The pitfalls of contracting energy procurement services

In recent years, E&C as an energy procurement consultant is increasingly confronted with competition of companies that are generating revenue from other sources than consulting fees: brokerage fees, hidden or transparent, premiums that they can add to OTC quotes when they’re not just advising but also executing the hedges and a recent phenomenon: trading revenue by integrating customers’ demand flexibility and battery storage capacity in their own portfolios. Because of these extra and sometimes hidden revenue streams, they often offer advice for a low fee or even for free. However, as often said by Milton Friedman: “there’s no such thing as a free lunch”. In this article, I unveil the hidden costs of using energy service companies who are not just charging you consultancy fees for the work they do. And I highlight the benefits of the clear alternative applied by E&C.

When I founded E&C together with Luc and our other partners in 2005, we made a clear choice: we would deliver a set of services, clearly defined in our contracts, and charge clearly formulated consultancy fees for that, all 100% transparent. We did that in opposition to so-called “no cure – no pay” fees where the consultant is paid a percentage of the savings, which was quite a common practice back then. Common practice but resulting in a lot of discussions with clients over the definition of savings. Later, when we defined our key values, we formulated the principle behind this fee policy as “non-opportunistic behavior”. We wanted to be a consultant that always puts the interest of the client in the first place. Make the client buy energy in the best possible way (to the best of your expertise) and charge them a fixed fee for such honest consultancy work. Later, we brought this down to “independence”, we wanted to operate free of any other than our client’s interest. Recently, in reaction to some of the practices we see in our business, we’ve upgraded this to “integrity”, with a strong focus on our capability to deliver unbiased advice. Transparency, non-opportunistic behavior, independence, integrity, this might all sound very self-evident. But as you’ll read in this article, there’s a lot of energy market advisory firms out there these days, who have revenue streams that create incentives that are not necessarily aligned with the client’s interests, making it hard for the people working for them to put such values into practice.

In this article, I will talk about our own corner of the energy market. I realize that this is slippery ground and that any critical observation regarding the practices of other energy consultancies and data providers can make me sound like a resentful competitor and I completely acknowledge that my statements here are colored by my own interests. However, I have little to be resentful of. Our approach to energy procurement consultancy and data management, based on our integrity value, has proven to be very successful, with a high scoring rate in RFPs for our services and the fastest organic growth rate in our sector. I offer you my observations because I realize that many companies are totally unaware of how their service providers are making money. And because, honestly, I am shocked by the amounts I hear about, the money that is earned by service providers at the expense of their customers in our sector. And because I see how the way many procurement organizations of large companies are organized, block the kind of Total Cost of Ownership considerations that should lead away from such (ultimately) expensive services.

Contracting services

As a large user of energy, you can use energy procurement service providers such as E&C to help you find and sign energy contracts in deregulated energy markets. This service has gained interest and importance due to the energy transition which leads to more diversified portfolios, with more types of contracts to be negotiated, each of them with a specific complexity:

1. Power Purchase Agreements (PPAs) for direct sourcing of renewable power from off-site assets,
2. Agreements for on-site renewables,
3. Purchases of EACs (Energy Attribute Certificates such as Guarantees of Origin or Renewable Energy Certificates) outside of the physical supply contract,
4. Recently we also see many new contract types / services pop up to deal with intermittent supply issues, contracts regarding batteries, flexible demand and/or optimization services,
5. Third party hedging services. Some clients had such contracts before energy transition, the more complex hedging operations necessary on a diversified portfolio has increased interest in setting up separate contracts for hedging, next to the physical supply contracts,
6. The traditional supply contract will always continue to be the cornerstone of your energy supply situation. If energy transition has resulted in a portfolio where you need to blend in large volumes of intermittent renewables, these contracts become more crucial and more complex, with special attention to be paid to volume clauses and pricing of the energy that you feed into the grid.

Because of this higher complexity, having a good service provider for energy contracting by your side is more impactful than ever before. In the first place, we take away workload with this service. We’re involved in the sourcing of more than a thousand energy contracts each year, and we’ve done this for 21 years now and in every deregulated energy market in the world. With all that experience, we take care of all the practicalities so that you can focus on taking the right decision. In our early days, we had a slogan for that: “Sit down and decide”. But we offer more than comfort. Having a seasoned energy market specialist by your side can help you to sign better deals. Our network in the energy markets can lead you to suppliers you didn’t have on your radar. Our RFP process has been streamlined and is therefore highly efficient and effective. We have the tools and the expertise to make swift and correct analysis of every proposal received. We know what you can say and what you shouldn’t say at the negotiation table. And in all of this, we can continuously benchmark what a supplier is offering against all these other proposals we receive (for you and for our other clients). This benchmarking doesn’t stop at the borders. In many countries, we’ve explained to a local energy company in a certain market how their colleagues in other countries structured contracts, helping them to develop new contract types and offer the solution that is best for our customers.

