Energy
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| Written by Mike Coulten, Head of Strategy and Markets, Energy Information Centre (EIC), July 2005 | |
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The importance of getting your energy contract right is often overlooked by busy facilities managers. If your energy contract is at the bottom of your 'to do' list, there is a good chance that you could get caught out by one of the many unscrupulous energy brokers. Here, we look at some of the pitfalls to watch out for.
A wide range of service providers in the UK offer various utility procurement support services. These can be one-man bands, small family-run businesses or new ventures created by staff leaving the supply sector as this has become further rationalised. This Utility Procurement Support Sector (UPSS) is in many respects the Wild West. There is no official organisation representing the sector or laying down rules and standards, no regulation from OFGEM, the FSA or any other body and normally no audit of performance delivered. Individuals providing advice in UPSS companies rarely hold any professional qualification in procurement or traded commodity markets despite offering their clients advice on exposures that dwarf a residential mortgage, something you must by law hold a qualification to offer advice on. In this state of anarchy, many millions of pounds of fees are being charged annually by procurement advisors and some £8 billion of trade is done. No small beer. So how do you know the service you buy is value for money? Indeed, do you even know the total payment your advisor is receiving in relation to your business? Often consumers make matters worse by insisting that UPSS companies recover their fees directly from suppliers, encouraging just these non-transparent transfers. One easy way to find out what you are paying is simply to ask your UPSS supplier precisely, "What was the total revenue you received from us or third parties in relation to our procurement activities in the last 12 months?" And do this in writing, insisting on a written reply. Often advisors will attempt to avoid the question and this is always a sure sign that payments are being received from third parties, usually the successful supplier, which the advisor will be reluctant to disclose. Sometimes, the UPSS will answer quite honestly by telling you that their fee of just 1 per cent has been accounted for within the energy supplier's marketing budget. This just isn't true. Energy suppliers operate on a small margin, high turnover basis. Typically their margin will be about 2 per cent, out of which they need to fund their data collection, billing, account management and customer service activities as well as making a deserved return. Do you think they would accommodate a request for 1 per cent for the broker? Of course not! The reality is that it will be added onto your price by the supplier to fund the broker. While 1 per cent doesn't sound much, on an energy bill of £2 million for a typical medium-sized factory, this would amount to £20,000! Will you have received £20,000 worth of value? Fees are often expressed on a pence per kWh basis, and while 0.04p/kWh sounds negligible, for a large user consuming 100GWh of energy it quickly mounts up to £40,000! If such undisclosed payments are being received from your advisor then how can you be sure that they are acting in your best interests and not their own? The answer is simple. You can't. Many suppliers are concerned about this situation as it can reflect badly on them. It's not uncommon to hear talk of collective action on the supplier side to publish all fees paid. At the moment however no single supplier can afford to act alone since the UPSS companies hold the key to significant volumes of business. Do you know what kind of service you are getting? Is it any good? Given that utility prices are extremely volatile and that delivered prices are a complex function of wholesale, delivery and taxes, most consumers will have no idea whether a different advisor could have provided a better performance at the time. This complexity has allowed the UPSS sector to literally get away with murder. The market is increasingly complex as consumers are driven by unacceptable year-on-year price increases to utilise more flexible pricing terms that are now being offered by suppliers. The service delivery quality issues noted thus far are therefore about to become much greater as wholly new skill sets and standards of professionalism are required to successfully procure in this new marketplace. At EIC we regularly hear of incorrect advice given to clients through other channels, and are often called to give a second opinion. Following are some of the key statements that we frequently hear, each of which facilities managers should be mindful of: "Aggregation will allow you to get a better price"The wholesale market is liquid, meaning that whether you buy 10MW or 100MW, the price remains the same. As such there is no economy of scale at the wholesale level. Suppliers always quote from the forward curve regardless of consumption volume. Improving the shape of the aggregate portfolio merely means that one consortium member is subsidising another and in an opaque way.There can only be any economy of scale in aggregation in the administration and supplier margin charge, which usually accounts for less than 2 per cent of delivered cost. Given that the wholesale element of delivered cost often moves by over 2 per cent in a single day, aggregation, by slowing down decision-making and restricting timing, can often deliver significantly worse value. "E-auction is an efficient way to procure electricity and gas"By restricting market timing (when you take a fixed price), e-auctions destroy value. E-auctions are only suitable for 'standard' products like paper clips that are not volatile, traded commodities. Also, in UK gas and electricity, flexible pricing terms are not suitable for e-auction as in any flexible price contract e-auction is comparing apples and pears (one contract offer may have a day-ahead option, the other not, for example) so the process is false. Imposing 'standard' terms and conditions on suppliers to square this circle just adds cost to suppliers that will be reflected in the prices you are subsequently quoted for supply. Impose the same cost on everyone and you will end up paying it."A performance-based fee will ensure we work in your best interests"If your UPSS supplier was told that a good result, though risky to aim for, would return a fat fee if successful and no loss if it fails, what do you think they would do? For the UPSS supplier it is like being given the opportunity to bet with someone else's money. Your money! All procurement advice should be provided on a fixed fee basis for a fixed scope of work and be quoted in advance. The UPSS supplier is incentivised to perform well to retain the business next year. Such an incentive is quite sufficient and will ensure uncoloured advice is given, though of course there can never be any guarantee that the advice will be correct in either case."Waiting until the end of a round gives a better price"Waiting until the end of the round is revealing advice. Historically this was the best thing to do. Recently, since the 2003 October round, it has been the worst thing to do. An advisor who merely recounts last year's experience is reading a chart for you. An advisor who justifies their recommendation by structured argument supported by facts and analysis is actually adding value, even if the advice turns out to be wrong. The chart reader is not adding value, even if they turn out to be right.ConclusionIf nothing else, the message that facilities managers should be left with is that of caution. There are huge opportunities to be had in negotiating and securing your energy contracts. Get it right and you could minimise your exposure to rapidly increasing prices. Get it wrong and it could cost you thousands. Likewise, outsourcing your energy procurement could reap reward; but know who you are getting into bed with and don't let them pull the wool over your eyes. Further information |
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