Confronting Electricity Costs in the United States

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1 Confronting Electricity Costs in the United States As consumption patterns change and prices rise, electricity bills are skyrocketing. Several moves can tilt the balance of power and help a company control costs.

2 As technological transformations and shifting energy sources continue to be the engines for economic growth, America s previously biggest electricity consumers are being overtaken. Today s major wireless providers spend hundreds of millions of dollars on power annually sending signals to the nation s mobile devices, while the IT revolution is pointing to Google and Facebook as two of tomorrow s largest power consumers. Manufacturing is changing as more processes become further automated and add greater value. While these rapid developments in usage trends have caught many off guard as they grapple to control rising energy costs, players that capitalize on the formidable complexity of the electricity value chain can capture sizable savings. Consider the Power Profile Before diving into new energy strategies, take a look at your power profile. For example, geography and consumption will affect strategy choice. Players with a national footprint will need state-by-state strategies, often encompassing both regulated and deregulated markets. While users typically have less freedom to influence prices in regulated states, such as Florida, Georgia, and Washington, hidden opportunities do exist. In deregulated states, such as New York, Illinois, and Texas, the generation portion of power costs (typically about 50 to 70 percent of the total) is set by the free market. Customers have several choices: Use utility companies for fixed tariff rates; look to third-party suppliers to establish a more competitive fixed rate; or buy directly off the market index in real time. Be aware that deregulation does not necessarily mean lower pricing. Open markets tend to produce both winners and losers, and volatility drives complexity. Understanding your consumption profile and how it relates to complicated market dynamics is crucial. Developments in usage trends have caught many off guard but players that capitalize on the complexity of the electricity value chain can capture sizable savings. Next, consider the load curve. Few markets are as volatile as the electricity grid. On a typical day, generation costs in a deregulated market could vary between to 4 per kilowatt hour (kwh) in the wee hours of the morning to 6 to 8 at peak usage time (see figure on page 2). Renewable energy subsidies, which often provide a fixed price adder per kwh generated, can have the somewhat aberrant effect of driving generation prices to zero or even negative (consumers receive money to take electricity). At the other end of the spectrum, during summer peaks in some regions without excess capacity, electricity can top 50 per kwh. Many companies have electricity needs that drive market trends. For example, retail stores or restaurants often have high demand during the hottest, busiest times of the day, while a wireless network might maintain a relatively flat 24-hour load (see figure 2 on page 2). In theory, these On average, there are major variations in generation s portion of the price depending on the source, region, user type, and time of purchase.

3 Figure Electricity prices fluctuate depending on the time of day Example Hourly prices for power generation ( per kilowatt hour) Winter Summer Time of day (24-hour time) Sources: PJM; A.T. Kearney analysis Figure 2 The consumption patterns of the various users are strikingly different Electricity consumption by U.S. customer type (billion kilowatt hours) Industrial Residential Commercial January 200 July 200 January 20 July 20 January 202 July 202 January 203 Source: A.T. Kearney analysis 2

