INDUSTRIAL APPROACllliS TO REDUCING ENERGY COSTS IN A RESTRUCTURING ELECTRIC INDUSTRY

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1 INDUSTRIAL APPROACllliS TO REDUCING ENERGY COSTS IN A RESTRUCTURING ELECTRIC INDUSTRY Elizabeth T. Lowe Project Director Barakat & Chamberlin, Inc. Oakland, CA ABSTRACT Electric restructuring, currently proposed in California and being reviewed elsewhere, can produce many opportunities for large companies to reduce their electricity costs. As the electricity market changes, electric utilities and other potential suppliers are likely to develop a portfolio of options and creative pricing to attract customers in a competitive market. In attempting to be "energy neutral," i.e., to be indifferent to energy costs in one state or utility service area versus another, many companies are looking at a corporate approach to energy procurement, similar to the procurement of other products. Industrial customers may be looking for regional or even national energy suppliers for their facilities. Electric utilities, in an attempt to be competitive and retain customers, wil1likely work to be this regional or national energy supplier. The expectation will be that these suppliers can offer competitive pricing and a portfolio of options from which to choose. These options may resemble those that have developed in the natural gas market as a result of restructuring in the fuels industry. Tllli CHALLENGE FOR INDUSTRY As companies face increasing international competition, environmental regulation, and the task of recovering from the nationwide recession of the early 1990s, they are striving to become more competitive and to reduce costs in all areas of operation. Understandably, companies have begun their efforts by focusing on high-cost areas, such as labor and raw materials, and streamlining product offerings. With the proposed deregulation of the electric market, many large companies now have the opportunity to achieve significant energy cost savings by developing natural gas and electricity procurement strategies. Tllli DAWN OF RESTRUCTURING On October 8, 1992, the U. S. Congress passed the National Energy Policy Act. This legislation authorizes, among other things, wholesale electricity wheeling on a national basis and gives states the authority to implement retail wheeling. On April 20, 1994, the California Public Utilities Commission (CPUC) issued a new Rulemaking/ Investigation (R ; ) that proposes significant reforms for the state's electric industry. The strategy proposes two parallel paths: direct access and performance-base ratemaking. This direct access scenario ("retail wheeling") is proposed to be phased in over a six-year period. The first group to become Direct Electric Customers (have direct transmission access) woul be large industrials, with service available on January 1, Next, smaller industrials, commercial customers, and residential customers will be eligible for the program in 1998, 1999, an 2002, respectively. Although other regulatory conunissions acros the states have been reviewing retail wheeling proposals, the California proposal has drawn significant national attention because utilities, electric generators, regulators, power marketers, and customers see it as a potential model for the rest of the country. CHOICES IN A RESTRUCTURED MARKET Customer Options in a Restructured Electric Industry In a restructured electricity market, customer wil1 have choices similar to those currently available inille electric industry in the United Kingdom and the restructured natural gas market n the United States. Although many electricity providers will offer their services in a restructure U.S. electricity market, it is not clear which pow r producers industrial customers wil1 buy from. James Rouse, associate director of energy policy for Praxair, Inc., thinks that utilities wil1 continu to be the major providers of electricity, but at lower rates: "AT&T stil1 has about 70% of the long-distance business, but it's priced more competitively thanks to Sprint and MCI. The 131

2 choices we will have will force [utilities 'J rates down" (1). Electric Industry Restructuring in the United Kingdom The open access system for electricity being implemented in the United Kingdom is a three-part process, with customers being phased in based on size (the process is similar to that proposed by the California Public Utilities Commission). Under the U.K. system, customers with loads in excess of 1 MW have been able to purchase power from alternative suppliers since In April 1994, customers whose usage ranges between 100 kw to 1 MW became eligible for open access. All customers will be free to choose suppliers beginning in According to a regional electric company representative, the average savings for a mediumsized customer in the United Kingdom have been 8 %. One indication of customer response to electric industry restructuring in the United Kingdom is that in less than two months after they became eligible, nearly 13,500 commercial and industrial customers with loads between 100 kw and 1 MW dropped their local utility in favor of another provider (2). Natural Gas Restructuring in the United States The experience of the natural gas industry in the United States is also useful for companies to draw on in assessing the changing electricity marketplace. In the late 1980s, states began unbundling their natural gas tariffs so that companies could purchase gas from third-party suppliers. However, Federal Energy Regulatory Commission (FERC) Order 636, which resulted in the release of firm pipeline capacity, really opened up the natural gas market for competition. The order has provided many opportunities to procure and transport natural gas at competitive prices. Before natural gas tariffs were unbundled by state and federal regulators, local distribution companies provided gas supplies, gas transportation, and most gas services on a bundled basis. With unbundling, companies have more choices, and more opportunities to reduce costs as well (see Figure 1). An Enron Capital & Trade Resources Presentation estimates that over $90 billion has been saved since natural gas unbundling began in the mid 1980s. Estimates of cost reductions are in the 25% to 30% range. Figure 1 Wellhead to Burnertip: Some of the Variables and Options Industrials Need to Consider Wellhead -.. Commodity Pricing Transportation Pricing ~ Transportation -... ~ Burnertip Indexed Nymex with basis differential Fixed Border index Marketing Company Pipeline Options Pipeline Pricing LDC Tariffs - Offers bundled burnertip service 95mOOlbel2l95.3p 132

