Sticker Shock: Utility Pricing Skyrockets in a Deregulated Environment
Winter is over for most of us. However, the cold chill of skyrocketing utility prices will linger for many months as owners and property managers seek to recover from unforeseen energy expenses and overages that wrecked havoc with budgets. Utility deregulation and re-regulation have created savings opportunities, but as the dramatic fluctuation in commodity prices attests, not without substantial risk. From 1999 to 2000, the price of gas on the New York Mercantile Exchange (NYMEX) increased 500% from the low to the high. Strip pricing (or the average cost of the commodity in a 12-month period) has fluctuated more than 300% during the same period. What does the future hold? That's a question a number of owners and tenants are asking of their property managers. In order to provide credible responses, owners and managers must learn to recognize the harbingers of future pricing.
Lesson number 1: Past pricing is not a predictor of future costs. This is an alien concept for most managers. Logic would hold that if you have three years of price data, weather trends and consumption patterns, you should be able to predict within 5 to 10% the costs you are likely to incur in the coming year. However, when you look closely at those numbers, don't be surprised to find that there is no pattern. Price fluctuations of 40 to 50% have become commonplace. That leads to lesson number 2: Financial windfalls from deregulation are going to be harder to come by because utility costs are affected by many factors beyond a manager's or owner's control such as state and federal regulations, international policy, property locations, timing, and economic growth.
Owners and managers have two primary paths they can take to help avoid the impact of dramatic energy price swings. First, they can immerse themselves in the components of utility pricing to understand why prices are the way they are. Alternatively, put your trust in someone else such as a marketer or aggregation group. Either way, owners and managers can expect to expend considerable amounts of financial and human resources to maintain positions of control with respect to utility costs.
Regardless of the path selected, owners must have realistic expectations of the opportunities presented by purchasing power in a deregulated environment and develop risk tolerances they are willing to live with. Owners and managers also need to be cognizant of tenant reactions to pass-through costs 50 to 75% higher than they were a year previously. Higher costs should not come as a surprise to tenants. The ongoing energy crisis in California has been front-page news for months. Single-family bills in many areas have doubled and tripled. Nonetheless, the ability to control cost increases provides an opportunity for managers to positively differentiate themselves from other buildings and highlight services that tenants either don't know about or take for granted.
Moreover, risks can be controlled or mitigated by the length and type of contract purchased. Generally, this means looking forward in the market with short-term contracts or buying very long-term contracts. Regardless of whether you purchase short-term, long-term or fixed contracts or let someone else do the buying for you, managers cannot abdicate their responsibility to monitor and track utility costs. Don't wait until month 11 of a 12-month contract to decide what they are going to do in months 13-16. As the past winter experience suggests, it is also extremely difficult to try to guess what the price of commodity will be at any given time. According to George R. Owens, President of EESIenergy.com, owners and managers need to create an energy management strategy for each property that looks at both side of the utility cost equation: purchasing commodity and controlling consumption.
Another key to helping control utility costs is to verify monthly that the charges received actually reflect contract terms and conditions. Utility bills must be reviewed either by the person in the organization who negotiated the contract or someone who understands the contract. As simple as it may sound, knowing how much power you need, when you need it, load profiles, etc. are critical risk reduction components. You can't effectively purchase utilities in a deregulated environment if you don't know how much power the property uses, when it is needed and what that peak demands are.
We are in the first inning of utility deregulation. Moving toward the future, the challenges are likely to become more severe especially as electricity deregulation becomes more prevalent. According to energy consultant Lou Tagliafaire, the price you will pay for electricity will be affected by whether or not the state in which your properties are located is an importer or an exporter of power. Exporters will have an advantage because the existing infrastructure does not exist to support a national electrical transportation network. Location also will have a dramatic impact on long-term budgeting and strategy. Economic growth in your region is most likely to result in disproportionate increases in utility costs because there is not sufficient infrastructure to meet the increased demand.
Most of the deregulation focus has been the ability to save on the cost of commodity. The other side of the equation is to control consumption. Effective energy management programs and controls can generate equal if not greater savings than can be achieved through savvy commodity purchasing.
There are many valuable sources of information that managers and owners can use to keep apprised of energy developments that will impact pricing. Becoming involved in industry trade organizations such as the Property Management Association provides an invaluable network of peers facing similar challenges. Tapping their experiences and expertise can pay huge dividends. The Internet also offers a wealth of useful information. Sites such as www.nymex.com and www.quotesino.com offer information on current commodity pricing. To keep track of deregulation developments in your state go to www.eia.doe.gov/cneaf/electricity/chg_str/.
Utility deregulation is a double-edged sword. Yes, it creates opportunities for significant savings (and often times unrealistic owner expectations). However, there is a cost to obtaining them that depends on the resources owners and managers put forth to develop in-house expertise. One thing is for certain, the process of purchasing and budgeting utility expenses in the future is not going to get any easier.
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