I work on electric power procurement issues in the Philippines for a living. But if you come to me and ask “Show me how to get the cheapest power,” you’ve already asked the wrong question up front.
First: There is no answer to “What is the cheapest power?” Frankly, neither you nor I would know it if we saw it. Whatever deal you cut today, conditions will change tomorrow. What looked the cheapest today, may not look so cheap tomorrow compared with what the market is offering at that time.
Second: When procuring power for a one-year term, or five-year year term, and most especially a twenty-year term, we are not trying to find the one offer that beats all the other offers on price. We are trying to find the one offer that is most likely to beat all the others when compared to new market offers (for that same product) as they change over time.
This second concept is important. Everyone (your friends, enemies, customers, stockholders, bankers) will eventually not care WHY you chose any particular Offer in a procurement – even if it’s the lowest price by far. Down the road, their only criterion will be what is currently available in the market and how your past choice now stacks up against it. That is: is your choice now “above market” or “below market” and by how much.
The single most crucial implication of the second concept is: Flexibility has value! This is why price alone cannot be the determinant. You have to also recognize and quantify the value of whatever flexibility there is in each Offer to respond to uncertain or volatile market conditions.
The implication of that implication is this: The value of flexibility can only be assessed using probability. Which further means, in the absence of any regulatory guidelines on this, that you or your Board may have to come to grips with your own tolerance for risk. That is, if there is a chance that one Offer’s costs could skyrocket under certain low-probability market conditions compared to that of another Offer, how will you handle that? If there is only 1% chance of that occurring, you may reasonably choose to ignore it. But what if there is a 10% chance? A 30% chance. At what point are you willing to pay more as an “insurance premium” to protect against possible adverse market events? Or how much are you willing to pay to have flexibility in benefitting from unexpected but favorable market events?
The above paragraph addresses “hedging” and is important part of power procurement in the competitive market structure under EPIRA.
Of course, if you’ve specified the product that you are procuring so tightly that there is no variation in “flexibility” among Offers, then indeed you may be in a position to use price as the sole determinant. The important point, however, is to recognize when an Offer is providing you more flexibility to adapt to changing market conditions than another offer.
Third: The third reason the initial question above is the wrong one is that you have to define what you’re seeking the cheapest price on? What is the product you are procuring? Is it a three-year product or a twenty-year product. Suppliers are faced with different cost structures for those. You can’t compare apples with oranges. Also, on a per kWh basis you can pay a higher price for peaking energy than for base-load energy but the higher priced peaking energy may very well result in the least-cost total supply when combined with other resources.
Fourth: So what is the right question? It comes down to understanding the difference in Tactics and Strategy. I recommend you read what Kevin O’Keefe has to say here about how law firms mistakenly focus on tactics over strategy because his discussion is transferrable to our issue.
Designing a specific procurement is tactics. I honestly do not like to be asked to do that without the client having first adequately addressed his or her strategy. I can design a procurement to accomplish almost anything if I’m given an objective to accomplish – but it may be the wrong objective. Strategy is outlining your objectives.
Seth Godin here is correct when he says “Most of us are afraid of strategy, because we don’t feel confident outlining one unless we’re sure it’s going to work.” Tactics are easy because we can say “I am going to procure this” and if we procure it, we succeed. “Strategy is scary to outline, because we describe results, not actions, and that means opportunity for failure.”
So the right questions revolve around “How can I put together a procurement or sequence of procurements to achieve my strategic objectives.” Which presuppose you know your strategic objectives with some specificity.