3 Many companies have jumped at the chance to reduce their natural gas costs on both a facility basis and at a corporate level. The natural gas experience has shown that companies with numerous facilities in various regions of the country served by several pipelines are in a strong negotiating position vis-a-vis the suppliers and transporters of natural gas. Many of these companies have been able to obtain low-priced gas at the burner tip and superior reliability and service. Similar opportunities for reducing costs are likely to arise in the electric industry as it is restructured. APPROACHES TO REDUCING ELECTRICITY COSTS Traditional Approaches In the past companies have used several approaches to reduce their overall electricity costs, including rate incentives (interruptible rates, timeof-use rates, cogeneration deferral rates, and economic development rates), demand-side management/conservation, and cogeneration. Rate Incentives. Rate incentives are typically offered by utilities under regulatory-approved rate programs or tariffs. As the market becomes more competitive, however, negotiated rates are becoming more and more widespread, as evidenced in the Arizona and North Carolina cases below: Arizona Public Service is giving special discount rates to Cyprus Bagdad Copper, which in return has agreed to defer an 80 MW cogeneration project, The North Carolina Utilities Commission has approved a Carolina Power & Light (CP&L) plan to offer AlliedSignal, Inc., a LO% rate discount for five years at its polyester-fiber factory. In exchange for the rate discount AlliedSignal has agreed to continue buying all of its electricity from CP&L and to defer the construction of its proposed self-generation facility. The deal will save the chemical company $60 million a year. Demand-Side Management/Conservation. Demand-side management has boomed as a strategy for utilities as regulatory commissions have made it profitable for utilities to offer these programs. As the market becomes more competitive, however, these programs are being downsized by utilities. Some examples of successes from DSM programs include the following: Greenfield Industries of West Springfield, Massachusetts, an industrial tap manufal;:turer served by Nortbeast Utilities, cut its energy costs by 82 % by replacing a barium salt-bath heat-treating process with bigh-efficiency vacuum furnaces. The Boeing Company of Seattle is participatin in a conservation project that uses recycled municipal wastewater as tbe energy medium for a chiller cooling system. Boeing expects t save 20% of the energy it uses in cooling and $500,000 a year in power and water costs. It will use 40 million few gallons of water each year. AK Steel Company says it has revitalized its Middletown, Ohio, steel mill by slasbing energy costs under an interruptible rate program with Cincinnati Gas & Electric and internal energy conservation program. Together, those two programs are saving the company more than $ I. I million annually. Cogeneration. Cogeneration/self-generation has been an approach for companies to get off the utility syst and to create their own electricity and' process steam. As markets become more competitive however, and utility prices are pushed downward the potential savings from on-site generation will decrease. Some recent examples of on-site generation contracts include the following: The Saginaw, Michigan, division of General Motors executed a 20-year service agreemen with Indeck Energy Services, Inc., under which Indeck develops, constructs, owns, operates a cogeneration unit that meets all 0 the division's power needs. Flo-Sun, a Florida-based company, has ente ed into a second partnership arrangement with U.S. Generating for construction of a 52 MW cogeneration plant that will provide multipid benefits. 133

4 Innovative Approaches In addition to reducing their costs, companies with multiple facilities in various utility service areas have sought to be "energy neutral" across all their facilities. In other words, they have wanted their electricity costs to be the same at all of their facilities. Discrepancies in electric costs can be a driving factor for expanding product lines and staff in facilities with low electric costs and reducing product lines and staff in facilities with high electric costs. Companies are also becoming sensitive to the energy costs of their competitors. According to some industrial customers, this sensitivity is one of the main reasons why companies wish to accelerate the implementation of retail wheeling. Addressing FERC in 1994, John Anderson of the Electricity Consumers Resource Council (ELCON) emphasized this point as he called for retail wheeling: "Within many states, some industrials pay rates of two or three times what their competitors pay at facilities that may be only a few miles apart... It is time to make retail electricity suppliers compete for their customers' business." (3) As large companies press the issue that they want their various facilities to have the same electric costs (i.e., to be "energy neutral "), utilities have begun to provide incentives to companies to build or expand in their service territories. Several recent cases illustrate this trend: Brass Foundry Company decided not to relocate its production facilities to another state after the Illinois Commerce Commission approved a special economic developmentl retention (EDR) rate offered by Central Illinois Light (4). A new Parkdale Mills yarn-spinning plant that could eventually require more than 35 MW will be built in Virginia instead of Alabama largely because Appalachian Power offered lower industrial power rates than what the company would have received in Alabama (5). Nucor Corporation is in the process of choosing a site for a $400 million mill to serve East Coast markets. The company has said that power cost and reliability are "very, very important factors" in deciding whether to site the mill in Virginia or South Carolina (6). Cleveland Electric Illuminating (CEI) offered a special interruptible, curtailable contract to Birmingham Steel that helped seal the manufacturer's decision to construct a new $110 million steel bar and rod facility in the CEI service territory (the company rejected sites in Kentucky, Pennsylvania, and other parts of Ohio in favor of the CEI service territory) (7). A Kentucky municipal utility undercut its competitors in six states with a firm rate for electricity that played a key role in the mid August 1994 decision by MacMillan Bloedel, Inc., to build a $IOO-million paper mill in Henderson, Kentucky (8). Pacific Gas and Electric Company (PG&E) is seeking expedited approval from the California Public Utilities Commission for a proposed electric service agreement with Genentech, Inc., designed to ensure that the biotechnology company expands in California rather than in one of four other possible sites in other parts of the country (9). Flexible electric rates at PG&E persuaded the world's third-largest cookware manufacturer, Meyer Cookware Industries, Inc., to build its first U.S. factory in Vallejo, California (10). THE NEXT FRONTIER FOR COST SAVINGS A Menu of Choices The use of rate incentives and flexible pricing to attract and retain customers is for many utilities their first foray into a competitive market. As the market moves toward deregulation, it is likely that these utilities and other electricity provides will develop a comprehensive products and services menu to supplement their current customer retention measures. These products and services, such as unbundled product lines and creative pricing, will hold additional cost saving opportunities for electrici ty consumers. Unbundled Product Lines Utilities and other electricity providers are likely to draw on the electric industry experience in the United Kingdom and the natural gas industry experience in the United States to develop unbundled products. These products may include such items as: 134

