California’s skyrocketing energy costs and energy price volatility all across the U.S. have turned the spotlight on energy costs, and that’s a good thing for energy management outsourcing providers. “The run-up in energy prices has forced the issue. Now there’s a corporate edict ‘to do something about energy costs,'” says David Pickles, a director at Navigant Consulting, an energy management outsourcing consultant based in Dallas, Texas. Pickles, who has specialized in energy management outsourcing since 1994, says his business has grown 200 percent in the last 18 months.
Suddenly, energy management has become a strategic issue that can burn a big hole in a corporation’s budget. “In the past, as long as the CEO’s office was 60 degrees and the lights were on, everything was OK with energy,” quips John Detzel, chief commercial officer for TXU Energy Services, a Dallas-based energy services company owned by TXU. Now, companies are realizing that ignoring energy management “can hurt my business,” Detzel continues.
The Past Explains Today’s Volatility
The volatility in energy prices is the result of skyrocketing natural gas prices and deregulation in some states, which eliminated stable tariffs in energy commodities, including electricity and natural gas. Until 1999, local public utility commissions set the rates. “For the last 90 years it made no sense to have multiple energy suppliers because the infrastructure was too expensive, creating a barrier to entry. So the government regulated these natural monopolies to ensure the prices were fair and reasonable,” explains J. Paul Forrester, a partner in the chicago office of the international law firm Mayer, Brown & Platt. Forrester specializes in structuring and negotiating energy outsourcing agreements.
Energy management outsourcing got a boost following the Energy Policy Act of 1993, which created “exempt wholesale generators” and power marketers. Then the Federal Energy Regulatory Commission passed Orders 800 and 888 providing open access electricity transmission. These steps spawned the creation of energy services companies (called “ESCOs” in the trade), which provide sophisticated energy services to customers.
Now, for the first time, users can negotiate prices with their energy providers. But few had experienced traders on the payroll to do this. “Companies debated whether they should hire a staff to understand their new choices or outsource to an ESCO that offered resources, people, market knowledge, and technology,” says Forrester.
“Our trading and risk management presence gives us a feel for the market that companies that don’t buy and sell energy on a daily basis can’t replicate,” adds James A. Ajello, president and COO of Reliant Energy Solutions, an energy services company affiliated with the electricity utility in Houston, Texas. Ajello says Reliant’s business has grown 10 percent per year in the last decade, 20 percent last year and will grow even more this year.
Forrester says many companies in an energy critical or energy intensive business have decided to outsource in today’s business environment. “If they haven’t, they should,” he maintains. Many vowed to avoid California’s mistakes. “They learned, if they screw up energy management, they might have serious reliability problems. If they are making computer chips and there’s no power, they just blew $300 million,” Forrester reports.
But deregulation is not the only reason companies are turning to energy management outsourcing providers for help. “Companies are entering into these agreements in markets where electricity is not being deregulated. There’s a growing understanding that energy management outsourcing is a good thing to do,” says Pickles.
Focus on Improving the Process
Early adopters hoped outsourcing would save them mega dollars because they could negotiate cheaper rates for their megawatts. But that didn’t happen, reports Rick Wirth, marketing manager for DukeSolutions, an energy services company owned by the utility company that’s based in Charlotte, North Carolina. “If a company just focuses on procurement, we can save them about 1 percent of their energy costs,” he says.
Instead, outsourcing providers work to improve the process — operations and maintenance — along with handling procurement. And that’s where they can generate savings. But here’s the catch: The equipment must be new and efficient–an expensive proposition.
Companies were coming to the same conclusion about their energy plants. With the spurt in prices, they began focusing on their energy requirements. When the light bulb went on, the sight wasn’t pretty.
Most companies had invested little or no capital in their energy equipment, channeling their hard-earned cash back into their core businesses. “When it comes to energy infrastructure, most choose to operate in a crisis mode. They don’t want to put capital into the plant until it falls down,” Wirth reports.
The outsourcing vendor provides the financial component needed to solve this problem. “The supplier takes non-performing assets and monetizes them or upgrades equipment by bringing capital to the table,” says Detzel. “That’s usually very attractive to our clients.”
Wirth says DukeSolutions had one customer whose manufacturing process was dependent on steam. Year after year it neglected to invest in the upkeep of its boiler. The boiler deteriorated and now required $500,000 just to keep it running. This boiler also had potential to generate “some environmental liabilities,” notes Wirth.
In a classic outsourcing scenario, the BPO provider used its capital to upgrade the equipment. The new boiler burns waste material from the manufacturing process, saving even more dollars since the company had been paying to dispose of the waste.
Wirth says the company was paying $7.50 per million pounds of steam. DukeSolutions guaranteed a fixed price of $6.75. “How can we produce steam at 10 percent less and still make a profit?” Wirth asks rhetorically. “That’s how neglected energy plants in America are,” he answers.
Outsourcing Provides Risk Management
Risk management is another key selling point. “In outsourcing, someone else takes the risk in your business. In energy management, our experienced energy traders as well as our asset base combine to provide a reliable supply of electricity and natural gas and reduced price risk for our customers,” Ajello explains.
Detzel says TXU Energy Services often installs small generators (not the big diesels) in its customers’ buildings to provide electricity when they are off the grid. TXU’s experts negotiate lower tariffs for the customer by agreeing to allow the power provider to kick it off the grid during peak demand periods. “The company saves money day in, day out. The two or three times the company finds its power interrupted, it just turns on the generators,” he explains, describing a popular risk management strategy.
Already energy outsourcing is developing like it’s IT predecessor. “Only we’re doing it faster,” says Detzel.
Lessons from the Outsourcing Primer:
- Deregulation is one of the causes creating price volatility in the energy markets. To control the energy line on their budgets, companies are outsourcing their energy management.
- Most companies don’t have the expertise or technology to handle their energy management needs in house, so they are outsourcing to energy services companies.
- Outsourcing providers supply risk management strategies.
- Providers may provide capital infusion. Traditionally, most companies have ignored their energy plants, plowing their money into their core businesses instead. The disrepair of these plants causes them to outsource.