Factoring Energy into a Location Decision | energy availability and costs

The results of Area Development's 2008 Corporate Survey suggest that corporate location decision-makers are less concerned with energy availability and costs as a site selection determinant than they were in 2007. These results may come as a surprise when we reflect on 2008's volatile gas prices, the heated presidential debates on energy independence, and the need to revamp the nation's electrical transmission network. The 160+ manufacturing companies surveyed, however, regarded access to a robust highway network, labor and occupancy costs, and need for tax exemptions as more critical to their deployment decisions than energy infrastructure. This article aims to provide insight on the survey results and to highlight the importance of energy availability and costs - particularly electricity - when deciding on an optimal location for future
operations.

A Look at 2008
For much of 2008, the public's attention was focused on rising prices at the pump. In July, the average retail price of a gallon of gas peaked at $4.10, and - while it was anticipated that such costs would ease in the long term - there was little expectation that they would fall to $1.64 per gallon by December '08. This price volatility, however, was not as evident among other energy sources, particularly electricity. On average, for the entire U.S., electrical rates rose by less than 5 percent in 2008. This was a comparatively low increase - in terms of future rate sustainability - given the increases in price of electric generators' hydrocarbon inputs: crude oil increased by almost 40 percent, natural gas by 28 percent, and coal by 11 percent during this same period. Electricity costs are, in fact, generally less responsive to input price volatility due to market regulation and controls.

By the summer of 2008, the economy began to hint at slowing demand. As production slowed to accommodate a shrinking market, so did companies' energy consumption. Many companies, particularly manufacturers, may have shifted their efforts to manage fixed costs rather than variable costs; though machines sat idle, workers' wages, occupancy expenses, and property taxes held steady. Anecdotal evidence of this shift could be the now ubiquitous layoffs across the economy.

Thus, the reduced importance of energy availability and costs may be a factor of:

• Comparatively low increase in electrical rates - For manufacturers where electricity comprises less than 10 percent of the overall operating costs (e.g., food manufacturers), the average increase of 5 percent in electrical rates was not dramatic and would likely not have garnered as much weighting in the survey as a potential 5 percent increase in labor costs or taxes.

• Slowing demand due to economic recession - It is understandable that companies could see energy - especially electricity - as a manageable cost that would reduce with slowing demand and comprise a smaller proportion of overall operating costs. Fixed costs, on the other hand, would be unchanged by the downturn and may become a greater cost burden on businesses.

Existing vs. New Locations
It is also vital to distinguish the importance of energy when examining existing operations and when searching for a new location. Existing, sizable energy consumers that have a consistent load cause few unexpected demand surprises to local utilities. These consumers already have the infrastructure in place and may be exposed to lower and less volatile electricity and natural gas rates. When searching for a new site, however, it is imperative to examine both the reliability of the existing infrastructure and offered electrical rates for future cost savings.

While average manufacturing labor costs may vary ~20 percent between states, electrical rates have a much wider range of cost deviation. According to the Energy Information Administration (EIA) 2009 report, average electrical rates for industry consumers can vary between $0.039 and $0.14 per kWh in the continental United States. For sizable manufacturers with electrical demands of 10 MW or greater, these rate differentials can result in significant annual cost impacts. In addition, energy availability and costs are bound to gain in importance as operations increase their dependence on manufacturing automation including robotics, process controls, and data management. These factors require electric reliability; volatile electrical rates can cause significant operational cost variation.

Thus, when deciding on a new investment location, it is vital to confirm the existence of readily available infrastructure that can support the required capacities. Existing infrastructure can lower the project's one-time costs and allow it to meet its timeline. Global shortages in certain energy infrastructure (e.g., substation transformers) can cause long wait times and delay plant start-up.

Factors Companies Should Examine
Companies seeking to establish new or expand existing operations should examine how the following energy factors may affect their site selection decisions:

• Rising demand in electricity - Certain locations may not have as robust generation or transmission sources to meet the rising electrical demands from residential and industrial consumers. These factors can cause reliability challenges and rising costs.

• Increasing costs of generation fuels - As prices of natural gas and coal continue to increase, their cost differentials will need to be passed on to the end consumer in the form of higher electrical rates. When conducting site due diligence, companies should analyze the generation sources of the utility providers to determine how well hedged they are against rising fuel prices. In addition, they should consider rate differentials among potential locations, as they can be significant between geographies.

• Generation portfolios of local utilities - Generation sources may experience upward cost risks due to fuel and carbon tax exposure.

• Quality of the transmission network - Transmission networks in certain areas of the country are becoming outdated and strained. This may cause reliability issues and rising costs.

• Timelines for infrastructure upgrades and costs - In certain locations, utility providers may require significant lead times for permitting, line extensions, and procurement of transformers.

• Role of renewable generation sources - Renewable sources are becoming more common in many domestic generation portfolios. Utilities are being required to meet minimum renewable generation standards, while manufacturers are encouraged to reduce their carbon footprint. The advocacy for green power sources is increasing; some companies may be willing to pay a premium for green generation sources as a component of a sustainable manufacturing campaign. Again, it is important to review the generation portfolios of the local utilities and the associated electrical rates.

What ED Groups Should Do
Economic development (ED) groups working to attract and expand industrial operations should focus on the following factors - from an energy availability and cost perspective - in order to improve their competitive positioning:

• Develop strong rapport with local utility providers. ED groups should closely monitor the most recent developments at their utility providers, including generation sources, planned or on-going infrastructure upgrades, electrical rate schedules, and potential rate increases.

• Offer sites with little need for infrastructure improvements. For projects that have an aggressive timeline, it is vital to offer sites that will require little lead time in providing the necessary infrastructure for development. Infrastructure improvements can be timely and costly.

• Demonstrate the ability to offer a reliable energy (electricity, natural gas) supply. A disruption in manufacturing operations, especially those that are heavily dependent on automation and computer controls, can result in significant productivity losses. As a result, it is imperative that local ED groups are able to demonstrate reliable infrastructure (e.g., by providing historical electricity disruption data).

Looking Ahead
In summary, macroeconomic factors may have caused the importance of energy availability and costs to be subordinated by fixed operating expenses in last year's survey. As the U.S. economy recovers, however, the critical importance of energy factors in the site selection process is likely to be restored for more manufacturers. Companies with sizable energy demands will become more sensitive to these variations in the upcoming years due to rising costs of fuel, impact of proposed carbon taxes, and greater push toward "green" operating practices. As the role of energy in site selection evolves, the current economic slowdown may be a singular opportunity for economic development groups to focus on developing their energy infrastructure (e.g., leveraging economic stimulus and recovery assistance) and for companies to carefully analyze the advantages they may gain in a location that can offer more favorable energy costs and reliability.

Darin Buelow and Jovana Trkulja are location strategists with Deloitte Consulting's Global Expansion Optimization practice.

Note: Data for this article was obtained from the Energy Information Administration (EIA.doe.gov).