Green energy supply: source or invest?

A growing number of companies adopts renewable energy goals and commits to green energy supply. Top of the bill might be Ikea, that has committed to produce as much renewable electricity as it consumes in its industrial sites, storage sites and shops by 2020. Apple is approaching the 100% renewable electricity supply rapidly, and was already at 93% in 2015. And here’s just a handful of famous company names that have committed to the symbolic 100% renewable electricity supply by 2020 target:

Swiss RE, Bank of America, BMW, British Telecom, Coca Cola, Goldman Sachs, ING, La Poste, Phillips Lighting, Sky Entertainment, UBS, Unilever

(These names and much more information on corporate renewable energy efforts can be found on the RE100 website.)

With a climate change denying Trump administration in the US, one could easily be pessimistic about the prospects of greening the world’s energy supply. However, I believe that the renewable energy revolution is a train that is rolling and can’t be stopped in its tracks:

1. A large part of the public is convinced that climate change is a real problem. Companies feel a pressure to present green energy credentials to clients, current and future employees, investors, or they just go green because of an inborn sense of social responsibility.

2. The costs of building renewable energy generation has dropped spectacularly. Energy from windmills now costs between 52 and 110 euro per MWh, according to Wind Europe. That is 48 to 102 dollars at the current exchange rate. Electricity from photovoltaics looks even more spectacular. According to the International Renewable Energy Agency, a project in Dubai that was commissioned in May 2016 will produce power from the sun for a cost as low as 30 dollar per MWh.

In many places in the world, the all-in cost of consuming electricity from the grid is higher, making it profitable to generate on-site green electricity rather than buying from the grid.

For feeding the green electricity into the grid, the 110 euro per MWh needed for some windmill projects, might still be too high for the investment to make business sense. Subsidies and governments willing to grant them to windmills and solar panels might still be needed for the time being. But then the energy industry has always been subsidized. The UK will pay EdF 92,50 pound sterling per MWh for building a nuclear power plant at Hinkley Point, that’s a 107,54 euro per MWh. Isn’t that money more wisely spend on windmills?

Renewable energy is also playing a crucial role in bringing electricity to poor countries. Access to green electricity in remote regions, isolated from reliable grids, can be crucial for those regions’ development. The recent acceleration of growth of renewables in developing countries is likely to continue.

If Donald Trump thinks that his skeptic approach to greening energy supply is part of his businessman’s attitude to the presidency, then he is mistaken. A 21^st century businessman integrates green energy supply goals in his corporate strategy, because they make business sense. As an energy buyer, the chances that you will be asked to buy green energy are increasing and they will continue to do so, whether Mr. Trump is in the White House or not.

Getting that question on greening the energy supply confronts the energy buyer with an important dilemma:

Will you go green by sourcing green electricity from the grid or by investing in your own green electricity production? To give an answer to this question, we have to make some considerations:

1. The physics and logistics of electricity supply make it difficult to label

Many years ago, we researched the green energy options of a client of ours. One of their team members kept insisting that he wanted proof that the green electricity was coming from a particular windmill near their factory. Due to the physics of electricity it’s impossible to do this. You cannot produce MWh’s in your windmill and attach a label to them saying: “Electricity from windmill so-and-so, to be delivered to company so-and-so”.

Electricity supply works by keeping the tension on the grid at a constant level by injecting as much electricity into the grid as the end-consumers are collectively consuming. But there is nothing that is physically being moved from place A to B. Therefore, it is impossible to say where the MWh’s that you consume were produced.

To deal with this, systems such as the European ‘certificates of origin’, have introduced a double marketing system. Producers of green electricity in Europe receive a certificate of origin. This is a piece of paper that says that a MWh of electricity was produced by a windmill, solar panel, by hydro, geothermal, biomass, etc.

The green electricity producer will sell electricity twice. The product itself (often called the “grey electricity”) goes to the grid at market prices. Next to that, the producer will make some extra income by selling the certificates of origin in a separate market.

Energy suppliers buy these certificates and bundle them with the physical MWh’s that they supply in green electricity products. That doesn’t mean that the power you consume comes from a particular windmill or solar panel. It means that as a consumer you have made an extra investment to support renewable energy. Some consumers have taken the labeling logic a step further by buying certificates of origin themselves in quantities equal to their physical consumption.

2. Green comes in many shades

More than 20 years ago, I read a book of which I vaguely remembered the title to be “Grass instead of atoms”. It envisioned a future in which all of the world’s energy would be supplied by biomass. The theory was that biomass is carbon-neutral, as the carbon dioxide produced by burning the plant material would be compensated by the CO2 sucked from the air by the growing plants. Green activists embraced the biomass idea heartily.

Twenty years later, the world and definitely the green movement has grown much less enthusiast about biomass:

1. Due to its low calorific content, you need a lot of plant material to produce a reasonable amount of energy. This causes huge logistic problems.
2. Not the least of it being the huge amounts of land that you need to produce sufficient biomass for supplying the world with energy. Land that in many cases could be used better to grow food. And land that was sometimes won by cutting down valuable, bio-diverse and more carbon-sucking rain forest. Next to that there are the environmental issues caused by monoculture. Very rapidly, we discovered that the world would not be better off if the whole equatorial zone was transformed into a massive palm oil plantation.
3. The theory of the carbon-neutrality of biomass can be challenged, especially if you cut rain-forest to plant palm oil and when you ship your biomass halfway across the globe.

Many well-intentioned biomass projects have ended in a public relations nightmare due to the questionable environmental credits of burning plant material. To investors’ horror the environmental groups that push for more green energy are often the first ones to raise protest against specific projects. Think about the many times local green activists have raised protests against the construction of a windmill.

The certificates of origin are granted to any green electricity project, regardless of its real environmental merits. If you consider going ‘deep green’, you might make some extra investments by buying some higher quality certificates.

3. Buying green electricity is very cheap

In Europe, you can currently buy certificates of origin. That is very cheap. The reason for this low price is simple: demand is lower than supply. Every MWh of green electricity produced in Europe gets a certificate. At this moment, 29% of all electricity produced in Europe is green (2015 data coming from Agora Energiewende). As long as all the citizens, companies, public authorities, etc. that buy green electricity consume collectively less than 29% of all electricity consumed in Europe, the demand for green electricity will be lower than the supply. Hence the low price of buying green electricity.

If your only interest in buying green electricity is “green-washing”, getting the paper on the wall to say that you buy green so that you can satisfy the customers that are asking for it, the low price of green electricity is good news. However, many customers have a more genuine interest, more serious intentions of making a valuable contribution to the environment. For them, just spending a few ten thousands of euros or dollars on certificate-buying will not be very satisfying.

Moreover, a public relations catastrophe is looming again. Environmentalists are increasingly aware of how easy and cheap it is to claim ‘100% renewable electricity’ by buying certificates of origin. Clients that involve NGO’s in their sustainability policy (e.g. through the WWF Climate Savers initiative), already feel that pressure to do something more valuable than buying 15 cent per MWh certificates of origin.

4. Not all green electricity is good for the environment

Certificates of origin don’t work as a tool for putting pressure on energy companies to increase their green electricity production. But it works as a system for having companies with green intentions invest money in greenery. Unfortunately, that money isn’t always effective.

