Managing Energy Costs: Have a Procurement Plan in Place

Managing Energy Costs: Have a Procurement Plan in Place

As an engineering firm, we look at energy consuming systems for costs savings, but often significant savings can be realized by developing a basic energy procurement strategy.

In many areas, energy prices are rising, driven largely by a sharp spike in the demand for natural gas. And as the price for natural gas rises, so does the price of power. This volatility means that now is an important time to consider how you procure and use energy in your organization and whether you need a comprehensive strategy to mitigate risk and control costs.

One piece of energy management–energy procurement—is like managing a personal retirement account just as you’re on the verge of retirement. You need to understand a few elementary components: What are your current and near-term demand needs? What have you purchased and consumed in previous years? What are your targeted goals, and how can you manage your accounts to meet those goals? How will predicted changes in the market alter your choices? A relatively simple plan can help an organization ask the right questions and find answers.

Why Are Energy Prices Rising?

According to Bloomberg Businessweek, natural gas is used to heat half of U.S. households and generate 27% of the country’s power. That number is expected to rise as coal and nuclear plants shut down across the country, which will increase demand for natural gas. In January, 2013, the nation consumed 3.2 trillion cubic feet of natural gas—the highest ever for a month. Domestic production of natural gas is also reaching record levels, but pipeline bottlenecks are creating supply shortages as demand increases. This situation accounted for an average 5% nationwide rise in electricity costs and a 10% increase for natural gas this past winter, according to the U.S. Energy Information Administration (EIA).

New England serves as an example of what the rest of the country can expect in coming years if the natural gas bottleneck isn’t fixed. “New England sits on the doorstep of the Marcellus shale, which has increased supply and lowered natural gas prices significantly, at least in areas of the country that can access that gas,” notes Gordon van Welie, president and chief executive officer of ISO New England, the operator of the region’s bulk power system and wholesale electricity markets. “However, the limited pipeline capacity coming into New England means that sometimes natural-gas-fired generators have difficulty getting fuel, and that not only pushes up prices, it also creates a risk to reliable operation of the power system.”

As a result, the average price of natural gas in New England, currently the highest in the country, was nearly the same price in 2013 as it was in 2003 ($6.97 and $5.96 MMBtu respectively). That isn’t as high as the peak in 2008 of $10.07, but it is almost double 2012’s price of $3.95 MMBtu. In addition, natural gas is used to generate about half of the region’s electricity. This has driven the average New England wholesale price for electricity in 2013 up 55% over the previous year’s historic low price of $36.09/MWh.

Wholesale prices for power can also be affected by consumer demand, which is influenced by weather and the economy. Overall demand rose by about 1% in New England in 2013, largely due to the weather, but the significant driver of the increase was the increase in the price of natural gas. During the winter of 2013, daily spot power prices in New York were up 91% from a year earlier, double in Texas, and almost triple in the mid-Atlantic states.

As the image below indicates, the average spot price for natural gas rose nationwide last year. If this trend continues, even if the weather moderates and growth in the economy remains relatively flat, power prices will continue to spike.

Developing an Energy Purchasing Strategy

Beyond understanding energy market activity, there are a number of questions to consider and options to analyze when developing an energy procurement strategy.

The strategic evaluation begins by gathering and consolidating prior and existing energy purchasing information for your organization to understand your current approach and needs. For example, what have been your previous twenty-four months of bills, previous bids, existing accounts, and deliveries? What are your future growth plans and projections? Who are the stakeholders that determine your organization’s purchasing needs and priorities? We have found that bringing all these pieces together often immediately identifies cost savings opportunities to consolidate accounts, look at terms, or secure competitive supply.

Some organizations focus on price stability while others may have the flexibility to take advantage of fluctuations in the market. With that in mind, an organization can work to develop a purchasing program. This step would include the development of a plan that outlines the frequency of contracting, purchasing term, relevant account information, and the portion of energy to purchase. This strategic plan is the basis for developing a Request for Proposals, which typically includes pricing and delivery tolerances, in addition to evaluation criteria.

Woodard & Curran and our partners assist organizations by developing energy projects and management plans. For procurement, this would include consolidating and reviewing proposal bids as well as a negotiation of contract terms and conditions. This may involve comparing bid results to available pricing information (such as EIA forward pricing models) or include creating multiple scenarios and total-normalized cost comparisons based on a contract term or structure.

A comprehensive energy procurement strategy doesn’t end with signing a contract. It’s essential to monitor use and maintain a clear focus on an organization’s established goals. A straightforward plan can be a roadmap to cost savings.

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