Struggling at the margins: Residential electricity retail rate updates

Let us say I am an electricity retailer who wants to serve residential customers. I have heard that people like fixed-price contracts and I want to provide those contracts. I don’t like gambling, so I want to make sure that I make a consistent profit on all my customers.

But how can I make a consistent profit when energy prices change every hour?

Enter energy futures

A normal way to make a consistent profit as an electricity retailer offering fixed-price contracts is to buy energy futures to cover the future consumption of all customers. That way, I always know how much the energy I provide to customers will cost. If the rate I charge customers is The cost of energy futures for the customer + a profit margin and I buy the correct amount of futures to cover the customer’s consumption, then I have a good business where I will get a consistent profit margin. Unfortunately, it is not easy to charge customers for the cost of energy futures for two reasons:

1. The price of energy futures changes every day
2. Energy futures can only be purchased in relatively large quantities. It is not possible to buy energy futures for an individual residential customer – it is only possible to buy energy futures for a group of customers

Remember that these contracts are fixed-price. During the contract term, the price for a given customer will not change. However, I can change the price that I offer to new customers (or renewing customers) as often as I want. Now I am wondering, how often should I update the rates offered to new customers to maintain a consistent margin?

Worst-case scenario simulation

First I want to look at the worst-case scenario where energy future prices increase every day. I created a simulation to explore this question based on some assumptions:

1. I acquire 1 new customer every day
2. I can buy energy futures to cover 10 customers’ consumption. Therefore, I will buy energy futures every 10 days (based on the previous assumption)
3. Energy future prices increase by 1 every day
4. I simulate 100 days

In this worst-case scenario, I am undercharging every customer. But the more frequently I update customer rates, the less I undercharge. The results of this simulation look like this:

In the worst-case scenario, updating customer rates daily is almost 2X better than updating rates every 10 days. This scenario may not seem very realistic, but this is how energy future prices look for Texas in 2025:

Let’s move on from the worst-case scenario to a more general analysis.

Simulation with random energy future prices

We can simulate many different scenarios by generating random energy future prices. I decided to randomly generate a number between 0.97 and 1.03 to represent the movement of prices. This is clearly a huge approximation – a stochastic process would be much better. The results of 10,000 simulations yield the following results:

And the following outcome histogram:

Frequent rate updates significantly decrease the standard deviation of profit outcomes. But energy futures are not the only source of randomness for electricity retailers.

Simulation with random customer acquisition

When I update the simulation to randomly acquire 1, 2, or 3 customers every day, the results change quite a bit:

The benefit of frequent rate updates increases when additional randomness is introduced.

This simulation does not take into account customer churn; feel free to extend my code to implement a churn model!

The Sales Pitch

A key piece of this puzzle is having energy forwards that are accurate and updated frequently.  At Willard Energy Software, we know how important this is, and you can expect a laser focus on our data quality.  Check out our offerings at willard.energy!