An effective investment in green electricity means that less carbon dioxide is emitted. Very often, the money you pay for certificates of origin goes to an old hydro power station or a windmill, solar panel or biomass power station that have been there already for many years. For hydro, wind and solar, the marginal cost of production is 0, meaning that their owners produce the electricity whenever they can. Bringing us to the startling conclusion:

Whether you pay for the certificate of origin or not, the green electricity would have been produced anyhow.

So, your effort to pay extra for the certificates of origin isn’t keeping a gram of carbon dioxide out of the air. You could solve this by buying higher quality certificates. However, if you invest every euro you spend to source green electricity in your own renewable energy production, you are effectively keeping CO2 out of the air. It will mean that a windmill, solar panel or other project gets built thanks to your efforts that pushes fossil-fuel fired MWh’s from the grid. As the investment costs to produce your own energy are so much larger than what you spend buying certificates, it might be financially impossible to achieve the symbolic 100% renewable goal. But the money is spent so much more wisely and with a net better effect on the environment.

5. Sourcing means spending money without return, contrary to investing

Which brings us to a next observation. Spending money on certificates is just that, spending. Investing money means that you can expect a return on your euros or dollars. On-site renewable energy production is often developed by a third party with a power purchase agreement. In many cases you will receive a fixed amount of money for renting your terrain or rooftop. Next to that, you can buy the electricity at a price far below the price at which you buy from the grid. Such projects always lead to savings, and thanks to such third party arrangements without even having to invest the company’s money.

When you invest in off-site renewable energy projects, the return will depend on the particular set-up, and often on the subsidy arrangement. In many cases, renewable energy is an interesting investment as the return is relatively stable and reliable.

6. What do you want to achieve with your green energy efforts?

As you can read from the observations above, greening your energy takes more reflection than just buying a green power product based on certificates of origin. Investing the money in your own green electricity production is a more valuable approach, both for the environment and for your financial bottom line. However, not every company might be ready to have such large amounts of cash flowing to green power investments.

As an energy buyer, your research of the energy markets can lead to more valuable choices for your company. To determine your approach, it is worthwhile to make a good preliminary analysis of what you want to achieve with your green energy efforts, e.g. through a stakeholder analysis. If you’re just greening to satisfy customers, you might be happy with the certificates of origin. If you also want to prove your green credentials to environmentalists, you might decide to go deeper.

Why you should continue to negotiate your energy contracts

Way back in 2000, when Europe’s continental energy markets were deregulated, I remember how many business clients were thrilled by the prospect of negotiating their energy contracts. After decades of nerve-wrecking non-talks with arrogant monopoly utilities, they would finally get the chance to unleash the power of their contract negotiation skills on the important energy budget. A decade and a half later, we see more and more clients questioning whether negotiating energy contracts makes sense and if it’s not better to ‘just expand your running contract’. Reasons for that disillusion? First of all, in mature energy markets the part of the energy bill that you are negotiating, what we call the retail add-on, is just a tiny part of the overall energy bill. And as it is small, the amount of “savings” you can make by negotiating it is small as well. Moreover, energy companies often run highly standardized contracting procedures, making the room for improvements small. Nevertheless, with every contract negotiation that we as E&C do, we see that improvements can be made. And even if they look like small steps (dots and commas), they often lead to important improvements in the energy procurement practice.

Natural gas and electricity have become highly commoditized products. A product becomes a commodity when standard quality and service characteristics have been defined or developed for it, meaning that it can be bought with “price” as the primary focus. As far as energy is concerned, the quality is standardized. Whether you buy from supplier A, B or C, the natural gas or electricity as a physical product will not be different. Regarding the service, we have to remark that most of the traditional service aspects of a delivery of a product have also been standardized as far as energy is concerned. I’m talking here about aspects such as timing of the delivery, security of supply, responsiveness of the supplier in case of a supply interruption, etc. In the case of electricity and natural gas, it’s not the supplier but the grid operator that is responsible for the delivery at the gate of the client. And this is a regulated company delivering a legally regulated, standardized, one-size fits all service.

The standardization of quality and service level is an important step in the development of a wholesale commodity market. Wholesale markets, whether they are exchange traded or OTC, always face the liquidity dilemma. For them to become successful, they need to have sufficient volume traded. If there is a large diversity of products traded, the total volume traded (or the amount of money flowing into that market) will have to be spread out over all these different products, reducing the liquidity per product. With insufficient liquidity, bid-ask spreads will run up, price changes become erratic and it becomes difficult to find counterparties. As far as energy is concerned, it has proven to be possible to sufficiently commoditize energy products for successful wholesale markets, even exchange-traded, to develop. We have first seen this in the oil markets and in the US Henry Hub gas market, the UK’s NBP and Scandinavia’s Nordpool, and recently also in continental Europe’s natural gas and electricity markets with TTF and EEX being the best-of-class examples, but for example Poland’s Polpx recently developing very rapidly as well.

When products become commoditized, a phenomenon called ‘margin erosion’ occurs. The suppliers become retailers in the sense that they buy the product in the wholesale market and then sell it on to end consumers. The basic price reference becomes the wholesale price, which is the same for every supplier – retailer. They have to make their living from the add-on that they charge on top of that wholesale price. As suppliers can no longer distinguish themselves with better quality or service levels, it becomes increasingly difficult for them to charge a price premium for that add-on cost compared to other suppliers. That’s why we observe that as markets mature, the price differences between the suppliers become marginal. This is clear in a very transparent manner in the TTF-based gas markets, where suppliers offer energy at a very simple TTF + add-on in euro per MWh price formula. For consumers above 20.000 MWh per year, we often see at the end of a negotiation that there are three – four suppliers that are offering at TTF + 0,2 or 0,3 with differences of less than 5 eurocent per MWh among them. If you consider that the total value of the natural gas (commodity + other costs) is around 18 euro per MWh, you can clearly see how marginal a phenomenon retail price distinction has become.

Having observed this commoditization of the product, you could easily conclude that the energy supply business is commoditized as well. Hence, comparing energy supply offers is a simple matter of putting prices next to each other. “Negotiation” is even a hyperbole when we speak about commodities, as it’s just a matter of picking the best price, which in the case of many gas markets in Europe has become childishly simple. However, even if their product has become commoditized, the energy supply business hasn’t, on the contrary. As markets mature, energy suppliers have become suppliers of a set of services regarding the delivery of energy commodities that we can subdivide in the following categories:

1. Profiling services. In the wholesale markets, energy can only be bought on a forward basis in rudimentary blocks. And the physical delivery of the electricity and natural gas goes through a complicated process of balancing. A supplier will buy the blocks for you and perform the complicated day-ahead, intraday and end-of-day financial settlement operations to make sure that you get delivered exactly what you consume. This profiling service constitutes the main economic rationale for buying energy through a supplier – retailer and not directly in the wholesale market. Due to his portfolio effect (he can go through the balancing mechanism on a portfolio-wide basis), the supplier can deliver the profiling at a very reasonable cost.
2. Volume services. The blocks that you can secure on a forward basis in the wholesale markets come with no or very limited volume flexibility. Energy suppliers can increase the amount of volume flexibility offered to an end-client by using their portfolio effect again.
3. Price hedging services. As the links between the end-consumer and the wholesale market, the energy suppliers have developed services to perform price hedges. Again, because of their portfolio effects, they can deliver these at a price and with a level of flexibility that is often unachievable for the individual client.
4. Payment services. Suppliers offer payment terms which are longer than the terms they themselves have to pay to the counterparties in the wholesale markets or the grid companies and authorities in case they offer a single utility bill service. This means that they actually become a credit provider. The amount of credit that they provide and the conditions at which it comes can be more or less strict.
5. Other services. Suppliers can develop other services in terms of invoicing services, advanced meter reading services, cost monitoring services, energy efficiency services, etc.

