When evaluating offers from electric suppliers, many businesses tend to focus on price. Price is an important variable – don’t get me wrong. But an often overlooked variable is tied to “pass-through charges.” It’s an important part of electricity procurement.
What are Pass-Through Charges?
Pass-throughs are new or incremental costs incurred by the supplier passed onto the customer. Pass-throughs appear on electric suppliers’ invoices. They can either be itemized or reflected as a price adjustment.
Pass-through charges generally reflect cost increases, not cost decreases. When a pass-through results in an upward adjustment to an invoice, the total per-unit of cost of electricity increases.
Most importantly, suppliers can pass through incremental costs during a pre-negotiated fixed-price electric contract.
Why do electric suppliers do Pass-Throughs?
In general, fixed price offers from electricity suppliers include their costs and their margin. Some of their expenses are internal, like commodity costs, operational costs, and risk premiums. But some are external. An example of an external cost would be “generation-related capacity costs.” Regional transmission organizations like PJM collect generation-related capacity costs from suppliers to support the operations of network power generators. Suppliers, in turn, collect these expenses from their customers.
Generation-related capacity costs change every June 1 in the PJM network. If this cost goes up for electric suppliers, they may initiate a pass-through charge to collect the cost increase from their customers. Without the ability to do pass-throughs, some suppliers may find that their electric deals transition from profitable to unprofitable.
Suppliers Do Not Treat Pass-Throughs The Same Way
Not every supplier does pass-through charges, but some do. But, not all suppliers that do pass-through charges do them the same way . Two suppliers may initiate pass-through charges to recover an increase in the generation-related capacity cost, but each may calculate and allocate these costs differently. In other words, the same pass-through event could have two different cost consequences, depending on the supplier. One supplier passes through a higher charge, the other a lower.
Given the variability, businesses must value potential pass-through cost impact.
Pass-Through Charge Example
Let’s run through an example.
A business receives two fixed price offers, both at $50/MWh. Both suppliers are subject to the same external cost increase. Supplier 1 passes through $4/MWh in incremental cost, but Supplier 2 elects not to initiate a pass-through charge.
Although the fixed price offers were the same, the proposal from Supplier 2 was the better value. Because of the pass-through charge, the deal from Supplier 1 was ultimately more cost-effective.
Why Are Pass-Throughs Overlooked?
Many businesses don’t value pass-through potential because they don’t know they need to. Suppliers provide consumers with price offers because that is what consumers’ request. The prices don’t reflect the potential for pass-throughs. In other words, pass-through isn’t a price-offer issue; it’s an electricity contract issue. Suppliers tend to avoid the pass-through conversation outright, as highlighting the issue could scare a customer away. When they do, they may infer that all suppliers treat pass-throughs the same, which isn’t true. Moreover, many electric agreements are vague about pass-through charges.
What’s A Business To Do About Pass-Through Charges?
Businesses need to get a handle on pass-through charges to properly value electric supply deals. Due to pass-through increases, a supplier with the best price might not have the best deal because it will result in the highest total cost.
Businesses can ask suppliers questions like:
- Do you do pass-throughs?
- What can initiate a pass-through charge?
- What does not constitute a pass-through?
- How do you differ from your competition regarding pass-throughs?
- What is my potential pass-through cost?
- Can pass-through ever reflect a cost decrease?
- How do I know you will treat me fairly if your company initiates a pass-throughs?
- Where are pass-through charges in the electricity supply agreement?
Pass-Through Charges: A Wrap-Up
Businesses need to consider the potential impact of pass-through charges when doing electricity procurement. Suppliers can initiate pass-throughs to recover new or incremental costs that they become responsible for during an existing electricity supply contract. Not all suppliers treat pass-throughs the same. Businesses should ask suppliers about the potential implications tied to pass-throughs, as pass-throughs tend to be addressed in electricity supply contracts.