Supply Management Outsourcing Gets Mixed Reviews
Can you trust a marketer with all of your regulated assets? It's
a question many LDCs are asking themselves these days as
derergulation and competition are stranding more and more supply
contracts, upstream transportation and storage. But there's no easy
answer, according to several panelists speaking at GasMart/Power
'99 in Dallas yesterday.
Asset optimization clearly is not a one-size-fits-all solution,
and outsourcing may not be the right strategy for every unbundling
distributor. "Why do it? One reason would be to increase earnings,
make more money," Consolidated Edison's Paul Olmsted noted. But
that is by no means a sure thing.
"If you fully outsource you could get rid of many of the people
that performed that function and cut your costs a little bit.
Smaller companies may not have the staff resources on hand or
really the scope of assets to really be able to effectively sell
into the marketplace and get the best return."
That was part of the reason Providence Gas signed a total asset
management contract with Duke Energy in September 1997. "The key
issue that we were faced with was the issue of price volatility,"
said Tim Lyons, vice president of marketing and regulatory affairs
for ProvGas. "We had over the prior three years experienced
tremendous volatility. We had a [gas cost adjustment] mechanism
where basically the price we were charging customers was the Nymex
price. So as the Nymex went shooting up so did our prices, and as
the Nymex went crashing down so did our prices. And it was this
volatility that created a lot of problems for our customers and our
regulators. We tried a couple of things. We tried a pilot hedging
program to mitigate some of that, but we weren't that successful."
Providence Gas has a net income of about $80 million but its gas
costs are about $100 million "so even a 10% slip up in any of these
risks could wipe out our earnings for an entire year so it's very
critical for us to manage those risks."
There were other reasons as well. ProvGas needed some extra
revenue for old gas main replacement and an expansion into new
economically attractive areas. Meanwhile, regulators and
legislators dealing with electric restructuring were calling for a
rate cut for both electric and gas customers.
What the LDC came up with was a condensed formula for all of its
supply delivery needs that would provide a reduced and fixed rate
for its customers in addition to the revenues required for its
system upgrade. Lyons described it as Nymex plus X, with X
representing costs of delivery in addition to the pure commodity.
ProvGas then held an auction and granted the winning bidder, Duke
Energy, an unprecedented deal that allowed total control over
ProvGas' assets in return for a promised savings of $75 million
over three years. It has saved customers 4% off their bills and,
according to Lyons, has encouraged competition because marketers
like having a fixed regulated rate to underbid in the retail
markets. ProvGas has 14 marketers participating in its unbundling
program, and customer savings have averaged 5-20%.
Other LDCs have jumped on the outsourcing bandwagon recently,
including Brooklyn Union, which signed a $500 million, one-year gas
management contract with Enron, who promised savings of more than
$10 million, 80% of which would go to ratepayers. And Sempra Energy
Trading agreed in January to manage the supply and delivery of gas
to serve Southern Connecticut Gas Co.'s 158,000 customers,
including 37 Bcf of supply, 4 Bcf of storage capacity and 162
MMcf/d transportation capacity.
But Olmstead issued a warning to LDCs who are thinking about
signing on with a marketer. "You're entrusting the delivery of gas
to another company who does not have the same interest in
maintaining that reliable supply that we do... We're the guys with
the matches. If the gas doesn't come to the citygate, we're the
guys who have to re-light all the pilot lights, and I can assure
you that re-lighting a million pilot lights in New York City would
be a horrendous undertaking."
Olmsted pointed out that none of these new outsourcing deals
"have been really tested by a really cold winter like we had in
1993-94 or an exceptionally high-priced winter like a couple of
years after that. We're all praying for a return to normal weather,
but if it gets really cold we just don't know how things will
Another problem is that total asset optimization it's "pretty
much irrevocable," he noted. "Once you go whole hog, you can't go
back because you're going to disperse the folks who have been doing
it, and you're going to lose the expertise."
But the deciding factor, according to Olmsted, is the risk of
making less money. "If it's an all-or-nothing thing, you have a lot
ConEd has done some partial outsourcing, sharing assets with
marketers and splitting the results. But many times the benefits of
these deals aren't worth the trouble, he said.
"In other cases what we've found is the activity of the marketer
has not actually increased the value to us. It's possible that a
marketer with national scale is putting our asset into this big
picture, and if they do that, theoretically they can generate more
value than I can. The problem has come after that in many cases,"
with marketer transaction fees and revenue sharing.
"I would never say never about doing the whole thing because the
world could change and we might find that someone does give us more
value than we can generate on our own. But when we look at our
overall strategy for maximizing our bottom line and minimizing the
cost of gas to our customers we look at outsourcing as one of many
tools" and not the only solution for the changing needs of the LDC.