By Jim Tompkins, CEO, Tompkins Associates
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Hello, this is Jim Tompkins, I’m the CEO of Tompkins Associates and Tompkins International. I am pleased to be with you today to present the last part of our 3rd series of the Global Supply Chain Podcast. This 3rd series is on the topic Supply Chain Cost Reduction. We have been working our way through the major costs of the supply chain.
We have covered first the overall supply chain strategy for cost reduction. Second, Asian Sourcing. Third, Transportation. Fourth, Distribution Operations. Fifth, Material Handling Integration. Sixth, Inventory. Seven, Supply Chain Technology. Eight, Logistics Outsourcing and today our ninth in this series, Energy.
As many of you listeners know, energy and energy cost reduction is not a topic within Tompkins’ expertise. Nevertheless, we want to make sure we offer you and our clients a full line of services. So we have partnered with the firm American Energy. Our guest today, Mike Moore, is the co-founder of American Energy and now serves as President and Chief Executive Officer. He has a wealth of experience with marketing energy services and has implemented energy solutions for a wide range of industrial and commercial clients over the years. Prior to co-founding American Energy, Mike gained experience with a number of energy- related companies. He was the President and CFO for Private Energy Partners, a developer of independently owned and operated mid-size, inside-the-fence cogeneration projects.
So let me welcome you Mike to our podcast, and let me begin with our first question.
Jim:
How do you define energy management to your clients?
Mike:
American Energy sets out to help evaluate both supply and demand side savings opportunities for our customers. We think it is real important to start out every assignment with the audit of all energy accounts and all procurement practices. This allows us to gather historical billing information which allows us to track costs, demand, consumption -- it helps us evaluate the procurement practices the client has in place, to include how they manage energy contract. What we find is that most commercial and industrial customers have never had an audit conducted on their energy accounts. So it is a logical first step.
We then expand the definition of energy management to an active management of energy contracts and that can be natural gas in deregulated states, electricity in deregulated states and developing a process to not only make good selection of energy suppliers, but also provide day-to-day management of those contracts. That would include the management of price risk. This part of our energy management practice is somewhat complicated, but it is based on good fundamental and technical market information and expertise, and allows us to help customers make informed decisions with respect to the volatility of energy commodities.
We then help our customers as part of this whole idea of energy management to identify financially acceptable ways to decrease energy consumption. We focus on the financially acceptable because in the real world, customers are not going to implement projects that don’t meet acceptable rates of returns on investments or simple paybacks or whatever the metrics is that the customer uses to measure their Cap X budgets.
Then lastly we think the overall energy management process should include: how do you identify your current inventory of greenhouse gases and how do you go about developing a program to reduce greenhouse gases, as that becomes more and more important over the next couple of years as we see potential legislation and statutory requirements to reduce greenhouse gases.
Jim:
Thanks Mike. Has it become increasingly important to manage energy costs?
Mike:
The volatility of energy prices makes it more and more important to manage energy commodity costs. If you look at how the markets work, and sometimes they don’t make sense, but crude oil contract has a very direct impact on the natural gas conttact. I am referring to the contracts that are traded on the futures market on the 9Max and there seems to be this correlation between crude oil and natural gas. It doesn’t make much sense, because different fundamentals impact those markets differently.
But there is a sensitivity that as crude oil runs up, natural gas seems to follow it. What we’ve learned over the last few years is that there is a pretty tight correlation between natural gas and electricity prices. So as you look at the whole word of energy in an industrial/commercial application, what happens internationally with the crude oil market will have a direct impact on what is happening with natural gas, which will have a direct impact on electricity.
Now the impact on electricity can either be immediate if you’re in a deregulated environment when you are taking electricity from a 3rd party or it can be delayed if you are taking service from a regulated utility. But in every case, the impact of fuel prices is going to eventually impact electricity prices. So our objective is to help customers understand those correlations, help customers make decisions in both regulated and deregulated markets to do what they can to mitigate price risk, work to develop budgets based on real-world instead of some type of artificial cost-of-living adjustment and then assist in managing those budgets through the use of pretty traditional hedging techniques. Hedging can be as complicated as opening a margins account on the futures market and trading futures contracts or it can be as simple as entering fixed price contracts with a credit-worthy 3rd party supplier.
