Managing Electricity Costs & Cheap Natural Gas: Keep Heat Rates off The Table for Now

Ryan Basballe

The April NYMEX gas contract recently settled at $2.59/MMBTU, the lowest monthly settlement since June 2012. This underscores current sentiment that the market is well-supplied and short-term outlook is generally bearish, at least for the remainder of the shoulder season.

While customers who previously signed heat rate electricity contracts may be reaping benefits from today’s cheap natural gas, now may not be the best time to enter into a new heat rate-based deal.

Heat Rate contracts are a semi-variable form of electricity supply contract. The customer “locks in” a heat rate multiplier, and the price per kWh is derived from a basic equation:

((Multiplier value * NYMEX gas monthly settlement price) + Retail adder)/1000

In some instances the customer may also lock the cost of gas to further control costs.

The multiplier value is representative of the thermal efficiency of the generation facilities used to supply the electricity. This value can vary in different regions based on the generation mix.

Heat rate contracts present the potential for reducing prices over time when the longer-term outlook for natural gas prices are bearish, while short-term natural gas prices are elevated. Currently, this does not seem to be the case. With natural gas prices currently hovering around 2-year lows, there appears to be more upward price risk versus downward price potential as we move into summer and beyond.

Decreasing natural gas costs are contributing towards higher heat rate multipliers across most markets. Heat rate values are denoted on the right-hand side of each graph.





Signing a heat rate contract with a high multiplier, coupled with increased gas costs down the road, can produce undesirable budgetary outcomes.

However, current conditions are creating a favorable opportunity to enter into a fixed-price power contract for many consumers. For example, in ERCOT commercial customers may currently find it possible to lock in an energy price between $.04-$.045/kWh for the next 12-months or more.

Until NYMEX gas prices return to a state where elevated short-term pricing is paired with a bearish longer-term outlook for natural gas, consumers with a medium to low appetite for risk should strongly consider shying away from signing heat rate deals. Multi-year lows in fixed pricing are offering significant value for most consumers at this time.

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The information in this page is offered only for general informational and educational purposes. It is not offered as and does not constitute legal advice.

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