Monday, November 26, 2007

Ten Energy Management Case Studies

Energy management is practiced to varying degrees by manufacturers throughout industry. No one company or industry dominates the practice. While it is easier to identify energy management leaders among Fortune 500 companies, there are also small, privately held companies that excel at stewardship of energy and other resources. Here is an overview of ten companies’ accomplishments (Full text of these case studies is included in The Industrial Energy Harvest):

3M. This diversified manufacturer seeks to reduce energy consumed (Btus) per pound of product by 20 percent over the 2000 – 2005 time frame. This goal will require 3M’s tier-1 plants (52 facilities worldwide) to achieve 3M’s own “World Class” energy management label. 3M has already surpassed that target and uses its energy performance in its product marketing. Superior energy cost control at 3M reduces the embedded energy cost that 3M’s customers would normally absorb. Notable feature: 3M’s executive management believes that resource stewardship makes good business sense. Energy management goals and results are routinely communicated to Wall Street analysts. 3M, and the manufacturers that purchase inputs from 3M, are responding to markets that increasingly demand products with low environmental impacts.

C&A Floorcoverings. Based in Georgia, this privately held, five-plant company demonstrates successful energy management by a mid-sized manufacturer. C&A has implemented a management system for matching energy-efficiency initiatives with business goals. After two years, C&A achieved 10 percent savings on an annual natural gas expenditure of $824,500. Notable feature: C&A adopted MSE 2005, an ANSI-certified standard for energy management developed by Georgia Tech, as a template for an in-house energy management program. By the end of 2004, C&A was close to becoming the first organization to become fully certified per the MSE 2005 standard.

Continental Tire North America. Continental began shutting down certain North American facilities due to energy waste and other cost inefficiencies. One Illinois-based facility became proactive at energy management and was rewarded by getting a larger share of overall production quotas. The Illinois plant used a combination of energy consultants and in-house management structures to achieve a 31 percent reduction in energy consumption per tire. Notable feature: Continental successfully partnered with an energy services company (ESCo) to design and implement energy management procedures that were self-sustaining after the ESCo’s tenure concluded.

DuPont. With over 100 plants in 70 countries, energy management practices at DuPont are supported by two top-level strategies. The first is designating energy efficiency as a high priority corporate issue. The other is the application of “Six Sigma” methodology to the energy management process. Notable feature: Through 2002, DuPont applied Six Sigma to behavioral tasks, including plant utility management. Over 75 energy improvement projects, many requiring no capital, were implemented across the company’s global operations. The average project netted over $250,000 in annual savings.

This leading snack food manufacturer’s energy management features aggressive energy reduction goals with a focus on results. This demands a high degree of monitoring, measurement, and communications. Frito-Lay organized the required engineering talent as its Resource Conservation Group. While surpassing intermediate targets on the way to even larger savings, Frito-Lay’s efficiency initiatives have returned over 30 percent on investment. Notable feature: Large and challenging energy reduction goals were used to rally and motivate staff to generate results.

Kimberly-Clark Corporation.
This personal care products manufacturer has a broad mandate for environmental stewardship. KCC’s more than 165 plants worldwide practice energy efficiency, air emissions abatement, wastewater treatment upgrades, process water use reduction, packaging reduction, landfill elimination, toxic chemical elimination and environmental management system implementation. Five-year plans help coordinate benchmarking efforts across a global facility network. KCC’s energy conservation efforts are currently in the middle of a second five-year plan, which seeks to expand on the success of the first plan (1995-2000). The first plan led to a corporate-wide, 11.7 percent reduction in energy use per ton of product. Notable feature: A large, global population of mills allowed KCC to generate its own proprietary energy benchmarking discipline. Sharing best practices across plants prevents “reinventing the wheel.”

Merck & Co. Inc. This pharmaceutical products and services corporation seeks to improve the productivity of existing assets while reducing energy expenses. A corporate energy program is mobilized by goals that hold site managers accountable for annual performance targets. Energy costs at manufacturing sites are on a growth-adjusted pace to be cut 22 percent between 2001-2005. This equates to at least 250,000 tons of avoided carbon emissions and 11.5 percent energy expenditure savings. Notable feature: Energy efficiency was employed to boost the production capacity of existing assets, thus avoiding the need to finance new capital assets.