5 Commodity sales and pricing of electricity Commodity pricing would be designed for Price risk management customers that want the lowest price in the market. Financing Prices could be indexed in a variety of ways (e.g., Physical services, such as load management, wholesale-based prices or bulletin board prices). storage Administrative services Risk management pricing would include a Engineering support product line with fixed or escalating prices or an index line based on several options, including Evolution of Creative Pricing publicly available indexes, prices linked to Also likely to develop in a restructured market competitor prices, fuel prices, or even the prices 0 are creative pricing structures (i.e., product lines product lines. that vary in price, risk, term, and services). Electricity providers, especially the electric utilities, Portfolio pricing could combine selections fro will continually reassess price and risk (see Figure commodity pricing and risk management pricing. 2). These providers will individually tailor the pricing of electricity to fit a consumer's needs and A la carte pricing options could include other level of risk. Potential pricing structures might options that customers might choose for increased include: reliability, price security, or enhanced service. Th s Commodity pricing type of pricing might include some or all of the following features: Risk management pricing Portfolio or combination pricing Discount options An a la carte menu of options Price collars Designating a utility as exclusive provide Take-or-pay contract Relative Price Higher Figure 2 Competition May Require Repositioning Average 95mOOlbeL2I95.ap Lower Relative Lower Average Higher Value -=============~ 135

6 Premium options Price cap Guaranteed peaking service Power quality Special billing On-site energy manager Demand-side management services Utilities have begun to offer creative pricing in advance of electric industry restructuring to retain some of their larger customers and to gain experience in implementing creative pricing mechanisms. Some recent cases include: Baltimore Gas & Electric (BG&E) signed a ten-year contract with Bethlehem Steel Corporation that made BG&E Bethlehem's only electric supplier. General Motors, Ford Motor Company, and Chrysler Corporation signed a ten-year power contract with Detroit Edison to reduce costs and to meet the demands of worldwide competition. A Steel Dynamics, Inc., representative said that a special ten-year contract that the company signed with Indiana Michigan Power to serve its minimill is "one of the better energy-competitive contracts in the U.S." (11) Wisconsin Power & Light is trying to win a 10 MW power contract from Motorola for its proposed cellular phone manufacturing plant, even though Motorola is siting the plant in Illinois (in Commonwealth Edison's service territory). In an unusual agreement, an investor-owned utility and a rural electric cooperative will jointly serve a new $300 million steel minimill on the Ohio River. The agreement is expected to help create one of the largest new employers in the region and help the plant compete with comparable technologies. CONCLUSION The proposed restructuring of the electric markets has spurred a wave of cost-saving opportunities for large industrials. These savings are likely to continue. In the near-term, large energy consumers, particularly those located in high-cost utility service areas, will continue to see savings as the threat of competition will drive down electric prices. As deregulation unfolds, power marketers/brokers and independent power producers will challenge electric utilities for their customers. Industrial customers will continue to realize savings as electric utilities and other potential suppliers, having to compete for customers, develop portfolios of cost-saving products and creative pricing options. REFERENCES 1. Industrial Energy Bulletin (leb), May 6, 1994, p IEB, July 1, 1994, p IEB, April 22, 1994, p IEB, September 23, IEB, October 21, IEB, November 18, IEB, October 21, IEB, August 26, IEB, August 26, 1994, and December 2, IEB, July 1, IEB, August 12, 1994, p. 11. pd95moojlrcduce.ppri2 9-9S 136