So what we tried to do is help customers understand the need to manage energy costs, put a program in place that is based on good fundamental and technical market analysis, then help customers develop budgets and manage to those budgets to make sure they are achieving their objectives and our feeling is giving access to the information that we have access to, and our ability to interpret that, enhances our customer to make decisions that are right more often without us. We certainly are not able to predict the markets, but we can certainly help our clients understand what impacts prices and what they can to mitigate volatity. When you look at the last few years, you have seen the crude market go from $30 to nearly $150; we have seen the gas markets fluctuate from under $4 up to $15. Those kinds of wild swings of the market can have a big impact on operating costs.
Jim:
Mike, something I am sure our audience would be interested if given the proper attention, how much money is at stake if energy is properly managed?
Mike:
That is a tough question, and the answer to that question depends a lot on the type of business we are talking about. Obviously a big industrial with a tremendous amount of process and heat, and things like that, may have more opportunities than a hotel or something like that. Our experience tells us that if a customer has not really done a good job of really establishing procurement practices, auditing their utility bills, managing their contracts, and looking at tariff alternatives with the same eye that we would have on that, we could see anywhere from 1-10% in savings off of total energy spend -- just by auditing and reviewing the procurement side alone.
We’ll find things such as tariff changes; and in some cases there can be significant differences in one tariff vs. another. We will find ways to push the envelope a little bit on identifying tax exemptions for customers that are eligible for either manufacturer’s tax exemptions or other unique type exemptions. We will be able to help customers look at supplier choices in areas that are deregulated and maybe find supplier choices in newly deregulated areas that the customer, without the process, may not know exist and without the management process will not be able to find.
Then we will find mistakes and that is harder to find, but we have found some interesting stuff over the years where there have been mistakes on invoices, particularly when you taking service from a non-utility provider where there have been mistakes and we have been able to go back and seek refunds. The energy contract review and management of those contracts -- this is a real subjective analysis, but proper management of contracts and proper negotiations of contracts, we could see as much as maybe 20% savings as opposed to a customer doing it without a skilled staff. There is a variety of things that impact price.
Both, in the natural gas and electricity area, then there are a variety of things that cause you to fix prices and hedge your prices with that supplier either on a seasonal basis or based on market data and market information. While it is very difficult to say that the customer would have done this, but we would have done this to save them money; I think if you go back to clients -- that have not had a professional management process taking place -- would affirm the fact that there is significant value in having the proper expertise in the management of these contracts.
We think market information is the key, we think it is very difficult for the customer to have a person or 2 people that understand how the commodity markets work, understands how to gather information with respect to supply and demand,.whether other types of market factors that will influence pricing and our ability to have that information, learn from it, make recommendations is the key to trying to driving costs down as best you can through proper contract management. Then equally difficult is determining how much can you save with respect to energy conservation and again depending on the type of business it can be modest to significant.
But, we think the key to it is: energy engineers look at facilities with a different eye than a plant engineer. A plant engineer may have multiple functions from production line improvements to sourcing equipment to being involved in developing manufacturer processes. Our people look at one thing and one thing only: that is energy consumption. So we look at facilities differently and we are looking at ways to drive consumption down in a way that meets the customer’s financial objectives.
Jim:
Okay, what are the important considerations for businesses in identifying energy conservation projects?
Mike:
We think starting with an audit of a typical facility, or if the customer is really committed, auditing all facilities to identify and prioritize projects. Then the prioritization of the projects really depends on what the customer’s objectives are, whether they have budgetary constraints, whether they are looking at certain returns on investment or whatever their metric is. We like to focus on areas that have rebates or tax incentives available to them. The customer will also look at where these measures would have operational impact. Would the operational impact limit the ability to do the project? Out of a facility audit we will see things from heat recovery to compressed air systems to high efficiency lighting, motors and drives; all the typical things you would see and in our opinion those would be the 4 or 5 areas that the customer would consider before implementing any identified projects.