Remarkably enough, having a good level of the services described above doesn’t necessarily come at a price premium. It depends mostly on the operational and commercial practices that the different companies have developed. However, the differences in the level of these services makes contract negotiation important. And makes it necessary for clients to have the necessary experience to make a good assessment of the different contractual possibilities. Having a good insight into how suppliers work, e.g. when they perform a price hedge, can be very helpful in getting a better result negotiated. As a consultant, I’m obviously biased, but believing that the suppliers themselves will help you getting the necessary insights into their complicated worlds is somewhat naïve. Not just because of their ill will, but also because the account managers that you talk to often don’t have those insights themselves. As markets mature, we see that energy suppliers’ services in themselves become more standardized, as all the suppliers have to gradually adapt to the best-of-class service standard to stay competitive. However, even then a small difference in wording of e.g. a volume or a price fixing condition can make a very big difference in operational outcome, making it important to carefully check every offer received and negotiate conditions.

But not only such service aspects make it important for a client to have good contract negotiation. Even if the price differences are small, there is still one offer out there in the market that is the cheapest. It’s the responsibility of a professional procurement organization to go out and find that cheapest contract. This importance obviously grows as the consumption grows. 10 eurocents multiplied by 500.000 makes for more money to be made by contract negotiation than for a client consuming just 10.000 MWh. But then the price differences can be larger when the consumption is lower. So it is still worthwhile to go out in the market and negotiate the price conditions. With almost every RFQ we see that we can create value with contract negotiation, that the contract that the client ultimately signs is a better contract than what he would have signed without the negotiation, not just in the conditions but often also in price. The market has come to this stage of low retail add-ons and good service levels thanks to the negotiation efforts of many buyers and consultants. And it’s worthwhile to keep up the effort!

A decade of low energy prices?

Written by Benedict De Meulemeester

In March / April of this year, energy prices across the globe hit historical lows. The Brent oil price dropped to 27,88 dollar per barrel, WTI to 26,21. The price of coal for the world markets dropped to 36,55 dollar per ton. Natural gas in the US (Henry Hub 12-month forward strip) traded down to 2,11 dollar per MMBTU, European gas for next year (TTF) dropped to 13,02 euro per MWh. With fuel prices that low, it’s not surprising that power prices hit historical lows as well. The German baseload electricity price for next year dropped to 20,85 euro per MWh. Pricing in the US is very scattered, but the price for Northern Illinois as an example, traded as low as 25,30 dollar per MWh. Since then, prices have rebounded, but they remain at very low levels. Oil is currently trading just below 50 dollar per barrel, less than 11,8 % of the prices seen in the last ten years were better than that.

For buyers of energy this opens up important questions of course. Should you take this historical chance and make long-term fixings? Or are the supply and demand fundamentals supporting this bearishness so strong that we are heading for a decade of low energy prices, so it’s better to stay in the spot market? Some insight into what has been driving prices in the past decade, will teach us that giving a definitive answer to this question is impossible. Hence, the best bet is to prepare for both scenarios.

What on earth happened to peak oil? In the period 2000 – 2008, prices of energy and other commodities increased steadily to reach peaks in the first six months of 2008. An old theory that was popular in the 1970’s was revived. It assumes that production of energy resources follows the path of a bell-shaped curve whereas demand just continues to increase. Once the right-hand side of the bell-shaped curve has been reached, there is an inevitable supply crunch (peak oil). The maker of this theory, M. King Hubbert, was relatively successful in predicting the moment of the crunch in US oil supplies, giving him some credibility. An increasing number of energy market analysts interpreted the energy price bullishness as proof that peaks were occurring (Peak oil! Peak gas! Peak coal!). 8 years later, with prices at these historical lows, the declarations of the peak theorists seem ridiculous. A quick visit to the website of their association http://peak-oil.org/ will make most of us smile, or worse, get annoyed at the lack of empirical backing of what is said, e.g. that the production of oil has been almost flat since 2005, whereas in reality we’ve seen an increase of almost 12%.

Nevertheless, way back in 2008, the peak oil idea had a huge following. Goldman Sachs forecasted an increase of the oil price to 200 dollar per barrel. Many energy buyers fixed prices at the high levels of the first six months of 2008 as they believed the scary stories of ever increasing energy prices. I remember a meeting with the CEO of a big company that said: “we all agree that energy prices can only increase, don’t we”. Why were business people so easily scared into thinking that energy prices could know only one direction: up? First of all, I think that most of us have a hard time not to think in trends. It takes a lot of guts to believe in a decline when for months and months, even years and years, prices have continuously increased. Secondly, when it comes to energy pricing, many of us tend to be pessimist, energy is always too expensive, never cheap. Thirdly, the idea of scarcity was nurtured by environmentalists. When you can’t motivate people to reduce energy consumption for the sake of the environment only, fear of higher prices might be quite helpful. Eight years down the road, and on the other side of the price ranges, it might be tempting to think the other way around, to believe that the decline can only continue. Thinking back about 2008 can be a powerful reminder always to expect the unexpected, to run an energy buying strategy that is ready for the changes in the trends.

If we look at the long term developments in energy markets, we see a pattern of continuously low prices, temporarily interrupted by sharp upticks. This is caused by the way elasticity, the adaptation of supply and demand to price evolutions, works in energy markets. On both sides there is elasticity, but it works slowly, with significant delays. And the delays tend to be longer on the supply than on the demand side.

On the demand side, short term reactions to prices can occur in the shape of fuel switches, e.g. an industrial using fuel oil instead of gas for producing steam. Mid-term, consumers can lower their consumption when prices increase with behavioral efficiency gains, e.g. driving less kilometers with the car or decrease the temperature in one’s house. On the other hand, if prices are low, consumers will become more profligate. Long-term changes in energy demand due to periods of high or low prices can be caused by investments in structural energy efficiency improvements and by the effects of high or low energy prices on the economy. It would be far-fetched to say that the economic crisis that started in 2008 was caused by high energy prices, but it is clear that there was a link. Another example of this can be found in the 1980’s when the high prices of the 1970’s resulted in a sharp economic crisis resulting in much lower energy demand and two decades of low prices.

On the supply side, short term reactions occur in the shape of marginal cost decisions not to produce when prices have dropped below production costs. These reactions cause a continuous rebalancing but no structural price movements, as the capacities come back online as soon as prices increase above the production costs. More structural adaptations can be found on the mid-long term when installations are shut down when prices are too low. However, due to the high stranded costs of energy production installations, this shutdown is often rather temporary (the installation is “moth-balled”) and can be undone as soon as prices increase again. In the same fashion, we often see a supply side correction when prices are very high in the shape of bringing very old installations back online. The real structural adaptations of supply to price occur in the shape of production capacity adaptations by investments or lack of it in new production facilities. And the terms can be very long. The construction of a new power station, an LNG export terminal, ships for transporting coal, the development of an oil or gas field, etc., they can take more than a decade before the first energy is available to the market.

