Recently my wife and daughter came home with several bags of newly purchased items after a fun day of shopping. After pretending to be interested in each fashion forward piece they excitedly showed, I got to the real question that had been burning in my mind, “How much did this cost”? My daughter quickly pulled out the long receipt of itemized expenditures and as I attempted to find the total spent, she immediately directed me to the highlighted and circled area at the bottom that clearly stated “SAVINGS” – which was nearly 50% of the total amount that was spent!
Wow…Really?! 50% savings? Compared to what benchmark? An inflated and unreasonable price most budget conscious individuals likely would not have paid? This made me ponder… what does “savings” really mean to individuals?
Determining What “Savings” Really Means
For example, take the natural gas market, which has been deregulated at the industrial level for decades. Most public utilities still buy gas for some number of customers, mostly residential, behind their system and have a default gas cost pass-through rate for anyone that hasn’t taken advantage of third party supply; which is usually higher than any market price where true competition exists. Would it be acceptable to calculate savings based on a market-based tariff price from a utility that hasn’t served large industrial or commercial accounts with supply for the last 15-20 years? Or what about a calculation of savings that compares the current year to the previous year, or the average from the previous 2 or 3 years?
How about including only sites with a reduction in cost and not including any sites that had an increase in cost? We’ve seen these types of savings, along with many others, used by various companies and energy consultants to try and quantify the financial benefit of an energy purchase strategy, project, hedge or decision from the past. Unfortunately, there is not yet a way to determine what qualifies as “savings” when it comes to looking in the rear-view mirror to quantify how much money was saved. As a result, I wanted to attempt to categorize a few different ways in which we, at Edison Energy, have seen savings defined.
What I’ve come to understand from managing energy supply for hundreds of commercial and industrial site locations over the past 20+ years is that each of one has their own way of defining savings. Often, a company or purchasing policy dictates how an entity defines the term. One item that is important in choosing the right energy consultant is that both customer and consultant understand and agree on the benchmark that allows savings to be reported.
Another similar, although non-standard term in the energy business is “Cost Avoidance”. Often even more difficult to explain and quantify than savings, this term considers actions that are taken to avoid or reduce future costs. Because the cost is reduced or completely avoided, it requires “what-if” scenarios to be developed and agreed upon to be quantifiable. Some corporations and energy brokers consider savings and Cost Avoidance one and the same, while others would never even think of trying to calculate Cost Avoidance, let alone call it savings. For this discussion, I’ll focus on the savings term.
We know there are a lot of ways savings for energy supply can be determined. The first category of savings that many clients use, I’ll call “Market Savings”, and can be a true reduction in cost, one caused by a downward movement in market pricing, even if it is through a short window of opportunity that disappears quickly. Timing a supply procurement event to capture this value is very possible and something Edison Energy excels at doing, however, the market still needs to drop to provide a financial benefit in this area. If pricing goes on a multiyear upward price trend, like the NYMEX did from 2012–2014, it would have been difficult to show year on year Market Savings in this category for anyone that chose a NYMEX LDS price structure (See Exhibit A below). Choosing the most appropriate pricing structure at the right time and being nimble enough to transact during the open window will determine whether the Market Savings category saves or loses money.
For any savings metric that compares a look back at various pricing structures, the original reason for choosing a one structure vs another would need to be documented, i.e. was a fixed price structure preferred over a market-based structure to protect the budget? If so, it would be unfair to compare a market based structure to that fixed price if the market price ended up being lower. Other common ways companies track energy cost value includes the following:
- Actual third-party supply cost vs Utility default supply cost – The result of this comparison is often influenced by how often a utility changes its gas supply rates. For example, a utility that changes its rates once every 12 months and is under-collected during a higher priced market period will appear lower until the true-up year occurs in year two.
- NYMEX LDS + Basis (monthly market pricing where basis is fixed and NYMEX is floating) vs Regional Monthly Index price (IFERC or NGI) (where basis fluctuates monthly)
- Fixed price vs Monthly Index vs Spot / Cash pricing structures – When using this comparison, regional supply / demand factors for a forward contract term aren’t known. Typically, a high demand period like a cold winter in an area without excess delivery capacity would produce a higher monthly Index price.
Other common ways energy procurement groups can quantify, or could at least be considered “incremental value” or “cost avoidance”, include:
- Demand response
- PLC tag management
- Invoice errors (pricing & volume errors, late fees, inconsistencies with contract, Btu conversion, fuel calculations, etc.)
- Supply contract terms negotiations
- Utility contract negotiation
- Utility tariff interpretation, application and representation / support
- Regulatory intervention / better rate filing outcome
- Transaction confirmation review
- Scheduling/Operations management (asset utilization, balancing, OFO coordination, nomination services)
- Penalty avoidance / least cost option analysis
- Meter errors and meter error resolution
- Tariff analysis / switching to lower cost rate schedules
- Bypass analysis
- Forecasting / load modeling
So, when someone asks or is asked by their company to quantify savings, it is important to first define what would qualify. It is also key to document the reasoning behind any contract structure, term, and any site-specific conditions or company policies that may prevent certain structures or terms from being used or require others to be utilized would be wise to keep. Without a set of ground rules clearly stating what can or cannot be classified as “savings”, the number can achieve unrealistic highs or unfair lows in the final calculation of any savings amount. No matter how narrowly or widely defined by you or your company, Edison Energy can help educate you with energy expertise to help you meet financial goals, mitigate unwanted risk, or protect the resiliency of your facilities while meeting your savings targets.
To find out more about how to get independent, comprehensive, expert and data driven advice on your energy supply management, contact Edison Energy.