The second thing from the audit is to develop a strategy based on availability of capital and we’re well aware and the customer is well aware that energy projects compete for capital expense budgets like all other projects do. Approaching and attacking this issue on a corporate-wide basis, seems to make a lot of sense and let’s just say for example that the best payback projects are lighting retrofits. You could develop a program to implement lighting retrofits, facility-wide, nationwide, on some kind of a basis that allows capital to be budgeted properly for it. So implementing a strategy based on the amount of capital available we think is really important as well. And then we think it is increasingly important to look at the impact of these projects on greenhouse gas emissions. We think that the changing regulatory and statutory environment in that area will drive customers to include emission reductions as a part of their overall considerations in implementing projects.
Jim:
Mike, help us out here, explain rebates, who pays for them and why are they available? For the most part, utility companies fund rebate programs.
Mike:
When you say that I think it is also important to note that there is a small line item on utility bills that funds these types of programs. So the money typically comes from the rate payers. Now with that said, it is fair for the utility companies to promote rebates as a way to reduce demand which has a positive impact on the fact that their load is generally increasing. That may not be the case today with the economic decline that we are in, but for the most part low growth curves in most regulated utility service territory. So to respond to that increasing load they have to either build generation or find a way to reduce demand in their existing load. So rebate programs serve a number of purposes, one of which is to avoid the costs of having to build new generation, which is becoming increasingly difficult.
Number 2, and maybe becoming more and more important, is that demand reduction also reduces carbon and other greenhouse gas emissions and the utility companies are more and more sensitive to making sure that they achieve those goals due to the potential economic impact of whatever carbon legislation we end up with. So for customers that are looking to identify and implement energy conservation projects, we think it is critical to understand the rebate application process, to take as much advantage of these as possible. They are not easy. We need someone with a well informed eye helping you look at these rebates and identify a process to maximize them.
Jim:
Mike, do you believe that we will see legislation mandating GHG emissions reduction?
Mike:
Without a doubt it is likely. I had a meeting earlier this year with our local United States representative congressman Emanuel Cleaver, and he said at the beginning of the year he would have been 100% confident that a Greenhouse Gas law would have been passed this year. In April when I met with him he said it was about 50/50 that one would be passed because of the increasing difficulty in the business sector.
Adding any type of additional costs or taxes is not politically expedient, but over the last couple of weeks we have seen some increased activity and a lot of talk about legislation being passed. Every business may not be required to comply with the law; they are obviously going to focus on the big emitters. But everybody’s going to be impacted by it because the biggest emitter of all are coal-fired power plants. Whether it is a cap in trade scenario or it’s a carbon tax (which is unlikely), but in either event there is going to be a cost of producing carbon emissions and that cost is, depending on who you talk, to ranges from 2-3 cents a kilowatt/hour on the electric side and will have an equal impact on large natural gas users, because there are carbons that are emitted from natural gas processes as well.
Some of the things that we are encouraging our customers to do today and what I think is critical is to begin step 1 in the process which is to develop what your greenhouse gas inventory looks like. It’s a relatively time consuming process, but from all indications we are going to be looking at a baseline year of 2005 and there are going to be mandatory reductions in the greenhouse gas emissions, primarily carbon emissions based on 2005 levels. The early reports are that it could be as much as 60-70% by the year 2050.
Energy conservation will play a large part in meeting these objectives. So for customers that are in compliance industries, it would be a way to avoid having to buy carbon credits from a volatile market we would expect and reduce carbon themselves through a variety of conservation measures. These measures need to be properly documented and naturally the first step in that is to figure out where you are.
It’s an important piece of the puzzle right now in energy management to understand what your emissions inventory is and then develop a strategy to reduce it, based on whether you have a legal responsibility to do so or whether you are looking at it as a way to take advantage of economic opportunities.
Jim:
Thank you Mike. We very much appreciate you being with us today. It’s a great discussion.
That concludes our series on Supply Chain Cost Reduction. In two weeks we will begin our 4th series in this Global Supply Chain Podcast as we discuss the Great Comeback to the Great Recession that we have all been living through over the last 12 months. Thanks and talk to you real soon.
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