Having these elasticities in mind, we can perfectly understand what has happened in the energy markets in the last two decades. The strong global economic growth of the late 1990’s and early 2000’s with the exponential growth of emerging economies and China caused a voracious growth of demand for energy and other commodities. As of the mid 2000s this started to result in supply shortages causing prices to increase rapidly. Many decisions to invest in new production capacities were taken, but most of them only hit the market as of 2010. In the meantime, mid-term demand adaptations started to occur, we saw e.g. Americans choosing more fuel-efficient cars, causing a slow-down in demand growth. As of the second half of 2008, demand was slashed by the economic crisis which, as I’ve said before, was partly linked to the higher energy prices. This resulted in a sharp reduction of prices. When as of 2010 demand started to pick up again, supply extended more rapidly, resulting in a new supply glut that ended in the historically low prices of the beginning of this year. The recent bullish correction can be explained by higher demand and the mothballing of older production capacities.

It is however too early to say whether this is the definitive turnaround. It is clear that investments in new energy production capacities are slowing down, as we can see in this graph from the IEA with figures until 2013:

Source: Special Report: World Energy Investment Outlook, International Energy Agency, 2014, p. 20.

At some point, this slowdown in investment will result in a supply crunch such as the one that we have seen in 2005 – 2008. Whether that will be next year or whether we will see a decade of low energy prices is impossible to say. A lot will depend on how demand evolves in the meantime. Will we see another period of rapid economic growth or not? Moreover, we are seeing an increasing drive towards higher energy efficiency on a worldwide basis, meaning that more economic growth means less energy demand growth. This efficiency drive in the framework of climate policy started in Europe that has seen its primary energy demand drop by more than 10% since 2006 (although in 2015 it increased again for the first time in nine years). It is now being copied in more and more parts of the world. Will this keep down demand growth sufficiently for prices to remain low?

Slow elasticity sometimes leads some observers to the reasoning that the normal laws of economics (Adam Smith’s invisible hand) don’t work in the energy markets. They are wrong. Trends such as the sharp decrease of energy prices seen in the last five years do end at some point. Whether the recent turnaround is just temporary or the beginning of a longer period is impossible to forecast. Therefore, as an energy buyer you better prepare for all scenarios.

Copernican revolutions in international (energy) procurement

One of the main rationales for M&A activity in international business is the search for “synergy effects”. In procurement this means that companies hope to achieve cost savings by buying goods and services in a centralized manner. In the last decades, many international companies have gone through a Copernican revolution in their procurement divisions: buying decisions have been centralized. Buyers are buying goods and services for factories across the globe. Sometimes they carve up the world in zones. It always makes me smile when I see ‘EMEA’ on a business card. It means Europe, Middle East and Africa. That’s quite a big and diversified geographical zone, I would say. Other companies still have their procurement functions organized on a local or even on plant-level. And we have even talked with some companies that are turning their Copernican procurement revolutions back again, scaling down the centralized procurement organizations and bringing back the previously centralized buying decisions to local procurement people.

 

As often, there are no laws written in stone about this topic. Centralized buying has advantages and disadvantages. For some products and services the advantages will be larger than the disadvantages, for others it will be the opposite. In a general sense, the advantages of centralized buying decisions are to be found in the economies of scale that they generate. Bringing together the tons of goods bought in e.g. 20 different factories can lead to serious price reductions on the prices that each of these factories can obtain individually. And in services, things like joint account management or usage of IT infrastructure can make the pricing of centrally procured services cheaper. The potential for such cost savings is limited by transportation costs. If transport is an important cost component, locally supplied goods and services can be cheaper. Further advantages can be derived from the accumulation of procurement knowledge by the international buyers. Working in different countries in itself can provide a deeper insight into how markets work. And whereas local buyers might have a very broad range of products and services categories for which he has to buy, large centralized procurement organizations will allow for more specialization with category buyers that acquire a deep insight into the specific products and services for which they are responsible.

 

These advantages can disappear for goods and services for which local circumstances have a big influence on their value. Country- or even region-specific geographic, legal, cultural or other factors can have an important impact on the pricing, quality and/or service level. For centralization of procurement to be successful, it will be important that a company makes the distinction between the goods and services where the localization have an important impact and those for which they haven’t. A hybrid organization with central and local buyers working together is therefore often a good solution. Another problem of centralized buying can be the distance from the operational practice. The local buyer often has its office in the factory where the goods and services that he buys are being processed, giving him a better insight into, for example, quality and service levels that are required. Smart central procurement organizations will therefore make sure that there is sufficient travel budget to allow the buyers to go to the factories and see the results of their buying decisions in the operational practice. Unfortunately, we only see too often that in its cost-reduction attempts, companies first decide to centralize procurement and then to cut the travel budget. This will cause further disadvantage for those products and services for which frequent personal contact with the suppliers is necessary.

 

Finally, due to their size and their distance from operational reality, centralized procurement organizations can degrade into corporate bureaucracies. They can start to create unnecessary formalistic tender procedures that hamper rather than promote the signing of good deals. Local buyers will often have a more entrepreneurial approach to energy buying, working closely together with plant managers that really care about the budgetary impacts of buying decisions on their factories. Sometimes, local managers complain that the central buyers can take the decisions but they are the ones that get blamed when there is a negative impact on the profitability of a factory.

 

A smart centralized procurement organization will make a good combination of central and local decision-making. It will centralize the buying decisions for those categories of goods and services where the economies of scale and knowledge concentration can be beneficial. It will keep the buying decisions local for those categories where local presence is important. It will facilitate collaboration between central buyers and local buyers and plant managers and make sure that taking decisions also means taking responsibility.

 

Now, what does this mean for energy?

 

When thinking about the centralizing of energy procurement, organizations always think about negotiating cross-border electricity or gas supply contracts in the first place. We have to remark here that the potential for this is still limited at this moment as the electricity markets and to a lesser extent natural gas markets are still largely organized on a national level. Negotiating a cross-border electricity contract is still largely an illusion. Best case, you can get some sort of framework agreement under which different electricity contracts per country are brought together but the conditions per country will often be widely different. For natural gas, the negotiation of cross-border contracts has become much easier in the last years. At E&C we have assisted many international companies to negotiate contracts under which natural gas in several North-West-European countries is bought under one and the same (commodity) price arrangement. Other arrangements such as volume regulation, price fixing services or payment conditions can also be brought together for different countries. What advantages should you expect from such cross-border contracts?

 

Some economies of scale can be expected, but should not be exaggerated. An energy bill contains three main components: 1. The wholesale value of the energy, 2. The retail add-on, 3. The regulated component, the grid fees and taxes. Economies of scale can only impact on the second component, the retail add-on, but that component is just a few percentages of the overall energy bill, so you shouldn’t expect miracles in terms of savings on the total cost of energy. Non-price advantages will often be more important. For example the bringing together of volumes from different factories in different countries under one common volume arrangement. Or the reduced time for processing price fixing decisions when this can be done for a collection of factories rather than for each factory individually.

 

Accumulation of knowledge can bring important advantages. As the length of some of the articles on this blog illustrates, buying energy is a very knowledge-intensive activity. Local buyers that have to buy a large diversity of products and services often lack the time for acquiring all the knowledge necessary to buy energy. Having a central energy buyer dedicating 100% of his/her time on studying the energy markets is therefore no luxury. We have seen many companies taking large step forwards in e.g. their energy procurement risk management practices when specialized central buyers take over from local buyers.

