Should you relax as energy prices dip?

June 12, 2006
It's not unusual for plant managers to suffer from a severe case of amnesia as soon as energy prices begin to fall. In his monthly Energy Expert column, Peter Garforth explains why it's so important to remain diligent in cutting energy costs even as prices dip.

Last year, we saw natural gas prices hit record highs, and now they’ve fallen to levels of about half their peak. Oil brushed against the inflation-adjusted historic peaks and has now backed off a few dollars. We even saw the prices of greenhouse gas emissions in Europe drop from more than 25 Euros a tonne to less than half that in the space of a week. The near-record highs grabbed everyone’s attention, and there has unquestionably been a massive surge in better managing energy costs and risk.

Unfortunately, we all too often suffer from a severe case of amnesia the moment prices start to fall. Yesterday’s best intentions to deploy world-class, breakthrough energy management programs, such as we have been discussing in this column, start to fade. This is especially true once companies begin to realize the depth and breadth of the process and culture changes needed to deliver the year-on-year energy productivity gains that are the hallmark of a truly successful energy management program.

How do we overcome the temptation to slow down when prices appear to be dropping again?

Before addressing this question, let’s recap the drivers of U.S. energy prices. Natural gas imports are increasing, requiring construction of LNG tankers and terminals to ship the volume. This logistics chain is constrained by both capital and availability of infrastructure. Economic growth in China and India continues to generate massive new demands on the globe’s primary fuel resources. Increasing demand for electricity, combined with constrained and aging generation, grid and rail transport infrastructure, will continue to pressure prices. The bottom line is that there’s no convincing scenario for sustained, long-term, low energy prices if the world economy stays reasonably healthy. In addition, political uncertainties and oscillating market sentiments are going to add a high degree of price volatility. This picture will be a fact of life for industrial energy users for the foreseeable future.

All this being said, a 50% drop in natural gas prices from a wholesale peak above $12 MMBtu to below $6 today in less than nine months does make it tempting to slow down on implementing energy efficiency programs, especially if the plan was made at $9 and we are way ahead on the year’s energy budget. Succumbing to this temptation could lead to a huge competitive disadvantage. It’s a statement of the obvious, albeit rarely respected, that an excellent time to invest in productivity is when unit costs are low. This applies to energy as much as any other area.

During times of lower energy prices, most companies fall into a false sense of security, and begin to defer energy productivity measures. As a result, there’s more qualified expertise and supplies available at competitive prices, making the potential cost of a high-quality implementation somewhat lower than average. This is also a time when overall margins will tend to be somewhat better, partly as a result of low energy prices, making continuing investment in energy management activities and projects easier to fund.

As soon as energy prices or fears and uncertainty about supply increase, everyone jumps on the energy management bandwagon, and competent resources in the market become overstretched and overpriced. At this time, overall margins will be under stress from high energy prices, making any investment in productivity tougher.

Most energy productivity projects, whether from procurement, low-cost behavioral programs or capital investments, take between three months and a year to start delivering results, and will only deliver their full potential if managed consistently. Given this, trying to turn energy productivity measures on and off during periods of high volatility is an exercise in futility, and will result in minimal or even negative results.

These are times when leadership and consistency are what it’s all about. If during cheap times senior management sends signals that energy is no longer a priority, or demands unreasonable and unrealistic reductions during the pricey cycles, employees will rapidly learn to pay lip service to energy management and quietly continue business-as-usual.

Ensuring this doesn’t happen is hard, but simple. Management needs to ensure teams have clear energy productivity, efficiency and procurement goals, and that meeting these goals is tracked and rewarded. When low market prices are helping you exceed those goals, resist the temptation to take the windfall margin to cash, and even consider accelerating planned energy productivity investments while both the cash and market resources are available.

Companies that learn how to do this, year after year, enjoy a huge competitive advantages when energy prices run up because they’re both generating more cash and avoiding panicky investments at times where the market for skills and supplies is tight.

Peter Garforth is principal of Garforth International LLC, Toledo, Ohio. He can be reached at [email protected].

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