Mercury Marine. This manufacturer of marine propulsion systems consolidated energy decisions under the authority of a central facilities manager (CFM) and implemented a power monitoring system that permits electricity costs to be tracked and billed to individual cost centers. Valuable energy flow data gives the CFM leverage in gaining corporate approval of energy technology upgrades. The centerpiece of these efforts in 2004 was the installation of a new, centralized compressed air system that carved roughly half a million dollars from an annual $7 million electricity bill. Notable feature: Simple and effective energy management (1) placed the authority to make energy improvements in a single manager, (2) assigned cost control responsibility to production units, and (2) used information technologies to monitor energy flows and to directly bill production units for their actual energy use.

Shaw Industries. Concerted efforts to manage energy at Shaw Industries got underway in mid-2004. By primarily using the U.S. Department of Energy’s plant audit methods and BestPractices reference materials, a newly-hired demand-side engineer documented potential energy savings at a rate of $1 million per month for the first six months of his tenure. Notable feature: U.S. DOE resources were effectively adopted by in-house personnel to drive their energy auditing and remediation activities.

Unilever HPC. Unilever’s Health and Personal Care Division’s energy management program coordinates 12 facilities by combining energy-use targets with an energy service outsourcing strategy. A simple budget-to-actual spreadsheet compares energy performance at 14 facilities. Notable feature: Because its use resulted in a saving $4 million on energy and another $4 million in avoided costs, the spreadsheet has captured the attention of individual facility managers as well as Unilever’s Board of Directors.

A comparison of the 10 case studies presented here suggests that industrial energy management is not prescriptive in nature. It is tempting to argue that some companies’ approaches are stronger than others’. Upon further thought, it is useless to suggest that Company A is somehow “better” at energy management because it achieved greater relative energy reductions than Company B. After all, one company may have already been somewhat more efficient to begin with. The structure of authorities within companies is a major factor. So too are market conditions and asset management strategies. Is energy management helped or hindered by corporate policies regarding investment, human resource development, and outsourcing? The answers are unique for every company.

A few forward-thinking companies have allowed their energy management experience to be documented for industry’s wider benefit. It is clear that each corporation approaches energy management with a strategy that reflects the company’s organizational characteristics. Among the leading determinants are the degree of corporate authority and involvement, depth of in-company technical support, leadership, and the capability to express energy performance’s contribution to business goals.


Tuesday, November 20, 2007

Rethinking "Payback" on Energy Projects

Today’s post takes a new look at the financial criteria that businesses use for justifying energy improvements. The take-away points are these:

1. By focusing on payback, the business explicitly perceives energy cost control as a series of isolated projects as opposed to a coordinated and continuous improvement process.

2. As you will see below, "payback" is a risk management tool that is mistakenly used as a measure of profitability. Payback is severely limited in its ability to analyze investment performance.

3. Make sure that your evaluation of energy projects asks the right questions—and that you use the right tool for answering those questions.

Whenever a business invests in itself, it implies making a change. With change comes risk. Before committing money to creating change, top managers will want to know the risk of losing their investment, or at least the risk of failing to invest in more valuable alternatives. Energy investments, like all investments, put time and money at risk. Therefore, proposed energy improvements need to withstand hard scrutiny:
• What’s the value that the investment will provide?
• How quickly will the benefits become available to the business?
• What will the proposal cost?
• What’s the most that should be paid for the improvement?
• How does this investment compare with other ways to use money?

Many business decision-makers depend on "payback" as a way to evaluate proposed energy improvements. Payback, of course, is a measure that describes the number of years that it takes for an investment to "pay for itself" through the annual savings or benefits that the investment creates. Compared to more sophisticated financial measures, payback is simple to understand and calculate—perfect for "back of the envelope" analysis. But its inherent simplicity also creates problems. Payback measures are routinely (and mistakenly) used to measure profitability when thousands or even millions of dollars are at stake.

Investors use payback simply to decide whether they will accept or reject an investment proposal. The greater the investor’s concern with investment loss, the shorter the payback time demanded. For example:
• A 12-month payback is preferred to a 24 month payback, and
• A 6-month payback is preferred to a 12-month payback.

Now take this to its logical conclusion: a zero-month payback would be most preferred—because there’s no wait to get the money back! The investor is assured of avoiding loss only by making no investment at all.

Payback only indicates whether a proposal should be accepted or rejected. It reduces investment analysis to a “yes/no” decision. As a consequence, this approach reduces energy management to a stop-and-go process. The company's beleaguered energy manager has to reset his or her agenda back to zero with each project rejection.

