What goes in to longer term natural gas and electricity pricing?

August 26, 2016

If you are shopping for electricity or natural gas contracts, you’re most likely going to find one common theme: longer-term contracts will be more expensive per unit of consumption than shorter-term contracts. The explanation for this is very simple: since longer-term commodity contracts offer price protection for a longer period of time than shorter-term commodity contracts, the risk on the product increases. Naturally, the further out the contract goes, the more risk is involved.

Longer-term energy contracts may protect from future market fluctuation

Essentially, by locking in a long-term energy contract you are purchasing the certainty of price now for the energy you will consume later. And when market prices are at very low levels, it could be a great time to lock in. For example, natural gas costs recently hit a 17-year, historically low rate. Locking in may help you avoid the potential shift in the natural gas and electricity pricing market in anticipation of rising energy prices.

Your supplier assumes the financial risk of commodity pricing

Prices are always fluctuating and there are many variables that can impact the price of natural gas and electricity, such as:

  • Weather and seasonal shifts (Remember the Polar Vortex of 2014?)
  • Supply and demand
  • Standard inflation
  • Political issues

All of these factors can significantly influence future energy prices; and while energy suppliers take all of these factors into account, there is no crystal ball to energy pricing. So, suppliers are taking on a financial risk when purchasing energy into the future for their customers. This is the reason why longer-term energy contracts are typically priced higher than shorter-term ones.

However, even though long-term prices may be higher to start, a longer term contract allows consumers to avoid a potentially higher cost in the future. Starting at a historic rate, for instance, can position the savvy consumer (with a long-term plan) to reap significant benefits for several years.