Day Ahead Prices Good Indicators of Real Time Hourly Prices?

Correlation Breaks Down When Most Needed

In a recent newsletter we addressed a question from a subscriber about the cost of being on hourly pricing and how the subscriber thought it was supposed to be cheaper than fixed rate electricity supply. In our response we detailed that most customers should not even consider hourly pricing, with the exception of a small group who can actively manage their consumption profile. Within that small group, the thought is that with optimal management, one can shift load from a high-priced hour to a lower-priced hour, thereby reducing overall electricity expenses. To accomplish cost-effective load shifting, however, you need good information and you need to act on it accordingly. But is there good information available? Or are we laboring under a misconception that there is good load intelligence available and we are just fooling ourselves? And if that is the case, are we really managing our energy budgets or are we just gambling?

Day-Ahead and Hourly Real Time

Day-ahead prices are posted after 4:00 PM the day before they become effective. These prices reflect what market experts think tomorrow’s price will be by way of their buying activity. Suppliers often, but not always, take positions for supply for each hour for the next day. After midnight, the hourly real time market kicks in, and any imbalances between what the suppliers have committed for supply and ultimate consumption is “settled” in the real time market at the hourly rate. The basic idea is that hourly-managing energy users will plan energy usage for the next day based upon day-ahead prices, shifting consumption from higher-priced hours to lower-priced hours. The aforementioned process would work great if day-ahead and real-time hourly prices were the same. Unfortunately, they aren’t – not by a long shot, especially when price parity is most sorely needed.

Using R-Squared

We investigated how well day ahead and real-time hourly prices correlated. The standard statistical correlation for evaluating how well sets of data correlate is R-squared (also known as the coefficient of determination). If R-squared is 1.0, then there is a direct correlation between the two sets of data; and if R-squared is zero, then there is no correlation between the two sets of data. Statisticians generally state that if R-Squared is above 0.8, it is assumed that the two data sets are correlated.

During most days, when there are no unusual demands on the electric grid (i.e., prices less than 10¢/kWh), R-squared is right about 0.8. And this is what you’d expect, as there is little information that alters the prediction of energy consumption from one day (day ahead) to the next (real-time hourly). R-squared values above 0.8 encompass 80+% of the days. But, on days when the system is stressed (e.g., January 7, 2014), R-squared falls to 0.25, which means there is little correlation between the two sets of data. Since this occurs on only a small percentage of days, it shouldn’t be a big concern. Being right over 80% of the time is a darn good batting average. Unfortunately, all days and hours aren’t equal when it comes to market pricing and your budget. When you look more closely on the days when the system is stressed, you will see that being wrong has a much higher cost – so much so, it can wipe out months (or years) of being on hourly pricing. Also, with day-ahead and real-time hourly having very low correlation a good deal of the time, it illustrates that energy experts have no idea what the price is going to be tomorrow if the weather gets hot, gets cold, or is a polar vortex rolls through, etc.

Hourly vs Hourly+1 Time Series

Because we found no correlation between day-ahead and hourly prices on days when the grid was stressed, we decided to look a bit deeper to see if we could find some correlation so that managers could get some forewarning of what the next hour’s prices were going to be. We looked at hourly prices as a time series. The most common example of time series is the weather: the best predictor of tomorrow’s weather is today’s weather. In our hourly challenge we compared the last hour’s settlement price to this hour’s settlement price. Interestingly, for many days we got R-squared values above 0.6 – not a great correlation but much better than 0.25. While this is better than using day-ahead prices, to take advantage of this one would have to employ a dynamic strategy rather than setting the operation plan the day before (after day-ahead prices are published). Other than those who are doing hourly energy management for sport, very few managers have the time to dynamically alter energy consumption from one hour to the next.

What about the Smart Grid?

Isn’t the Smart Grid going to make being on hourly less risky and more financially rewarding? We need to acknowledge that the Smart Grid has potential – but it isn’t there yet by any means in bringing economic benefit to the masses. Yes, there are a few exceptions of end users who are using sophisticated software management strategies to respond to hourly real time prices, but they are dwarfed by the number of end users who are on hourly pricing. Just because the Smart Grid has future potential, it doesn’t translate into reducing your energy budget or financial risk today.

