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The Complexities of
Contracting with
Electric Power
Suppliers and Brokers

Lori Grifa  Marc Pfeiffer
By Lori Grifa, Commissioner
& Marc Pfeiffer, Deputr Director,
Division of Local Government Services,
NJ Department of Community Affairs
hand drawing lightblub
Can third party suppliers provide your municipality with lower electric rates? Depending on the town’s circumstances, using the right process can result in energy cost savings.

We have all witnessed, in various ways and to varying degrees, the significant drop in energy prices since they peaked in the summer of 2008. Recently, many municipal officials have been approached by electric power suppliers and brokers offering electric supply contracts, if officials simply “sign-up” with their firms. This article provides background information about the changes in energy markets and offers insights and advice about how to implement a successful procurement process. Depending on the town’s circumstances, using the right process can result in energy cost savings.

About Electric Bills Individual public electric utility bills have many elements that fall into one of two general categories: 1) delivery service; and 2) power supply. Delivery service constitutes the utility’s cost of building, operating, and maintaining its distribution network in addition to maintaining its metering, billing and customer service functions. Power supply constitutes the cost of building, operating, and maintaining electric-power-generating plants. This also includes the cost of fuel burned in those power plants, as well as the cost of the high-voltage, interstate transmission grid.

Delivery service is always provided by your local electric utility and is fully regulated by the New Jersey Board of Public Utilities (BPU). Power supply is obtained from the electric utility under the BPU Basic Generation Service (BGS) tariffs or obtained from a competitive third party supplier (TPS) under the state’s “retail choice” program. Retail choice is a program that permits electricity users to contract with a TPS to obtain power supply that is delivered over the utility’s distribution grid.

The vast majority of municipal electric accounts (e.g., municipal buildings, libraries, schools, police headquarters, etc.) receive electric service at voltage levels and power levels that makes them eligible for their utility’s BGS-Fixed Price (FP) tariff. Under the BPU program, the BGS-FP tariff prices are set annually, and as part of a policy to minimize spikes, reflect the average of staggered, 3-year, wholesale-supply contracts. Because the BGS-FP tariff prices in any given year are based upon contracts signed from several months to several years prior, tariff prices tends to lag behind market prices.

For most of the decade, prior to the summer of 2008, as market prices rose rather steadily, tariff prices for power supply were consistently lower than market prices. This meant that third-party suppliers were largely unable to offer contracts that could compete with the utility BGS-FP tariff prices.

That has changed with the recession-driven drop in market prices over the past two years. Many third-party suppliers are now able to offer contract prices for power supply below the utility’s tariff prices. Many are aggressively pursuing the small-to-mid-sized electric account market, which includes municipalities. Unfortunately, some TPS or brokers are not familiar with public procurement laws and may be offering municipal officials services in ways not permitted under the Local Public Contracts Law.

The Power Supply Question So what is a municipal official to do when approached by third-party suppliers with contract offers that promise, and in some cases, deliver eye-popping savings? The answer is to step back and review the following areas of concern.

How to Procure Electricity First, it is important to emphasize that the procurement of power supply must be consistent with the Local Public Contracts Law (LPCL). The bottom line is: when the estimated amount of spending for power supply is above the municipality’s bid threshold, power supply must be publicly bid or purchased subject to an exception to the bid law.

MANY THIRD PARTY

SUPPLIERS ARE NOW ABLE

TO OFFER CONTRACT

PRICES FOR POWER SUPPLY

BELOW THE UTILITY'S

TARIFF PRICES.

Under the LPCL, power purchases from regulated public utilities that use their BGS-FP tariff are exempt from bidding. And while there are several other public bidding exemptions on the books that apply to unique electricity purchasing scenarios, none of these is applicable to purchasing retail supply from a TPS. In other words, procuring power supply from a TPS (directly or through a broker) requires a public bid. Moreover, for electric accounts large enough to warrant attention from a third-party supplier, the contract value will be above the bid threshold.

Also to be considered is the time and cost aspects of preparing bid specifications and conducting the bidding process. This can be a time-consuming and possibly labor-intensive process. Municipal officials should carefully consider all these factors in determining whether they should proceed with a public bid or stick with the BGS-FP tariff.

If the decision is made to publicly bid power supply, the next important matter is whether to go out to bid for your accounts as a single municipality, or to join or “aggregate” with fellow municipalities or other government contracting units by using a cooperative purchasing arrangement.

