Energy Cost Control: Beyond the ‘Demand’ Side of the Equation
By Mike Lobash - March 2004 - Energy Efficiency
President Jimmy Carter was on to something. During some chilly Washington winter nights of the late ’70s, the president would wrap himself in a wool sweater and cozy up to the White House fireplace, using his unfettered access to national television to encourage Americans to turn down their thermostats.
Energy management has come a long way since the Carter era. Turning down the thermostat might work fine in a living room — even one in the nation’s capitol — but it doesn’t cut the mustard in a workplace lunchroom. Instead, thanks to improvement in design an technology, energy efficiency has evolved into a reliable way to cut energy use and reduce costs without requiring workers to don sweaters. That’s why so many facilities jumped on the incentives that utilities and state energy offices offered throughout the 1990s for those organizations that switched to high-efficiency lighting, HVAC and other technologies.
But energy gain without productivity pain is only one of the changes that has reshaped energy management. Today, facility executives realize there are opportunities that extend beyond the demand side of the energy equation.
Facility executives taking a comprehensive view of energy costs consider energy supply costs as well as demand-reduction strategies. In finding ways to lower supply costs, facility executives can consider a number of avenues. Exactly which one will wind up being the path to reduced expenses depends on how much time and money can be spent on investigating and implementing a new energy procurement strategy; whether facilities are located in a regulated or deregulated market; and what other factors — such as power reliability — enter the decision-making process.
Pressures to reduce the amount of money spent on energy have taken on an importance not only to individual organizations and their facilities, but to the nation’s economy as a whole. Consider Federal Reserve Chairman Alan Greenspan’s comments in June warning that dwindling natural gas supplies could drive up energy prices and shatter an already fragile U.S. economy. After his warning — which carried the caveat that there was no evidence indicating energy prices had already affected the economy’s health — stock indexes fell.
It’s as though the mere mention that energy prices should be watched was enough to send investors running. Greenspan’s words got some facility executives moving too.
“Greenspan’s mention that people need to watch over utility costs and reduce expenses did more for our business than any other single event,” says a general manager who heads the energy procurement efforts for an energy services company.
Why Care Now?
Perhaps even more surprising than the reaction to Greenspan’s comments, however, is the fact that he mentioned energy at all. His speech came at a time when natural gas energy prices were threatening to rise, yet were still affordable compared to the previous few years.
Natural gas prices for commercial users peaked in 2001 at $8.44 per million Btus, according to the Energy Information Administration, an arm of the Department of Energy. The price dropped to $8.08 in 2003 and is expected to average about $7.57 this year. Meanwhile, electricity is expected to drop from its high of $23.43 per Btu in 2001 to $21.57 this year. According to an EIA forecast, this year is expected to be the most expensive year for both natural gas and electricity for the next 20 years.
So if energy is expected to cost about the same in two decades, why all the fuss now? Volatility, says the president of an energy consulting and procurement firm.
Energy is one of the most unpredictable costs with which facility executives have to contend. Natural gas prices that end-users pay can fluctuate quarterly if their organizations have not signed a fixed contract. Electricity is more stable, but it too can fluctuate over the course of a year, generally lagging natural gas prices by six to eight months.
Of course, if a facility is purchasing energy on a real-time basis, then retail prices will fluctuate with the ups and downs of the wholesale market.
Reducing exposure to the ups and downs of energy prices is one of the most powerful drivers to investigate energy supply options. Volatility is such a factor, says one energy buyer, that some facility executives don’t mind locking into extended energy contracts and paying more than they would have for a shorter contract. They simply want to know how much they will spend on energy and budget accordingly.
“Energy has inelastic demand,” he says. “Regardless of the price, you still have to buy it. It’s not like the stock market where if the price goes up on a certain stock you can just wait to see if it comes down again.”
Because of the volatile nature of energy prices, he says he has one rule that guides his decisions in buying energy for facilities: He never goes into a summer without a fixed price for electricity and never goes into a winter without a fixed price for natural gas. Those are the most volatile pricing times for each commodity when wild swings in demand can send prices soaring.
What’s a Facility Executive To Do?
Few facility executives have either the time or the resources to research how best to secure the lowest energy price possible, let alone actually execute and follow-up on the plan. Even preparing an energy contract for bid can take weeks. After that, it takes time to review bids, participate in reverse auctions over the Internet and monitor spot market prices to know when it might be best to extend a contract or to simply let it expire and sign a new one.
Because of the data analysis that goes into determining the best contract and purchase options, most facility executives either outsource the function or work with an in-house energy manager.
But before running out to find a firm that can procure energy, however, it’s worth knowing exactly which commodities you can buy.
Most facilities have the ability to purchase natural gas from a variety of suppliers. That’s been the case since the natural gas industry started deregulating a decade ago. In addition, facilities in states where deregulation of the electric utilities has taken hold can choose their electricity suppliers.
There is no single formula for finding the best electric rate. Rather, the process involves looking at the components that comprise the final rate paid as well as the rate the facility wants to pay.
