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Kilowatts and Btu's - Energy Procurement

Author(s):

Russell J. Shroyer
Russell J. Shroyer, Purchasing Manager - Ingredients, Chef America, Inc., Englewood, CO 80112, 303-790-0303

81st Annual International Conference Proceedings - 1996 - Chicago, IL

Whether a company is categorized as a manufacturing, commercial, service or public entity, some form of energy will be used to help bring the company's product to their customer. Natural gas, electricity, coal, fuel oils and hydro-electric sources are considered the major energy commodities. Coal, fuel oils and hydro-electric sources are used in specific industries or geographic regions. This presentation will concentrate on the procurement of the most commonly used energy commodities, natural gas and electricity.

What is Purchasing's Role ? Traditionally the procurement of energy has been done by disciplines other than Purchasing for the following reasons. There was no negotiation involved in the energy transaction. Most Purchasing professionals were lacking the knowledge. Why are companies turning to Purchasing now ? Because corporations have down-sized to such an extent that employees are required to do several functions. Increased competition is forcing companies to save money in every possible way.

What Does Purchasing Bring to the Function of Energy Procurement? Negotiation skills, finding and developing suppliers, linking together different company functions, issuing and monitoring contractual agreements.

Government Regulation. An important aspect to understand about these two commodities is the historic and current role of government regulation. At the national level the Federal Energy Regulatory Commission(FERC) has jurisdiction over energy transactions that cross state lines(interstate). Each State has a Public Utilities Commission(PUC) that has jurisdiction over energy transactions within that state's borders(intrastate).

Natural Gas. FERC Order 636 was the culmination and most significant event of the 15 year natural gas deregulation process. Some fine-tuning has been done since the 1992 enactment of Order 636, but no other major legislation has been passed. The most important part of the Order was the "unbundling" of services. This gave natural gas consumers the option to purchase only the services that they needed. A second important aspect was how the service costs would be determined, by market forces.

Electricity. The electric utility industry is still highly regulated. Two past Federal legislative acts and one pending piece of legislation have started the industry down the road of deregulation.

In 1978 the Public Utilities Regulatory Policy Act(PURPA) required utilities to purchase electricity from co-generation and independent power producers. This has increased the competition(lower prices)in the generation component of the industry.

The National Energy Policy Act(NEPA) of 1992 allowed "wholesale wheeling" between utilities and generators. Wholesale wheeling is defined as the transmission of electrical power from a generation facility to a distribution point, at a fair and reasonable price.

In March 1995, FERC issued a Notice of Proposed Rulemaking (NOPR), commonly referred to as the "giga-NOPR", that will address the concept of "retail wheeling". Retail wheeling is similar to wholesale wheeling except, instead of limiting the wheeling of electricity to only utilities, other industries will be able to participate too. Electricity will be purchased from the most efficient generator and utilities will be required to do the transmission at a fair and reasonable price.

To a greater extent than natural gas, the battle for electric deregulation is being fought at the state level as well. And since most electric utility's service areas do not exceed state lines, this may be the most important battlefield. Most states have investigated deregulation, but have not progressed beyond that point, due to intense lobbying by utility coalitions.

In any competitive industry, the companies with the best rates or highest quality of service will prosper, the rest will fail. The electric utility industry has not had to face this type of competition. Is it any wonder that most utility companies are fighting deregulation every step of the way ?

Private Industry's Role in Deregulation. Most Purchasing professionals and companies operate in competitive environments. So grasping every advantage possible to make purchases at the lowest cost to the company, has to be done. Therefore it is in our best interest to participate in debates on policy changes. The best way to participate in the debate is through a local, regional or national energy group. These groups help you to keep informed, express views to legislators and the public, without draining your financial resources. Two of the largest national groups are the Process Gas Consumers Group and the Electricity Consumers Resource Council.

Managing Your Energy Procurement Process. In the past, the process of procuring natural gas and electricity was very simple. You opened a valve or flipped a switch allowing gas or electricity from your Local Distribution Company (LDC) to enter your facility. At the end of the month the LDC sent you an invoice. The invoice was paid. End of the process. The process can still be that simple. Simple is good, but compared to other methods, expensive.

Developing an Energy Purchasing Strategy

  1. Step 1
    Determine the dollar value of fuel expenditures. Is the dollar amount spent on natural gas and electricity a significant cost factor compared to other items. In other words, will your time be used effectively.
  2. Step 2
    Investigate the company's demand pattern for the two commodities. Energy sellers are attracted to companies having the following characteristics: small variation(high load factor), the highest constant usage(base load), infrequent and low spikes(peak demand)in usage.
  3. Step 3
    Review your current LDC's tariff. LDCs frequently make mistakes in applying the correct tariff or invoicing at the wrong rate.
  4. Step 4
    Educate yourself and your company. This will help you analyze alternate options. There are many ways to become an "expert". Read as many energy related articles as you can. Subscribe to a energy newsletter. Attend educational conferences or seminars. Ask your current vendor to review their tariff with you in case you may have missed an option. Solicit information from competing supply sources. And as I stated earlier, join a energy coalition group.
  5. Step 5
    Now that you are an expert, you can assess procurement alternatives. Each alternative should be evaluated for risk, potential savings, reliability and the effort requiredto monitor the process.

When following these steps, an important aspect to remember is that all of these factors have to fit into your company's overall business plan.

Specific Options to Explore
Natural Gas. There are three cost components to consider when procuring natural gas. The cost of the commodity, transporting the commodity, and choice of services.

Natural gas can be purchased from the LDC, a marketer, or directly from the wellhead. The purchase can be made through a long term contract, a short term contract or on an as needed basis. Pricing(commodity charge)can be based on a published index, a set price or on a "spot" basis. The commodity cost is the most expensive component.

Transporting natural gas is the second largest component cost. The transportation (demand charge) can be a firm or interruptible service. Firm service implies that only in the most extreme circumstances can the LDC require your company to reduce usage of natural gas. With interruptible service the LDC can require reduced usage for several different reasons. Firm service is typically more expensive.

Other types of services are also available. These services typically include storage(inventory), contracting for capacity release, hedging fuel purchases, management reports on usage, price forecasts and much more.

Electricity. Electricity also has three major cost components. Generation, transmission and distribution. Unfortunately, with the current state of regulation, options are limited.

The only option for generation is "co-generation", or creating your own electricity. Typically this is done with a natural gas fired turbine. Capital costs are very high.

Currently only utilities have access to the transmission of electricity across other utilities facilities(wholesale wheeling). There is no retail wheeling permitted.

Options with the distribution component of electricity are most readably available. Firm or interruptible service may be contracted. Lower your peak demands. Increase the power factor. Shift usage to system off-peak hours. Negotiate with the utility for lower rates.

Plan For The Future, Plan For Now. Energy procurement, like all other purchasing functions, has become more sophisticated. Natural gas prices have dropped 35% since deregulation. It's not to late to seize the opportunity for decreasing your company's natural gas costs. Electricity deregulation is probably still several years away. Now is the time to prepare for this change, for the change will occur. If you can become knowledgeable on the procurement of natural gas, it will position you well for electricity procurement.


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