Successful suppliers do not assume the risk of an hourly product, so why should you? If they can’t hedge their position, they take a pass on that opportunity. Take a good look at the risk you are assuming by being on an hourly product versus the ultimate reward you could achieve. If it was your money, would you be placing that bet?

EnergyNewsFlash– March 2014 — DA and RT correlation breaks down

When’s a fixed price not a fixed price? Answer: when it’s ComEd’s Price-to-Compare

Residential and small commercial customers still have the option of receiving electricity service from ComEd with a “fixed price.” Larger customers are in rate classes that have been declared competitive so their service option from ComEd is hourly pricing. The downside of hourly pricing is that you don’t know what price you are paying for electricity until after you’ve consumed it. This plays havoc with planning and budgeting as you can be rudely awakened by $1.90+/kWh electricity (such as what happened in the real time hourly market in the middle of the Polar Vortex earlier this month). As making one’s budget is paramount for facility managers, most of the larger customers secure their electricity supply through third party energy providers under a fixed rate option. That way they know the price they are paying. But what about the residential and small business customers who are on ComEd’s “fixed rate” – Do they really know what price they are paying?

ComEd’s Price-to-Compare

When evaluating electricity supply options beyond ComEd, it is suggested that the standard metric to employ is the utility’s Price-to-Compare.

From the ICC’s Plug In Illinois Website: (www.PlugInIllinois.org)

Price to Compare = Electric Supply Charge + Transmission Services Charge

ComEd’s Electric Supply Charge has summer and non-summer values. Thankfully, to simplify the math, the transmission charge is set annually. So if you or your community wants to compare an offer from a third party supplier they just add up the two charges, making some allocation of how much electricity used in the summer and non-summer months (which is information the average consumer doesn’t have readily available), to yield the Price-to-Compare. While that satisfies the above equation, it is only a Price-to-Compare in name only. It has very little relationship to the price you actually pay to ComEd for electricity supply.

Purchased Electricity Adjustment (PEA)

The IPA was established six years ago to protect smaller utility customers from market abuses in the purchase of wholesale electricity supply. The Illinois Power Agency purchases electricity for ComEd to resell to residential and small commercial customers. (ComEd is no longer in the electricity supply business and does not profit from the resale of electricity.) The IPA purchases blocks of power based upon what they project electricity demand will be for the coming period. If the IPA projects electrical load incorrectly, because customers either leave ComEd or the weather is hotter or colder than normal, power has to be either sold back into the market or more must be purchased. Invariably, there is some fund transfer with these transactions. This is where the PEA comes into play. Since the IPA and the utility can’t make or lose money on electricity transactions, the rate payers either pay more or less each month in an attempt to balance the IPA’s books. Since ComEd’s rates changed in June 2013, the price customers pay has varied from 5.011¢/kWh to 6.005¢/kWh – a price swing of almost 20%. How is anyone able to make an informed decision when your “fixed price” varies by almost 20%?

The Cost of Inaction

The process has been like this for three years, so why is it a problem today? In the past, third party savings for a municipality or an individual were several cents per kWh. With that magnitude of savings, a half cent swing in cost didn’t make much difference, and it surely didn’t determine whether you had savings of not. Some level of savings was assured. Now, with ComEd’s pricing being market based, and, therefore, more competitive with third party supply, the half-cent price swing can determine if savings are booked or not. But consumers want guarantees. Contracts are now being written by consultants to “eliminate” the possibility of getting into a contract where the electricity price is greater than ComEd’s delivered price. With millions of dollars at stake, litigating these contracts is going to be nirvana for lawyers as ComEd’s “price” comes into question. The current situation isn’t going to play out well for everyone. At minimum, there will be lost opportunities as some communities and individuals stay with a more expensive utility supply option because they are confused or scared by the price risk that is unnecessarily shouldered by the customer.

Proposed Solution

The energy supply product to solve this problem is simple and has been utilized since retail open access of electricity came to Illinois in October 1999. It’s a fixed rate, load-following product. No matter how much electricity the customer uses, the utility, by way of their supplier(s), sells electricity at a fixed price for that annual contract period (i.e., the supplier assumes all weather risk). A short annual open-enrollment period for utility supply, coupled with an early termination fee for those choosing to leave during the year for third party supply, will eliminate the need for any adjustments such as the PEA.

