Long-Term Power Contracts: The Art Of The Deal

Buyers generally acquire a mix of long- and short-term contracts, with the goal of finding the optimal trade-off between price and flexibility.

For both buyers and sellers, forward contracts guarantee the exchange of a known quantity of goods at a known price and for a given time frame. From the buyer's perspective, such a contract not only guarantees delivery of a critical good, at an agreed upon price, but also reduces the costs of procurement operations, as prices do not have to be negotiated continually.

The contract lengths selected generally depend on the lifecycle of the industry and product. For example, in the pork industry, the type of product and product specifications (quality, delivery points, lot sizes, etc.) could be considered constant, and demand easily forecasted. As a result, hog cash contracts typically have durations of 3 to 7 years.¹

Companies such as Intel, with products such as CPU processors that have shorter lifecycles and less predictable demand, negotiate contracts anywhere from every quarter to every several years. Multi-year contracts typically are avoided.²

Electricity, as a commodity, has fairly constant quality and definition, and total market demand can be forecasted reasonably well.³ In other words, electricity can be viewed as a commodity with a long product lifecycle, and contract durations of 3 to 10 years seem reasonable.

Long-Term Cooperative Supplier Relationships

One recent trend in industrial purchasing is a decrease in the number of suppliers and an increase in longer-term contracts and cooperative supplier relationships-bolstering the view that buyers benefit by buying for the long term. This trend provides useful insights for default electric service provision.