How buyers survive the energy cost crunch
Purchasing professionals are trying to save dollars by hedging the energy market, becoming off-peak rate payers and locking-in advantageous prices. They have no choice with crude oil, natural gas and electricity selling at new record highs.
By Tom Stundza -- Purchasing, 4/10/2008
Global industrial conglomerate Eaton is working with an energy management partner. Kennametal, a worldwide metalworking and tool production company, is working with a third-party energy provider. Electric heating products firm Marley Engineered Products has been working to pull energy purchasing away from facilities managers. Regional commercial food products producer Michael Foods required buyers to become energy commodity experts to keep up with supply, demand and pricing trends. What's the common denominator? The purchasing and supply chain managers at these and other companies are making it a priority to try to manage the buy and reduce the price paid for energy, which has gone from an overhead fixed-cost item to an erratic yet expanding drain on the bottom line. Terry Wahlgren, global manager for capital and MRO at Cleveland-based Eaton, recently was able to switch a Pennsylvania plant's electricity supply from a utility with a fixed rate to a third-party supplier with flexible pricing. The move came after a regional market analysis and supply-switch recommendation from energy management partner Summit Energy in Louisville, Ky. Likewise, Summit Energy client energy manager Lana Isaacson says Eaton facilities in the Central Plains region were able to revamp the purchase of natural gas after corporate buyers and her staff "found a way to 'time a buy' that captured 'price lows' on one piece of the natural gas spend." They could do that because the price of natural gas actually varies greatly depending on location, the type of consumer and the region's supply of the energy. Wahlgren says that "users of energy can no longer sit on the sidelines as rate takers, or as rate payers, so we have challenged our buyers and our energy-management partners to find the lowest cost at the least associated risks so we can reduce the $150 million electricity and natural gas buy 5% every year." Of course, it takes certain skills to do that, skills that are not usually on the resumes of plant managers or facilities managers—often the people in companies charged with buying energy. Those skills reside in purchasing, says Carol Maicher, director of strategic sourcing at SPX Fluid Power, a manufacturer of hydraulic and pneumatic products in Houston. Previously, she worked at Markey Engineered Products, an SPX-owned electric-heating-products firm. "There are corporate environments that embrace the help of procurement/sourcing teams" in buying energy, but too often "energy has turned out to be one of many spends typically with the wrong skill set," she says. "Having been in the supply chain field most of my life, I have found that when the sourcing group handles energy the savings results have been amazing." She contends that millions of dollars can be saved by hedging the energy market, or negotiating the purchase of additional storage that isn't being used, as well as locking-in prices when the timing is right. Then there are additional savings achieved by extending terms or level-loading payments. Getting those savings requires negotiating skills that a typical operations or facility manager wouldn't have, she asserts. Jim Cebula, the global director of purchasing and travel at Kennametal, adds that another weapon purchasing has that other corporate departments lack is data. Purchasing can collect and analyze electricity and natural gas bills to find inefficiencies in energy use and develop cost-avoidance systems, he says. Kennametal of Latrobe, Pa., does that with a tool from Advantage IQ (formerly Avista Advantage) that helps provide energy market intelligence, coordinate multi-facility energy management and provide bill consolidation and payment services. Dan Rathbun, the manager of strategic sourcing for Michael Foods in Minnetonka, Minn., says "efficient energy buyers are those that understand their suppliers' pricing models and cost drivers, the energy market's volatility and the associated risks to supply—as well as their own firms' actual energy needs for operations and manufacturing." He says that is important because of all the numerous and complex pricing models used by suppliers—and because industry buys such products as natural gas for production and processing as well as heating. Michael Foods is a diversified food processor and distributor with businesses in egg products, refrigerated grocery products, specialty dairy products and refrigerated potato products. "To keep all the factories running efficiently requires our energy-buying teams to know what prices will keep our manufacturing operations competitive," he says, "and that gives them legitimate cost-savings goals." Similarly, after discussing energy costs at a recent corporate sourcing council meeting, the purchasing executive of a large industrial packaging products firm concludes that dollars are being wasted when buying electricity and natural gas in the "traditional way"—i.e., from utilities or pipeline operators. Suppliers have been able to maintain complex pricing schemes with cost penalties because of this plant-by-plant energy-buying system. Upshot: He and his team are developing strategies so the headquarters procurement organization will end plant-level decision-making on energy supply and establish cost-saving procurement leverage. Interestingly, the purchasing of energy for heat, light and power applications often is considered an indirect buy. However, sometimes