Simple Solution; Difficult Implementation?

When the Illinois Attorney General’s office noted that power was being procured in a manner that put residents and small business at risk, they stepped in and got things changed – the IPA was established and the procurement process was developed. Unfortunately, as shown above, the process needs to be fine-tuned. Now is the time to act before this round of power is purchased.

The IPA will be going out soon for electricity supply for the post-June 2014 period. If things are going to change, now is the time. Contact the AG’s office and share your views and have your voice heard.

Energy NewsFlash — Price to Compare

“What Happened? I thought hourly pricing was supposed to be cheaper!”

Polar Vortex is a Game Changer

We’re from Chicago. We can take the cold. When the Polar Vortex settled over the Midwest last week, yeah we were cold – but we play football OUTSIDE in that kind of weather. We’re Ditka-tough in the “City that Works.” We complained a bit and bundled up – but then we went on and did what needed to get done. And now, a week later, with the current heat wave rolling over the area (20F with a stiff breeze), we can look back and assess what else was affected by the cold. Unfortunately, some utility budgets may have been left in the Polar Vortex’s wake.

Winter Electric Demand

Chicago is one of the few northern cities that has many buildings heated by electricity. The purpose of using electric heating was to even out the annual electric demand for the region so the many nuclear plants could be deemed “used and useful” by the Illinois Commerce Commission (which then allowed ComEd to be paid for their investment). With electric heat, when the temperature goes down, electrical demand goes up. And with the increased demand comes higher prices in the real time market (i.e., hourly). For everyone on hourly pricing, the higher price experienced last week was bad enough. But for those on hourly with electric heat, a multiplier effect is in place as your cost is a function of both price and consumption. Another hourly electrical service that didn’t fare well was dusk-to-dawn street lighting. The long, dark winter hours (approximating 16 hours per day) shift a disproportionate amount of the annual lighting load to the winter months resulting in a very expensive January. In case you were wondering, that sucking sound you heard wasn’t the Polar Vortex moving east, but rather your energy budget going down the drain. For many it was a short lived “Happy New Year.”

How bad were hourly prices?

The two really cold days were January 6th and January 7th. The hourly price peaked during this period peaked on 8:00 AM January 7th at $1.93/kWh – about 60 times the historic price.

Doing some quick calcs for hourly customers using electric heat indicate that as much as 30% of the annual heating budget could have been consumed over a three day period. And for street lighting the increased price for the three days equates to paying more than an additional month of electrical service. Not a good way to start off the year.

So what can you do to avoid this problem in the future?

The first thing you should do is determine if you should be on hourly pricing or not. If you have no ability to shift or curtail load in times of high prices, you shouldn’t be on hourly pricing. Also, if you don’t have sufficient resources to monitor hourly prices (so you aren’t blind-sided by a steep run-up in hourly price), you shouldn’t be on hourly. Hourly pricing is not for everyone. If you can’t shift load, opt for some form of fixed rate.

If you decide you are a candidate for hourly pricing, to minimize your exposure you should opt for block and index over just hourly pricing. With part of your load on a fixed block price fewer kilowatt-hours are exposed to the highest rates. The downside is that by purchasing a block, you limit your potential of paying a lower overall price – there is no free lunch. You can also investigate purchasing some call options that would limit the maximum you would pay for electricity during any hour. Again, purchasing options will increase your overall cost.

If you want to limit your risk on the operations side, you can participate in some third party service that helps you shift load. Some of the curtailment providers can assist you, but if you really want to be on hourly pricing and dynamically control your building, taking advantage of every pricing opportunity (and avoiding pricing pitfalls), consider QCoefficient . They’ve won many awards for utilizing building thermal storage for shifting electrical load.

Fixed Rate Contracts

The advantage of an hourly contract is that it is cheaper than a fixed rate contract. And a fixed rate contract should be more expensive – someone else is assuming the load-following/weather risk. But what is the premium end users typically pay for offloading this risk? And is it worth it? If you look at data over a long period of time (multiple years), the fixed rate premium is about $2/mWh. That’s about 5% of the cost of the energy component alone – not a large cost for a good night’s sleep.

