Top 10 energy buying mistakes you didn’t realize you were making (and how to avoid them)
Mistake Number 9: Poor Energy Supply Contract Negotiation
This series on the Top 10 energy buying mistakes that purchasing professionals make is nearing its conclusion. Previous installments discussed issues of not procuring proactively, missing the most competitive rates, developing an inappropriate procurement strategy for your specific needs, neglecting a pre-determined goal of what you want to achieve, utilizing an aggregation for purchasing energy, taking a decentralized approach, hiring one company to handle all energy activities, and focusing too much on the process instead of the results. By taking all these mistakes into consideration, you will be well equipped as a purchasing professional to handle upcoming energy procurement needs.
In this ninth installment, we will discuss problems that arise from poor energy supply contract negotiation. This article will focus on five key areas of energy supply contracts that many times are not given proper consideration during contract negotiation:
- Payment Terms
- Termination Fees
- Adding/Deleting Accounts
- Energy Usage Bandwidth
- Material Changes
An even bigger mistake is to not negotiate your contract at all. If you have gone through a very thorough energy procurement process, all can be lost by then establishing a contract that puts you as the buyer at a disadvantage. Make sure that, once you have gone through your procurement process, you move on to the stage of actually reviewing and negotiating these five key areas, as well as the general terms inherent in all energy supply contracts.
The Mistake: Not matching payment terms to your payment capabilities
Payment term language is the most basic of all clauses we will discuss here. In general, suppliers want to be paid as soon as possible. You as a customer want the lowest rate, and the prices a supplier offers are typically lower when shorter payment terms are in the contract. So, if you have a contract with Net 10 payment terms, you should ensure you can turn a bill around and issue payment within 10 days.
Why It Happens: You think you can pay faster than you really can
Most organizations think their administrative operations are more efficient than they really are. It is fairly common to end up paying significant amounts of late fees each year just because your check doesn’t make it to the supplier by the due date. Not only is this wasting your administrators’ time by forcing them to contact suppliers to discuss payments, but it also has a cascade effect of impacting your credit rating.
How to Fix It: Establishing terms that reduce or eliminate late payment fees
If it really takes you a month to process a bill and pay it, be realistic during negotiation and request 30-day payment terms up front. This may mean your energy rate is a bit higher, but you will pay less in the long run by eliminating late fees.
The Mistake: Lack of awareness regarding facilities you may be buying or selling
Termination fees kick in when even one of your energy accounts is removed from contract. If you have 10 buildings, and you sell one of them, you are considered to have “terminated” that one account. Most termination fees comprise a combination of market losses for selling unused energy back into the market and the ensuing administrative costs. Not being aware of future facility plans can lead to undue termination fees.
Why It Happens: You don’t think there will be changes to your property portfolio
As with other clauses, negotiating more favorable termination language for you as the buyer leads to a higher rate from the supplier. Prior to entering into an energy contract, check with your organization’s real estate group or facility department to see if there are any anticipated future moves, and then discuss what your needs may be with the supplier.
How to Fix It: Negotiate termination fees that are consistent with your future plans
If there truly will be no changes to your facilities, a termination clause has little effect on you. If, however, there is a likelihood that your organization may sell or vacate one or more facilities, push for language that will allow you to leave with no penalty if you give sufficient notice. This will provide a level of protection against termination fees.
The Mistake: Not including an add/delete clause when necessary
This clause is something that many suppliers will not include unless the buyer requests it. Again, it comes at a premium, so only ask for this stipulation if you anticipate adding or removing locations from your contract.
Why It Happens: As with termination fees, there is little awareness of future facility needs
If you are not involved in organizational forecasting and remain unaware of future needs, you most likely will sign a contract with no add or delete provisions. This means that if you add a new site, it will be priced at current market rates; if you delete a site, you will pay a termination fee (see above).
How to Fix It: Insert add/delete language to cover your future needs
Add/delete language is typically inserted by allowing a certain percentage of change. The most generous add/delete clauses are around 20%, which means you can add or delete accounts from your contract at no penalty as long as the change does not exceed 20% of the overall load. So, make sure you have a percentage negotiated that matches your anticipated needs.
Energy Usage Bandwidth
The Mistake: Bandwidth language is not broad enough to address changes in usage at your facilities
Unlike termination fees, bandwidth clauses can lead to fees resulting from using more or less energy than estimated in the original contract. A 0 percent bandwidth clause would mean that you would pay the contract rate for all estimated energy: If you use less than contracted, you would pay a fee to sell that unused energy back. If you use more, you would pay the current market rate for that extra energy.
Why It Happens: Again, typically a lack of knowledge regarding changes in operations
You must understand both your usage profile and your likelihood of significant change to determine what percentage bandwidth you may need. If your energy needs are fairly predictable and have been stable for several years, you can achieve a lower rate by agreeing to a lower bandwidth percentage, such as 10% or 20%. But if your needs are unpredictable or have varied over the past few years, you’ll want a higher bandwidth percentage or even unlimited bandwidth.
How to Fix It: Negotiate bandwidth that covers anticipated changes
If you want the most protective language, push to negotiate 100% or even unlimited bandwidth. This would mean that any changes in your usage are covered under the contract, and you would always pay the contract rate for any and all energy you use. The more comfortable you are with the predictability of your usage, the lower the bandwidth you can agree to.
The Mistake: Not being aware such a clause exists
Material changes are typically defined in contracts as any change in usage resulting from a change in operations that becomes permanent or semi-permanent. The majority of the time, a buyer focuses on bandwidth language but is not aware of material change language. The result may be unlimited bandwidth but a very restrictive – and ultimately costly – material change clause.
Why It Happens: Lack of experience in negotiating supply contracts
When a material change clause is triggered based on changes in usage/operations at your organization, it will usually give the supplier the ability to unilaterally establish a new price. This can lead to huge disruptions in your energy budget, should such a clause be triggered.
How to Fix It: Ensure such clauses are worded fairly or eliminated altogether
During your negotiation, first attempt to have the material change clause deleted. If you cannot eliminate this clause, it is important that you remove the vagueness inherent in many of these clauses. You should define any actual change in energy usage such as duration (ask the seller to identify exactly how many months a deviation in usage lasts) and percentage of change (be sure the seller spells out whether “material” is considered a 10% change, a 50% change, or something else). Work to make these as advantageous to you as possible.
Conclusion: Proper Negotiation is a Balancing Act
Picture a scenario in which you have lined everything up properly throughout your procurement process. You have found the optimal market window for savings by working with your energy advisor and leveraging key market intelligence. You have then maximized competition by bringing all suppliers together to compete in an apples-to-apples process. You have arrived at a price that provides excellent savings and budgetary control. But then you end up signing a contract that ultimately results in higher prices due to fees and penalties resulting from operational changes on your end. The end result negates all the great work done on the front end.
Don’t let your process become bogged down like this. Be prepared to address – and then negotiate – these key terms to your benefit. But remember, it is a balancing act: If you negotiate the terms too much in your favor, premiums will be added to your price, thereby jeopardizing your savings. By striking an optimal compromise that is fair to both the energy supplier and you as the buyer, you’ll achieve both the right contract terms and the right price.
Bob Wooten, C.P.M., CEP, is Director of National Accounts for Tradition Energy, and has over 20 years of experience managing commercial, industrial and governmental procurement programs for a wide variety of clients. Bob holds professional certifications from the Association of Energy Engineers and the Institute for Supply Management, as well as a B.A. from Texas A&M University, and a Master’s Degree in Public Administration from the University of Houston.