The 19th annual Manufacturers’ Education Council Energy Conference was held in Columbus last month. In what was an otherwise fantastic conference, an out-of-state energy broker gave a breakout session presentation hyping a gimmicky electric generation product. When the presentation ended, and the attendees began filing out, one of the presenters turned to a member of the audience. He asked him in wide-eyed, high-energy fashion, “So, what did you think?”The audience member, a gruff, long-time veteran of Ohio manufacturing, bluntly replied, “Sounds like a bunch of hooey!” The exchange gave those of us from Brakey Energy who attended the energy conference a good laugh.Our company has always prided itself on being transparent and straightforward when soliciting generation quotes for clients. Unfortunately, there is a large contingency of brokerage companies that are more interested in peddling smoke and mirrors than sound advice. Below are examples of three electric generation procurement gimmicks to avoid.
Reverse auctions are by far the most widely accepted generation product gimmick. But scratch the surface and anyone can see how flawed reverse auctions are. Energy brokerage companies that follow this business model have generation suppliers bid against each other in a declining auction to serve a customer’s load. This allegedly produces the lowest possible price. Some of these brokers have online portals or other fancy-sounding ways of supposedly getting suppliers down to rock-bottom quotes. I do not think reverse auctions are the best way to get the lowest price for a generation product. Most suppliers would agree with me on this point. Furthermore, some suppliers refuse to participate in these auctions for a multitude of reasons.But if I were to accept, even for a moment, that reverse auctions produce the lowest possible price, the auctions are fundamentally flawed for a very different reason: Reverse auctions, by their very nature, can only differentiate suppliers based on price.
Any competent energy management partner will weigh important factors like supplier contract terms, counterparty risk, customer service, and past business dealings when evaluating offers. Entering into a generation contract based solely on price makes about as much sense as doing the same when buying a house.
Yet reverse auction brokerage companies have hardwired this fatal error into their core business model. Reverse auctions often produce the electric generation equivalent of a foreclosed home with a flooded basement and stolen copper wire. And to the extent a reverse auction brokerage company attempts to remove their blinders, and takes other important variables into consideration, the auction framework collapses in on itself.
‘Heat Rate’ Products
A heat rate product allows a customer to lock in not a price for electric generation, but instead a generation plant’s operational efficiency or “heat rate.”After the heat rate is locked in, the price a customer ultimately pays for electric generation will be based on what happens to prices in natural gas markets. What happens to prices in electric generation markets becomes irrelevant.To strip this complicated gimmick down to its naked elements, the price of electric generation is being turned into the price of natural gas in order to be turned into the price of electric generation.This roundabout conversion is the equivalent of doing laps in a revolving door. The uselessness of the conversion is all the more true since natural gas and electric generation prices are already positively correlated on a near one-to-one basis. Assuming past trends hold, turning electric generation prices into natural gas prices has little to no effect since the two commodities already move in lockstep.
Making four right turns to get to a generation price makes little sense for consumers, but it makes perfect sense for brokers. The heat rate product creates opaqueness and needless complexity. This creates the perfect breeding ground for unconscionable commissions.
‘Not-to-Exceed’ Price Offers
Two separate clients have asked me in the last few months about a brokerage company that is offering “not-to-exceed” price contracts. The company also refers to its product as a “protected price point.” Essentially, the gimmick works like this: The broker quotes you a fixed price for electricity that sets your ceiling price. Though the broker doesn’t disclose it, this quote is far higher than anything out on the market. You contract for that price as a ceiling, and you now are obligated to use that broker for your next generation contract.The broker (hopefully) goes out to the futures market and buys a call option to hedge its upward price exposure. The higher-than-market premium built into your agreed-upon ceiling price includes the broker’s cost of the call option along with a hefty profit.If the market falls, you indeed can lock into a lower price relative to the previously agreed upon ceiling price. However, that lower price still includes the price of the call option and a large profit to the broker. It will be a price far higher than what you would be able to secure through a traditional procurement process.
Worst case, in an upward moving market, you will contract for an extremely high price relative to market conditions at the time of the hedge. Best case, in a downward moving market, you will contract for a very high price relative to then-market conditions.
Avoid the ‘Hooey’
The common thread to these gimmicky generation products, and the many others like them, is isolation. Customers are forced to enter into procurement decisions through a rigid, overly complicated broker-provided framework. Once you are caught in their mousetrap, you are at their mercy when it comes to commissions and accountability.
There is no substitute for a competent energy management partner that will go out and solicit commission-free quotes on your behalf. There are indeed many sophisticated products out there that are a good fit for many customers. However, customers need to find reputable firms to help them separate the gimmicks from the good.
Note: This article was authored by Brakey Energy President Matt Brakey and was originally published by Crain’s Cleveland Business on 4/3/15. You can view the original version on crainscleveland.com.