4 daily and, to a lesser extent, seasonal load variations should dictate what prices a company pays. Unfortunately, many procurement departments and energy managers underestimate the market effect. Strategies in three areas energy efficiency, sourcing, and capital projects can help reduce electricity spending. Energy Efficiency Often overlooked or underappreciated, conservation efforts can create the most substantial cost reductions. Many companies do not take a calculated and objective approach to addressing the number of kilowatt hours absorbed by their operations and are missing out on big opportunities to lower costs. Energy efficiency technology and approaches continue to evolve even though many of the enhancements such as improved automation, lighting, HVAC, and refrigeration may require upfront investment and the business case might struggle to meet the corporate internal hurdle rate. Employing third-party energy managers with a touch of basic financial engineering can work to turn a capital-burdened project into a contracted, reduced operating cost. Many companies do not take a calculated and objective approach to addressing the number of kilowatt hours absorbed by their operations. With the U.S. energy policy push for both economic and environmental efficiency, utilities are incorporating more and more dynamic energy pricing. With cheaper and more widespread deployment of smart meter technology, utilities often will charge different rates based on the variation of consumers usage throughout the day with time-of-use pricing a major advantage for those with relatively flat or non-peak demand. In this situation, companies should look to load shift that is, to move their consumption away from peak price times. For example, factories, which use the most electricity when machines are turned on, can create significant savings by taking operation away from peak grid hours. Some utilities will also pay energy users to decrease consumption with demand response. During power shortages, companies commit to reducing energy by an agreed amount for a certain time and, as a result, receive a substantial credit, either immediately or against the monthly bill. The effect of demand response is especially pronounced during the summer. For example, on August 2, 202, the regional transmission organization PJM reported $230 million in savings to customers from demand response. These voluntary curtailments reduced wholesale energy prices by more than $3 per kwh during the highest usage hours. While for many users power shortages will never occur, for some they are relatively frequent. Further drawbacks must also be considered. Depending on the sophistication of its energy management group, a company may require a third-party energy manager to support demand response contracting because the details can be complicated and a misstep could be 3

5 disastrous for operations. A probability study based on historic data will be required, to understand the commitment and the associated operational risks of partnering with a utility. And, of course, a company pursuing discounts from demand response will need the ability to make do with off-the-grid sources, including self-generation. For example, in wired telecommunications, much of the network has reliable backup generation, so demand response is widely used to save on power bills. Wireless players, however, are reluctant to rely on the batteries in their towers during peak periods. Sourcing Regulated sourcing opportunities Utilities rate structures often incorporate load patterns, aggregate usage, site usage, and geographic footprint into a complex variety of rate offerings. The challenge for large consumers, especially those with an atypical consumption profile, is to determine which rate is most beneficial. How much due diligence has the company done around this? Performing full-scale invoice and rate audits will help ensure regulated market procurement is as effective as possible. Determining the most attractive rate available will often require detailed analyses of consumption patterns combined with a thorough understanding of local rate structures and regulations a potentially daunting level of detail, especially when the footprint is widespread. Using a qualified third-party auditor to support the task may be the only realistic way to go; the best partners will have a detailed nationwide rate-structure database that can be used for comparative purposes. We recommend that once consumers understand their consumption, they enter the open market and look to suppliers that buy, sell, and trade generation. Deregulated sourcing opportunities Most consumers want to avoid the inherent risks and complications involved in strategically procuring electricity in deregulated markets, so they acquire it directly through a utility. This standard generation rate is likely the highest rate. It is analogous to paying the rack rate displayed on the back of a hotel-room door: very high, but at least it is fixed. We recommend that once consumers understand their consumption, they enter the open market looking to energy suppliers that buy, sell, and trade generation to purchase a relatively fixed consumption. This is done through a closed request for proposal tenders or open online auctions closed tenders are more likely to provoke aggressive bidding than a reverse auction, which forces suppliers to reveal their bidding hand. The next step is to look at the problem a little more closely: Given its consumption profile, how can a company optimize its procurement strategy with inherent regional, seasonal, and daily volatility in electricity prices? 4

