Top five misconceptions about the procurement of energy commodities
Every day, energy decision-makers are bombarded with phone calls and emails from energy firms proclaiming they have the best ideas about how to procure energy. However, energy procurement may be just one of many “hats” the decision-maker wears. The resulting confusion can lead to faulty opinions about energy procurement best practices. These misconceptions are typically held by those ”responsible” for energy procurement – purchasing agents, facility managers, assistant superintendents, city managers, county judges, auditors, and others. While most energy managers have a great deal of expertise managing facility operations, they are not experts in the energy commodity markets. Here, we outline the five most common misconceptions held by energy decision-makers or anyone who is part of a team making energy procurement recommendations for their organization.
Misconception 1: “I already understand the energy markets and how to procure energy.”
Especially if the decision-maker is someone who has procured energy before or has some background in the energy markets, the tendency is to believe he or she knows enough to handle things successfully. While many energy managers are certified to handle demand side issues, which relate to how an organization uses energy once it’s delivered to them, managing the physical energy commodity itself requires a completely different knowledge base. Just as you wouldn’t want to trust cardiac surgery to someone who “used to be in the medical field” but never performed surgery, you wouldn’t want to leave energy procurement in your own hands or anyone else’s who is not fully involved every day in the energy wholesale markets. Your job is not to be an energy expert, but rather to shepherd the process for your organization – you must rely on seeking expertise to make the process successful.
Misconception 2: “I manage procurement of all commodities according to the bid calendar.”
Every purchasing professional maintains one, and it is the lifeblood of the procurement organization: the master bid calendar. This is how almost all procurement is managed, by working with contract expirations and end user needs to determine when each contract should be bid. The reason this doesn’t work with energy commodities is the same reason energy is so unique – volatility. Energy commodities in general, and specifically electricity, are the most volatile commodities you will ever procure. The impact on your budget of locking in a fixed price for electricity on Tuesday afternoon as opposed to Friday morning, for example, can easily be a difference of hundreds of thousands of dollars annually. While you can’t do anything about the volatility itself, you can manage your procurement process by having the tools and resources in place to follow the market and lock in prices during favorable market dips, thereby saving your organization tremendously in the long run.
Misconception 3: “My supplier is very good and always helps me secure the best price.”
It has been a growing trend to foster “partnerships” with suppliers, and in the energy world this sometimes means sticking with one supplier and trusting that they will always help you secure the best pricing. We mentioned before how essential it is to follow the market in order to find the best windows to secure pricing, and relying on one supplier to provide this guidance can lead to problems. This one supplier is only able to give you “their view” of the market. In addition, they are only able to deliver one solution – theirs. To ensure you are achieving the best possible procurement (product strategy, price, term, contract, etc.), you must use a competitive process that incorporates supplier responses from all suppliers in the market, not just the incumbent. Don’t worry – your current supplier will understand.
Misconception 4: “My contract doesn’t expire for another year, I’m fine.”
So many opportunities for savings in energy commodities are lost by not being ready to execute a contract. Unless they are within six to twelve months of contract expiration, many make the mistake of believing there is no point to even discuss energy procurement. It has been shown time and time again, though, that this strategy is the equivalent of rolling the dice and hoping for a seven. The best approach is to continually monitor the markets, because history shows that the best contracting window may be even three years prior to the expiration of the current contract. For example, in today’s market, known as a “declining market,” energy market prices are lower the more years you go out. This characteristic can mean that a 12-month contract purchased and starting today may be priced at 7 cents per kilowatt hour whereas a 12-month contract purchased to start in 24 months may be priced at 5.5 cents per kWh. The bottom line? It’s never too early to start looking at energy prices!
Misconception 5: “We can ’t control energy prices, so there is no need to monitor the market.”
This is a summation of much that has already been discussed. The misconception is that since no one has a crystal ball, there is no point in even trying to manage the process. In this scenario, the decision-maker just throws up his or her hands and says “We’ll bid this out next September.” The procurement is executed regardless of what other factors are happening in the market, and frequently attempts made by consultants and others to help are rebuffed because the belief is that no one knows the future, so why even try. Just because you have “put the energy contract to bed” for the next three years doesn’t mean you shouldn’t be monitoring the market and your contract’s performance. This monitoring will help determine how well your previous strategy performed, as well as show you market windows to make future decisions. A continuous feedback loop regarding contract strategy and performance is essential to increase an organization’s opportunities for future savings and cost control.
So all in all, don’t be a reactionary victim of doing things the same old way. Many analytical studies show that energy is one of the top three areas of spend for organizations. Take charge, and establish a proactive, managed strategy that pulls in expertise and professional resources to truly transform your organization, save thousands of additional dollars and make energy the hero of the annual budget.