Decision Support Modeling
Independent Energy Consultants uses a variety of decision
support models to help our clients make well-informed decisions. Some
clients prefer to keep the process simple and often rely on instinct.
Other clients prefer detailed analysis that captures the potential impact of
uncertainty and assigns value to intangingle benefits. Whatever your
preference, contact us for help in understanding
and managing your your energy needs.
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Welcome,
Independent Energy Consultants, Inc. is committed to helping its clients make well-informed and cost-effective decisions regarding
their energy supply and consumption. We are sending you this newsletter
to help you understand how decisions that are made, or not made, effect
your company's bottom line.
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Objectives Drive Decisions
Energy prices in 2008 have
fluctuated far and fast. These circumstances present a wonderful
opportunity to demonstrate how two decision makers faced with the same set of
conditions, can make very different decisions, with different outcomes and yet
each meet their objective. To illustrate, try walking in the shoes of two
civic leaders who are tasked with having to set natural gas rates for their
respective community aggregation programs. The setting is June
2008. Many commodities have doubled in price in less than nine months and
there appears no end in sight. Every day, media pundits are rationalizing
the new highs and speculators continue to drive the markets onward and
upward. Crude oil is approaching $150/barrel, gasoline is headed towards
$5/gallon and natural gas has reached $20/Mcf in Europe. To
make matters worse, we are entering the peak hurricane season and natural gas
inventories are well below the prior year's mark. Each leader has been
advised that this is an unsustainable commodities bubble, much like the
"dot.com" stock market craze of 2000. Unfortunately, no one
knows when the bubble will burst or how high prices will go in the
meantime. Now let's get to know our decision makers.
Client 1 began their community program with the desire to obtain rates
lower than those provided by the local utility company. The utility rates
change monthly and are driven by prevailing market prices. The client has
established a good track record vs. the utility when it buys on market dips and
also sets rates on a monthly basis. For this client, the actual rate is
not nearly as important as beating the alternative utility rate.
Client 2 is
most concerned about its large senior citizen population
living on fixed incomes. The alternative rates from their utility
are
also set on a monthly basis and fluctuate with the natural gas futures'
market. Their community program was established to provide a
fixed-rate
alternative for those who desire price certainty and protection from
higher
rates. Client 2 knows it is taking a political risk by setting rates so
far in
advance of winter. The rationale used for protecting residents
from higher-priced forecasts, may be forgotten if rates fall before the
winter
arrives. The Monday morning quarterbacks may line up and question
the
high rates. To address this concern, the client communicates the
rationale often and through various media. It also communicates a
very
important contract clause that it has negotiated. Residents have
the
ability to sever their individual agreements free of charge, for any
reason, at any time. If the market
continues to rise as forecasted, residents are protected from further
increases. If prices fall, residents can leave the program and
seek
offers elsewhere.
The table below shows how things have turned out and how each client achieved their
objective.
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A Tale of Two Cities
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Client 1
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Client 2
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Primary Objective
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Beat the local utility natural gas rate. Those rates
change monthly based on prevailing market conditions.
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Cap the winter rate now to protect residents from further
possible increases.
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Secondary Objective
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Obtain a rate lower than what residents can obtain on their own
at the time.
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Obtain a rate lower than what residents can obtain on their own
at the time.
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Political Risk to Elected Officials
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Low
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High
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Price Risk to Residents
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High
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Low
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Risk of Rising Prices from Hurricanes
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High
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High
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Natural Gas Storage Inventory
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16.2% below prior year
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16.2% below prior year
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Energy Market Price Trend
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Upward
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Upward
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Prevailing Short Term Energy Market Price Forecasts
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Crude oil $150 - $200/barrel
Natural Gas $18 - $20/Mcf
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Crude oil $150 - $200/barrel
Natural Gas $18 - $20/Mcf
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Contract Clause:
Early Termination Fee
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Negotiated to zero. Not a vital factor as client is
employing monthly variable pricing and will never deviate too far from
prevailing offers.
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Negotiated to zero. An extremely important factor and the
basis for client's decision to lock in fixed rate well before winter
arrives. Client fully understands that prices could fall before winter
arrives.
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Offer Price June 25th for upcoming winter months
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Approximately $15/Mcf
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Approximately $15/Mcf
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Prevailing Comparable Fixed Rates on 6/25/08
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Average $15.98/Mcf
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Average $15.98/Mcf
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Offer Price Accepted 6/25/08
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No
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Yes
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Savings versus alternative offers at the time
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N/A
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$0.98/Mcf
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Program Rates for November 2008
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$9.55/Mcf
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$15.12/Mcf
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Objectives Achieved
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Yes
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Yes
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Rates available now for May 2009
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Less than $8.70/Mcf
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Less than $8.70/Mcf
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The
same decisions are faced by commercial and industrial customers having to make
energy purchase decisions, sometimes on a daily basis. Once you know your
objective and risk tolerance, you can begin to develop meaningful strategies
for the market conditions at hand. Both clients were wise to have an
"exit" strategy, particularly Client 2. In business, as in
life, exit strategies are not always possible or practical. When exit
strategies are not possible, that factor must be carefully considered before an
energy purchase decision is made.
If
energy costs are a small percentage of your spend, you may be willing to gamble
on where prices are headed. If energy costs are a high percentage of your
spend and/or meeting budgets is critical to your success, then your outlook and
decisions will be drastically different.
Finally, if these examples
seem abstract, think back on some of the important decisions you have had to
make in your lifetime. We are usually only successful when we are clear
about our objectives. We choose a place to live, we choose a spouse, we
choose a career path, we choose our faith, we choose the school our children
will go to, we choose between saving and spending on discretionary goods, and
we choose to serve others or act in our own self interest. The list is
endless and the decisions made by some, may be thought strange or even foolish
by others. The wise among us, are able to come to terms with their
objectives, make sound decisions that will support those objectives, and then
move forward with their lives and/or businesses.
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