Energy improvements need to be held to a different standard. Why? Once a business commits to operations, it commits to using energy. Understand that some portion of energy consumption is subject to waste. That portion—the energy at-risk—is an expenditure that the business is committed to make. The real question is: How much is the business willing to pay for the portion at-risk? The choice is simple: the business will either (A) continue buying the energy at-risk at the prevailing market price, or (B) implement an energy-reducing improvement when the annualized cost to save energy on a per-unit basis is less than the price to purchase it. Seen this way, energy improvements are not a yes/no choice, but a question of degree. How much do you want to pay for energy that can be avoided?


Tuesday, November 13, 2007

Managing Energy as Currency and Wealth

Energy is simply another form of currency that embodies wealth. Currency creates wealth if it is used properly. Fuel and electricity, like currency, are expended by a business to create new value. A well-run business controls its currency and the wealth it represents. That "currency" can and should include energy.

Consider how currency is used in business. Every business transaction represents some exchange of wealth. Sales, receivables, operations, payables, bank deposits, dividends, and investments—all of these represent a value that is contractually recorded and carefully tracked according to well-documented accounting procedures.

Think now about energy, which is expended at every step of a business operation. Wealth, in the form of money, is used to purchase fuel and power. In factories, energy purchases are converted to heat, pressure, and motive power that convert inputs into finished products. Those products are sold to generate income, which accumulates again as wealth. In commercial and institutional settings, energy improves indoor climates so that staff and clientele are made comfortable and productive—to create wealth.

Many organizations still perceive energy as something less than wealth. Machines are left running unnecessarily. Combustion processes are not regularly optimized. Steam and compressed air leaks allow energy to escape because no one is held accountable for the losses. If energy is handled as anything less than wealth, no one measures its contribution to value added. After it is wasted, no one tabulates the value of potential wealth that is lost. When companies direct their revenue into buying more energy to replace what has been lost, they direct money away from income that would have created more wealth. A large organization may have an army of clerks who track $20 taxicab receipts, yet no one can clearly account for the wealth created by its $20 million in annual energy expenditures.

Energy management establishes the means for managing the wealth that energy represents. Energy, like currency, can be invested, preserved, and positioned to grow a business. Companies that understand this will manage energy like cash, tracking what they consume, waste, recover, and apply to the creation of wealth.


Monday, November 05, 2007

Electricity Deregulation Explained (3 of 3)

This is the third in a series of three blog entries that attempts to explain electricity markets: why regulation was necessary at one time, why it may not be now, and what it means to be an electricity consumer in the wake of deregulation. Part 1 provides the background. Part 2 explains how deregulation works from a consumer’s perspective. Part 3 describes the choices available to deregulated market participants and the near-term outlook for deregulation at the time of this writing (November 2007).


The consumers that exercise choice in electricity markets pursue a trade-off among simplicity, price, and fairness. A consumer usually can obtain any two of these merits at the expense of the third. These are the options:

• “Simple and cheap” at the expense of fairness. Electric utility service requires a lot of capital investment in distribution infrastructure. Utilities hate to lose a large customer because the capacity to serve that customer becomes idle. There’s no revenue to offset the ongoing carrying costs of this idle capacity—unless the cost is passed on to remaining utility customers. By the way, these other customers as a community may already be suffering because that big facility has moved elsewhere for cheaper electricity rates, taking with it the employees who supported local businesses. The simple and allegedly cheap solution would be to redistribute utility’s cost of serving the large ex-customer among the many remaining small consumers, so that each bears a small burden. After a series of these redistributions, the remaining customers will ask if their growing cost burden is indeed fair.

• “Simple and fair” is not always cheap. Would it not be fair and simple to have electricity prices reflect the cost of its production? This sounds good until we recall that the cost of power production is tremendously volatile even within the course of a single day. A price spike at the wrong time could ruin the budgets of businesses and households alike. In these instances, electricity prices pegged to the cost of production expose consumers to up-side price risks.

• “Cheap and fair” is not simple. Today’s volatile electricity prices can be managed with sophisticated portfolio management techniques borrowed directly from the financial sector. This involves paying a premium for contracts to receive electricity at predetermined prices, terms, and quantities in advance of a specified date. Note that these contracts do not provide “cheap” prices. Instead, the contract provides a reliable price which ostensibly reduces the consumer’s exposure to future, unpredictable price spikes. The consumer pays the supplier a premium (an increment of value over and above the electricity commodity itself) for the privilege of having a reliable price. Portfolio strategies allow a consumer to cover some or all of their anticipated electricity needs for months or even years in advance. The portfolio manager follows daily power markets for opportunities to make contract purchases. This may sound complicated because it is, especially for residential and small business consumers. Larger power consumers either develop a staff professional to perform these tasks, or enlist a consultant to do the same.