If you are ready to swear off hourly pricing and switch to a fixed rate, make sure the terms and conditions don’t expose you to balancing risk as this is the risk you are trying hard to avoid. Look hard at the terms and conditions. If a supplier is saddled with some large unexpected balancing charges, they could be looking for ways to pass them on to their customers. Just don’t let it be you.

Take a few steps back and assess your situation to see if hourly pricing is right for you. Spend some time determining which supply product fits your needs. Then implement a thorough and well thought out procurement process that takes advantage of some of the many opportunities to drive your cost down (e.g., online reverse auction). Then sit back and enjoy Chicago’s weather.

Energy NewsFlash — Polar Vortex

Last Minute Holiday Gift Ideas

As we approach the clubhouse turn of the holiday buying period, last minute gifts can be extremely helpful for procrastinating shoppers. This edition of Energy Newsflash is our Holiday Issue in which we pull together some gift ideas that are not only energy efficient, but are also sustainable. Fortunately, most of these gifts can be purchased on line, so they can be bought last-minute.

Chicago’s Bike Sharing Program (http://divvybikes.com/)

From DIVVY’s website:

DIVVY GETS YOU AROUND CHICAGO IN A JIFFY Divvy is a new bike sharing system featuring thousands of bikes at hundreds of stations from Andersonville to Hyde Park, available 24/7, 365 days a year. Each station has a touchscreen kiosk, station map, and a docking system that releases bikes using a member key or ride code. You must be 16 years or older to ride Divvy.

Bikes can be rented by the day, or for those more committed, an annual membership can be purchased giving riders unlimited 30-minute access to bikes. Members are also allowed to rent bikes by the hour for modest additional charges. Rented bikes can be returned to any station throughout the system which makes one-way trips most convenient. There are 4,000 bikes and hundreds of bike stations throughout the city with expansion to Evanston and Oak Park planned for the coming year. DIVVY’s website is most helpful, as is the smart phone app, especially when it comes to finding a station’s location and system availability of bikes when you are out and about.

While DIVVY is a new hot, new program that has received very positive publicity, there are some drawbacks with the bike share program. For example, the baskets are extremely small and as such, aren’t very useful if you are making a run to the grocery store. In order to avoid disappointment, before you venture off for your first ride experience with DIVVY, you should check out the comments on Yelp ( HYPERLINK “http://www.yelp.com/biz/divvy-chicago” http://www.yelp.com/biz/divvy-chicago).

DIVVY’s annual membership fee is $75. However, (at the time of writing) there is a $65 Groupon for a one-year “Gear” membership that includes not only the regular membership, but also extra rental hours (beyond your unlimited 30-minute trips) and a DIVVY beanie. Total value is stated to be $125.

Uji Shower

According to the US Department of Energy, the heating of domestic hot water accounts for 18% of all residential energy use. And of that 18%, over half of the hot water is used for showering. Utilities have been promoting the use of low-flow showerheads for years. While low-flow showerheads decrease the flow of water, they don’t tell your teenager it’s time to get out of the shower. The Uji Shower provides a not so subtle hint that it is time to finish up in there. Developed by engineers at Tufts University, at the beginning of a shower, the Uji is lighted green. As showers approach seven minutes in duration, Uji turns red.

Controlled tests in higher education have shown that Uji reduces shower times by 12%, providing a six-month simple payback time. For more information, please visit http://ujishower.com.

Feit Electric LED’s from Costco

Anyone who knows me knows that I’m a strong advocate of Compact Fluorescent Lamps (CFLs) – and that I prefer them over LEDs. With comparable lighting quality and efficacy (i.e., lumens per watt), the much lower cost of CFLs trumps any advantage LEDs could have in instant-on and dimmable capabilities for over 80% of the sockets in which screw-in bulbs are used. However, times change and with LEDs coming down in price and quality improving, LEDs have an expanding role in energy-efficient lighting. Recently I tried some LEDs in a chandelier in my dining room. I split the sockets equally between dimmable CFLs and LEDs. There was no contest in with regard to their ability to dim – LEDs won hands down – better turndown and less flicker. With the cost of LEDs coming down, coupled with the longer life, they were much cheaper than the dimmable CFLs, also. The LEDs tested were 40-Watt Conserve-Energy LEDs (manufactured by Feit Electric) – three bulbs for $18 at Costco. While this may not seem like a cool holiday gift, the recipient will not only enjoy the energy, but will be thankful that they don’t have to replace a light bulb for the next 20 years.

