Last Updated 1 year by Lukas
Have you ever wondered if there is a way to check whether the price of electricity, gas or long-term loans is fair? And how is it even possible for normal, ordinary people to check it easily? In this article, let’s explore together some ideas and ways how to do it. This article will try to answer the above questions in a simple and understandable way. And after going through this short text, you can immediately start using your newly acquired superpowers to judge whether the offer is reasonable or not.
Let’s start with basics
Introduction
In order for us to understand how to evaluate if we are being offered good price/value. We need to be familiar with at least a few basic terms. In the case of electricity and gas, these will be future contracts and the current price within the venue (daily market).
In the case of long term loans we will talk about interest rates announced by national banks and we will also briefly touch on something called IRS (interest rate swap). Once we have a basic understanding of these terms, we will move on in the article to explore how we can use them to our advantage.
Finally, we will touch on some information about how trading these products generally works. This will be done in a very general way just to give us enough context to be able to use the knowledge.
How are commodities or products traded?
For a company to be able to trade electricity, gas or interest rate swaps. It must either enter into a direct (so-called bilateral) contract with another company. This type of contract gives both companies a lot of freedom in terms of the terms they want to agree. Of course, it’s also a bit riskier.
Alternatively, a company can either directly (or indirectly, if regulations only allow certain companies to be part of the venue) become a member/participant of an exchange, which allows it to trade goods or products. In the case of exchanges, a lot is already standardised, there are safeguards in place to protect participants and it’s a very easy and convenient way to obtain standardised products.
In the case of the money market, where interest rate swaps are traded, this can again be done within the exchange where standardised rules are used. Or companies can agree with each other on a bilateral contract. If you think that most trading takes place on exchanges, you are right.
The electricity market
When we talk about electricity, we need to consider only a few members within the supply chain. There is one company that regulates the market for a given country (in the Czech Republic it’s ERU). There are few owners of the distribution network (it is a natural form of monopoly when few companies own the network through which you get electricity).
There is one peculiarity of electricity, even with the current level of technology and given the huge amount of electricity consumption. You can’t really store electricity on a large scale. This creates the need for the existence of a grid regulating company so that the quality of electricity is kept at an acceptable level. In the case of the Czech Republic, it’s a single company called CEPS.
And finally we have companies that are allowed to be part of electricity exchanges (in Czechia called OTE or PXE), they are regulated by ERU (in Czechia) and these are the final companies that the average person has a contract with and buys electricity from. These companies, on the other hand, buy electricity for their customers according to their expected consumption, either through exchange or bilateral contracts.
The gas market
The gas market is very similar to the electricity market. There is one very important difference and that’s that we are able to store gas in large quantities in underground gas tanks. Similarly to the above, we have a regulating company (ERU), owners of the distribution network within a given country, a single company that handles the transport of gas from abroad (Net4Gas) and finally companies that are allowed to sell gas to ordinary people living in a given country.
The money market
Money markets are highly regulated and usually only a few companies are allowed to be part of the venue. These companies are usually supervised by national banks and financial trading regulators. This division of participants allows for a high level of control and to create the fairest possible conditions for participants.
Basic terms
Electricity and Gas markets
In the case of electricity and gas, there are usually two types of products used for trading these commodities. The first product is the so-called SPOT price, which is created thanks to OTE in the Czech Republic (the exchange where trading takes place). The role of the exchange is to facilitate trading and calculate daily prices based on supply and demand. It works in a similar way with gas prices.
On the other hand, if we want to buy something in advance to make sure we know the future price (future price can be anything, but we fix the price by contract), we usually use a product called futures contract. Simply put, it’s a contract between two parties where one side agrees to deliver a certain amount of a commodity at a known price in the future. And the other side agrees to pay that price and consume that commodity when the time comes.
The most common types of futures contracts in the case of electricity and gas are (M) – monthly, (CAL) – calendar year, (Q) – quarterly. And in the case of gas we can also meet with the so-called (S) – seasonal contract for winter/summer. When we buy a future contract, we fix the price in the future and we know it today. This makes planning very easy for companies that do not want to take the additional risk of fluctuating prices.
Money market and interest rates swaps
In general, money markets in the vast majority of the world are regulated by the mutual influence of national bank and commercial banks. Simply put, national bank through available tools either causes (indirectly) more money to be released or removed from the money flowing within economy.
The most basic principle used by national bank to control money markets is to set three interest rates. The most important one is the 2-week REPO rate, which is used to control the short-term price of money between the National Bank and commercial banks (and thus indirectly within the economy).
Besides REPO rate we also have Lombard and Discount rates. These two are used to set the price at which commercial banks can borrow money overnight from the National Bank or deposit money inside the National Bank at a certain interest rate.
Interest rate swap is a way in which two companies can change fixed and floating interest rates. Simply put, if two companies both borrow money, one with fixed interest rate and another with floating interest rate. They can enter into a swap contract and change these two characteristics of their loans. IRS is also used as a marker for the long-term price of money. The most common types of contracts are 1Y, 3Y, 5Y and 7Y (years).
What can we do with this information?
We can use this knowledge to assess whether the electricity prices, gas prices or long-term loan prices on offer are fair and within some reasonable guardrails. Of course, there is usually a lot more that goes into the final price, but at least we will have a starting point to know if something is twice as big. And if it is, we can question it and find a better deal.
Electricity and Gas prices
In the case of electricity, we can use the daily market or the futures market to assess the prices (excluding VAT) offered by the selling company. Of course, we can only compare the price of the commodity itself, not the final price, which is usually made up of many parts such as tax, payment for distribution, for services, etc. In general, the payment for the commodity itself is usually at least 50% of the final price.
We can access daily market (Czechia – OTE) here.
We can access futures market (Czechia – PXE) here.
Simply put, if someone offers me price for electricity or gas 200 EUR per 1 MWh and I know that current daily price is on average 80 EUR / MWh and long term futures contract for next year is 100 EUR / MWh. It’s clear that I might be able to negotiate a better price. Because 100% price increase against current prices (which is profit of selling company) is a little too much. Of course, we will never get exactly to the market prices, but we should try to get as close to them as possible.
We can also see something like ‘BASE LOAD’, ‘PEAK LOAD’ and ‘OFF PEAK LOAD’. These terms refer to when you want to consume energy. Is it at the time when everyone else wants it, throughout the day or outside of peak hours? This also affects the final price.
Long term loan prices
In general in most cases long term loan prices, which usually translates into the most commonly used long term loan called a mortgage. We can check national bank pages to learn current interest rates and then we can check interest rate swaps. These two pieces of information are the most important ones to assume what fair interest rate (price of money) would be. Of course, usually the rate we can get is higher, but again taking into account our risk profile + the current market situation. If it’s 3 times higher, we might want to check other offers.
We can access current interest rates from the Czech national bank here.
We can access current interest rate swap prices for 1Y, 3Y, 5Y, 7Y and finally 10Y.
Simply put, if you see that banks between themselves use 5Y interest rate swap value of 4% and your national bank announced discount rate of 6%. And the bank is offering you a mortgage at 5%. You can safely assume that’s a fair offer. As usual, these offers iterate around the national bank’s discount rate + taking into account interest rate swaps.
If you look at the prices of interest rate swaps, you can also get an idea of what the ‘market’ thinks about future interest rates. Are they going to go up? Will they go down? This can help you decide whether to wait for better conditions or take the current ones.