Expectation vs. Reality (December 1999)
Three major sources have contributed to the unrealistically high expectation for savings in the 30% range:
- Exaggerated early deregulation pilot program results;
- A misleading “percentage game” with only the generation portion of the utility bill; and
- Shrewd “bundled” energy services deals that take credit for savings from additional demand-side energy management service projects. We will examine each of them below.
Steered Wrong by Pilot Program?Although part of the answer depends largely on the state in which the business operates, more revealing clues can be found in the lessons learned from earlier pilot programs. In most of those cases, overly optimistic reports of more than 30% savings on utility bills by some customers proved to be highly exaggerated. In the few pilot programs that claimed 25% savings or more, subsidies and local politics played more of a role as artificial contributors rather than deregulation itself.
The early results caused a phenomenon within many organizations, which promptly reacted by raising their expectations beyond reality. Some top-level executives, impressed by the publicity, implemented directives to facility personnel to begin achieving energy cost reductions which were commensurate with the predictions. The reaction for many organizations was chaotic.
The reason for such wide differences between expectations and reality is more misleading than it is complex. A closer look at a typical deregulated-state utility bill, which is comprised of at least three distinct components, will provide a clearer explanation. The first component is the generated electricity, which accounts for about one third of the total bill. Second is the high-voltage transmission and local distribution service, which is a fixed cost that comprises another third of the total bill.
Last is the infamous Competitive Transition Charge, or CTC. This transitional and temporary charge, which appears on the customer’s bill, is levied to recover or write off the electric utility’s significant stranded costs and other investments as set by the Public Utility Commission (PUC). The CTC could be as much as a third of the total bill and can be either a fixed or variable amount.
Playing the Percentage GameEssentially, only the electricity commodity itself, or about a third of the total electric bill, is actually affected by deregulation. That means the remaining two thirds of the costs will change little or not at all for the near term and will continue to be managed by the Utility Distribution Company (UDC). The user must continue to pay the local UDC fees for transmission and distribution services, as well as other surcharges such as the CTC.
Therefore, when an energy supplier promises to sell a very large customer cheap power, with as much as a 30% discount — and assuming the customer is being told the truth — it translates into a 30% discount of the 33% commodity component (0.30 x 0.33), or about 9% or 10% of the total bill. While this figure will vary from state to state, the amount of actual savings is unlikely to exceed 15% of the total bill for the foreseeable future. Typically, customers should expect considerably less than that.
In reality, the profit margin for power marketers at the wholesale level is already razor thin, which means that fewer and fewer customers are being offered substantially discounted deals. As an example, a mid-sized commercial customer in California today should realistically expect savings of between 1% and 5% off the total bill, at least until the CTC is eliminated.
As electric utility deregulation picks up across the United States, most states are currently involved in some form of evaluative, legislative or regulatory activity. About 18 states have already enacted deregulation laws. In terms of truly competitive retail electricity sales activity, the most active states are California and Pennsylvania.
The structure of deregulation in a given area can also affect the cost of electricity as well as how long the costs will remain in effect. In California, for example, electricity customers have been paying transition surcharges that amount to nearly 40% of the total energy bill. These charges are designed to cover the utility’s stranded investments as the utility “transitions” from a fully regulated business to a deregulated, competitive, retail business in a free market.
Until the transition is complete over a period of 3.5 yrs, high percentages of savings on utility bills are virtually impossible. However, as some observers point out, California’s structure could be considered “good medicine”: the sooner the surcharges can accrue and cover the transition costs, the sooner the energy user can realize substantial savings.
Beware of Bundled DealsWith actual savings so much less than early expectations, many potential energy customers must now learn how to play the percentage game. Competitive marketing tactics by an energy supplier can be particularly appealing to high-level financial decisionmakers who are offered seemingly attractive package deals and one-stop shopping.
Smart buyers know that these “bundled” deals — packages that combine the energy commodity with additional services — can be easily unbundled so they are certain that each piece is the best deal, whether they purchase them individually or bundled.
Purchasing the energy separately allows buyers greater accuracy and clarity in shopping for and comparing commodity prices. This avoids complex contracts with extensive provisions and conditions for services, particularly if the services involve self-funding facility improvements (performance contracts) that are measured in 7- to 10-yr payback terms.
In addition, buyers who avoid bundled energy contracts also avoid the unforeseen political risks of having the CTC percentage and duration repealed, modified, or extended. Equally significantly, customers that buy electricity separately from energy services also avoid the potential conflict of interest by an energy supplier proposing to serve as both the supply-side energy provider and demand-side energy manager for a given customer. These factors must be taken into account individually by the energy user well before negotiations over energy contracts begin.
By purchasing energy separately from services, buyers also avoid the additional research (and anxiety) in qualifying the energy supplier in terms of its ability to deliver complex, demand-side energy management strategies. Quite often, customers themselves have far more expertise in this area. Customers that operate or plan to install high-level, highly advanced integrated building systems have acute needs for comparable systems integration expertise that can deliver the best total building management solution.
For major energy users, this often involves the integration of critical laboratory, research, medical, and cleanroom environments, security and fire-life safety systems, hvac systems, and building submetering into a centralized, facility-wide building management system. Large customers such as these cannot afford to let the commodity price become the driving force in dictating critical facility management programs.
Unique Factors Can Affect PriceThe percentage of savings is also affected by several factors that are unique to the specific customer. For example, how a customer’s electricity rates compare with the national average is key, because the percent of savings will most likely be the greatest in areas with the highest rates. Likewise, the CTC will most likely be the greatest in these areas.
The changes that a customer is willing to make to improve their load profile, as well as the overall state of preparedness of the organization, will also play an important role in the amount of savings that customer realizes. The manner in which the customer tracks, modifies, and understands the facility’s total energy usage (and in particular, how that customer uses the information to the organization’s advantage in negotiating the best rates and contracts), will be a factor in their bottom-line performance.
Experience is the true teacher that will provide more reliable data for future predictions of energy savings.
The Good NewsEven though the gap between reality and expectations may be wide for the pilot programs, energy users have a number of reasons to be optimistic about the near-term and future savings potentials and benefits of deregulation.
First, by shopping for the best energy supplier in a competitive marketplace using the price of energy as the primary basis for selection, customers can expect potential, early savings of between 5% and 10% of the total energy bill. For large electricity users, these savings can be substantial. To improve the odds, follow the three basics of shopping success: Do the homework and the math so that accurate comparisons can be made based on facts; avoid energy contracts that “bundle” energy with additional services — they cloud the true savings and confuse the process with misleading information; and set realistic expectations for energy savings. The results will be considerably more reliable and can be planned more easily into the budget. Also, after the CTC is finally eliminated, the savings potential could climb to as high as 25% to 40% of the total energy bill before deregulation. The actual percentage, and the length of time it takes to realize, will depend largely on the state and local political and economic conditions.
And finally, the notion of a deregulated electricity market should have a positive impact on the industry. A free market will introduce many new and beneficial energy services that will enable commercial, industrial, and institutional customers to become even more proactive in managing their utility costs and improving their bottom lines. ES