In This Issue
Decision Support Modeling
Objectives Drive Decisions
A Tale of Two Cities
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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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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.
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.
A Tale of Two Cities

 

 

Client 1

Client 2

Primary Objective

Beat the local utility natural gas rate.  Those rates change monthly based on prevailing market conditions.

Cap the winter rate now to protect residents from further possible increases.

Secondary Objective

Obtain a rate lower than what residents can obtain on their own at the time.

Obtain a rate lower than what residents can obtain on their own at the time.

Political Risk to Elected Officials

Low

High

Price Risk to Residents

High

Low

Risk of Rising Prices from Hurricanes

High

High

Natural Gas Storage Inventory

16.2% below prior year

16.2% below prior year

Energy Market Price Trend

Upward

Upward

Prevailing Short Term Energy Market Price Forecasts

Crude oil $150 - $200/barrel
Natural Gas $18 - $20/Mcf

Crude oil $150 - $200/barrel
Natural Gas $18 - $20/Mcf

Contract Clause:
Early Termination Fee

Negotiated to zero.  Not a vital factor as client is employing monthly variable pricing and will never deviate too far from prevailing offers.

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.

Offer Price June 25th for upcoming winter months

Approximately $15/Mcf

Approximately $15/Mcf

Prevailing Comparable Fixed Rates on 6/25/08

Average $15.98/Mcf

Average $15.98/Mcf

Offer Price Accepted 6/25/08

No

Yes

Savings versus alternative offers at the time

N/A

$0.98/Mcf

Program Rates for November 2008

$9.55/Mcf

$15.12/Mcf

Objectives Achieved

Yes

Yes

Rates available now for May 2009

Less than $8.70/Mcf

Less than $8.70/Mcf

 

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.

Independent Energy Consultants, Inc. | 820 Deepwoods Drive | Aurora | OH | 44202