Energy Procurement a Challenge

LIZ PARKS

Hurricane Katrina changed the way Benny Smith buys energy.

Until Hurricanes Katrina and Rita hit the Gulf Coast back-to-back two years ago, Smith, director of maintenance at the 116-unit Price Chopper chain, based in Schenectady, N.Y., usually bought energy on the variable market. He made all the purchasing decisions himself.

“Before the hurricanes, the energy market had been fairly stable,” said Smith. “In those days, we contracted with a supplier and stayed with a variable market strategy. We bought going with the market, because if prices went up, they would also come down.”

But when Katrina and Rita struck, “we all got surprised, and it really gave us a wake-up call,” said Smith. “We came to the realization that it was not an engineering decision alone; it was a financial decision as well.”

Smith estimates that energy supply costs right after Katrina soared approximately 38% in New York. “Nobody planned for that kind of increase. Nobody knew Hurricane Katrina was about to happen, so no one could plan for it.”

Today, the Price Chopper energy procurement team includes Smith as well as the company's senior vice president of operations, the chief financial officer and the vice president of finance. Instead of buying with the market as prices vary day by day, Price Chopper now looks at market trends, particularly prices for natural gas, which informed sources say is a good barometer of where electricity prices will trend.

One of Price Chopper's main tools for tracking trends is the Hess index, provided by one of its main energy suppliers. “Most of our long-term energy suppliers have Web-based market tracking tools that they share with us,” said Smith.

Last November, Price Chopper locked in its energy prices in New York and Connecticut. “We were protected this summer,” said Smith.

“We got decent prices. Throughout the summer we have been watching the market going up and down, and we've made decisions based on looking out into the future, through the end of this year and through next year.”

Still, Smith said Price Chopper balances its purchasing strategy by sometimes buying day-to-day as the market varies and sometimes buying long-term.

Price Chopper has also purchased energy via online reverse auctions conducted by Intesource, Phoenix. “Our tools help buyers and category managers manage the core sourcing function more efficiently,” said Tom Webster, executive vice president of sales and marketing, Intesource.

Intesource's applications have executive dashboards and supplier performance scorecards to help retailers stay on top of changes such as rising kilowatt costs by geographic region, or the status of energy supply contracts.

Smith said reverse auctions for energy procurement are “great when the market is very stable and you want to squeeze out the last few tenths of a point.” But when the market is unstable, “reverse auctions may not be as effective, because the market may have dropped another point by the next day.”

In such a market, said Smith, retailers need to have strong alliances with energy suppliers “that you trust and that you know are working for your best interests.”

Consequently, while Price Chopper will take advantage of various software tools and online reverse auctions, its core strategy is “to align ourselves with suppliers who really know the marketplace and who are in business for the long term,” Smith said.

BUYING WHOLESALE

Price Chopper is not alone in modifying its energy procurement strategy.

Other retailers are also trying to contain price volatility and limit their exposure by turning to technology, trusted suppliers and energy procurement experts to help keep fuel and electricity costs in line.

San Antonio-based H.E. Butt Grocery, for example, which has over 300 stores and 11 manufacturing/distribution facilities, is using an approach to energy procurement developed by Pittsburgh-based Strategic Energy, a provider of energy to retailers.

The majority of Strategic Energy's food retail customers, including H-E-B, have chosen its PowerPortfolio plan, which gives retailers the opportunity to purchase power directly from the wholesale market. The program is popular because “it offers a very flexible combination of term and spot supply purchasing,” said Mike Young, executive vice president of sales and marketing for Strategic Energy.

“We can give a retailer access to purchasing wholesale energy blocks. For example, they may decide to buy 20% of their load under a fixed price block, and then as we see trends in the market, we can overlay additional purchasing of blocks into that strategy.”

Retailers are also able to use the services of Strategic Energy's “portfolio strategists,” who focus on meeting their energy management and risk tolerance needs. H-E-B “values the opportunity to have assigned strategists who are proactively working for us to advance our business goals,” said Bob Manning, H-E-B's director of engineering, in a case study provided by Strategic Energy.

With Strategic Energy's input, H-E-B has developed a procurement strategy that allows the company to take advantage of longer-term buying opportunities, with fluid purchasing options that keep pace with the addition of new facilities and with demand, according to the case study.

THE RIGHT PRICE?

The energy procurement manager for a national chain, who asked not to be identified, agreed with Price Chopper's Smith that in the three years prior to 2005 most buyers would have done better by not hedging and essentially buying on the daily market. “But in today's highly volatile energy markets, you need to hedge against the risk of escalating, blowout prices,” he said.

The procurement manager works with Chicago-based RMI Consulting to help him determine the best price. “If I know that California electricity on peak in fiscal 2009 is $72.50, is that a good price or not? Who the heck knows? If Hurricane Dean hits the Gulf in 2009, electricity prices could zip up to $92.50, and if no hurricane occurs, prices could drop to $65. If I lock in at $72.50 and no hurricane hits, management could say, ‘That was a stupid decision. You paid a $20 premium for insurance.’”

Jeremy Schupp, director of commodity strategies for RMI, stressed that retail energy buyers need defined objectives to make effective energy procurement decisions. “If you don't have that defined or written down in this type of volatile environment,” said Schupp, “you cannot build a plan, and your procurement process inevitably will be speculative and inefficient.”

RMI specializes in helping multi-state retailers make the energy procurement process more efficient by centralizing it. For example, a large retail chain with thousands of stores turned to RMI because its energy procurement process was fragmented across the country.

“Obviously, they were making significant purchases of energy,” said Schupp, “but it was challenging for them to collect all the data they required to make informed purchases across the country, and they did not have consistency in their contracting process in different regions.”

Schupp said that by having an energy procurement plan for buying competitively in deregulated states, retailers have been able to reduce their per-kilowatt-hour costs for medium-sized energy consumption from 9-10 cents per kilowatt-hour to 7 cents per kilowatt-hour, shaving approximately 20% to 30% off their energy bills.

Despite the upheaval in the energy markets caused by the convergence of Katrina and Rita, the procurement manager still believes in being an informed buyer. “To base a whole energy strategy on those events would be a bit ridiculous,” he said. “So I tend to be bullish, do my research, using the best tools I can find, and then I buy using the strategy that best fits the moment.”