Outsourcing energy procurement: feel the fear and do it anyway

Top of the wish list for a large number of organisations has to be establishing a way to control the dizzying spiral of ever increasing energy budgets. Never a minor consideration, the cost of energy is now a key factor for a large number of companies' very survival.

Winter 2005 saw a number of plants reduce operation thanks to a series of price spikes. A number of profit warnings have already been delivered and more recently the murmurings of stunted economic growth have grown louder - the cost of energy will almost inevitably be blamed for both.

Chris Bowden, CEO of Utilyx explains how outsourcing energy purchasing can reduce costs and exposure to financial risk.  He urges procurement professionals to feel the fear, and do it anyway.

The role of the energy buyer has become a critical one in the last twelve months. Thrust into the unaccustomed spotlight, many have found themselves ill-equipped for this new leading role. The problem is that there has been little if any incentive to respond to the paradigm shifts that have taken place in the energy markets in the last decade or to adapt their tried-and-tested energy buying procedures in the brave new world of deregulation and fluctuating energy costs.

Why? Well firstly, as every procurement professional knows, buying a fixed contract at a fixed time every year offers certain advantages - not least that budgets can be set, making financial management comparatively straightforward, and covering against short term risk.

Secondly, in the first years of deregulation, prices actually fell. The maxim 'if it ain't broke, don't fix it,' was applied, and energy was bought in the same way it always had been. Invitations to tender were issued, bids were received on a certain date, the cheapest was chosen, and that was energy sorted for the next twelve months.

Neither energy buyers, with their typical engineering background, nor the new breed of procurement managers, who have energy purchase under their remit, are in a position to take advantage of the complexities of energy trading ushered in by the new deregulated regime. Why worry about flexible contracts, hedging against potential price rises, or separating commodity and supply, when prices kept falling anyway?

Recent events have disabused many of this idea. The latest contract round in April saw the electricity base load price rise to £57.50, representing an increase of more than 200 per cent on prices for the same underlying period two years previously. The forward price for the October 2006 annual contract is already at £59 - its highest ever level.  Any organisation coming out of a two or three year deal would have received a very nasty financial shock. To put these prices into context, the lowest prices for these two contract rounds were £24.95 and £28.58 respectively.

Prices for gas are no better. The furore caused by rising prices in the face of diminished native supply and early predictions of an unusually cold winter can be seen everywhere - from the front pages of the broadsheets to the House of Commons. Underneath all the FUD (fear, uncertainty and doubt) spread by the media, the fact remains that spot prices hit highs of 170 pence and more per term - three times what many companies were used to paying and, for anyone purchasing for immediate supply, potentially crippling.

What the debates about gas supply did was to focus shareholders' attention on these issues in a way that hadn't been seen until now. Now, even the most disinterested of individuals knows that energy prices are a significant problem, and those who take a professional interest in seeing their portfolios perform well are beginning to ask serious questions about how energy procurement is managed.  It is perhaps not surprising, therefore, that a number of energy buyers and procurement managers are feeling extremely hot under the collar.

So what is the solution? Well, for all but the very largest consumers, retaining the in-house specialists in market analysis and hedging strategies is simply unfeasible.  Using third party expertise, and taking advantage of the economies of scale offered is perhaps the most effective way of addressing this particular challenge: a challenge that shows no sign of disappearing in the foreseeable future.

Many senior managers are however, still reluctant to outsource the procurement function to third party experts, who can use their skills to out-perform the market and minimise bills - the combination of circumstances presented this winter would not be a problem for firms who had hedged against the risk of rising prices. The prospect of another year buying energy at the wrong time in a market whose volatility shows no sign of calming down however, is equally unpalatable.

But like many individuals who have faced the prospect of having their core business function outsourced, the most common reaction among procurement managers and energy buyers to this suggestion is fear: fear of losing control, fear of losing face, fear even of losing their job. But this is often misplaced. Far from heading to the dole queue, when handled in the right way an outsourced solution can create heroes out of those that implement them.

The well used procurement manta that says never outsource a problem to a third-party and watch them try to resolve it from the sidelines is as valid for energy procurement consultancy as for any other service. Third party suppliers have to be carefully selected, policies and procedures put in place and channels of communication opened up. The key to success in any outsourced service, and energy procurement is no exception, is to ensure that it is effectively managed and that the procurement team understands the results it is expecting from a supplier. For this to happen extensive dialogue both pre and post contract needs to take place.

It is vital to ensure the right supplier is on board - bearing in mind that cheapest is not usually best. A third party should be able to demonstrate by how much it expects to beat movements in the wholesale market, and should couch their proposal in these terms.  It is better to choose a company that may cost more up front, but can slice a greater amount off the energy bill; the result will be higher net savings than those delivered by a cheaper company that is less effective.

Both parties also need to understand the nature of energy consumption in the organisation and, indeed, what the company's overall strategy is. If the number of premises will change, or new types of activity undertaken these will impact on energy use. Analysts who are watching the markets and making purchase recommendations on the company's behalf need to be armed with this kind of information.

Risk management procedures also need to be established and then signed off at board level. Both the organisation itself and its chosen supplier need to understand what the appetite for risk is, and how far the company is prepared to go for increased returns. Once the policy is in place it is up to the energy buyer to manage it effectively and ensure that it is adhered to.

But most of all, dialogue needs to be maintained. Ultimately all decisions to purchase come back to the client company, who procure based on information and recommendations provided by their supplier. As the markets move rapidly, optimal buying opportunities are often fleeting. Power prices can turn in a matter of days, sometimes even hours.  What's more, the basic act of purchasing can also have an impact on price - particularly for larger trades. Channels of communication between the company and its third party representatives need to be maintained at all times. In addition, energy buyers still need to keep up to date with activity in the markets: without that information they have no benchmarks against which to measure results.

An outsourced service does not mean that procurement managers are in for early retirement. In fact the reverse is true. The purchase of energy needs to be managed even more effectively than before - what has changed is the resources being used. By selecting and managing a third party effectively, they can ensure that procurement is controlled, and ceases to be the corporate black hole it has become of late. With the right team behind them, energy buyers no longer need to hide in the wings: they can take the spotlight for the right reasons, and enjoy the plaudits and praise that comes with it.