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Energy Strategy: Flat Bills, Peak Satisfaction?

 

Why a risk-hedging product for small customers isn’t the gamble you may think.

Fortnightly's Energy Customer Management - Jan-Feb 2002

the customer. Conversely, if mild weather occurs, then the amount collected by the flat bill would be greater than the amount otherwise paid by the customer.

In some industries this risk might not be manageable; however, in the electric industry it acts as a natural hedge. In hot weather years, when the flat bill is under-recovering, the company is generating unusually high returns from its other weather-sensitive customers not on the flat bill. In mild weather years, at the same time the flat bill is over-recovering, the company is generating unusually low returns from its other weather-sensitive customers. Some energy companies in the industry even purchase weather insurance, a hedge the flat bill program provides for free.

Another financial risk is the change in individual customer behavior. During the first year it is impossible to predict how an individual customer may respond to the flat bill. But the overall average response can be anticipated and distributed evenly into all customers’ flat bills during the first year. In fact, changes experienced with customers volunteering for budget billing can be used as a good first approximation. When a customer renews their offer, however, their actual usage with their demonstrated behavior change could be built into the renewal offer instead of that for the average customer. This practice in itself can be expected to reduce inefficient consumption changes. 

An additional risk is that a customer might use more electricity during the first year than predicted, and then decide not to renew. This “free-ridership risk” can be measured and forecasted. The predicted impact can then be built evenly into all future customers’ flat bill offering. We theorize that even if participants return to the traditional pricing tariff, they will retain some residual behavioral changes that will generate further profitable sales.

Finally, you have risk associated with the accuracy of the cost variable going into the flat bill pricing model. That variable includes the predicted base energy price and fuel price, customer billing history, predicted customer behavior and the accuracy of the weather-normalization model. How does the flat bill compensate the supplier for these financial risks? The answer is the risk adder. We have already determined that customers are willing to pay a premium to have this risk transferred to the supplier, so if customer sensitivity to the risk adder is equal to or greater than the acceptable risk of these components, then this portion of the risk can be managed. 

To manage the portfolio of financial risks, we created a spectrum of potential outcomes based on all risk variables. We tested the severity of these risks by creating a range of worst-case, expected and best-case scenarios, where the risks can be quantified and therefore managed through the flat bill price. 

Reality Check. The financial results of the pilot during the 12-month period supported the hypothesis that the risk could be managed. The actual outcome fell within the risk spectrum and very close to where we predicted given the actual outcome of each risk variable. That does not mean that the financial results were positive. In fact,