energy is bought as a direct material as well since such products as natural gas are used in the overall manufacturing process. So, there are purchase-cost penalties that can be quite high when energy is a direct buy as a commodity required for end-product manufacturing or processing, says David Price, director of supply chain management for filtration products maker Clarcor in Franklin, Tenn. Electricity, for example, is ubiquitous. Yet, few people know how the flow of electrical power for lighting also provides the muscle for computers, printers, commercial equipment and industrial machines. Even fewer people recognize the different costs involved in buying electrical service—from generation, the production or purchase of electricity; to transmission, the movement of electricity over high voltage power lines from the generation source to a local distribution system; to distribution, the delivery of electricity to individual customers. Crude oil, downstream processed products and natural gas are sold as commodities; as such, their prices change often—at times, drastically. Producers insist that transaction prices are set by market forces—the buying and selling of these commodities by market players, based on supply and demand. This is typically true in the spot market but the futures market has also been pushed into volatility by investors seeking to diversify holdings. So, Rathbun at Michael Foods says that buyers need to look at energy products the same way they look at other manufacturing components. He suggests that buyers use a sourcing technique in which natural gas is cost out on a single decatherm basis, electricity is priced a single kilowatt hour and fuel oil is paid on a gallon basis. In this way, it becomes easier to determine whether or not the products will be hedged or bought directly from a utility or a third-party intermediary. "So much attention is paid in tracking oil-based energy costs that natural gas prices are often overlooked," says Price at Clarcor. "Too often, people look at natural gas as a home heating fuel, especially in winter, when cold weather typically boosts the use and price of natural gas." Another issue that impacts natural gas pricing is efficient and effective transmission of the fuel from producing regions to consumption regions, which requires an extensive, elaborate and expensive transportation system consisting of a complex network of pipelines. Transportation costs of natural gas are closely linked to storage costs also since inventorying is part of the supply chain. "And that's why separate negotiations on storage and transportation prices sometimes have to occur when sourcing natural gas supply," says Cebula of Kennametal. That's because natural gas is stored at 30 different locations throughout the country at "market hubs" created at the intersection of major pipeline systems. Because of this, natural gas trades at slightly different prices at the major hubs, depending on the supply and demand for natural gas at that particular point. When sourcing electricity, buyers need to be aware that pricing volatility is normal so wholesale electricity costs can vary substantially from hour to hour. Buyers in industry who are able to shift demand from peak hours to off-peak hours can save money. Almost all retail customers in the residential and commercial market sectors usually pay for electricity at fixed prices determined by utilities (and confirmed by public service commissions) long before consumption occurs. Industrial buyers sourcing spot, therefore, try not to purchase energy in fixed-price blocks any longer than 24 hours. Pursuing tactics like that requires new expertise, says Bruce McLeish, senior vice president of products and pricing at Constellation NewEnergy, the Baltimore-based supplier of electricity and natural gas to commercial, industrial and institutional customers throughout North America. Constellation is one of several third-party energy-sourcing and energy-buying firms that are helping corporate purchasing organizations. Other companies that help buyers manage energy risk are Summit Energy in Louisville, Ky; EnergyConnect in Portland, Ore.; Energy Window in Boulder, Colo. and Sempra Energy in San Diego. Sempra generates electricity and distributes natural gas, among other things. Summit, which manages more than $14 billion in annual energy spend, provides strategic guidance for negotiations on energy contracts and for energy-efficiency or risk-management projects. One company Summit works with is Eaton Corp., with whom Summit works to provide end-use data collection, cost-benefit analysis of alternative sourcing options and timing of energy buys. Despite the volatility of energy markets, the buck stops with purchasing. "The world runs on energy and energy costs money," says Kennametal's Cebula. And with the costs so high, purchasing is the most logical function to control them. See Purchasing.com for "Third parties help with the energy buy."
2004
2005
2006
2007
2008/F
Natural Gas Liquids and Other Liquids
Pentanes Plus
0.13
0.12
0.08
0.1
0.11
Liquefied Petroleum Gas
2.13
2.03
2.05
2.09
2.09
Unfinished Oils
-0.04
0
0.03
0.03
0
Finished Petroleum Products
Motor Gasoline
9.11
9.16
9.25
9.3
9.36
Jet Fuel
1.63
1.68
1.63
1.62
1.64
Distillate Fuel Oil
4.06
4.12
4.17
4.23
4.26
Residual Fuel Oil
0.86
0.92
0.69
0.74
0.74
Other Oils *
2.84
2.78
2.78
2.61
2.65
Total Consumption
20.7
20.8
20.7
20.7
20.9
Source: Energy Information Administration
Other Oils * includes aviation gasoline blend components, finished aviation gasoline, kerosene, petrochemical feedstocks, special naphthas, lubricants, waxes, petroleum coke, asphalt and road oil, still gas and miscellaneous products.
