Smaller Businesses Reaping Bigger Gains: As options increase, so does the role of counsel in crafting smart energy strategies

Wednesday, September 16, 2015 - 10:23

Every company uses utility services such as electricity and natural gas. The current economy has increased the pressure to examine cost reduction strategies, with utility services being a prime target for many businesses. Many organizations also have sustainability and environmental objectives that can be incorporated into their energy strategy. Although most companies rely on their engineering, facilities management and procurement departments to take the lead, legal teams have an important role in ensuring that the organization is making the most of the opportunities and in protecting against risks that may undermine the energy and efficiency strategy.

Historically, utility services were treated as monopolies, with the state-regulated provider being the sole source for the commodity and its delivery. The primary legal battles were waged by regulatory attorneys for the utilities and customers at regulatory commissions and focused on the regulated rates that the utility would be entitled to collect from customers. In the late 1970s and 1980s, larger customers began to access third parties for natural gas supply, with the utility providing the delivery. In some cases, the customer would bypass the utility by building a pipeline to the interstate gas system. In the 1990s, this supplier choice concept was extended to electricity, with over 15 states adopting retail electric choice statutes. During most of this time, the largest customers also pursued alternative fuels (e.g., using propane or fuel oil for boilers) and opportunities to generate their own electricity.

Today, because of changes in the wholesale electric and gas markets, the restructuring of states' retail markets, and advances in technology, the energy strategies that were once available to only the largest customers are available to businesses of all sizes.  Because the options have increased, the role of attorneys in energy and efficiency strategies has expanded.

Effective Procurement

Developing an effective energy strategy starts with understanding the options for purchasing supply. In many areas, the utility remains the monopoly provider of delivery and the commodity. The rates, terms and conditions of service are set forth in the utility's tariff, which is approved by a regulatory commission. Each customer must monitor requests filed at the commission to change rates or tariff terms, determine whether the changes are detrimental to their energy strategy and, if so, consider participating in the regulatory case. Disputes with the utility also generally must be litigated at the regulatory commission.

In locations that offer retail customer choice, customers have more options, and the legal team has more roles. Regulatory litigation still occurs because the utility maintains a tariff for delivery. In addition, the regulatory commission and state legislature may periodically reexamine aspects of "retail choice" that can change customers' costs and options. In most instances, legal advisors take the lead in evaluating and commenting on those proposals.

More significantly, in retail choice states, customers can procure the commodity from third-party retail suppliers. Electric supply contracts are negotiable between the parties, with the traditional concept of caveat emptor applying. Although many of the terms and conditions are similar to other product procurement contracts, the review of these contracts is more complex because the retail product contains over 10 individual wholesale products, with the wholesale products being heavily influenced by the regional transmission organization ("RTO") rules and the Federal Energy Regulatory Commission. In this situation, there are at least four key provisions that require special scrutiny:  (a) does the quoted price include a fixed element and, if so, which of the underlying wholesale components are included in that fixed price; (b) what is the scope of the price change or regulatory change clause; (c) what taxes are included in the price; and (d) are the metered volumes used to bill the account or grossed up for so-called losses. Because the wholesale markets and rules change often, it is important for the attorneys reviewing retail contracts to have a good understanding of those markets and of the commercial arrangement that the energy team is trying to negotiate.

Careful review and negotiation of retail supply contracts will help to minimize the risk of unanticipated cost increases. For example, during the 2013 polar vortex, some customers experienced cost increases of $1 million and more because their contracts contained provisions adjusting the cost for the actual hourly RTO prices, which skyrocketed. Other customers that paid "fixed" prices were asked by their suppliers to pay surcharges for the additional wholesale costs, and each customer's ability to object to the surcharge was determined based on the language in the contract. Effective review of both types of contracts prior to execution may have helped to identify the cost variability risk and, if that risk was not acceptable, caused the company to negotiate more specific parameters for when the cost could change.

