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Negotiating Energy Supply Agreements: A Tricky Balancing Act For Even The Most Seasoned Procurement Professional

HiResEverything seems to come down to price.  After all the talk and all the negotiation, ultimately the decision comes down to one question: “What am I paying?”

When negotiating an energy supply agreement, such as for electricity or natural gas, the same focus applies.  As a buyer of energy, however, you need to realize that the “price we all want” is not necessarily “the price stated on the agreement” because the total price you pay once the bill arrives might be impacted by your agreement terms.

There are several aspects of energy agreements that can easily trip up even the most seasoned buyer.  When negotiating with a supplier, there are typically two elements of the agreement that buyers gravitate toward: the price of the commodity, and the terms and conditions.  Unless you, as the buyer, are aware of some key terms and how even slight verbiage adjustments can drastically affect the price you pay on your bill, you could walk away thinking you secured a good deal – when, in reality, the agreement tilts in the supplier’s favor.

It’s Business, Not Personal

Energy suppliers may try to capture revenue through additional fees resulting from agreement terms that are more favorable to them than to the customer.  This isn’t to suggest that suppliers are sneaky or underhanded.  It’s just business.  Suppliers need to make a profit to stay afloat.  And just like almost any industry where the customer pays for some type of service on a regular basis, energy suppliers often treat penalties and fees as a source of revenue.  Some suppliers count on a fair amount of it, which is why they may write agreements a certain way to affect their terms.  In fact, it’s often a part of their business practice to budget for revenue coming in from fees and penalties, and they take that into account when they negotiate terms.

It’s all a balancing act, shifting risk from seller to buyer. On the one hand, a supplier can offer a low base rate if they can write agreement terms that are more favorable to them – which results in them collecting penalties that will more than make up for the low rate they offered.  On the flip side, if you negotiate contact terms that are more favorable to you as the customer, that reduces the ability of the supplier to collect more revenue through fees – and therefore they will typically charge you a higher price.

Depending on how your agreement is negotiated, every one of the points we’ll address in this article can result in the supplier assessing additional fees.  While many terms comprise an energy supply agreement, a handful directly affect what you pay every month.  Structuring these five elements appropriately is key to your agreement success.

1. Payment Terms

While the most familiar, this aspect of your agreement can also be the trickiest – and potentially the most costly – in terms of achieving a lower cost.  Agreeing to shorter payment window, for example, may earn you better rates… but can also result in you not paying your bill on time.  The resulting late fee you incur then ultimately increases your costs.

Keep in mind that, in many states, governmental agencies are allowed by law a certain number of days to pay their bills.  As a governmental entity, you need to be aware of any rights you may have and any state statutes regarding payment.

2. Termination Fees

Among suppliers, termination fees are typically the least flexible of the points we address here.  Sure, you can try to negotiate the terms, but termination language is typically set in stone.  It’s more a matter of being aware of how the terms affect you.  Even though you never enter a agreement intending to cancel it, you should be aware of how this language can affect what you pay – whether you cancel the agreement entirely or just remove an individual meter.

Termination fees are assessed if you terminate an agreement before it expires.  The rationale for the fee is that, when you sign an energy supply agreement, the supplier buys that specific amount of energy for you.  If you terminate early – without using/paying for all the energy they secured for you – the supplier is forced to sell that unused energy back into the market.

And the fees can range.  On the low end, some suppliers simply charge the cost of selling that unused power back into the market.  On the high end, other suppliers include exorbitant penalties for terminating on top of any losses incurred from selling the energy back into the market.

One of the more common questions energy buyers ask is:  If I find a lower rate, can I just sign a new agreement to start before my current agreement expires? The vast majority of negotiators think that’s a viable option… but typically the best you could do in this situation is come out even.  The agreement early termination fees you’ll end up paying the first supplier for exiting that agreement will negate any difference you’ll save by signing a new agreement at a lower rate.

3. Adds/Deletes

Buyers for large organizations or jurisdictions have to deal with expansion and adding (or deleting) meters to (or from) their energy agreements.  Energy expansion is common for customers with multiple meters spread over various locations, groups that frequently open new locations or build new sites, or enterprises that establish (or remove) lots of infrastructure need to pay close attention to these clauses.  Working closely with your energy advisor to structure agreement language appropriately is key to your agreement success.  Failure to do so can add penalty fees when not negotiated properly.

There is a direct relationship between price and add/delete clauses, represented as a percentage of the energy usage that you can add or delete.  Once you exceed that add/delete percentage, you are subject to either current market rates or some type of assessed add/delete fee.

