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What Is a Pricelock?

K. Kinsella
K. Kinsella

A pricelock is an agreement whereby a supplier agrees to freeze the price of an asset or service for a specific period of time. The term is most commonly used in the energy sector as some firms attempt to entice new clients by offering guarantees that energy costs will not increase even if the cost of these assets on the open market happens to rise. Aside from energy firms, service providers such as cable companies and phone networks sometimes offer pricelocks. As with any long-term financial agreement, a pricelock may or may not always be in the best interest of either the supplier or the buyer.

Natural resources such as oil, gas and coal are sold on exchanges around the world; the price of these assets is largely driven by supply and demand. People tend to use more energy to heat or cool their homes during unusually cold winters or abnormally warm summers. Consequently, energy prices often rise in the summer and winter but drop in the spring and fall. During periods of recession, prices of commodities including energy tend to rise since investors flock to buy these tangible assets rather than more speculative instruments such as stocks or credit default swaps (CDS). Trucking companies, airlines, homeowners and school districts are among those having to adjust budgets to account for fluctuating energy prices.

Man climbing a rope
Man climbing a rope

Many firms offer pricelock contracts with terms ranging from a few months to several years. Energy purchasers that take advantage of these arrangements are able to more easily budget over the long-term since energy costs become fixed rather than variable liabilities. On the other side of the equation, energy firms can also create more accurate budget forecasts when large numbers of clients have agreed to a pricelock since these firms do not have to contend with reduced revenues during times of year when commodities prices tend to drop. Buyers can lose money in the long run if energy prices actually fall while suppliers could have problems if prices rise more than expected.

Energy firms would become insolvent if steps were not taken to protect these entities from the downside of a pricelock because if prices were rising then the firm's own costs would increase while its income remained the same. Therefore, many firms buy futures contracts from energy brokers. In a futures contract, a broker or energy producer agrees to sell a quantity of energy to another party for a specific price on a particular date in the future. Brokers attempt to predict future price movements before issuing these contracts. Generally, brokers agree to lock in the current market price if the broker believes that energy prices are likely to fall before the futures contract comes to fruition.

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