For many industrials, electricity procurement is a brick wall that solidly blocks even the most ambitious cost control campaigns. The new reality of a highly volatile market complicates the issue. Energy-efficient equipment and usage monitoring can help in curbing costs, but ultimately, how you buy electricity is as important as how you use it.
As high-volume consumers of electricity, industrial businesses in deregulated states have the most advantageous buying opportunities through direct purchases on the wholesale electricity market. If your business follows a conventional RFP on a purely fixed-price approach, your electricity budget can be largely dictated by the market conditions during your bid cycle. But by structuring a customized portfolio-style strategy, businesses can take advantage of the volatile market's spikes and dips for electricity buys that support short- and long-term objectives.
A more flexible, customized approach to procurement can empower the entire enterprise by shifting the electricity supply's position in the business model -- from uncontrollable cost center to a value-added resource for cost control initiatives.
Translating Cost Control To Electricity Buys
First, it's important to provide a clear definition of cost control within the context of a volatile electricity market. Obviously, cost control should not be confused with immediate cost savings, although wise buying decisions may produce cost savings over time or at moments in time.
Traditional thinking would dictate that a contract locking the entire load at a fixed price would yield the greatest degree of budget certainty, and, in turn, the greatest degree of cost control. But from a different perspective, we can see that a purely fixed-price product isn't entirely free from risk. In fact, it delivers maximum cost control in only two conditions:
- If actual usage does not significantly depart from estimates (+/- 10-20%.)
- If the lock-in price secured through a formal RFP is timed, by chance, for a period when pricing is historically low.
By incorporating a market-based product into the buying strategy, the business is positioned for opportunistic buys, including the lock-in of low-end prices for forward positions. Ideally, those flexible buys will support business processes and work in synchronicity with realistic business dynamics. It's this distinction that strengthens the value of the electricity buy and positions the business for comprehensive cost control initiatives.
Electricity Procurement For Cost Control: A Case Study
With annual electricity consumption exceeding 30,000 MWhs (translating to one third of its total output costs), a large industrial enterprise in Texas was seeking a new electricity procurement program to support company-wide cost control efforts.
The company's energy management and finance teams partnered with Strategic Energy to determine that buying on the wholesale market with a portfolio approach could provide flexibility for customized procurement and usage -- while achieving internal compliance guidelines.
Together, we agreed that the ideal procurement portfolio would use short-term purchasing strategies as part of an overall long-term approach. The portfolio was structured for flexibility, and ongoing guidance made it possible for the business to respond quickly to market conditions by optimizing their mix of day-ahead and real-time prices as well as forward purchases.
Compared to the alternative of locking in the bulk of their power buy at a single point in time, the company reduced its costs by layering in relatively small forward purchases. The flexibility also allowed them to look for value in the term markets and make forward purchases for just one month at a time. Rather than lock in most of the power for that month with a single purchase, they break the buy into several purchases, rarely taking out more than 15 percent at one time.
Business objectives and risk tolerance drive the buying strategy; conversely, buying opportunities drive operational decisions. By using their portfolio to work in concert with their demand response program, they shed load on very short notice to avoid significant price spikes. They synchronize cost-effective, short-term purchasing strategies with annual plant maintenance duties, when they operate with 20 percent capacity. Finally, they sell excess power back into the market at hourly index prices, which helps the business avoid potential losses from being long on power purchases.
Unlocking A Competitive Advantage
To expand cost control initiatives into electricity procurement, management must understand the potential for procurement to provide value beyond the input of energy supply into production processes.
The value-added procurement strategy blends fixed-price buys, which minimize risk exposure for short- and long-term cycles, with market-based buys, which seize opportunities while respecting business constraints. In this context, price becomes just one factor in determining the value of the electricity supply product.
A customized, flexible electricity procurement approach should not be confused with the lack of a clear plan. Instead, the procurement strategy is more fully integrated with the business objectives. Devising such a plan requires an understanding of the interplay between your business objectives, usage profile, load requirements and market conditions.
Contract evaluation criteria must investigate areas beyond the price-to-beat, with focused discussions on topics such as:
- The effects of current and pending energy policy on the business.
- The reliability and frequency of market information sources that influence buying decisions.
- The commitment to a clearly defined, long-term procurement strategy.
- Billing statements that provide valuable information for business planning.
- Data reports that provide opportunities for enterprise-wide continuous improvement.
- Understanding the true costs of contract preparation and procurement execution, including human resources.
Industrials that have implemented cost control initiatives in other areas of the enterprise can successfully extend that business intelligence to electricity procurement activities. Within the new framework of volatile electricity market conditions, industrials can exert greater control over their electricity expenditures by evaluating and deploying buying strategies within a context of cost control opportunities and business cycle realities. Like other cost control and continuous improvement programs of recent years, industrials willing to adopt new approaches can gain a lasting competitive advantage.
Mark Kleinginna is the technical sales director for Strategic Energy. For 20 years, Strategic Energy has helped organizations across all sectors maximize their energy purchasing strategies and secure some of the lowest electricity prices available. The company is one of the largest competitive retail energy providers in the U.S. with extensive hands-on experience in helping industrial enterprises in deregulated markets implement custom energy purchasing strategies. To learn more, visit www.strategicenergy.com or call (800) 830-5923.