 

However, as I have said before, energy markets are organized on a local scale, which can create the disadvantage of a lack of knowledge of local factors of a centralized buyer. Energy markets are organized by regulations, and these are different in every country. As far as the commodity component is concerned (the wholesale value plus the retail add-on), as markets mature the differences between the different countries become smaller. But for the regulated part of the bill, the grid fees and the taxes, these continue to vary widely across Europe. This regulated part is an important percentage of the overall electricity cost, and to much lesser extent for natural gas. Good energy procurement means that you have a good insight into this non-commodity component so that you can budget it correctly. Moreover, every country has is specific set of exemption rules which you have to know to make sure you’re not missing out on an energy cost reduction possibility. It’s impossible for a central buyer to have in-depth and up-to-date knowledge of these tariffs and reduction schemes in all the countries in which you have to buy energy, moreover since they are written in law texts in a large diversity of languages. Consultants such as E&C with a local presence in the countries can make up for this. But it is also a good idea to work together on this with local buyers or for example technical managers in the plants.

 

As far as the commodity part is concerned, the buyer needs to take decisions regarding signing contracts and making price fixings. For contract negotiations, in pre-mature markets the contact of a local buyer with the local suppliers can play an important role in obtaining a good deal. But as markets mature, it becomes increasingly easy for a central energy buyer to negotiate in the different countries. Moreover, the experience from other countries can help a buyer in negotiating good contracts. As an international consultant we have several times negotiated new contract types in different countries by explaining suppliers how their peers in other countries were solving this or that issue. One important aspect to consider is the volume issue. Lack of collaboration between the central and local level can lead to delays in the signature of contracts as the central buyer lacks knowledge of the volumes for which he is to negotiate the contracts.

 

As far as the price fixing is concerned, the most important advantages of centralized energy procurement pop up. An energy procurement strategy can be defined that covers the whole company, making sure that no local buyer in a distant country is taking too much risk. And the centralized buyer will often have more time available for following up the different wholesale markets leading to more timely decisions at opportunity moments.

 

Centralizing energy procurement can have important advantages for international companies. But as with centralizing procurement in general, too much of it can create problems, especially as far as the non-commodity component of the energy bill is concerned. Smart energy procurement centralization will start by focusing on the development of a common price fixing strategy, then gradually get more involved in the contract negotiation process and the budgeting and bill validation. It will set up collaboration with local plant people to facilitate communications regarding expected volumes and local regulations regarding grid fees and taxes.

On buying and selling of forwards as an energy price hedging technique

In many countries, energy markets seem to have reached a new level of maturity with buyers looking for new products that allow them to deploy more sophisticated price hedging techniques. One of those is the selling back to the market of forward positions that have been fixed before. This buying and selling of forwards is sometimes presented as a miracle solution that inevitably brings ultra-low energy prices. It is true that adding the selling of the forwards to the hedging toolbox opens up new possibilities. If well applied, it can produce good results. But we don’t see that every client that sells positions as well as buying them pays much better prices than clients that don’t do it. It is not a miracle solution. Moreover, we sometimes see it being deployed without appropriate risk management. And that sometimes leads to disaster rather than miracle. Before considering the selling of forward positions, it is key that a buyer understands the ins and outs of this sophisticated hedging technique to the last details. It’s not something that you can explain in a few simple sales slogans.

This hedging technique of buying ánd selling is often confused with portfolio management. If you enter a portfolio management agreement, it means that you mandate somebody outside your organization to take the price hedging decisions for you. That portfolio manager will probably want to use the full scale of hedging tools, including the selling of previously bought forwards. But portfolio management is possible without the selling technique. And you can deploy buying ánd selling without the help of a portfolio manager.

When I talk about this hedging technique of buying ánd selling, many clients debunk it as being too risky, too speculative. On the other hand, most traders find the fact that traditional multi-click or tranche model contracts don’t have the selling option too risky. Both are right. By having the possibility of selling a forward contract if markets start to fall after you’ve fixed your price, you can reduce the price risk. But because it is a more sophisticated hedging technique, the risk of something going wrong is higher. This means that buying ánd selling adds system risk to your energy procurement.

To deal with this higher risk of something going wrong when applying buying ánd selling of forwards, it is essential that you have a good understanding of how it works. The basic principle looks simple. You buy e.g. at 40, you sell that position at 60 and then buy it back at 50. Your ultimate price will be: + 40 – 60 + 50 = 30. You have optimized your original position by the 10 (euro per MWh, e.g.) drop in the market. This is the simple + – + logic of applying buying ánd hedging. From it, you can derive two very simple rules for applying it successfully:

1. Buy in a rising market
2. Sell in a falling market

In theory, it looks dead simple, but in practice I see that even clients that have applied buying ánd selling for years make mistakes against this simple logic. For example, they get sloppy about their original buying positions, forgetting that the better your original price, the better your ultimate price. Or: they don’t want to sell at a price below the original buying price, losing valuable possibilities of improving the price in a downtrend. A third example of a misconception occurs when clients sell as soon as the price has risen above the original buying price, being too eager to cash in the ‘profits’ on the original position, but forgetting that they will have to buy back. To avoid such pitfalls, it is essential that everybody involved in the decision-making understand the basic + – + logic of this hedging tool.

Another misconception that I often hear is that people think that buying ánd selling is an energy procurement strategy in itself. It’s not a strategy, it’s a hedging tool. And how you apply that tool depends on your broader strategy that should be based on a thorough analysis of the type of risk that you’re exposed to in the volatile energy markets. Buying ánd selling can be used to optimize price results within the broader strategic goal of stabilizing energy budgets. But it can also be used by clients that have the opposite strategic goal of wanting to safeguard that they have competitive energy prices. Defining your risk limits and applying risk monitoring tools such as value-at-risk should help you in deploying buying ánd selling without excessive risk-taking.

If markets would move in straight lines, it would be very simple to be successful in buying ánd selling forwards. You would just buy everything if the straight line up starts and sell everything if the straight line down starts. But that’s not the reality of the markets. The price goes down for two days, then increases again, down again, etc. It’s this unpredictability of the markets that makes the application of hedging techniques so difficult. Some clients try to get around this by applying machine gun tactics, buying and selling at every first sign of an up-, resp. downtrend. That often results in big losses. I believe that it’s much safer to apply the piecemeal tactics, building up and down your positions in small steps, using your value-at-risk calculations to avoid excessive losses. I also recommend buyers to have patience. The real big gains are made in the big up- en downtrends. These don’t occur every year. If you trade too frantically in and out of every small intermediary trend, you’ll start piling up losses.

Operationally, the most important recommendation I can make is: apply the four eyes principle. Make sure there is at least one other person in your organization that completely understands the hedging technique to avoid disaster. Consultants such as E&C can also have an important role in deploying this sophisticated manner of hedging prices. I recommend to avoid black box solutions and to only use consultants that share all their information with you. Consultants should act as risk management consultants in the first place. The same is true with portfolio managers. Make sure that they are not taking excessive amounts of risk on your behalf by putting the necessary risk management practices in place.

