What is the difference between a fixed contract and a pass through electricity contract?

There’s no one size fits all when it comes to business electricity contracts. There are a wide variety of electricity consumers, ranging from the small shop to the large factory assembly line. Consequently there over 150 different products and contracts designed to suit the varying demands of UK business consumers. Generally the smaller the electricity demand, the more straight forward the contract. Half Hourly electricity clients, the larger consumers, are already familiar with the choice between a traditional fixed, versus the more complex pass through contract. Thanks to Ofgem’s P272 mandate, the launch of AMR devices for all Maximum Demand 05 – 08 Non Half Hourly meters, the fixed versus pass through dilemma will become more common for the ‘mid-sized’ business consumer in the future.

It is difficult to know which type of contract is correct for your needs, here are some basic thoughts to help you decide.

It is important to note, that contract Terms and Conditions differ from supplier to supplier. What one supplier refers to as fixed may differ to another supplier’s definition. Comparing prices for yourself will become more and more problematic as you are likely to end up comparing apples to lemons since offers can differ significantly. The problem is exacerbated by the fact that it is not unheard of that staff at some suppliers do not even fully understand what is included and what is excluded. In addition, the situation is constantly changing so you have to keep up to date with changes to ensure a genuine comparison.

Pass-through contracts explained

Imagine the price of petrol at your local garage forecourt. The price per litre is made up of many things, not just the cost of the fuel itself. Similarly, your electricity tariff is made up of numerous things with the actual cost of the power being just one part (see the headline diagram).

On a typical energy contract the non -power element of the bill, known as non -commodity costs, can be as much as 60%. The percentage might come as a surprise but it is made up of elements such as infrastructure costs to get power to your premises and the levies and taxes to secure future generation.

A pass-through contract splits your bill in two between the “fixed” power element, which you pay throughout your term and these non-commodity costs, which may vary over time. The basic premise is that the supplier passes these non-commodity costs direct to you and the risk (to your business) that these may increase over time. With a pass-through, you take the risk of these non-commodity costs increasing.

You also take the risk of being exposed to triad charges. Triads are how the National Grid charges for network (TNUoS) use and are calculated based on each meter’s average usage. This is calculated by measuring across three periods, between November and December. If you do not actively manage your usage during these triad periods you may see significant increases in your costs.

A fixed contract does what it says on the tin; all the elements are set out for the duration of the contract. If either of the elements increases or decreases, then it’s the suppliers’ risk and you don’t pay anything further.

Both fixed and pass through contracts have their merits, the below plain language advice is designed to help you to decide with option is best for your organisation:

Fixed Electicity Contract: You agree to rates and charges upfront.

Fixed Pros:

  • Budget certainty.
  • Ease of administration, no need to reconcile, or work around fluctuating costs.
  • Supplier absorbs all the risk.
  • Great if you anticipate rising future commodity and non-commodity costs (market has risen over 143% in the past 10 years).
  • Good if you have to pass on costs to tenants/clients, enables you to plan ahead.
  • Less complicated.
  • Advantageous if consumption is expected to drop in the future, and there is no volume tolerance penalty, you can secure costs based upon a larger historic consumption, benefiting from scale of economies.

Fixed Cons:

  • Supplier absorbs the risk, which increases costs.
  • Do not allow you to take advantage if costs fall in the future.
Pass Through Electricity Contract: You agree to some, not all rates and charges upfront, with the remainder being ‘passed through’ to you at cost.

Pass Through Pros:

  • Consumer takes on more risk, which lowers the costs.
  • Enables you to benefit if costs fall in the future.
  • Good for clients who can shift usage patterns to avoid ‘expensive times’ such as lowering consumption during M-F 16:00 – 19:00 November – February.

Pass Through Cons:

  • No budget certainty.
  • More administration burden as costs fluctuate.
  • More complicated.
  • Cost estimates are no guarantee of future costs.
  • If you consume energy during ‘expensive times’ you will be subject to very expensive charges.
  • Previous costs are no guarantee of future costs.  Increases in Triad charges alone have gone up by 80% over the last five years and are expected to increase by up to 40% to 2020.
In brief…

If you are risk averse take the simple route, opt for the low stress, low administration burden that is a fixed contract and comes with the benefit of peace of mind.
If you can tolerate risk, do not require a firm budget, and are prepared for more involvement, consider a pass through contract as a means to potentially lower your electricity spend.

When considering pass through type contracts, be sure to read the fine print of a contract, these contracts by their very nature can be difficult to understand and which elements are fixed and classed as pass-through can also vary between suppliers. Pass-through contracts can be advantageous if you fully understand how to use them to your advantage, but they can also cost you a lot more, if not correctly managed.