Energy - A Site Selection and Management Priority
An energy plan can help your company to maximize opportunities and mitigate risk, while holding on to earnings.
Greg Elam (Nov 09)
With energy supply currently being in the "Top 10" of site selection criteria, and electricity and natural gas prices having hit near 10-year lows, if your existing or new facility is a significant user of energy, we believe your "Top Three" criteria should now include energy.
However, there are several other factors that are an important part of this equation, including location, which drives how your energy is purchased and managed, and reliability, which drives up-front infrastructure costs and operational charges.
The facility site is critical, and there are pros and cons to any location. That is, is the facility located in a regulated or deregulated state? Even if in a deregulated state, a facility that is located in a municipal or cooperative service territory may or may not offer the freedom to allow you to manage your energy costs.
On the other hand, being located within an investor-owned utility system provides for Public Utility Commission (PUC) oversight. While the PUC is charged with "the public good," public policy is a major factor, and the commercial or industrial energy customer is not always the winner.
We believe there are solutions that can be developed for both markets, but this requires an in-depth knowledge of the market, a good working relationship with the utilities, and a customer's willingness to be open-minded and to listen to its advisors.
With energy prices reaching near 10-year lows, those customers that are being served by the investor-owned utility have several choices for supply, including working with their local utility, and should look to implement transactions that are part of, or modify, their company energy plan. In many cases, customers want to take advantage of the low pricing, but also want to do business with the local utility. We have found that both are achievable and can provide positive results for both the customer and local utility.
As an example, we recently assisted in a transaction that enabled a large energy user to save more than $2 million by working with the local utility to take advantage of attractive and competitive market pricing, something that would not have been possible without independent representation of the customer, market insight, and a good working relationship with the customer's local utility.
While municipals and cooperatives can offer attractive economic development transactions, we encourage a multiyear-term view be taken, looking at the net present value over a longer term. As an example, while a municipal may offer an attractive two- to three-year transaction, it is important to know what their long-term plans are. That is, your municipality or cooperative may be investing in [expensive] capital-intensive green technologies and betting the farm on Renewable Energy Certificates (RECS). If so, your company may be paying for the cost today, but the benefit will be for those customers that are being served 20 to 30 years later when the debt is paid off. This risk is elevated should the REC market be less than projected by the utility in its assumptions.
Utility infrastructure cost and reliability are key factors that must be negotiated and reviewed extensively no matter what utility system you chose: regulated or deregulated, municipal, cooperative, or investor-owned utility. As with energy purchases and management, there are pros and cons to each.
At a high level, a customer must make sure that it is provided the proper credits for its [projected] energy usage and that the utility is not overbuilding its system to enhance its future revenue growth at the expense of the customer paying for the infrastructure.
One of the largest unknown factors to new customers is the Contribution in Aid of Construction (CIAC) tax that is charged by investor-owned utilities. This tax averages about 25 percent, but we have seen it as high as 59 percent, i.e., if the infrastructure cost to your site is $1 million, the investor-owned utility will have the right to charge you an additional $250,000 (assumes 25 percent tax rate). The key to lowering the CIAC tax is to increase the customer's credits or lower the construction cost. Using this example, every dollar saved represents $1.25 - not a bad return on investment, especially when this return on investment is created by a reduction in capital spending.
In addition to the initial extension of utility infrastructure for electric power, customers must also evaluate the reliability, and whether such reliability should be enhanced by the utility, by the addition of generation, or both. To properly make this evaluation, each proposed site must be evaluated independently, and include things such as tariffs that may be filed with the PUC, tariffs within a municipality, or the rules provided within a cooperative utility. In addition, fuel pricing and other benefits such as any compensation that may be paid by the market for having such capacity available must be taken into consideration.
To summarize, while doing your site selection homework is certainly a task that includes many moving parts, the payoff in utilizing good advisors can be substantial, and can provide a return on investment that exceeds a company's initial estimates. Likewise, not executing an energy plan to maximize opportunities or mitigate risk can wipe out savings or minimize earnings. Greg Elam is an affiliate consultant at KMKC. For more information, contact Greg Elam at firstname.lastname@example.org or call him at 513-579-6932.
Reprinted with permission of KMK Consulting Company, LLC, as originally published in its CEO Resource, Fall, 2009 issue.