Buying ánd selling of forwards is a powerful energy price hedging technique. It reduces the energy price risk by giving you the chance to reverse buying decisions. And it optimizes your chances of making really good prices as it allows you to benefit from downtrends in the market, and not only uptrends. However, it is also adds a next level of complexity to your energy price hedging. And because of this complexity, things can go wrong. If you want to adopt this hedging technique, I recommend the following steps:

• Make sure that all the people in your organization involved in the energy price decision-making process understand how it works. Don’t use an instrument that you don’t understand. Don’t outsource because you don’t understand.
• Hire a consultant to help you understand the technique completely and at least check that you have no misconceptions.
• If you hire a portfolio manager, make sure you are capable of checking his operations as a risk manager should do.
• Set up a good energy procurement strategy based on a good qualification of your energy market risk exposure.
• Develop good monitoring tools that everybody involved in the energy procurement understands.
• Be patient. Go for the long term trends and not for the short term gains.
• Develop your buying or selling positions piecemeal.
• Use value-at-risk calculations to manage the risk.

Good consultancy is based on an open and free exchange of knowledge. In this perspective, I have written a whitepaper on this topic of buying ánd selling of forwards as an energy price hedging technique. This blog article is a summary of that whitepaper. Send an e-mail to Joke at joke@eecc.eu to get the full version.

Vlaams Energiebedrijf wil de Vlaamse overheid massaal op de spotmarkt laten kopen

The content of this blog article is very exclusive for the Flemish market, hence, it will be published in Dutch only.

Gisterenmorgen stond een artikel in de Tijd met als titel ‘Lieten laat Energiebedrijf in de pas lopen’. In de namiddag was de CEO van het Vlaams Energiebedrijf Dirk Meire spreker op de VIB & Roularta studiedag waar ik eerder had gesproken. Ik was dus wel eens benieuwd wie die stoute jongen was en waarom de minister hem aan de leiband wil leggen. Bovendien was eerder al bekend geraakt dat Inspectie Financiën grote vragen heeft bij de gang van zaken bij het Vlaams Energiebedrijf en onder andere het gedrag inzake risico’s nemen sterk in vraag stelt. Daardoor was mijn aandacht verder aangescherpt. Risicomanagement is nu eenmaal mijn core business.

Het Vlaams Energiebedrijf is ooit in het leven geroepen met de bedoeling een Vlaams alternatief voor Electrabel te vormen. De betrokken politici kwamen er al gauw achter dat een energieleverancier opzetten niet zo eenvoudig is. Bovendien, als je net een markt geliberaliseerd hebt, behoort het dan wel tot de kerntaken van de overheid om daarin als leverancier op te treden? Het Vlaams Energiebedrijf kreeg dus andere taken. Het zou zich bijvoorbeeld inzetten voor de promotie van energiezuinig beheer van overheidsgebouwen. Een op het eerste zicht nobel initiatief, maar komt het daarmee niet in conflict met privébedrijven die op dat vlak diensten aanbieden? Ook zou het Vlaams Energiebedrijf ervoor zorgen dat de Vlaamse overheid goedkoper energie kan aankopen.

Wat blijkt nu? Het Vlaams Energiebedrijf wil voor de Vlaamse overheid, haar instellingen en de Vlaamse gemeenten het aanbesteden van de energielevering gaan overnemen. En het komt daarbij met een vrij spectaculaire idee, het wil namelijk exclusief spotcontracten gaan afsluiten voor die overheden. Spectaculair aangezien dit zo’n grondige omslag is van het gebruikelijke energie-inkoopbeleid van overheden dat meestal eerder op het verwerven van budgettaire zekerheid is gericht. Laat ons even enkele van de door meneer Meire aangevoerde redenen om voor de spotmarkt te kiezen onder de loepe nemen:

1. Meneer Meire geeft aan dat de spotprijzen historisch bekeken een stuk lager zijn geweest dan de forwardprijzen. Hij gaf daarbij het voorbeeld van de elektriciteitsmarkt, een voorbeeld waarin ik hem wil volgen. Maar waar ik meteen wil bij opmerken dat dit in de gasmarkt in de afgelopen vier jaar niet het geval was. Wie vanaf januari 2010 gas in de spotmarkt heeft aangekocht, heeft 0,4 euro per MWh meer betaald dan iemand die op de gemiddelde forward prijs heeft gekocht. Dus, de stelling die meneer Meire in het aansluitende debat poneerde dat forward prijzen altijd hoger zijn, die klopt niet. Ervarving in de gasmarkt spreekt dit tegen.
2. De logica voor die hogere forwardprijzen ziet meneer Meire in het fenomeen van de zogenaamde ‘forward premium’. Ik ga niet ontkennen dat zoiets bestaat. Als verkopers een forward sale van energie overwegen, zullen zij inderdaad geneigd zijn om het risico op hogere prijzen enigszins te hoog in te schatten. Maar zeggen dat het dom is om die forward premium te betalen, dat is ongeveer hetzelfde als zeggen dat het dom is om verzekeringspremies te betalen. Als er niets gebeurt, ben je inderdaad over je leven bekeken een pak geld kwijt. Maar als er iets gebeurt, zal je maar wat blij zijn dat je braafjes de premies hebt betaald.
3. Wie visibiliteit wil inzake zijn toekomstige energieprijzen (inzake commodity) die kan die alleen maar verkrijgen door forward prijzen vast te leggen. Daar betaal je inderdaad een premie voor, maar dat is nu eenmaal de kost om de onvoorspelbaarheid van een energiebudget in te perken. Er kunnen zeer goede redenen zijn om dat te doen of om dat net niet te doen. Wat zeker een hele slechte reden is, is denken dat je weet waar de spotprijzen naartoe gaan. En dat doet meneer Meire blijkbaar. Want hij presteerde het om een grafiek te projecteren waarin hij de kostprijzen volgens hun spotcontracten voor de volgende jaren weergaf. Een pure forecast is zoiets. Meestal gaan dergelijke forecasts gepaard met ergelijke disclaimers die zeggen dat wat je net is verteld meer fictie dan feiten is, maar meneer Meire blijkt dat niet nodig te vinden. Zo overtuigd is hij dat die fantastische spotmarkt altijd wel laag zal blijven. Een overgang naar de spotmarkt promoten met grafieken met volstrekt niet waar te maken prijsprojecties, ik kan dat onder niets anders dan misleidende reclame catalogeren.

Spotmarkten zijn zoals alle energiemarkten onvoorspelbaar. Als er zich in de komende jaren een groot veiligheidsincident voordoet in een Europese kerncentrale waardoor alle kerncentrales moeten sluiten, dan kunnen we heel scherpe stijgingen van de spotprijzen voor stroom verwachten. Dat zou dan wel eens veel meer kunnen zijn dan de 50% stijging die meneer Meire gebruikt heeft in zijn ‘risico-analyse’. Kan dat gebeuren? Ja, Japan heeft het in 2011 meegemaakt. En zelfs zonder dergelijke drastische fenomenen, hebben we gemiddeld over het jaar 2008 een stijging gezien van de spotprijzen voor stroom van 58% tegenover het voorgaande jaar. Opnieuw, dat is meer dan de 50% die hij gebruikt in zijn ‘risico-analyse’.

