Energy Pricing Explained: Pass-Through Costs in Electricity

The energy market can be difficult to understand — and making the best choice for your business may seem like an overwhelming task.

In our recent article on cost components, we focused on the multiple components that comprise your energy bill and influence power and natural gas pricing. (If you haven’t read that article yet, we recommend you start there!)

By understanding the pricing components that go into calculating your price for electricity, you’ll be better prepared to ask questions about what’s included in the price you’re quoted — and better positioned to make decisions about which product, offer and supplier works best for your business.

In this article, we focus on an important component of your electricity bill: pass-through costs.

What are pass-through costs?

An electricity bill can include both expected and unexpected pass-through charges.

Expected charges are clearly outlined in your utility bill. There’s a defined method for billing these costs, though they aren’t always included within the contract price. These charges are known components and are often referred to as ancillary services.

Unexpected charges are just that — costs you don’t anticipate. In some cases, a traditional fixed rate with an “all-in” price tag may present a customer with an unexpected cost. If demand-based charges are wrapped into a fixed rate, but an independent system operator (ISO) or regional transmission organization (RTO) changes its formula, the extra cost can be passed on to the customer. This is, of course, an unwelcome surprise for businesses that depend on budget certainty. These unexpected costs often aren’t clear in a contract and can come through as a hidden fee. This can happen for a variety of reasons, including a change in law, making these unexpected costs reactionary charges.

It’s also important to note that pass-through costs can be either recurring or non-recurring, such as a monthly standard delivery charge or a charge to disconnect electricity service.

Examples of pass-through costs

The following charges account for the costs that the electricity industry incurs in delivering energy — and the costs passed on to the customer though changes in the market.

Reactionary (unexpected)

• Regulatory decision or change in law: Most suppliers have this section in their agreement, which may cover a wide variety of changes that impact your price.
• Weather: Drastic changes in temperature can affect supply and demand.
• Material deviation: This is designed to give suppliers notice of any changes to their customers’ long-term usage, which is known as load.

Ancillary services (expected)

• Capacity: This ensures there’s enough generation at a single point in time to meet peak demand at highest consumption hours.
• NITS: Network Integration Transmission Services (AKA NITS) are charges that are controlled by the ISO or RTO.
• Balancing: This may show up as a charge or credit according to real-time deviation from day-ahead energy position and vary by grid operator.
• Congestion: An undefined cost to get power to the grid, particularly in more populated areas.
• Reliability Must Run (RMR): A fee to help meet grid demand during energy emergencies, such as periods of extreme temperatures.

What you need to know about pass-through costs

It’s important to note that there isn’t a standard for how (or if) pass-through costs are applied. That’s why doing your homework before selecting a supplier and a pricing strategy is so important.

Here are some things to consider:

How much do these costs affect your energy bill?

Although pass-through charges vary, they do consistently make up a sizeable portion of the average energy bill.

How can you manage a supplier’s pass-through charges?

It can be easy to overlook this part of an energy supply contract, but managing what you’re charged for pass-throughs is critical. For many businesses, energy efficiency is part of the strategy, so you’re already putting thought into curtailment. Continual audits and review of your energy charges can also help to ensure you are managing these costs.

What should you evaluate?

When reviewing your energy options, ensure there’s an apples-to-apples comparison of electricity capacity pricing. Be sure that the contract language doesn’t allow for tag changes or result in prices being passed through that are not associated with change in law language. Having a knowledgeable energy partner who you trust to vet out the agreement is very beneficial to make sure you are not taking on potentially significant, unnecessary risk.

When you compare fixed-price options, make sure to pay attention to expected pass-through charges. Some suppliers include them as part of the fixed rate. But when these components are forecasted and locked in for the length of an energy contract — often several years — you may end up paying a premium on them. You may also miss out on potential year-over-year savings from your peak load curtailment, which refers to reduction in energy usage during a brief period of time when your demand is the highest.

Learn more about your options for managing your energy costs here.