One of the first steps facility executives in deregulated markets should take — whether shopping for natural gas or electricity — is to look at past utility bills. For electricity, that means looking at the three primary components that make up rates: generation, transmission and distribution. From there, says one energy buyer facility executives should benchmark their facilities against others to establish how much they should be paying for energy.
Outsourcing firms that specialize in energy procurement as well as energy management firms that purchase energy for customers generally take two to six weeks to ready requests for bids. Exactly how long it takes depends upon the number of facilities involved with the contract offer, the ease with which information can be gathered from existing utility bills and the way a facility uses power.
The last point is an important one in determining energy rates. A high or low power factor, high energy use during peak-demand periods and the shape of a load profile outside of peak-demand hours can all influence a supplier’s contract offer.
“The price you receive for power on a request for bids on a supply contract doesn’t come off a menu,” says one energy buyer. “There are a lot of factors that go into it.”
The prevailing thought among energy buyers now is that facility executives can generally help their organizations by securing one-year contracts for both natural gas and electricity. As one energy buyer for a property and energy management firm says, that’s long enough to remove volatility from the market but not long enough to keep an organization from jumping on a good price should one come along.
Plus, recent volatility in the wholesale energy markets has created a wrinkle in investment practices. In general, long-term contracts, those lasting longer than a year, have been more expensive than short-term deals, say energy buyers.
For most institutional and corporate-owned facilities, the length of a contract term is not as important as it is to investor-owned properties. That’s because investor-owned properties might be subject to penalties and expensive contract cash-out provisions should the building be sold before the energy contract expires.
“Make no mistake about it,” says an energy management consultant and energy buyer, “an energy contract is a legal agreement that deserves the same diligence and attention to detail as other legal agreements.”
If the contract is broken when the commodity’s market rate is higher than the contract price, suppliers will generally be willing to let the contract end. If it’s broken while the contract rate is higher than market price, however, the facility executive should be ready to pay to get out of the contract.
Facility executives in still-regulated electricity markets have to take a different approach to secure a better price for electricity. For them, the risk isn’t in staying in contracts for too short a time, but rather in thinking there is nothing they can do about price.
Over the past few years, electric utilities have offered a variety of new tariffs, according to those who monitor the new offerings. Attempts by utilities to avoid the capital expense of building new generation plants to meet growing demand within their service territories has spawned a new wave of rate and tariff offerings.
The new tariffs — agreements that outline energy rates and time-of-use provisions — are designed to encourage facilities to reduce demand for utility-supplied energy. They are typically called interruptible or curtailable tariffs.
Switching to such a tariff can net facilities savings as large as 3 cents per kilowatt-hour. For at least one company, that meant $1 million annually. And that’s a saving the facility sees even if the utility never has to interrupt or curtail service.
Such savings potential even prompts one energy buyer to look for new tariffs in deregulated markets before going to shop for supply contracts. That saves the expense and time of requesting bids while not opening the facility to any new service or reliability issues a new supplier might bring.
The risk with interruptible and curtailable tariff agreements, however, comes when the utility does need to cut or reduce service to a facility. Without a backup generator to make up the difference or a plan in place to reduce demand, the facility risks the reliability of its power feed.
Positions of Power
Short of interruptible and curtailable rate options are tariffs that serve facilities located in specific areas of a utility service grid. One property manager says the facility in the best position to negotiate with utilities is the one located on the border of two utility service areas. In a deregulated environment, a facility in that location might be able to shop the existing utility’s tariff against the neighboring utility.
It’s worth noting, however, that a utility asked to cut rates is going to want to know the load profile of the facility and other data that will give it reasonable assurances that it won’t lose money.
“The more information you can give about the facility’s circumstances, the more willing the utility will be to give a better rate,” says one energy buyer.
Perhaps the least important issue in resolving energy supply issues is a facility or organization’s size. Depending on the approach — supply contracts or tariff negotiations — smaller facilities can fare better than large ones. Large energy users, such as industrial plants, institutional campuses and some warehouse and storage facilities, are already on the best tariff available from their utility.
Smaller facilities, however, often aren’t. By defining an energy supply strategy that includes demand-reduction or backup generation efforts, smaller facilities can move to interruptible rate structures, says one energy buyer.
And when it comes to soliciting bids for new electricity or natural gas supply contracts, load shape has more importance than the volume of energy consumed. A facility with a relatively flat load profile will generally fare better than one with peaks and valleys. Better yet, a facility that consumes a significant portion of its energy during off-peak hours is more attractive to suppliers.
Effectively evaluating energy supply options is a painstaking task. It requires understanding how your organization uses energy and what its future needs might entail. It also requires an understanding of what options exist in a given geographical area.
In most areas with electric deregulation in place, the market is still immature. That means there might not be enough suppliers available to create real competition when soliciting contracts. Or it could mean that facilities might not be willing to take the risk of changing service providers from an established utility to a relatively new power producer.
Those concerns aside, however, there are opportunities for facility executives willing to invest the time, money and other resources to explore supply options. But as one energy buyer puts it, facility executives better have a strategy for energy use in place. The facility executive who goes out to shop for a new contract might find a better price, but isn’t in any better position to control energy costs for the long term until energy usage is addressed.
“After that contract expires, they’ll be right back in the same position,” he says.
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