Happy Holidays
from
Energy Choices!

Energy NewsFlash — 2013 Holiday Issue

Reducing Your Carbon Impact? Online Reverse Auction is Key

As awareness of the effect we have on the environment increases, organizations that consume large quantities of energy are seeking cost-effective ways to mitigate their environmental impact by reducing their carbon footprint. The following outlines a typical approach, along with solutions, for reducing your carbon impact cost-effectively. As with most challenges of this magnitude, there is no one answer, but rather a portfolio of activities to consider in order to move your organization toward the common objective.

Operation and Behavioral Changes

Usually a multifaceted approach is taken starting with no-cost/low-cost measures to reduce wasteful energy consumption. These measures typically consist of operational or process changes (e.g., retro-commissioning), coupled with employee awareness and behavior modification. The upfront cost is nominal and the economic performance of these measures is outstanding – a better investment for companies in any industry is hard to imagine. Utility incentive programs often support implementation of these measures, making the economics, thereby, too good to ignore. With effective timing, these measures can be implemented and completely paid for within a single annual budget cycle, reducing the level of internal authority needed for project signoff.

Energy Efficiency Measures

The next level in the process of reducing an organization’s carbon footprint is upgrading with energy-efficient equipment. Energy-efficient equipment upgrades take longer to plan and more money to implement than the abovementioned low-cost measures. Included in these measures is replacing mechanical systems, electrical equipment and instrumentation. These measures are also often subsidized by utility incentive programs. Unfortunately, even with incentives, simple payback for these measures is typically in the range of two to five years. This puts the decision in a totally separate category as the money allocated for these projects comes at the expense of cash that could be used for expanding other areas of one’s business. Because these energy-related projects are competing with core-business projects for funding, they typically get shelved. While performance contracting is a useful solution to this funding challenge, it too often goes unused because of the level of investigation required. Both the environment and the company’s bottom line suffer as opportunities go unexploited.

RECs and Carbon Offsets

With onsite measures having been considered and implemented to the extent possible, the next step often utilized in reducing one’s carbon footprint is offsetting the impact of onsite energy use. Two tools most commonly used are Renewable Energy Certificates and Certified Carbon Offsets. With the help of the US Environmental Protection Agency and their Green Power Partners Program, purchasing Renewable Energy Certificates (RECs) is now commonplace for many companies, institutions and governmental organizations. RECs allow organizations to participate in the green power market even if they are long distances from a wind, solar or low-impact hydro electrical generating plant. For each megawatt-hour of electricity generated by a certified renewable energy plant, one REC is produced, which can be sold to any consumer wanting to support the green energy industry. Currently, the price for basic RECs is less than $1/mWh on a national level. The premium for RECs adds approximately 1% to 2% to the delivered cost of electricity. While a few percent doesn’t seem like much, for large organizations this can add hundreds of thousands of dollars to their annual electricity bill. Fortunately, there have been some recent changes in how energy is being purchased that can offset the green power premium.

Free Green Power Upgrade

We’ve recently been using an online reverse auction platform for both electricity and natural gas procurement. Our recent experience with a very large institution has shown that a reverse auction can reduce the price you pay for electricity by $1/mWh when compared to the results provided through the typical RFP process. To come up with those stated savings, we ran a controlled test over two days and adjusted for the daily movement in wholesale market prices. The result was client savings of over $50,000/year or $1/mWh with the online reverse auction. Interestingly, the savings are more than the current price for Renewable Energy Certificates. So, if you combine the reverse auction with the purchase of offsets (i.e., have the suppliers bid green power), you can get a green power upgrade for “free.”