Bovendien, de hier genomende cijfers zijn volatiliteiten van gemiddelde jaarprijzen. Meneer Meire heeft niets gezegd over het fenomeen van de volatiliteit op korte termijn. In oktober 2007 bijvoorbeeld, steeg de spotprijs op Belpex, de Belgische stroombeurs, met 65 procent boven de spotprijs van september 2007. Dit zijn flinke aanslagen op de cashflow waar niet iedereen op staat te wachten, ook al vlakt zich dat in de volgende maanden wel uit. Februari 2012: +55%, September 2013: opnieuw +20%. Zijn gemeentes of andere overheden wel voorbereid op dergelijke schommelingen in de maandelijkse kasuitgaven?

Na het maken van dit soort nuancerende opmerkingen inzake spotmarkten zijn er soms verkopers van spotcontracten die ons beschuldigen dat wij iets tegen die spotmarkt hebben. Welnu, om hen gerust te stellen, heel veel van onze klanten kopen grote stukken of zelfs alles in die spotmarkt aan. Daar kunnen goede redenen voor zijn. Maar die moeten gebaseerd zijn op een grondige analyse van de effecten van energieprijsvolatiliteit op de financiële toestand van een bedrijf of organisatie zoals een overheid.

Volgens meneer Meire hebben schommelingen van de energieprijzen geen groot effect op overheden omdat ze niet energie-intensief zijn. Dat klopt, maar dan luidt zijn conclusie: ‘neem dan maar de spotprijs’. Dat is vreemd, want onze ervaring is dat net zulke organisaties eerder naar budgetstabiliteit streven. Als energie geen substantiële impact heeft op de rentabiliteit, waarom zou je dan het risico nemen dat de energie-inkoop toch een issue wordt omwille van een plotse, onverwachte budgetstijging? Ik ben geen specialist in gemeente- of overheidsfinanciën. Maar ik zie al die gemeentes nu zo’n grote inspanningen leveren om op de kosten te besparen. Als ze nu allemaal overstappen naar meneer Meire zijn spotcontracten, dan lopen ze het risico dat uit de hand lopende spotprijzen voor energie een deel van die inspanning opsouperen. Als belastingbetaler vind ik dat geen prettige idee. Bovendien, binnen gemeenten maar ook in een Vlaamse regering worden harde afspraken gemaakt over budgetten bij de opmaak van begrotingen. Ik kan me toch echt niet voorstellen dat er dan geen behoefte is aan enige budgetvastheid bij het inkopen van energie? We kennen allemaal de verhalen over overheden die stoppen met het inkopen van bv. printpapier omdat het budget is opgesoupeerd. Gaan die overheden dan de stroom uitschakelen wanneer een oplopende spotmarkt het energiebudget tegen september heeft opgevreten?

Meneer Meire minimaliseert ook de impact van schommelingen in de commodityprijzen voor energie. Hij wijst er (terecht) op dat het non-commoditygedeelte tot 60% kan bedragen van de totale factuur. Maar dan gaat hij er verkeerdelijk van uit dat dit een vast gedeelte zou zijn dat de volatiliteit van de commodity uitvlakt. Op de VIB studiedag gisteren liet de kabinetschef van minister Vandelanotte horen dat het de bedoeling is om het non-commoditygedeelte niet verder te laten oplopen. Maar deze morgen lees ik in de krant dat de netbedrijven alvast hun nettarieven willen verhogen. Het kan wel eens zijn dat die stijging van 50% van het commoditygedeelte samenvalt met een stijging van nettarieven en/of taksen en als we dan toch bezig zijn, ook nog eens een stijging van het verbruik. Dat zal toch niet zomaar passeren volgens mij …

Ik denk dat iedereen die in dit verhaal betrokken is, toch eens heel goed moet nadenken over die switch naar de spotmarkten. Ik denk daarbij in de eerste plaats aan de betrokken ambtenaren. Zij zullen met de vinger gewezen worden wanneer de keuze voor spotmarkten een fiasco wordt. Wij proberen hen ervan te overtuigen dat ze met hun organisaties goede afspraken moeten maken over de risico’s die je neemt bij het energie inkopen. Dit doe je niet door zoals meneer Meire heel eenzijdig het besparingspotentieel van een keuze voor spotprijzen in de verf te zetten. Als zo’n ambtenaar met meneer Meire’s cijfers over besparingen zijn oversten heeft overtuigd, en vervolgens krijg je een budgetstijging, dan zal hij toch niet echt comfortabel zijn. Ook voor politici lijkt mij de massale switch naar spotmarkten riskant. Stel, zij laten hun gemeente of overheid overstappen naar het Vlaams Energiebedrijf en zijn spotaankopen. En in het jaar voor de verkiezingen swingen die prijzen de pan uit. Is dit echt wat ze willen? Past zo’n spotcontract echt wel bij het risicoprofiel van een gemeente of overheid? Wat als we een herhaling krijgen van wat in 2007 – 2008 in onze energiemarkten is gebeurd? Wie gaat dan gelukkig zijn met die keuze voor de spotmarkten? Wie wil dat politieke risico nemen?

Wat mij nog het meest stoorde, was dat meneer Meire dit alles voorstelde als verschrikkelijk innovatief. Hij is daarmee de derde die mij in de afgelopen vijf jaar een spotcontract probeert te verkopen als iets verschrikkelijk nieuws. Hallo, een spotcontract, dat is het oudste commoditycontract in de wereld. Daar is niets nieuws aan. En daar zijn ook niet alleen maar voordelen aan, zoals meneer Meire in zijn presentatie probeerde aan te tonen. Bovendien laat hij daarbij grote onzekerheid over de hoedanigheid waarin ze dit gaan doen. Op één en dezelfde slide noemt hij zichzelf een energieverkoper en een aankoopcentrale. Hij geeft zelfs aan dat ze rechtstreeks in de groothandelsmarkt willen sourcen, waardoor ze al helemaal niet meer verschillen van een energieleverancier. Is het Vlaams Energiebedrijf dan een poging om een monopolie te vestigen over de levering van energie aan overheden in Vlaanderen? Want om eerlijk te zijn, om spotcontracten af te sluiten, daar heb je absoluut geen nieuw vehikel voor nodig. Er staan tal van leveranciers klaar om dat te doen.

Ik ga hier eens flink tegen mijn winkel praten, door te stellen dat het oprichten van een centrale die het aankopen van energie door overheden faciliteert, op zich een goed idee is. Wij stellen inderdaad ook vast dat bij overheden de marktkennis om succesvol energiecontracten af te sluiten vaak ontbreekt. Maar een aankoopcentrale houdt zich bezig met aankoop en niet met verkoop. Als het Vlaams Energiebedrijf een leverancier wordt, dan gaan wij alle overheden aanraden om hun aanbiedingen naast die van andere leveranciers te plaatsen. Ik denk overigens dat dit ook wettelijk verplicht is. Meneer Meire stelt dat er door te kopen via het Vlaams Energiebedrijf geen aanbesteding meer nodig is. Op één van zijn slides zegt hij letterlijk dat het Vlaams Energiebedrijf gaat leveren en factureren aan eindafnemer zonder aanbesteding. Dat lijkt me juridisch toch een vrij straffe uitspraak. Wanneer het Vlaams Energiebedrijf telkens zelf een aanbesteding organiseert, dan kan het volgens mij nog. Dan zijn ze inderdaad een aankoopcentrale die de aanbestedingen van de individuele afnemers overneemt. Maar wanneer ze de energie zelf in de groothandelsmarkten gaan aankopen, nogmaals, dan zijn zij een leverancier. En dan moeten hun aanbiedingen aan concurrentie worden onderworpen. Door bovendien zo pertinent te stellen dat het Vlaams Energiebedrijf gaat leveren en factureren, bevestigt meneer Meire overigens het beeld dat het Vlaams Energiebedrijf een leverancier is en geen aankoopcentrale.