The turmoil that follows in the wake of electricity deregulation has been attributable to a lack of preparation—on the part of suppliers and consumers. Deregulation has been subject to political compromise, particularly when electricity price caps were imposed for an interim period to “phase in” deregulated markets. Maryland experienced exceptional market turmoil when price caps set in 1999 were lifted as planned in 2006—exposing consumers to the prevailing cost of electricity. The timing was terrible, as it coincided with the aftermath of the 2005 hurricane season, which had caused extensive damage to the natural gas supply infrastructure upon which electricity production depends. Consumers faced a potential 70 percent rate hike for electricity. In response to popular outcry, legislators intervened in the rate-making process to “force-fit” low prices, which effectively usurped the administrative power of Maryland’s utility regulators. The “low price” solution, by the way, was one that simply deferred consumer costs over time.

Not surprisingly, there is popular support in deregulated markets such as Maryland for restoring traditional regulation to the electricity market. This means putting power generation and distribution under the care of a local monopoly.


Proceeding with electricity deregulation is like squeezing toothpaste from a tube: you can only go forward, and you can't put the toothpaste back in the tube. This is because deregulation required utilities to separate the assets that generate electricity from the assets used to distribute power all the way to the customer. To go back to the old business model, utilities would be forced to build or buy back power generating plants. This initiative would have enormous costs. Who would pay for these plants?
• If private investors foot the bill, then the utility needs to guarantee those investors a rate of return that is at least as attractive as other investment opportunities. Returns to the investor would have to be reflected in the rate for electricity sold by these new plants.
• If electricity consumers pay the utility to bring these plants online, this also means raising electricity rates.
• What about the “government?” This means raising the money through taxes. This money still comes from consumers’ pockets.

Add to this dilemma the potential for market friction between neighboring states. The delivered price for electricity could be very different in neighboring states simply because of each state’s regulatory approach. States that attempt to re-regulate electricity may impose costs that ensure that their electricity will be priced higher than it is in a neighboring state without that burden. The desire for price arbitrage across state lines would benefit consumers while possibly harming utility investors. This renews questions about fairness. And yet again, citizens may look to their lawmakers for arbitration.

As the year 2010 approaches, only a handful of states have implemented electricity deregulation. Their progress has been stalled by memories of California’s 2003 deregulation debacle, which was neither well-designed nor-well executed. Some states, like Virginia, are indeed taking steps to move backward in the deregulatory process. But for reasons discussed here, the outlook is for more deregulation, not less. Currently, the advantage falls to the informed consumer that is prepared to exercise the choices—however complex they may be—offered by today’s deregulated utility markets.


See Part 1 or Part 2


Electricity Deregulation Explained (2 of 3)

This is the second in a series of three blog entries that attempts to explain electricity markets: why regulation was necessary at one time, why it may not be now, and what it means to be an electricity consumer in the wake of deregulation. Part 1 provides the background. Part 2 explains how deregulation works from a consumer’s perspective. Part 3 describes the choices available to deregulated market participants and the near-term outlook for deregulation at the time of this writing (November 2007).


Welcome to the 21st century. Electricity purchase and consumption is a multi-part task. Keep in mind that electricity consumption is paid for in three parts: (1) the energy commodity itself, in units of kilowatt-hours, or kWh; (2) the capacity for delivering the energy (if electricity is the "beer," then the capacity is the "mug"); and (3) the ancillary services that ensure the safety and reliability of the distribution system itself. The electricity market constantly adjusts the output of power generators in response to the demands placed on it. A customer’s total expenditure for electricity reflects not just the price and volume of these components, but also the time at which they are consumed.

The traditional regulated utility “bundled” together the provision of electricity—a commodity—with the cost of distributing power and servicing the related infrastructure. In contrast, the deregulated market allows customers to shop their commodity needs in the open market. In this market, the local utility retains the responsibility for distribution and service, but acts a as a “middleman” between power generators and the consumer, making wholesale electricity purchases which are in turn delivered to retail consumers.

Regulators recognize that most residential and small business electricity consumers don’t wish to be saddled with the many choices presented by deregulation. Therefore, the traditional utility company remains the “provider of last resort,” which allows consumers to maintain the simplicity of a traditional utility relationship. However, the utility may not always provide the lowest of prices, especially when its procurement strategy is to make one or two large annual wholesale power purchases in a market that experiences price fluctuations in 15-minute intervals.

