Reducing energy costs to remain competitive is a challenge that businesses across industries are being forced to undertake. Strategic energy management practices can ease this daunting task and mitigate risk associated with an uncertain energy market.
When assessing the energy management needs of an organization, several key areas must be addressed. This article provides energy management best practices in three key areas to assist businesses with curbing their energy costs.
1. Establish a Risk Management Plan
A significant aspect of managing energy costs is to have a risk management plan that is coordinated with the budgeting process to ensure all energy expenses are taken into account. To establish this plan, a company should first identify usage by month and by season, as well as the variability of the cost components involved with obtaining energy. This information will then help identify pricing objectives and create a risk profile, which assesses a company’s tolerance of energy price fluctuation and helps the company identify whether it can operate if energy prices were to spike. If a company cannot afford to stay in business if prices rise drastically, then it is a good idea to hedge.
While it is important to set price targets and objectives in a risk management plan, it is even more critical to actually follow those objectives. Some businesses will not hedge when prices are low because they want to wait for the lowest possible price. This plan can backfire if a company waits too long. On the other hand, when prices are rising, businesses sometimes will lock in high prices out of fear that prices will continue to rise. Having price points in place in your risk management plan and adhering to them lessens the risk that market movements could have a negative impact on energy budgets.
When considering hedging, it’s imperative to evaluate your company’s objectives. If the company is budget- and margin-oriented and/or it has “future sold” its product, hedges should be executed when natural gas and electric prices fit its budget or margin targets. Hedging at this point makes sense, regardless of where the prices are, because its objective is to manage margins and budgets.
Companies need to consider how their energy costs fit into their budget requirements. There is no magic time to hedge energy; companies hedge at different times because they have differentiating objectives and processes related to managing their own cost exposure. Some companies will implement forward hedges every month or quarter, while others tend to hedge opportunistically when the market presents perceived value. There is risk associated with being an opportunistic hedger: if you miss a drop in prices, you may end up paying a high price for energy in the future.
2. Implement an Aggressive Energy Procurement and Delivery Process
A successful risk management plan should drive an aggressive energy procurement process that forces suppliers to systematically compete for business based on cost and quality. When addressing the natural gas buying process, there are two aspects that need to be considered: underlying market volatility and physically obtaining the molecules that make up natural gas.
Hedging natural gas on the New York Mercantile Exchange (NYMEX) does not give a business any actual natural gas; it only provides price protection. Companies need to procure physical volumes, and there can be a significant difference in price from one supplier to another. As you get closer to the point of consumption, there is less transparency and pricing information.
When procuring energy, there is a search process that needs to take place. Often times, companies rely on third-party energy management providers to undertake this process on their behalf. In this case, an energy management firm will structure systematic procurements that meet both the physical and financial needs of a company.
Energy management providers like my own company, U.S. Energy Services, can offer valuable assistance with creating competition between suppliers. Energy management providers break down the natural gas buying process based on the three components of service: commodity supply, long-haul transportation and local distribution. By focusing on each component separately, they are able to provide businesses with the lowest possible prices.
First, energy management providers arrange contracts and credit with three to five suppliers. This allows them to see the prices each supplier is offering and choose the lowest price. Since most energy management companies only deal with suppliers that offer a quality product, price is much more of an issue that the product itself.
Once the natural gas is purchased, it needs to move through the interstate pipeline. Energy management companies work with businesses to determine their flexibility in procuring energy. If a business can tolerate some interruptions, they will be able to pay a much lower price for the interstate transport and distribution services. But if a business has an extremely high reliability level that needs to be met, then the energy management company will find a more reliable service.
The last step is working with the local distribution company. Generally, companies take the posted price, but there are some situations where energy management companies can work with local providers to get a discount on natural gas distribution services. For example, if a client is located near an interstate pipeline, it can perhaps tie directly into the pipeline and bypass the local distribution company or get a discount from the utility in exchange for not bypassing.
Along with market activity, determining delivery costs is another important variable to consider. Specifically, businesses should examine the cost of moving energy from the commodity point to the consumption point. In the case of natural gas, businesses should compare what they are paying to the Henry Hub, a point on the natural gas system in Louisiana that is used as the pricing point for natural gas futures contracts traded on the NYMEX.
If a business transports natural gas from Henry Hub, then it simply needs to look at the cost of moving the natural gas through the interstate pipeline. However, most businesses are not physically served with gas from Henry Hub, in which case there is a basis differential that represents a combination of the value difference between Henry Hub and other liquid pricing points and the transport costs in getting natural gas to the delivery point. For example, a business that obtains most of its natural gas from the Mid-Continent area or Canada should closely examine the value of gas coming from both sources and the transport costs. The objective should be to manage price volatility in the supply basin and work to push down transport costs to the lowest extent possible.
3. Cost-cutting Best Practices
Being aware of the essential issues involved with energy management is important, but equally as critical is implementing processes that can help businesses optimize their energy budgets.
Assess utility tariff options: It is up to an individual company or its energy management provider to determine whether it is paying the lowest possible tariff. Utility companies generally have no obligation to ensure that energy users are receiving their best tariff. As tariffs change and operating parameters within companies are altered, businesses need to examine alternative tariffs to make sure they are on the one best suited for them.
Keep an eye on government regulations: Many states have already passed regulations on carbon emissions, and many industry observers believe that federal carbon legislation will soon be a reality. An increasing number of businesses are taking this seriously and have begun preparing themselves for a carbon-constrained world. Your company should have an idea of how potential – but sweeping – regulations may affect it, and what you can do now to cut emissions and save money in the future.
Evaluate demand response programs: Within the last few years, electric utility and power pool operators have developed programs that provide incentives for businesses to curtail their energy uses during times of high demand. In exchange for cutting back on the energy they use, businesses receive monthly payments from the utility. Such programs are basically interruptible electric programs, but the ability to manage the programs has been greatly enhanced with better meter and control technology. There are a growing number of businesses signing on to demand response programs, and it is beneficial for almost any plant to consider this approach.
Explore energy efficiency projects and programs: Companies should inventory potential energy efficiency projects and rank them in terms of payback. Upgrading compressor controls so compressors operate more efficiently can play a considerable role in curtailing costs. As circumstances such as energy costs and corporate payback thresholds change, it is important to update the inventory of energy efficiency projects and equipment upgrades. In addition to examining energy efficiency projects within the plant, it is also important to identify and take advantage of energy efficiency programs offered by utility companies and state and federal agencies.
Implement an energy use and cost-tracking system: Surprisingly, many businesses do not have a good idea of how much energy they use or how much it costs. Oftentimes energy bills come into A/P and get rolled into a general ledger, without tracking the energy costs in a manner that is useful at the management level. Companies that use U.S. Energy Services, however, can access their energy usage and costs through a Web-based system that provides a variety of reporting tools and information that can be tailored to fit a specific company’s needs.
Make Time to Save Money
Taking the time to implement a strategic energy management plan, enlisting the services of an energy management company, or a combination of the two, will provide businesses with an opportunity to save a considerable amount of money on their energy budget.
By implementing an energy management plan that is aligned with the corporate goals, companies can overcome market volatility and even take advantage of market movements to optimize the money spent on powering their business.