Indien het Vlaams Energiebedrijf zich toch tot zijn functie als aankoopcentrale zou beperken, dan is het heel eigenaardig dat die aankoopcentrale zo exclusief voor één product, namelijk spotcontracten kiest. Het is alsof je een aankoopcentrale maakt voor auto’s en die centrale vervolgens zegt: “we gaan alleen maar blauwe auto’s voor jullie kopen want dat vinden wij de mooiste”. Het zou veel logischer zijn dat het Vlaams Energiebedrijf voor de overheden de aankoop faciliteert van de grote diversiteit aan contracten die in de markt bestaat. Zodat elke overheid voor zichzelf kan uitmaken welk product het beste aansluit bij de specifieke verwachtingen. Het kan toch niet dat het Vlaams Energiebedrijf één bepaalde manier van aankopen zou promoten op basis van nogal stevige overtuigingen over enerzijds de prijzen in de groothandelsmarkt en anderzijds risico’s van energieprijzen voor overheden? Overtuigingen die ik op zijn minst ongenuanceerd en betwistbaar zou willen noemen, en ik was duidelijk niet de enige die er gisteren zo over dacht.

Procurement: generating savings or adding value?

Last week I had some interesting discussions with clients – procurement professionals – on the topic of reporting savings. It raised fundamental questions about the role of a procurement division in a company. We are witnessing some contradictory evolutions in corporate procurement practices nowadays. Some of our clients are still making the first steps in centralizing and professionalizing their procurement activities. Procurement tasks are taken away from local managers and a new corporate procurement team is set up at headquarters. But then we see other clients that have gone through this centralization a decade ago and now start to build down their centralized procurement divisions and push the responsibilities for buying goods and services back towards local site (procurement) managers. Is this a normal ‘ebb and tide’ phenomenon inherent to corporate life? Or is there something more going on? I believe that putting too much emphasis on the ‘savings’ made by procurement teams is responsible for this.

As a centralized team takes over the buying of certain categories of goods and services, they start to grab the ‘low hanging fruits’. The volume effects, the synergies and the professionalism of buying centralized often cause massive savings for different categories. It is obviously very tempting for procurement managers to make a lot of noise, “look how much money we have made for the company”. Moreover, setting up a large team of corporate buyers is very challenging in many industrial organizations. Especially when CEO’s have a background in production, they tend to be very skeptic about the value of large teams at headquarters, far from where the real value is created in the industrial processes. It is of course very tempting for the procurement manager to validate the decision that has just been taken to set up a corporate buying team by reporting the large savings made by the initial round of grabbing the low hanging fruit.

As energy procurement consultants, I recognize this temptation. One of the most gratifying aspects of our job is precisely this possibility of making cost reductions. Especially the savings that result from negotiations of contracts can give quite a kick. Last week, one of my colleagues was walking around with that recognizable big smile. He had reviewed the energy contract situation of a client with a large cogeneration unit and saved over a million euro per year with the negotiation of new contracts. It is of course very tempting to broadly “boast” about such savings. They obviously justify our consultancy fees. However, we try to resist that temptation, for a double reason. First of all, it is impossible to perpetuate such savings. They typically occur in the first year of working together with a client when the injection of energy market knowledge allows us to cure what went wrong in buying energy (the low hanging fruit). Secondly, however exciting they are, such savings by negotiations are just one aspect of the added value that we can create for our clients. Therefore, we have always preferred not to put too much emphasis on them. We don’t want to create the wrong expectation that we will make such savings every year and we want our clients to understand that buying energy is not just about making savings by negotiation.

I can only recommend corporate procurement managers to do the same thing. Making a big show of the initial ‘low hanging fruit’ savings round will create a pattern of expectation. The performance of the procurement division will be measured on measurable cost reductions only. You will find yourself struggling with an increasingly complex savings calculus. You will lose a lot of time in discussions with your buyers and with the financial manager over the realism of the reported savings. And especially if the savings reporting system is pushed all the way through to a bonus calculation for buyers, you will find out that it starts to live a life of its own. That your buyers are no longer doing what is best for the company, they do what is best in the (abstract) framework of the savings calculus. I have spent a large part of my professional life in the presence of corporate buyers. And at several occasions I witnessed buyers that “conspired” with the sales people to fake a saving. (For example: savings calculations that are based on differentials between initial, second best, average prices offered and the final price. Buyers ask the sales guy to make a first bid that is high enough. Don’t laugh, I’ve seen this happening before my eyes at least ten times.)

Too much emphasis on the savings reporting inevitably ends in the situation one of the clients I was discussing with this week told me about. He said: “a new CEO walked in and said, ‘I’m tired of procurement reporting astronomic savings of which I’ve never seen a penny in my bottom line’”. The client also told me that procurement in his company was now decentralized again and the corporate procurement team was scaled down. It happens too often that corporate buying teams are restructured because “the savings they generate are no longer justifying the costs”. As my client pointed out rightly: “why are they never asking the same questions about the corporate finance team?”, or corporate marketing? HRM? Because everybody acknowledges the value of doing such activities on a corporate level even if this value cannot be measured in exact ‘euros or dollars saved’.
Everybody will acknowledge that it is impossible to squeeze a lemon indefinitely. At some point, the low hanging fruit is gone. Reported savings inevitably decline (or they become increasingly ‘artificial’). That doesn’t mean that a central procurement team loses its added value for the company at that moment. Looking at procurement from the point of view of one category, namely energy, I see that in large international organizations, corporate buying generates the following added value:

1. Because of the smaller size of what they buy, site buyers will often buy a large number of categories. Corporate buyers can focus on one or more categories and become specialists in them. This inevitably leads to better decisions.

2. Companies shouldn’t just aim at making savings, they should aim at making savings “where possible”. That means that the buyers do all they can to “make the best possible deal, taking into account the market situation”. Professional buyers that are specialized in one or just a few categories are better at that. I observe again and again that local buyers or site managers sign sub-optimal contracts because they lack market knowledge.

3. Negotiating contracts is just one (albeit important) aspect of the procurement job. As they become specialists, corporate buyers can develop other aspects of their job and generate considerable added value with that. When they buy commodities, the procurement specialists can develop and implement the risk management and risk analysis tools that are necessary to protect the company against price volatility. And in products as well as services, buyers’ market knowledge can be an essential component of corporate supply chain management and quality control.

4. Even if cutting away the corporate procurement team is a direct cost saving, this will be compensated by the fact that buyers or site managers have to spend more time on procurement activities.

I recognize the need for metrics to judge a procurement division’s performance. But procurement professionals should avoid that the evaluation of their performance is reduced to savings reporting. They shouldn’t neglect the crucial role they play in the risk management, supply chain management and quality assurance of their company. Too much eye for savings is a dead end street. And moreover, too much emphasis on savings causes a regrettable neglect of other added values created by professional procurement, added values that are more difficult to measure. Everybody knows that reducing the role of the buyer to “the guy that comes in at the end to squeeze the lemon” is a farce. There are much more intelligent ways to do a procurement job and create a sustainable added value for the company. Management should judge their procurement teams on that broader added value.