When you’re buying electricity in a competitive market, one of the fundamental choices you’ll face is how to pay for your energy: do you lock in a fixed price or do you let it float at an index rate tied to the market? This decision can have a big impact on both your costs and your risk exposure. Here, we break down what each pricing model means and discuss their pros and cons for commercial energy buyers. By the end, you should have a sense of which approach (or which mix) might be the best fit for your organization’s needs and risk appetite.
Fixed Pricing – Budget Certainty at a Premium: A fixed-price energy contract means you and the supplier agree on a set price per kWh (or per MMBtu for gas) that you will pay over the contract term, regardless of what happens in the market. It’s like locking in a mortgage rate – your energy cost becomes predictable. For example, if you sign a 2-year fixed contract at 8 cents/kWh, you know that’s what you’ll pay for every kWh used in those two years (excluding separate utility delivery charges or taxes). The big advantage here is stability: you can budget energy expenses with confidence since the rate won’t spike even if there’s a heatwave, a fuel shortage, or other market turmoil. Many businesses value this certainty highly – especially if you operate on thin margins or have fixed budgets. It’s essentially an insurance against volatility.
However, fixed rates often include a risk premium. Because the supplier is taking on the risk of future price fluctuations, they tend to set the fixed rate a bit higher to cover worst-case scenarios. If market prices drop later, you could end up paying above-market for the remainder of your term. Also, fixed contracts can have commitment periods (1, 2, 3 years are common), so you’re locked in – if you try to exit early to chase a lower price, there might be exit fees. That said, a well-timed fixed contract can save you a lot if prices skyrocket, and it shields you from any market-driven bill shocks. It’s a trade-off: pay a bit more potentially, in exchange for peace of mind.
In summary, choose fixed if: budget certainty is crucial, and you’d rather pay a known slightly higher rate than gamble on market swings. It’s ideal for organizations that are risk-averse or unable to absorb budget variances. (Imagine a municipality or a school with a fixed annual budget – they often opt for fixed contracts.)
Index Pricing – Riding the Market for Better or Worse: An index (or variable) pricing plan pegs your rate to some market benchmark, often the wholesale market price (such as day-ahead or real-time prices in your region). Essentially, the price you pay will change over time (typically monthly or even hourly) depending on market conditions. For example, you might agree to pay the day-ahead market price for each hour plus a small adder for the supplier’s margin. If the wholesale price is 5 cents one month, you pay 5 (plus margin); if it’s 12 cents the next month due to a cold snap, you pay 12.
The obvious benefit of index pricing is that when market prices are low, your costs can be significantly lower than a fixed rate. Over a long period, some buyers with index exposure manage to save money because they catch the market in its lows – especially if they have the flexibility to reduce usage during high-price periods. Index can also be good if you suspect prices will fall in the future (though speculation is always tricky). Another advantage: usually there’s more flexibility – index contracts might be short-term or even month-to-month with easier exit, since you’re not asking the supplier to guarantee a long-term price.
The downside is volatility and unpredictability. Your energy spend can swing widely. If there’s a price spike (e.g. a polar vortex drives electricity to $1.00+ per kWh for a period, as has happened in extreme cases), you’ll feel the full brunt of it on your bill. This can wreak havoc on budgets if not managed. Index pricing essentially transfers the price risk to you, the customer. You must be willing and financially able to handle potentially sharp increases. It often requires more active management – watching market trends, maybe hedging partial volumes (we’ll touch on combining strategies shortly).
In short, choose index if: cost savings is your goal and you have a higher risk tolerance, or if you can be nimble in adjusting usage. Some large, sophisticated energy users with dedicated energy managers will take indexed pricing and then strategically hedge or reduce usage during expensive times (for example, a factory might plan maintenance shutdowns during predicted price spikes). If you’re considering an index strategy, ensure you have contingencies for high-price events and buy-in from finance that bills may fluctuate.
Hybrid Approaches – Best of Both Worlds? Many commercial buyers actually do a mix: they secure a fixed price for a portion of their usage and leave the rest on index. This is often called a block-and-index strategy or partial hedging. For instance, you might lock in a fixed rate for 70% of your expected load (ensuring that chunk is price-protected) and float the remaining 30% on the market. This way, you have a baseline of stability but still can benefit if market prices dip on the portion that’s indexed. We delve more into such hybrid contracts on the Types of Energy Contracts page. The idea is to hedge your bets – literally. Another approach is layering timing: maybe you lock in year one and plan to ride index in year two, hoping market conditions improve – though this is more speculative.
Which is right for you? It ultimately comes down to your company’s risk tolerance and budgeting needs. Here are a few guiding questions to ask internally:
- Can we handle budget volatility? (If no, lean fixed. If yes, maybe index or partial index.)
- Do we have any market insight or flexibility to respond to prices? (If you have energy management capability, index could be leveraged; if not, fixed keeps it simple.)
- What are prices doing now, historically? (If prices are at a relative low, fixing now could lock in savings. If they’re high and expected to drop, maybe wait or do short term.)
- Is sustainability a factor? (Sometimes renewable contracts or PPAs behave like fixed or index differently – see Sustainability page; for example, a solar PPA might be a fixed price for 15 years which could influence your strategy.)
One useful strategy if you’re unsure: start with mostly fixed, and experiment with a small portion on index to see how it goes. Over time, as you become more comfortable, you can adjust the mix in future contracts.
Key takeaway: Fixed = Stability, Index = Flexibility (with Risk). There’s no one-size-fits-all answer; two businesses could make opposite choices for valid reasons. The good news is deregulated markets give you the freedom to choose, and even change your mind next contract if one approach didn’t fit.
(After grasping fixed vs. index, you should also understand how different contract types handle costs – for example, some “fixed” contracts still pass through certain charges. Continue to Understanding Your Electricity Bill to learn what goes into your energy cost, and Types of Energy Contracts for how suppliers structure deals beyond just fixed/index.)