At home, utility bills are easy to control. If the electric's too high in the summer, cut back on the A/C. If gas is costing you a fortune in the winter, turn down the furnace and put on a sweater. It's a little more complicated for manufacturers, though, so methods to counteract escalating energy costs involved several strategic lines of attack. Much of the effort has focused on a combination of conservation and more energy-efficient operating practices, but many companies have also found that evaluating the manner in which they purchase energy can be a critical factor.
It's actually a relatively new practice, seeing as competitive energy markets only started emerging in the mid-1990s, after the National Energy Policy Act opened the doors in 1992. Deregulated states are still in a minority, but manufacturers that operate in open markets have used the opportunity to start shopping around with national energy services. As a result, energy prices are changing from a forgone operational cost to an element of their business that can be better managed to improve their bottom line.
According to Bruce McLeish, senior vice president of product development and pricing for Constellation NewEnergy, a supplier of electricity, natural gas and energy-related services, many companies were initially preoccupied with comparing rates with their existing utility when their markets first opened up. But as the potential benefits began to materialize, it didn't take long for the big picture to start coming into focus.
"Companies soon realized that the rates fluctuated so significantly that just beating their utilities might not be the best objective," McLeish explains. "Instead, many found that it was better to get on a risk management platform with a supplier, looking for opportunities when the market dips and trying to avoid exposure to price spikes."
By The Numbers
3.8 percentage of total material costs tied to energy and fuel purchases in 2006*
4.5 percentage increase in spending on energy and fuel purchases from 2005-2006*
48 percentage of total energy spending used for electricity purchases
$55.70 average cost for 1 megawatt hour (MWh) of electricity in 2006
8.4 percentage that the cost of 1 MWh of electricity increased from 2005-2006
7.3 percentage that spending increased on electricity purchases from 2005-2006
1 percentage that the total amount of procured electricity decreased from 2005-2006
*Energy and fuel purchases include all energy sources except those produced as byproducts of manufacturing activities or consumed as raw materials.
Source: U.S. Census Bureau, 2006 Annual Survey of Manufacturers
This process starts by determining which contract terms best suit your company, explains Ben Parker, director of commercial and industrial accounts for the New England region of Tradition Energy, a national energy procurement advisor. There are two main variables to consider: the length of the term (anywhere from one to five years) and how the product is structured (fixed price or index). Much like interest rates, fixed prices are higher but protected from market swings, while the prices on index-based products change constantly.
"With fixed-price contracts, you're buying a risk premium that's built into the price -- which is avoided with index pricing," explains Parker. "Your price is higher than what you would have paid had you been on index, but you have price certainty. If you're willing to accept the volatility in the market, then you might want index pricing. It depends on what your goals are -- budget certainty or obtaining the lowest cost."
In the past, those decisions were typically left up to a company's dedicated energy manager. But with the large amounts being spent on energy and the risk level involved, McLeish says CFOs have started to play an important role as well. "Going back 10 years, CFOs weren't as involved in energy [procurement], but that started to change when the market opened up. Now, energy costs might be the single largest cost for a manufacturer after personnel. And as companies have started to look at energy as much in terms of risk management as they do cost savings, CFOs will typically have a better understanding of those practices."
With prices changing every day, an extra set of eyes certainly can't hurt. Companies that pay close attention to the markets can make better decisions as to how much of their electricity usage to expose to hourly clearing prices. According to Parker, that makes it critical for manufacturers to monitor and analyze their energy costs on an ongoing basis. "No one knows what the market is going to do," he says. "There are many factors that affect price; it's a function of the weather, of supply and demand. All you can do is tune the terms of your contract to the needs of your business."