How to Reduce Costs with ‘Energy as Financial Planning’ Approach

by | Dec 21, 2017

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By Ty Eldridge

The diversity of options for securing energy and power available to an industrial energy manager today are vast and expanding. The complexity of these options is matched only by the evolving, opaque billing structures pushed by energy generation, transmission, and distribution companies. This article offers a simple rubric for evaluating industrial energy supply and outlines a critical exercise for assessing the short- and long-term health of industrial energy supply.

Having spoken to thousands of energy users across five continents, dozens of countries and countless utility footprints, I observe two key forces defining energy portfolio management today: first, the dazzling array of billing structures employed by utilities to eke out every penny they can; and second, the innovative approach taken by energy managers to eke in return. The back and forth between these two forces has borne demand for products and strategies that address the key needs of energy managers – namely lower cost and lower risk. These needs can be further delineated: lower cost means not only lower electricity rates, but lower penalty charges, lower CapEx and OpEx for energy strategies and products, and less time requires from the team for monitoring and maintenance.

Lower risk, too, has many facets: risk can be risk of supply interruptions, risk of price increases, risk of regulatory change, etc. Across geographies, the strategy that has been most useful in helping energy managers weigh costs and risks has been the Energy as Financial Planning approach. Put simply, this approach encourages energy managers to consider their energy portfolio – all the sources of energy their plant uses, along with other strategies for risk reduction – as they would their personal investment portfolio. Much in the way an investor seeks a mix of stocks and bonds to optimize risk and return, so should an energy manager consider a balance of energy sources and strategies to optimize energy portfolio performance.

How does this work? An energy manager should first list all their “energy investments” – that is, strategies and supply including long- and short-term grid contracts, wholesale market purchases, liquid fuel generation, on-site alternative energy generation, battery backup, demand reduction capacitors, energy efficiency initiatives, etc. Next, the energy manager should identify the risk and economic value (the “return”) of each energy investment as high, medium, or low. Locate each energy investment in the figure.

For categorizing risk, consider the following questions:

• What is the likelihood of this energy supply being interrupted (from grid outages, fuel shortages, equipment failure, etc.)?

• Can this energy supply meet changes in your energy demand (quality, quantity, etc.)?

• What is the likelihood of the price of this energy supply increasing in the next 5, 10, and 15 years?

• How predictable is the price of this energy supply? For categorizing economic value, consider both the operating cost ($/kWh, $/kW) of the energy, any capital cost (e.g., installation of a generator) associated with the energy investment, and the overall impact on your energy budget.

A completed analysis may resemble the figure below.

With this simple exercise, the basic distribution energy investment portfolio is now in place. Low-risk, low-value are your “bonds” – investments that don’t return a high value, but are consistent performers that stabilize your portfolio. Medium-risk, medium-value investments are your “blue chips”- core investments with limited risks that serve as the base of your portfolio. High-risk, high-value investments are you penny stocks and junk bonds – they don’t always perform, but when they do, they win big.

Two things to identify in the matrix: first, are you disproportionately concentrated in one box? We’ll discuss what a good balance looks like in a moment, but alarm bells should go off if all your investments have a single risk/value profile. Second, what energy investment opportunities are available to you that would bring balance or diversity to your portfolio? You’ll likely notice that risk and value are correlated (i.e., high-risk investments are high-value, and low-risk investments are low-value). Investments above this correlation (e.g., medium-risk, high-value) are preferred (in finance, we’d say they have “alpha”).

Energy investments below the correlation may be of strategic value for your company, but should be re-evaluated and avoided when possible. A well-balanced portfolio depends on the energy environment in which you operate. If you’re in a highly stable environment (e.g., prices increase <2%/year and contracts >10 years are common), invest aggressively – push 20% or more of your energy into high-risk, high-value sources. If you’re in a highly unstable environment (e.g., energy prices change rapidly, short-term contracts are the norm, and regulations change regularly), invest in a lower-momentum portfolio, with long-term (when possible), fixed priced contracts accounting for 60% or more of your portfolio. Above all else, consider how the needs and investments of your company resources complement the investments of your energy portfolio, and whether you as an energy manager have balanced risk and value in accordance with your company’s strategy.

Ty Eldridge is a global energy consultant, having spent nearly a decade financing and developing better energy solutions for the world’s leading manufacturers. Currently he heads Brasol Soluções Energéticas, a Brazil-based energy financing company. Ty holds a degree from Georgetown University’s School of Foreign Service and resides in São Paulo, Brazil.

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