Page 14 - CARILEC CE Journal CENOV 2021

BACKGROUND
Electric utility companies which rely on fossil fuels as an energy source often have to deal with the volatility
of fuel prices in the global market. The cost of fuel is often passed through to customers via a fuel clause
adjustment or surcharge on the electricity bill. This means that even if their consumption behavior is relatively
unchanged, customers may experience notable differences in their final bill value from one billing period
to another. Figure 1 shows how the fuel clause adjustment in Barbados fluctuates with market fuel prices.
This instability can make planning and budgeting difficult for both utilities and customers. Therefore, it is
understandable that companies would look for some way to mitigate these variations.

Figure 1. Historical Variation of Barbados’ Fuel Clause Adjustment with Market Fuel Prices
Source: Barbados Fair Trading Commission (2021)
Hedging is one strategy commonly used to address this uncertainty and gain greater control over fuel costs.
1
However, due to its complex nature, some utilities choose not to hedge, leaving their customers exposed to
the volatility of the fuel market through the fuel surcharge mechanism. This mechanism can also disincentivize
utilities from seeking alternatives to hedging, as it allows them to remain unaffected by changes in the market
fuel price. Rather, these changes are passed on directly to the customers. Many different methods of hedging
exist, each of which uses some financial instrument to support the agreement between the parties involved.
For example, several CARILEC utilities use a fixed price swap mechanism. This involves making an agreement
with an entity other than the fuel provider, such as a financial institution, to pay a set price for a particular
volume of fuel for a given period. If the market price increases past the set price, the utility receives payment
of the difference from this entity. Conversely, if market prices fall below this set price, then the utility must pay
the difference. The credits (or payments) received (or made) by the utility are often passed on to customers
via the fuel surcharge. While there is still some variability in the final cost of fuel, the extent of the fluctuation
is diminished, and the utility and its customers are protected against spikes in fuel prices. Figure 2 shows a
comparison of the effects of hedged and unhedged fuel costs on the electricity tariff in Saint Lucia.

1 Hedging is a financial strategy used by some utilities to offset the risk of high market fuel prices.

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