricity supplier and select the best contract for your needs, with potential savings averaging over €150 per year in the EU, with the current market conditions. Electricity costs typically make up the largest part of your bill, so making an informed decision is important.