Even the EPA’s Green Power Partnership’s “Guide to Purchasing Green Power” extols the benefits of an electronic reverse auction…“Electronic auction platforms (also known as electronic procurement or “e-procurement”) allow for real-time transparent bidding and “reverse auctions” drive bid prices lower than might be achieved otherwise.” “Online auctions can provide significant price transparency and control that the paper-based RFP process does not always provide. With the reverse auction approach, price quotes are delivered in real-time via a Web-based platform, which results in dynamic bidding and helps achieve rapid downward price pressure that is not normally achieved using conventional paper-based bidding and procurement.”

If you stay open to new ideas and processes (e.g., retro-commissioning and an online reverse auction for electricity and RECs procurement), you can not only reduce your carbon footprint, but also save money and get your company closer to achieving the common objective.

Energy NewsFlash — Green Power Upgrade for Free

How can making CO2 reduce Global Warming? Convert CH4 to CO2

This past week we had a discussion with a subscriber regarding reducing one’s impact on Global Climate Change. The discussion started with Renewable Energy Certificates (RECs – purchased to offset electricity consumption) and their associated positive attributes. However, it became apparent that the subscriber wanted to do more, as RECs don’t offset the burning of fossil fuels that are consumed for most domestic heating and hot water applications. The conversation quickly turned to carbon offsets. Carbon offsets are generated from projects that reduce greenhouse gases. The critical word in the previous sentence is “reduce.” There are many approaches to the problem. Some are simple, cheap and actually mitigate Global Climate Change – but they may require thinking a bit differently about decreasing one’s impact on the environment.

Global Climate change and CO2

There are six major gases that account for almost all of our atmosphere’s ability to hold in heat. Most of the earth’s ability to hold in heat is attributable to carbon dioxide (CO2) – the product of burning fossil fuels to power our homes, industry and cars. Because CO2 level has been correlated with human activity, it has received the most attention in addressing GCC. And that makes sense – why highlight a problem that has no solution? The association of our lifestyle with GCC has been effective in getting people to focus on the challenge. Unfortunately, this approach has also had the effect of crowding out other solutions that may be as good as – or even better – than energy efficiency and conservation, especially in mitigating GCC Global Warming Potential in the short-term.
Global Warming Potential

The ability for a gas to hold in the earth’s heat is quantified by its Global Warming Potential (GWP). But, not all gases are equal when it comes to their ability to hold in the earth’s heat.
The GWP scale assigns CO2 with the value of 1 (one). According to the EPA, “Methane (CH4) is the second most prevalent greenhouse gas emitted in the United States from human activities” and CH4 has a GWP of 21. So for every pound of CH4 you keep from getting into the atmosphere, it is equivalent to reducing 21 pounds of CO2 emissions. If one can find a way of reducing CH4 emissions cost-effectively, there is a multiplier effect in reducing GCC compared to reducing CO2.

From US EPA website:

What is Methane and where do CH4 emissions come from?

Methane is the major component of natural gas. It is the gas that heats many homes and is used for many industrial applications beyond generating heat. The most notable is fertilizer production. It is also the energy source for about 20% of the nation’s electricity production.

Methane is emitted unintentionally into our atmosphere from many sources. Included are: fugitive emission from the production of natural gas; the melting of permafrost in arctic regions (caused by a warming climate), agricultural production and the breakdown of organic material. Included in the “breakdown of organic material” is gas that is emitted from landfills (i.e., municipal dumps).

Landfill Gas Flaring

Organic waste in landfills anaerobically (in the absence of oxygen) digests predominantly into methane (55% of gas emitted from landfills is CH4). To comprehend the magnitude of the landfill gas emitted in the US, over 135 million metric tonnes of greenhouse gases are attributable to the food left on the plates of Americans each year. And this is only a small portion of organic waste that finds its way into our landfills. Methane emitted from these concentrated areas can be captured through piping collection systems, routing the gas for some industrial use or to be burned (flared). Purifying, drying and compressing landfill gas for industrial use typically isn’t cost effective, so the next best option is to flare the gas. Flaring converts the methane to carbon dioxide. While on the surface it doesn’t appear that making CO2 makes sense, converting a gas with a Global Warming Potential of 21 (i.e., methane) to a gas with a GWP of 1 (one) does make sense. QED

There are usually multiple solutions to any problem. And as conditions change, some solutions make more sense than others either with regard to environmental or economical factors. Understanding the critical issues that create the problem and contribute to the solution is the best way to adapt to our changing environment.