Natural gas supply contracts contain similar elements that are critical to ensuring that the contract meets the customer's anticipated reliability and cost needs. For natural gas contracts, it is important to review: (a) the delivery point; (b) each party's responsibility for balancing the supplies delivered with the actual facility usage; (c) whether the supply is firm or interruptible; and (d) the conditions, if any, under which supply can be interrupted. When unexpected events occur (such as a polar vortex or a hurricane), the cost of replacement supply often spikes. As lawyers, we can help the facilities and procurement teams to proactively anticipate and plan for those events.

Integrating Efficiency

Business pressures are causing many organizations to look at ways to be more efficient in their utility usage. At times, the utility tariff, regulatory commission regulations or RTO rules define opportunities for customers to be compensated for efficiency efforts.  Depending on what entity administers those programs, it may be necessary to sign a contract that explains the parties' obligations and compensation arrangements. If those contracts are not reviewed by the regulatory commission, then legal review will be useful to ensure that the contract is consistent with the customer's expectations. 

Many customers are negotiating arrangements with consultants and equipment vendors to assess and implement efficiency options (such as guaranteed energy savings contracts). Several contracts may be involved in this approach, including consulting, design and installation contracts. It is important to clearly outline the responsibility of each party, including items such as identifying local, state or federal grants to offset the costs. In states with retail electric choice, actions to implement energy efficiency may actually conflict with provisions of retail supply contracts. As a result, this is another issue to evaluate before committing to an efficiency or demand response initiative. Lawyers are often the best-situated member of the project team to address these issues.

Produce Your Own or Bypass the Utility

The current conditions contain many more opportunities than previously existed to bypass the utility for natural gas or electric service. Lower natural gas prices and solar equipment costs, among other elements, make connecting directly to a non-utility gas pipeline or installing on-site electricity sources more economic, even for midsized customers. When this occurs, the lawyer's job can include negotiating a variety of contracts for the design and installation of the generation source. Negotiations with the incumbent utility (or the RTO) must address any supplemental or back-up power needed by the location, as well as any obligation by the utility to purchase extra electricity that is produced. The parties will also address the cost of and operational responsibility for various equipment that connects the generation to the utility system or grid. Understanding the utility tariff, public utility law and regulations will help to ensure that the utility or the grid operator is treating the customer request fairly. If the new generation is fueled by natural gas, the supply and delivery of the gas will need to be addressed. This may involve negotiations with the utility or building a pipeline to connect directly to the interstate gas system. Connecting directly to an interstate pipeline or local gas supplier (in shale gas regions) is also a viable alternative for many customers that use natural gas for processing and other functions.

Regulatory and Legislative Components

Finally, energy strategies can be helped, or hindered, by regulatory and legislative initiatives. For example, utility commissions or state legislatures often consider proposals to fund universal service or energy efficiency through customer surcharges or utility-related taxes. The specific structure of the funding mechanisms can be very detrimental to larger consumers of electric and natural gas, especially if the mechanism is based on a uniform percentage of the total bill or based on a kWh or Mcf rate. In addition, unless the courts act on pending requests to stay implementation of the Federal Environmental Protection Agency's Clean Power Plan, each state must develop an implementation plan over the next one to three years to dramatically reduce carbon emissions. Those plans will be developed by legislatures and/or state administrative agencies. The structure of each state plan will have important energy cost impacts for many years to come. Proactive companies will participate in the implementation process to urge the state to adopt the most cost-effective approach. This will require a coordinated legislative and legal/regulatory approach.

Obviously, this article can address only a handful of the legal issues that arise in developing an effective energy and efficiency strategy. Overall, the energy team will benefit from having legal advisors involved to help identify viable options in tariffs, contracts and regulations to ensure that the contracts reflect the commercial arrangements that the other team members envision and to help to mitigate the risk of surprises that can have important cost or operational impacts.

Pam Polacek is a member of McNees resident in Harrisburg and practices in the Energy and Environmental Practice Group. She works with commercial, industrial and institutional customers regarding their energy strategies and other utility issuesShe can be reached at ppolacek@mwn.com.