2004
2005
2006
2007
2008/F
Residential
13.3
13.2
12.0
12.9
13.2
Commercial
8.6
8.2
7.8
8.2
8.4
Industrial
19.8
18.1
17.8
18.1
18.1
Electric Power *
14.9
16.1
17.1
18.8
18.8
Lease and Plant Fuel
3.0
3.1
3.08
3.2
3.2
Pipeline and Distribution Use
1.6
1.6
1.6
1.7
1.6
Vehicle Use
0.06
0.06
0.07
0.07
0.08
Total Consumption
61.2
60.3
59.3
62.9
63.4
Source: Energy Information Administration
* Natural gas used for electricity generation by electric utilities and independent power producers.
2004
2005
2006
2007
2008/F
Total Dry Gas Production
50.8
49.5
50.62
52.1
53.2
Pipeline
9.9
10.2
9.87
10.4
9.7
LNG
1.8
1.7
1.6
2.1
2.2
Net Imports
9.3
10.0
9.49
10.4
9.9
Supplemental Gaseous Fuels
0.2
0.2
0.18
0.2
0.2
Net Inventory Withdrawals
-0.3
0.1
-1.2
0.3
-0.1
Total Supply
60.0
59.7
59.1
63.0
63.2
Balancing Item*
1.2
0.6
0.2
-0.1
0.3
Total Adjusted Supply
61.2
60.3
59.3
62.9
63.4
Source: Energy Information Administration
* The balancing item is the difference between the components of natural gas supply and natural gas demand.
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Third parties help with the energy buy “New expertise is required,” says Bruce McLeish, senior vice president of products and pricing at Constellation NewEnergy, the Baltimore-based competitive supplier of electricity and natural gas to commercial, industrial and institutional customers throughout North America. So, there are such other companies capable of managing risks and addressing market challenges as Summit Energy in Louisville, Ky.; EnergyConnect in Portland. Ore.; EnergyWindow in Boulder, Colo., and Sempra Energy in San Diego. Sometimes, the source of assistance is as complex as the market it tries to understand. Sempra Energy generates electricity and distributes natural gas in the U.S., Europe, Canada, Mexico, South America and Asia. The company also provides natural gas storage services. Ands, it trades and markets such physical and financial commodity products as natural gas, electrical power, crude oil and petroleum products. Summit Energy doesn’t provide energy products; instead, it provides manufacturing companies with strategic guidance when negotiating energy contracts or engaging in energy-efficiency or risk-management projects. Summit Energy currently is managing more than $14 billion in annual energy spend by its industrial and commercial clients. The Eaton’s best-practices energy-management program is on a continuous improvement loop, says David Boon, vice president of client management at Summit Energy. “Basically, we were hired to be Eaton’s eyes and ears in the energy market and to analyze the best way to buy energy that keep supply flowing at prices that donlt bankrupt our partner.” He says the partnership is a strategic program that combines end-use data collection, cost-benefit analysis of alternative sourcing options and timing of energy buys. “The whole idea is to go to market and find the best terms at the best prices from the best suppliers, which varies from market to market and energy product to energy product,” he says. He and Wahlgren say the strategic sourcing program has worked so well in the U.S. that a version is being rolled out at Eaton’s overseas operations. Eaton and Summit Energy has been working together since 1999, collecting data on use and rates paid at 90 facilities in the U.S., seeking out alternatives and providing technical expertise to the corporate purchasing community on cost-reduction options. Then there is Constellation NewEnergy’s new procurement program known as i2i (information to implementation), which allows businesses to manage through market volatility to achieve energy budget goals. The i2i program links budgetary requirements and a customer’s so-called “risk appetite” with the global market factors that affect energy prices to deliver the optimal purchasing strategy. The i2i program was developed in direct response to the budget uncertainty many large consumers of energy experienced in the face of rising, turbulent energy markets. The patent pending i2i model links customer budgetary requirements and risk appetite with global energy market data and analysis to create customized purchasing strategies. Early users of the i2i program are CB Richard Ellis of Los Angeles, a global commercial real estate services firm, and Solo Cup of Highland Park, Ill., which produces disposable plastic cups, plates, and bowls. “Operating under a longer-term horizon, these and other businesses become more flexible in their purchasing decisions and are able to take advantage of volatility in energy markets to meet budget targets,” says McLeish. “Smart businesses are realizing that volatility in the energy market can work to their advantage when the right purchasing strategy is in place,” he says. “As a result, benchmarking conducted by i2i customers demonstrates that applying a long-term risk management-based strategy to the large-scale purchase of energy is the optimal way to achieve budget goals.” |
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