6 Suppliers like to provide fixed rates for a given usage for one-year periods or longer, and companies often like that certainty. However, if the company has a constant load, why should it pay a supplier a constant rate that is substantially above the daily average, and why does the supplier charge such a premium (see figure 3)? The answer is risk. The supplier wants to ensure it receives a premium rate to offset when it has to supply electrons cheaply while paying a fortune for generation at peak hours and seasons. Again, it comes back to how well a company knows its consumption. The shrewdest players are already prepared to negotiate for fixed rates and know if and when to take the next step choosing to ride the index. Rather than paying a fixed rate for a given amount of consumption, the company contracts the supplier to simply deliver power at market rates (with a small adder fee). Figure 3 Fixed energy rates provide certainty but may be high Illustrative Average price of generation ( per kilowatt hour) Tariff rate Client s fixed rate Index price Time of day (24-hour time) Source: A.T. Kearney analysis Remember these energy suppliers are often the same firms that sell consumption at fixed rates, though with this ride-the-index approach, they are passing the risk premium back to the company in the form of savings. Our research and work with clients shows there can be major advantages depending on consumption patterns. In fact, the savings can be substantial up to 40 to 60 percent of generation costs, often with a very acceptable level of risk. The devil, of course, is in the details, and the right procurement solution and risk level will vary across consumer profiles (see sidebar: Cutting Costs with Tailored Procurement Strategies on page 6). Those with peak consumption from 4:00 p.m. to 6:00 p.m., when the market reaches its highest, may be well served with a constant rate agreement to minimize the effect of spikes, if the supplier has not baked in an extensive risk premium. 5

7 Cutting Costs with Tailored Procurement Strategies A wireless provider with thousands of cell towers across the United States had hourly and seasonal loads that were generally flat. Spending in large states topped $5 million per year. We suggested a procurement strategy with three tactics: In regulated markets, negotiate at the state or regional level based on a rate audit. In deregulated markets, ride the index. Where regulated utilities offer time-ofuse rates, install smart meters. Projected savings for regulated markets is 3 to 6 percent; in deregulated markets, savings could reach 30 to 40 percent on generation. For a financial institution, self-generation was the best strategy. The firm had one central data server in a deregulated state, a flat load with some spikes, and high annual usage of more than $0 million. Investing in self-generation with low-cost natural gas could minimize transmission and distribution based on a detailed understanding of the hourly and seasonal consumption profile. Projected savings on generation could potentially reach 45 percent. Capital Projects As the manufacturing landscape alters, more major capital projects are incorporating utilities costs into the decision-making process. Once reserved for the high-consuming process-based industries chemical, steel, and pulp and paper the energy bill is now of growing importance for technology companies and their power-hungry servers. One approach is to participate far upstream in the value chain with self-generation. The savings impact can be more pronounced for self-generation, which includes the option of selling surplus power to the grid. But one question to ask is whether companies today are willing to spend capital to generate energy. Our experience shows they are not. They want to cut costs, but just as with investments in efficiency many are reluctant to dedicate capital. Again, this is where partnering with a third-party energy project developer can help in getting over the capital hump. A further advantage could make it worthwhile to invest in generation assets: It can be a profitable move for consumer product, retail, and other customer-facing firms that want to appear greener to discerning shoppers. 2 Once reserved for the high-consuming process-based industries, the energy bill is now of growing importance for technology companies. Another area to consider is the company s appetite for financial risk. Budgets are subject to very different types of pressures depending on the nature of the business and its management strategy. Does the company require certainty in electricity costs, confining it to deliver within budget every month, or is it free to take a more aggressive, but riskier, approach to 2 For more about green energy development, see The Profitable Shift to Green Energy at 6

8 reducing costs? The appetite for risk will, of course, have a big impact on the procurement strategy, especially in deregulated markets where searching for real-time price savings comes with strong volatility. Operational risks should also be taken into account. For example, if demand response is contracted to lower costs, what is the likelihood that this procurement solution will result in the lights going out? If this occurs, what is the impact on revenue-generating operations? Generating Margin Boost While electricity costs can seem like an immovable cost of doing business, many companies have yet to look behind the curtain of supply and demand. Long-term advantage can be found by first establishing your actual consumption profile and then using that profile to build a procurement strategy that capitalizes on the volatility and uncertainty of the nation s electricity markets to supply your power needs. The process starts with learning and will likely end with a non-controversial and substantial boost to margins. Authors Patrick Haischer, partner, New York patrick.haischer@atkearney.com Peter Findlay, consultant, Toronto peter.findlay@atkearney.com 7

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