Most suppliers do not include an add/delete clause option.  Not only is it an administrative hassle, but market uncertainty makes it a risky proposition for the supplier:  If the market is at 4 cents today and over the life of the agreement goes up to 12 cents, a buyer with a 75% add clause who doubles or triples the size of their agreement by adding meters would still be guaranteed the 4-cent rate even though the supplier must buy at 12 cents.

Some suppliers will negotiate this percentage of energy usage – but the higher the percentage goes, the more that increases your price.  If you really push to, say, 25% of usage, the supplier may agree and then increase your rate to make up for that.  Ultimately, the add/delete clause is driven by the customer: It’s more of a concession that the supplier can include in the agreement if a customer demands it or to be more competitive.

4. Usage Bandwidth

Many agreements are restrictive regarding the use of energy that falls outside (above or below) the pre-estimated monthly volumes. Limits to bandwidth can make for a costly bill if you are buying energy outside of your agreement terms while the market is much higher than when you first secured your agreement rate.

Suppliers are across the board as far as their standard agreement language regarding usage bandwidth, as well as their practice for negotiating this term. Agreement verbiage ranges from no allowance for change in bandwidth all the way to unlimited bandwidth. Some suppliers will offer unlimited bandwidth at the very beginning; others may offer it as a negotiation tactic; and still others may have a customer limit where they’ll only go up to a predetermined percentage before the customer starts being penalized from the standpoint of paying the market rate.

Natural gas agreements, for example, commonly do not allow any bandwidth changes: If you originally agree to a certain amount of gas that month, anything you use over that amount is bought at a different market-based rate, and anything you don’t use is sold back to the market (which means that you may potentially suffer a penalty if the supplier sells it back at loss). Electricity agreements, on the other hand, often see suppliers willing to guarantee the rate regardless of the actual amount of electricity you use.

With similar logic to the add/delete clause, usage bandwidth can affect your rate. Not discounting the fact that your energy use could increase or decrease because you add or delete meters, given the original meters that you included in the agreement, your usage could change on those. But contrary to add/delete, suppliers are a little more comfortable offering unlimited bandwidth. If the supplier has analyzed your usage history and expects your patterns to continue similarly, they may offer unlimited bandwidth as part of the negotiation to make their offer more attractive.

5. Material Changes

This element is often suppliers’ “trump card.” It’s the one clause that overrides all other elements of your agreement and offers fallback protection to the supplier: Regardless of anything else in your agreement, if your usage changes “materially” and it negatively impacts the supplier, the supplier has the right to impose high penalties, unilaterally reprice your rates, or even terminate your agreement.

The verbiage is often very loosely written, with a vague definition of “material change” and a broad range of consequences.  Some suppliers will define “material change” as a change in usage of 25%, consistent for several months. Others label it as a change in operations – as in, a hospital that starts extruding aluminum in a warehouse in back – that causes your energy usage to increase.

The clause interacts with the add/delete and usage bandwidth clauses in that changing one may affect how the supplier agrees on the other two.  As you negotiate one of these to your favor, the supplier will enact countermeasures in the other two to swing the agreement back into their favor. If you negotiate a clear and limited definition, the supplier may counter that by, say, lowering the add/delete percentage or by reducing your usage bandwidth.

Simply put, you won’t likely get the supplier to eliminate this clause from your agreement. This is why it’s important for you to clearly understand the specific verbiage during negotiation – and ideally get the supplier to narrow their definition so that there are no surprises.

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Conclusion

The most important thing to remember is that, as a negotiator for your organization’s energy agreements, you are engaged in a game of marble tilt. If you change the verbiage in one clause to tilt in your direction, the supplier will typically adjust other terms to tilt it back.

The importance of agreement terms also highlights the importance of a regular review of your utility bills to look at these aspects of energy costs.  You may find that you’ve been paying an “out of tolerance” fee for years that could be corrected by negotiating the right kind of terms for your organization. If your main goal is budget stability, you might opt to negotiate in more favorable terms even at a higher rate. On the other hand, if price is your main concern and you can be more flexible from year to year to get that lower price, you might be willing to grant the supplier more concessions on their terms.

This analysis is just the tip of the iceberg, as there are nuances to energy supply agreements that vary by commodity, region, and product type.  The key here is to pay attention to the language.  Be vigilant, and remember that it’s not just the price that impacts your cost – it’s also the terms and conditions. In other words, the terms make the price.

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