You’ve monitored electricity usage, modified production cycles, and upgraded to energy-efficient equipment.
If, after all that, electricity costs still loom as an unpredictable threat to your overall competitiveness, it might be time to consider shifting the focus of your cost control efforts up from the plant floor and deep into your business plan.
Industrial businesses are dynamic operations with natural variances occurring throughout the year. They can benefit from an electricity procurement plan that is equally dynamic, yet closely aligned with long-term business objectives. Manufacturers can exert greater control over their electricity expenditures by evaluating and deploying procurement strategies with a focus on cost control opportunities and the realities of the business cycle.
A successful cost-control initiative may require a departure from traditional electricity procurement methods. To gain the greatest advantage, the business must be willing and able to walk away from the predictability of a purely fixed-price contract and consider the procurement opportunities on the wholesale electricity market. Success springs from the company’s ability to develop a customized procurement strategy that seizes the buying opportunities that can support long-term business objectives.
Leveraging Wholesale Market Opportunities
Industrials with a peak demand of 1 MW or greater can gain direct access to the wholesale electricity market, with the ability to construct a portfolio of procurement options similar to those for natural gas.
Direct wholesale market buys may sound like risky business in today’s volatile electricity market, but with the right planning and execution, manufacturers can actually gain a competitive advantage by leveraging the flexibility of a customized, portfolio-style electricity procurement strategy.
With flexibility to support production cycles and profitability goals, the role of electricity procurement is shifted from cost center to value-added resource. 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.
Like any commodities market, the portfolio approach to electricity procurement must be examined through the lens of business cycles, risk tolerance and long-term objectives. This information is used to develop a buying strategy that supports energy budget goals, long-term cost control and continual improvement throughout operations.
Defining Cost Control
First, it’s important to provide a clear definition of cost control, particularly within the context of a volatile electricity market.
Cost control should not be confused with immediate cost savings, although wisely calculated buying decisions may produce cost savings over time. The cost control procurement approach requires a business to closely align the development and execution of its electricity buy with broader, long-term business objectives.
This distinction is important: all elements of the electricity supply contract should provide direct support to the business’ cost management practices. When viewed in this context, price becomes just one factor in determining the electricity supply contract’s value to the business.
Fixed-Price Contracts: Truly Low-Risk?
On the surface, an electricity procurement contract that locks the entire load at a fixed price would appear to give the greatest degree of budget certainty and, in turn, the greatest degree of cost control.
Fixed-price contracts are established from estimates based on historical data and forward projections. Because the contract locks in a price for a predetermined amount of time, the fixed-price approach is typically thought of as a shield that protects the business from the risks of market volatility.
But from a different perspective, a purely fixed-price procurement plan is not entirely risk-free. The fixed-price product delivers maximum cost control in only two conditions:
• If actual usage does not significantly depart from estimates (+/- 10-20 percent).
• If the lock-in price secured through a formal RFP is timed, by chance, for a period when pricing is historically low.
The timing of fixed-price procurement contracts is typically driven by the pending expiration of an existing contract, and in volatile energy market conditions it’s particularly difficult to determine that the price established at the contract signing will be advantageous for the long term. As such, an industrial business with a purely fixed-price procurement strategy is allowing the market conditions within a brief window of time to dictate the terms of its electricity costs for a significant term.
To avoid this risky scenario, manufacturers can incorporate a market-based product into their electricity buying strategy, which positions the company for opportunistic buys from the wholesale market, including the lock-in of low-end prices for forward positions.
Getting Started on Customized Electricity Procurement
The change from a purely fixed-price contract to a customized electricity procurement strategy requires a different approach to bid evaluation.
First and foremost, the business must have full consensus on a long-term buying strategy. Successful cost control begins with management’s agreement that improved cost management practices can enhance the company’s overall performance. Then, all energy procurement decisions should be evaluated for their ability to support enterprise-wide cost control activities.
As a cross-functional team, companies must look beyond the price-to-beat perspective of contracts. The bid evaluation must also assess the suppliers’ ability to support the cost control initiatives. The following criteria are particularly important:
• Check Your Sources for Market Information
When considering suppliers, determine if you have the in-house capacity to quickly and thoroughly analyze raw market data or if you can benefit from objective guidance on your procurement strategy. In a fast-paced market, a lag of information and recommended courses of action can result in missed buying opportunities.
• Look for Value-Added Billing Statements
Billing statements for a custom buying strategy are typically complex but can provide valuable insights for improving business performance and help management uncover new cost control opportunities throughout the company. This information can help industrials more accurately forecast expenditures and true production costs.
• Require Reports that Support Continuous Improvement
Ask potential energy suppliers about the types, detail, and frequency of reporting that will be included as part of your supply contract. If the right data is available, management can become better equipped to successfully forecast budgets, plan production cycles, and manage cash and credit flow. A frequent review of insightful reports can position the business for benchmarking and continuous improvement initiatives.
• Watch for Hidden Costs of Overhead
When calculating the costs of the electricity procurement strategy, consider the overhead required for contract management or procurement execution activities. Seek out procurement contract options that minimize your human resources requirements and deliver cost control to other areas of the business.
With no end in sight to the volatile electricity market, manufacturers can gain a competitive advantage by adopting a cost control approach to electricity procurement. Establishing a long-term buying strategy on the wholesale electricity market can empower businesses to take greater control of their energy costs—as well as uncover cost control opportunities throughout the enterprise.
Mark Kleinginna is Technical Sales Director with Strategic Energy, one of the largest competitive retail energy providers in the United States. Mr. Kleinginna has 20 years of hands-on experience helping industrial enterprises in deregulated markets implement custom energy purchasing strategies. He can be reached at firstname.lastname@example.org