Aggregating demand for power supply purchasing is a particularly important consideration. When responding to a public bid, a supplier can incur significant administrative and “transaction” costs in preparing a price offer and contracting to serve government accounts. While to most municipal officials electric accounts appear to take a significant bite out of their budget, in the universe in which most electric suppliers operate, the typical municipal electric account is quite small. Therefore, it is often helpful to the supplier to have one or more, large “anchor” accounts or a large number of small-to-mid sized accounts--to spread-out the suppliers’ relatively high transaction costs and attract as many suppliers as possible to compete for a contracting unit’s business. Under the LPCL, this can be done by forming power supply cooperative purchasing agreements among government contracting units such as municipalities, counties, local authorities, and boards of education (N.J.A.C. 5:34-7.1 et seq.).

There are many recent examples of contracting units successfully banding together to form a large aggregation group. Such a group offers an attractive and biddable electric load to suppliers, while achieving electricity cost savings for the participants. A critical component of a successful group is to have a strong, well-organized and trusted lead agency, empowered to make decisions on the participants’ behalf.

The key element to a successful procurement process is to design and implement bidding procedures that attempt to maximize bidder participation and drive down the bid price as low as possible.

Because of space limitations, it is not possible to go into full detail on each bidding element. However, the authors have prepared a document that explains each of the power supply procurement challenges and the potential process solutions in more detail. That document also reviews other ideas that local government units may want to explore in order to reduce energy costs such as financing, the implementation of energy efficiency measures, and renewable energy projects. That document can be found on the Division of Local Government Services’ website at www.nj.gov/dca/lgs/lpcl/#energy.
In summary, the elements are as follows:

Gathering Data and Providing Suppliers with Accurate Information While seemingly a simple task, in practice this step can be quite challenging, particularly when there is a large number of electric accounts involved. Accounts can be eliminated, account numbers can be changed by the utility, and transposition errors can be made in re-typing account numbers. It is critical to assure that each agency provides an accurate and current list of account numbers.

Developing an Accurate Estimate In order to evaluate bid prices, it is vital to understand how bid prices should be compared. The power supply component is the only relevant portion of the utility bill that should be used to evaluate bids; the delivery charge will remain the same regardless of whether you purchase supply from the utility or a third-party supplier. The average power supply price can vary significantly depending upon the usage profile of the account(s). Therefore, it is important to model your account(s) usage profiles in detail against utility tariff prices in order to develop an accurate “price-to-compare.”

Drafting Bid Specifications and Contract Terms There are a number of third-party suppliers competing in the New Jersey retail market. In private sector supply deals, these suppliers negotiate with customers, and typically use their standard form for supply contracts as the basis for negotiating the contract’s terms and conditions. These supply contracts have been extensively and carefully vetted by each supplier’s legal and risk management departments. In public bidding, the terms and conditions of service cannot be negotiated once bids are received and, moreover, competitors must be bidding on equal footing.

Timely Decisionmaking Energy markets are inherently volatile, with prices changing constantly throughout the trading day. This makes electric power purchasing relatively unique in the public procurement arena. When suppliers submit a fixed bid price, they are basing that bid on the prices quoted just prior to the bid submission deadline. The supplier will later lock-in the price with their wholesale suppliers, but only after a binding notice of award is issued. Between the time in which the bid is submitted and the contract is awarded, the supplier is taking the risk of price volatility. The longer the period of time between the bid submission and the contract award, the greater the risk to the supplier. In order to promote robust competition and push prices down, it is critical that the agencies implement procedures to rapidly review and award a contract. Ideally, this window of time is just a few hours.

Efficient Bidding In recent years, there are several forms of bidding that have been implemented for power supply purchases in New Jersey: traditional, sealed paper bids; sealed electronic bids; and online reverse auctions. Sealed paper and electronic bids generally have few incremental costs associated with their implementation; the use of an online reverse auction platform generally imposes additional costs for the municipality to implement, but may result in lower prices. Purchasing officials should give careful consideration to the appropriate means for accepting bids.

What Next? With all the attention being paid to municipal budgets, officials should review the cost of power in term of its cost-saving potential. As described above and supplemented by the Division’s online resources, due care and consideration must be given to ensure that moving to a TPS will provide the desired results. Municipal officials should consult their procurement professionals and other advisors to assist them in determining whether bidding for power supply or the traditional BGS-FP approach is to their advantage.

 

The authors thank Robert Chilton, Executive Vice President of Gabel Associates, for his assistance in preparing this article

First published in New Jersey Municipalities, Volume 88, Number 1, January 2011

 

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