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Energy Aggregations: Lower Prices, Higher Cost?

iStock_000018372486_Small-Keyboard_Key_Choice on Key_8-10-15Your organization’s electricity contract is set to expire, and you have to make a decision soon.  You’ve been told that you’ll get the best deal if you join a regional energy aggregation that already has a membership made up of around 20 organizations like yours.  You’ve also been assured that the size and membership of this aggregation will enable you to get the best contract terms and the best rates for your organization – better terms and rates, in fact, than you would get if you handled energy procurement on your own.

Does this scenario sound familiar?  To anyone with experience in energy procurement or energy buying, it probably does – especially if you work for a government organization.

There are benefits to aggregation, of course:  By joining an aggregation, you’re spared the time and labor involved in shopping around for the energy provider with the best rates.  You don’t have to negotiate or monitor the markets.  And in some cases, you do get lower prices.

From a pure purchasing standpoint, aggregating demand makes sense.  This is the logic that drives those members-only, bulk-style warehouse stores like Sam’s Club and Costco:  In most cases, the more of an item you buy, the less you pay.

Unfortunately though, what works for buying and saving on ordinary consumer goods doesn’t necessarily work for a process as complex as energy procurement.

Considering the Trade-Offs

When trying to describe the tradeoffs of an energy aggregation, we often use the metaphor of the standard one-size-fits-all conference lunch:  Everyone attending the conference gets the same meal.  More than likely, it’s probably going to be chicken and a side dish of some kind.

Now, the chicken might be a bit on the bland side for your taste.  Maybe you don’t even like chicken very much and would have preferred fish or a vegetarian option instead.  And given the choice, you probably would have selected a different side dish.  But the lunch was planned to suit the needs of the majority of conference attendees, rather than the tastes of the individual.  And although the meal may not be your favorite, you won’t leave the conference hungry.  It’s a perfectly adequate, perfectly unexceptional meal.

Think of energy aggregation like a typical conference lunch:  You’ll get what you need (in this case, electricity and/or natural gas) – but you won’t get much say in how it’s delivered and you don’t have any control over pricing, market timing, or anything else, for that matter.

The bottom line:  If your organization is considering an energy aggregation to get lower prices, it’s critical to think about what you won’t be getting.

Contract Terms

In an aggregation, contract terms are decided upon by the group rather than the individual – and in many cases, it is a small committee or individual representing the group that decides upon the terms.  In most cases, this means that the terms of the contract will be watered down to meet the needs of all organizations in the aggregation.  As a result, you may end up in a contract with terms that at best don’t especially benefit your organization and at worst may actually hurt your organization.  For example, the aggregated contract may agree that 20 days to pay is the best overall billing term, whereas your organization would really benefit from having 45 days to pay.  Bandwidth and usage tolerances are also key areas where, if they are not customized around your specific needs, they can result in costly financial penalties down the road.

Pricing & Market Timing

Although aggregation is often presented as a way for several organizations to save on energy costs, this group-buying strategy may not actually be the most cost-effective.  This is because pricing for an aggregation is based on the energy usage profile of the group as a whole, rather than individual usage profiles. What often happens in aggregations is that larger organizations that use more energy essentially end up subsidizing smaller ones that use less energy. If your organization is large and has an attractive load profile, you may actually be better off in an individual contract.

Another issue is timing.  The wholesale energy market is often the biggest determinant of the price an organization pays for energy.  But the market can change drastically from day to day and week to week; the only way to really take advantage of market behavior is to act quickly.  Because aggregations are so large, they often lack the ability to move swiftly enough to take advantage of specific market timing.

Flexibility and Customization

When it comes to energy services, price is only one of many factors that determine total value.  When choosing an energy provider, it’s important to look at all additional, value-added energy services that augment your operations before making a decision.  For example, some providers offer flexible rate structures, and others offer demand response or curtailment programs that provide organizations discounted rates in exchange for curbing use. Even the particular pricing product selected should be customized around your specific needs – for instance, a fixed-price product vs. a block-and-index product.

In a typical aggregation, though, these options rarely enter the discussion.  Most aggregations look at price only and ignore value-added products and services altogether.  In this scenario, the initial cost per kWh may look low, but your overall value is not as great as it would be through a customized solution.

The Best of Both Worlds: Outsourcing as an Alternative

In many cases, aggregation is presented as the best possible choice for government entities – and energy procurement decision-makers often face enormous pressure to join aggregations.

But is an aggregation really the optimum choice when it comes to getting the best possible energy contract?  Or is it actually better to strike out on your own to get a more customized and flexible agreement?

As it turns out, the best approach may be somewhere in between aggregating and procuring in-house.

Aggregation can be a convenient option – someone else does all the legwork, and your organization may pay less for energy.  But in exchange for convenience, you give up a lot of autonomy. Purchasing energy yourself gives you back that autonomy – but it can be time-consuming and difficult, especially if you lack energy expertise in-house.

Another option to consider is outsourcing your energy procurement to a third-party company or energy consultant.  This option gives you the convenience of an aggregation — someone else shops for the best price and negotiates the contract terms — with the freedom and flexibility of purchasing energy as an individual organization utilizing expert market intelligence.

There’s really no “right” way to buy energy, and there are tradeoffs to every option.  But when you understand the limitations as well as the benefits of an aggregated approach to energy buying, you are better prepared to evaluate your options and make the decision that is best for your organization and your budget.


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