Subscriber asks – “Do Energy Auctions save over the typical paper RFP process?”

This past week, one of our subscribers wanted to know if online auctions actually save money over the typical paper RFP process most entities conduct for energy procurement. Reverse online auctions have been popular for several years, with the most notable being municipal bond auctions. The early acceptance by the governmental community may explain why some local municipalities aggregating residential electricity accounts and governmental organizations have adopted the technology readily, while many others have been monitoring these activities. However, with rising commodity prices and outstanding savings levels published by auction providers, auctions warrant some investigation. Are savings being overstated? Is third party energy a commodity that is an equivalent product across all suppliers, thereby making it a good fit for online reverse auctions? Or is there some hybrid process that is the best of both the paper RFP and online reverse auction worlds? What are the nuances and caveats of which you should be aware if you put your toe in the auction pool?

What are Reverse Auctions?

In most auctions, buyers bid up the price of the object being sold. The auctioneers control the process and they (and the sellers) make more money the higher the ultimate selling price. In a reverse auction the roles are reversed in that the suppliers compete by bidding down the price in the hope of securing the sale. The suppliers know the margin they need to make the contract worth their while, and if there are enough suppliers in the mix, the price should be driven down towards the marginal cost of the hungriest suppliers. This is how many municipal bonds are now issued.

Do they save more than the Paper RFP?

In the paper RFP process, suppliers get one chance to offer an attractive price. As suppliers don’t want to “leave money on the table,” they guess what others will be bidding and they adjust their bids accordingly. They try to maximize their profits, while hopefully still offering a price that is competitive enough to get the contract. In an online reverse auction the initial bid prices are usually abnormally high as suppliers test the competitive environment. It is from these initial inflated prices that savings are often calculated and professed. However, if sufficient competition is generated during the auction process, then energy prices are continually bid down as suppliers adjust their margins to secure your business. In an open auction with full information available, the lowest price should be just below the marginal cost of the second lowest bidder.


Extracting more from the suppliers

The open bid process only gets prices down so far. Variations beyond the open auction process (described above) are introduced to secure even lower pricing. For example, the auction time can automatically be extended each time a bid is registered, thereby keeping the pressure on the suppliers to sharpen their pencils even further. Another variation is a final blind bid that encourages suppliers to bid below their last registered bid. In theory this could encourage the lowest bidder to drop their price even further, closer to their marginal cost, to fend off other suitors.

What is the magnitude of Auction savings?

If you look at the websites of the few online auctions that are available, they typically state 30+% savings. Needless to say, savings of this magnitude are vastly overstated for the performance of a reverse online auction over a paper RFP process. It may, however, speak to the inexperience of those offering online auctions. Assuming all is done correctly and an active bidding environment is created, where all lower bids are accepted, a savings of up to 0.3¢/kWh could be reasonably achieved, with very large customers saving a bit less. This isn’t 30% by anyone’s math – but there are savings.

The Auction supplements the RFP Process

Combining the auction process with the current paper RFP process, eliminating overlap and some unnecessary function, is probably the best of both worlds. Third party retail suppliers purchase energy on the wholesale level through a commodity exchange. The clearinghouse ensures the trade and it details a specification for the product being delivered. Energy on the wholesale level is a commodity. Unfortunately, while retail suppliers purchase commodity energy, they go out of their way to sell a differentiated product. While the RFP tries to make an apples-to-apples comparison, there are always adjustments that need to be made to supplier responses to ensure adequate assessment. The current RFP process also ensures the creditworthiness of suppliers and it takes into consideration things such as billing performance and how client problems are handled. These latter issues, which can have a significant influence on which supplier should be chosen, cannot be assessed adequately by way of an online auction process, where all is quantified numerically.

The online reverse auction can be an important adjunct to your current procurement strategy. However, it is not a panacea for getting the best deal and value on energy for your facility. It is a process that has to be carefully navigated and integrated into your procurement process in order to achieve real savings.

Energy NewsFlash — Online Reverse Auction