Energy Procurement Tools for Property Asset Managers

ompanies whose business is not producing, but rather using, energy have discovered the havoc which volatile energy costs can play upon one’s financial statements. Perhaps with the possible exception of labor costs, few other elements of variable corporate expenses have been paid such attention as energy recently.

       
This has been the case both in those industries which use significant amounts of energy and steam (e.g., chemicals, food processing, manufacturing, office parks, health and education facilities and hotels) as well as in situations where reliable energy is of critical importance to the corporate mission (e.g., pharma/biotech, mutual funds, online services, credit card processors, investment banks, etc.).

       
A number of practical options have emerged for energy consumers to manage energy reliability and efficiency, particularly in those states undergoing deregulation or where transmission congestion has become a significant issue.

       
Historically, utilities have been vertically integrated monopolies providing generation, transmission and distribution services in a bundled fashion. Beginning in the early and mid 1990s, several states, including New York and California and many others, began to unbundle the energy services package by requiring utilities to sell their generation capacity to competitive suppliers and recover any “stranded” costs related to generation infrastructure through transition rates. Under these models, transmission and distribution (the “wires” components of the energy business) remain regulated, but generation became a wholesale market subject to market forces.

       
Parallel with deregulation at the state level, on April 24, 1996, the Federal Energy Regulatory Commission (FERC) in its Order 888 established the principle that owners of transmission facilities must provide transmission access to third parties on the same or comparable terms and conditions as applied to the owners’ own use of such facilities. Order 888 provided the ability of merchant suppliers, marketers and others to access existing transmission service for delivering competitive retail energy.

       
Deregulation brought mixed results. In California, due largely to legislative flaws which prevented utilities from (a) entering into longer-term purchase contracts to hedge price volatility and (b) passing fuel price increases to consumers, massive price volatility, bankruptcies and blackouts have occurred. In other states, such as Massachusetts, a competitive market has yet to fully emerge due to the attractiveness of a “subsidized” statutory rate, which, while temporary, has hindered full competitive entrants.

       
The success or failure of deregulation, however, will be judged over a longer term.
       
Knowledgeable market participants will understand that deregulation does not guarantee absolute lower prices, but lower prices compared to a regulated environment when properly structured. Hence, despite recent energy price decreases, corporate users of significant amounts of energy are wise to consider practical energy procurement tools now while opportunities are relatively attractive — especially in deregulated, competitive markets. Some of them include the following:

       
1. Negotiating Competitive Supply Contracts. Many corporations are now issuing RFPs for power procurement to licensed energy suppliers and brokers in their state where deregulation permits locking into attractive current rates which may be “south” of the standard or statutory rate. Some of the key issues with negotiating these contracts include (a) where is the wholesale market in relation to the statutory or standard offer rate? (b) How quickly will the two come together? (c) What are the pricing variables in connection with the contract (i.e., capacity charges, firm or interruptible)? (d) What is the reliability of supply based on fuel diversity and creditworthiness of the supplier (i.e., the Enron effect)? (e) What is the fixed term of the agreement and how does it compare to the statutory protected rate? (f) Does the consumer have early termination, self -generation rights or curtailment rights? (g) Does the supplier seek and is the consumer willing to accept supply-side management in return for reduced pricing? (h) Does the consumer’s operations permit it? (i) What type of service level agreements on reliability exists in the agreement if any? (j) What exceptions are there to those SLAs, including maintenance and force majeure? (k) Does the supplier have control of the energy source through affiliates, or is it merely a conduit for merchant generators?

       
2. Aggregation. Many industry organizations, typically those in a distinct industries with level or predictable load profiles (e.g., health care, hotels), have established aggregation groups to purchase power collectively at a reduced rate. Larger companies have pooled the needs of various divisions or disparate locations. The advantage of these efforts includes greater negotiating leverage, simplicity of negotiation and sharing of expenses. The disadvantages include lack of flexibility and time-consuming, multi-party coordination of contract negotiation. Key issues are the “flatness” of the user’s energy load profiles — generally, the flatter the load, the easier to pool such loan with others to gain price concessions of suppliers. A precondition to aggregation is typically finding ways to reduce spikes in load.

       
3. Demand Side Management. In addition to the institution of conservation and energy-saving devices and technologies, both consumer and utility sponsored real-time demand curtailment is slowly appearing as an option for energy procurement managers, although much of the technology is still in the planning stage. At one level, utilities who are metering will be permitted to self-select certain dispatch capacity which a consumer has preauthorized for curtailment in certain conditions in return for certain pricing concessions. This works only in certain areas of the country and in certain industries where curtailing is possible and predictable or where the user has its own energy plant. Another variation are companies which, at their cost, install energy-saving equipment at their cost and share in the savings with the user. The “savings” in those contracts is, as expected, a central point of negotiation.

       
4. Lease Negotiation. For those energy users who do not own the building or the facilities in which they operate their business but rather lease the same, several prenegotiated provisions in lease and related documentation will be critical to maintaining control over energy procurement and cost-containment policies. They include (1) the flexibility to directly negotiate and receive metering or submetering from a competitive supplier other than one chosen by the owner or landlord; (2) by covenant, achieving the benefits of energy conservation in aggressive energy procurement and competitive negotiation practices of the landlord as a pass-through item (this comes up most frequently in leases which provide for an operating estimate for electric charges above which the tenant must and is responsible); (3) in multi-tenanted buildings or parks, isolating high energy users from lower energy users; and (4) reserving the ability to self-generate or purchase via distributed generation or direct wholesale purchase.

       
5. Distributed Generation. More in response to the need for reliable power than high energy prices, distributed generation has become a means for corporate users to control the reliability and “cleanness” of power close to the load site without line loss or transmission restraints. This has been done in some cases for backup power, and other cases as a peaking use during high cost periods or as parallel operation to export excess energy back to the grid to make such DG projects economic. With the continued volatility brought on by deregulation and fuel price fluctuation, DG is expected to have an increasing role both as regards to efficiency and reliability, particularly in uses where any downtime is costly and riddled with significant financial and operational consequences (e.g., mission-critical facilities, semiconductor manufacturer, biotech/pharma). DG technologies range from tried and true reciprocating engines to microturbines to fuel cells, some of which are still unproven technically and may be unfeasible due to expense, low demand, and technology fit. Those uses which make the most sense are where there is a need for a relatively high amount of reliable power in a business where system failure can have consequences well beyond the capital cost of the DG system.

       
Utility interconnection practices, permitting issues (e.g. air regulation of number of hours of operation per year), exit and standby charges assessed by utilities to recover imbedded “stranded” costs, and zoning regulation have been obstacles in the past to siting DG on campus. Although by some estimates DG will make up as much as 20% of the distributed load of the U.S. utility market in the future, in all likelihood, it will be a supplement of small proportion in specific situations.

       
A corollary to DG is, of course, full-blown “inside the fence” project development which entails numerous other considerations including fuel purchase risk, regulatory constraints to obtain interconnection, ability to “wheel” excess power over utility lines and environmental permitting.

       
Deregulation has not been a failure. Rising fuel prices, inadequate transmission facilities and defective legislation in some states have masked what will be an eventual successful transition to a competitive energy environment in those states embracing deregulation. Large consumers of energy will be presented with increasingly competitive options as wholesale prices attenuate. As transmission and generation capacity expands, more robust competitive markets are beginning to emerge. Now is the time to consider locking in the benefits of that competitive market when options are at their maximum and the ability to commit to a longer-term arrangement presents greater opportunities. Corporate real estate professionals and their facilities management professionals should consider a mix of the above-referenced suggestions to meet their financial and operational objectives.