The open market for electricity is notoriously volatile for a variety of reasons. The demand for electricity varies with the weather and the time of day. Power generation facilities are not all created equal: some are more expensive to run than others. The cheapest-to-run generators tend to operate the most. The more expensive units add to power supply as demand increases, as it does on hot weekday afternoons when air conditioning is at a premium. Predicting electricity demand is about as reliable as a meteorologist’s ability to predict the weather. Coordinating power generation capacity is an imperfect task, and as a result, demand and supply imbalances create price spikes and volatility.

Whereas the price of an office chair stays constant, 24 hours a day, seven days a week for a long period of time, electricity prices vary by the 15-minute interval. You can store an inventory of chairs in a warehouse until they are sold, but you can't do the same with significant amounts of electricity.

Read Part 1 or proceed to Part 3


Electricity Deregulation Explained (1 of 3)

This is the first in a series of three blog entries that attempts to explain electricity markets: why regulation was necessary at one time, why it may not be now, and what it means to be an electricity consumer in the wake of deregulation. Part 1 provides the background. Part 2 explains how deregulation works from a consumer’s perspective. Part 3 describes the choices available to deregulated market participants and the near-term outlook for deregulation at the time of this writing (November 2007).


Most people have heard about electricity deregulation, but very few understand what it means. In brief, deregulation began as an attempt to restore fairness to electricity markets that have, over the last couple of decades, outgrown the 1930s business model upon which they are based. In practice, deregulation has been a fitful process for consumers, utilities, and lawmakers that are caught in the middle. Consumers have come to expect the market for electricity (or “power”) to be simple, fair, and offer low prices. Unfortunately, consumers can only obtain any two of those virtues, usually at the expense of the third. The good news is that consumers in deregulated power markets can choose which two virtues they wish to optimize. In other words, access to electricity can be:
• simple & cheap, while compromising fairness;
• simple and fair, which generally precludes cheap prices; or
• cheap & fair, which is not a simple market for its participants.

Regulation is the legacy of utility business models from years past, which in turn reflected the technology of the times. Prior to 1935, electric companies could and did clutter cities and streets with competing sets of distribution wires and ancillary equipment. Federal legislation passed that year would enable the utility business model as a regionalized monopoly, so that only one utility company’s infrastructure served a defined geographic area. In this format, a utility offered the simplicity of one supplier with one price schedule. In return for a monopoly franchise, utility businesses were closely regulated by state-chartered public utility commissions. Commissioners were tasked with representing the consumers’ interest by ensuring that the rate for electricity covered the utility’s operating costs while providing a fair return to the utility’s investors—and no more. From the 1930s through deregulation’s take-off in the 1990s, electric utility companies provided steady if unspectacular financial returns. Large institutions have come to rely on utility-issued equity as a key part of their investment strategies.

By the 1990s, a number of forces began to challenge the classic electric utility business model. Perhaps the most important forces were (1) the escalating cost of fuels needed to generate power; (2) the growing variety of power generation technologies; (3) and the increased willingness of large-quantity consumers to relocate their facilities in search of better electric rates, or to simply generate their own power onsite. The economic tension created by these forces demanded resolution.

Immediately, questions of fairness come to mind. Why should the large consumer be forced to accept the local utility’s electric rate when it can buy cheaper power in another location? Why should smaller customers subsidize the cost of serving larger ones? Why should the steady investment returns to utility investors be interrupted? If these returns are interrupted, utilities will find it a lot harder to attract investors. The only cure for that is to raise the rate of return on utility investments. In other words, the cost of capital for utilities would escalate, which in turn raises the cost to produce (and the price to buy) electricity. As electricity prices go up, common citizens begin to petition lawmakers for protection. Average citizens (and lawmakers) do not understand the cost-price relationship for producing electricity; many people assume that electricity prices can be determined by the stroke of a pen, regardless of its actual cost of production. Does it not seem unfair to have elected officials decide the price of electricity? Exactly how are they supposed to do that?

The solution to this dilemma is to open electricity markets to competition. Power generation can be accomplished by competing suppliers. Meanwhile, the local distribution and service portions of electricity provision remain the same—it’s still not practical to have competing sets of wires lining the street. By allowing competition among generators, big consumers can get access to lower electricity prices without relocating. But if you open the market to the big consumers, you must open it for all the small businesses and homes, too.

Proceed to Part 2


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