Negotiating power contracts: clauses that make or break value

However, procurement professionals can benefit from thinking beyond 'price only' arrangements, considering the other elements that influence total contract value and risk, as well as using tools such as repeatable negotiation checklists. Understanding power contracts and the clauses that help to negotiate not only value, but also shape and volume flexibility. We’ll explore the best way to negotiate electricity supply contracts, focusing on the commercial levers that affect cost outcomes far beyond the simple price per MWh driver.

The hidden value drivers in energy contracts

The headline price is what we call the price of the power at kilowatt per hour, and while this is a key metric in power contracts, it’s not the only important one. Factors such as the flexibility of the contract are also important, for example, how much the contract participants want to flex in relation to volume production levels and what penalties will be applied if those levels aren’t met. We can use this relationship volume tolerance, with specific commitment penalties in place for non-compliance. Risk is also an important factor - how do energy buyers approach force major: the instance that forces outside of an energy producer’s control affects production. 

Clause details are crucial because they allow the energy procurer to adjust levels of responsibility and, therefore, risk, making contracts potentially more valuable. Options such as pay-as-produced rather than baseload contracts allow buyers to pay only for the energy actually generated, which is helpful in renewable energy contracts where production is more volatile.

Cost pass-throughs and how to control them

Energy procurers can structure contracts so that energy bills are split into set pricing and pricing for actual energy consumption, with non-commodity-related charges passed through via a pass-through clause. Certain costs, such as those related to implementing new infrastructure or to government-led policies, such as carbon taxes, can sometimes be passed through to customers. Balancing costs are applied when the scheduled amount of power differs from the actual energy a customer consumes, while supplier fees often relate to administrative or management costs.

All of these pass-through costs must be highlighted, negotiated, and capped before contract signing, with specific caps, floors, and transparency requirements. Take a look at the contract language: is there a lot of flexibility for the supplier with minimal risk? Using data to strengthen your case, for example, looking at historical energy output before deciding on balancing costs, can put you in a good place for negotiation of pass-through clauses.

Volume, shape and tolerance clauses

 Banding for volume deviations

We determine value and risk in contracts such as power purchase agreements (PPAs) using a mechanism called banding, which measures tolerance, shape, and volume differentiators. They examine how much the procurer or producer of energy can deviate from what was entered into a contract, with this specific metric referred to as tolerance. For volume-related banding, clauses may take into account the baseload, or minimum energy delivery commitment, as a marker of the energy that must be produced and the flexibility around those delivery levels. For shape risk allocation, the delivery profile is set against the baseload amount, while also accounting for less steady forms of generation, such as more volatile renewable energy. The difference between expected consumption or production and the actual can result in financial penalties for the supplier or the buyer. While not required by law, penalty structures are among the key elements (and negotiation points) of a power contract. 

Flexibility and renegotiation triggers

Sometimes, a new mandatory government law or a change in legislation can affect energy production or the amount of a specific type of energy a procurer can buy. That’s why legal protections must be put in place for both parties to help manage the risk that these policies may change, particularly in renewable energy and fossil fuel production, which are subject to frequent changes in government policy globally. Clauses should be tight enough to make a contract competitive, but also allow flexibility to accommodate legislative changes over time, particularly in longer-term agreements. These mechanisms can take the form of market-reopeners or renegotiation windows, which would enable contract participants to adjust pricing, delivery, or tolerances after the contract has commenced. In the instance that one party wishes to leave the agreement, suitable termination rights should be negotiated before the contract is finalised, with appropriate exit fees applied.

Building a negotiation checklist

Preparation is key when it comes to negotiating power contracts, with negotiation likely to be more successful if your business’s priorities are decided before opening negotiations, for example, developing a structured clause checklist by risk family.

Different businesses will have different priorities depending on whether risk, value or ethics are more pertinent to your business, so you’ll need to decide which clauses to push hardest depending on your model choice. Making sure that your contract reflects your business's best interests is crucial: it's worth bearing in mind that the best-priced contract can be the worst deal if the clauses are wrong.