A key differentiator in the kind of services you can hire to help you with energy contracts is the difference between a consultant and a broker. And it is to be looked for in the different ways they get paid for their services, which creates different financial incentives. If you hire a consultant, then you’ll pay them consultancy fees for giving you advice. If you hire a broker, that broker will receive a commission when the deal is done. And in the energy space, it is almost always the energy supplier that pays the broker. Some clients therefore talk about brokerage fees as if they are success fees. However, the “success” in this case means, “a deal has been signed”, a deal, whatever deal. Even if that deal is a bad one, you as a customer will be paying up, the broker continues to receive commission payments. So yeah, it is a success fee … for the broker, not necessarily for the consumer. The essential risk in terms of the service you can expect of these brokerage fees is what I would call broker’s bias:

If the advisor is only getting paid when a deal is signed, the ability for unbiased advice is gone. Telling a customer not to sign a deal, because it’s a bad one, means you’re not getting paid for the work you’ve done, which is a strong incentive to advise your client to sign a deal, even if it’s a bad one.

This risk has become a painful reality for many large users who have signed brokered PPAs in the past years. Lots of those are loss-making, either because of a high price level or because they were signed for volumes that were too large, due to which huge quantities of excess power are to be sold to the market in moments of low spot prices. The large volumes are typical of this bias flaw. Commissions are often based on the size of the contract. Which means your advisor makes more money if you sign a larger volume PPA. To give you correct advice about the volume risks of the PPAs, such a broker (or commission-paid advisor, if you prefer), needs to cut in its own flesh.

(IMPORTANT NOTE: the terminology used by different service companies can be very confusing. Brokers will call themselves consultants and the word “Commission” will rarely be used, a “Service Fee” or “Brokerage Fee” raises less alarms. Keep a clear head in this by asking yourself the simple question: “Does my advisor have a financial interest in making me sign a deal?” If the answer is yes, you are using a broker and the advice you’ll receive will be subject to broker’s bias.)

Now, there are many competent advisors out there offering you their services for transparent brokerage fees. Which means that these fees are stated in an agreement with you and the same brokerage fee is billed to every supplier with whom you might sign a deal. I have nothing against such practices. Just be aware of the broker’s bias and how this might make this a bad choice for contracts you don’t have to sign, such as PPAs or battery contracts. And make sure that the brokerage fee is independent of the volume for which you will contract. But: we also see examples of brokers not applying the same brokerage fee to all suppliers, which makes the broker’s bias go into turbo: the broker does not only have an incentive to make you sign a deal, but they also have an incentive to make you sign a particular deal. In such cases, you should really question why your advisor is advising you to sign with supplier A rather than supplier B. Is that because supplier A has a better deal for you? Or is it because they pay your advisor a higher brokerage fee? And it can get worse: if the brokerage fees are not disclosed beforehand, you are allowing the brokers to haggle over commissions behind your back. And it gets especially murky, when the advisory firm is – consciously – hiding information on the commissions they receive from you, they are not disclosed in the contract you sign with them, and they agree with suppliers (behind your back) that they will shut up about the commission payments. More than a decade ago, such brokerage practices in the UK got so out of hand, with so much money being earned behind customers’ backs, that the regulator Ofgem passed regulation that obliged all commission payments to be explicitly mentioned as a line item on electricity bills. Today, in the world of PPAs there’s massive wheeling and dealing behind the scenes.

(“How do you know”, you might ask me. Because almost every supplier in every country that we get in touch with is asking us sooner or later: “How much do you want for yourselves?” And in some markets, getting kickbacks on deals you’ve been paid to advise on is such standard practice that suppliers don’t believe us, when we say: “nothing, we get paid by our customers.” Or: because in 2005, just four months after we had founded E&C and after having launched a handful of RFPs for clients, I was already invited by a supplier for a ski-weekend in the Alps and: “we can discuss what we can mean for each other during the après-ski”. I declined the offer. I don’t want to be the energy market tabloid here, but yes, I do have stories to tell …)

OTC quotes

Almost every large user these days has energy supply contracts where prices are to be actively managed. Flexible contracts, tranche model contracts, multi-click contracts, block & index, progressive contracts, etc., there’s a huge variety of terminology for these. The essence is: after you’ve signed your contract, you need to follow up on the wholesale market and choose moments at which you fix the price for part of your volume (or capacity). Given the huge volatility of energy markets, good advice on this can be extremely valuable. Services that can be provided are:

• Providing market intelligence,
• Risk management: this is again a widely used (and abused) term. I’m using it here in the very strict definition that we use at E&C, namely the analysis of how energy price variations affect your P&L and then taking hedging actions to minimize adverse effects,
• Price management advice: advice to fix, not to fix or unfix prices at certain moments (in a good practice, price management & risk management action go hand in hand),
• Price management handling: part of or all the communications, written or oral, with suppliers and/or third parties for the execution of such price fixings and unfixings can be delegated to a service provider,
• Price management guidance: extra advisory services at the moments that prices are being fixed or unfixed. An important element of this guidance is the proofing of OTC (Over-The-Counter) quotes. In many cases, this is the process of executing the fixing or unfixing of the price for part of your volume or capacity in the framework of a flexible contract:
  1. The client requests a quote for the fixing or unfixing from the supplier and/or third party / parties,
  2. The client receives a quote, reviews it and approves or disapproves. This needs to happen in a certain timeframe, often very short, quotes can come with a 5-minute validity,
  3. If approved, the supplier or third party executes the hedge.
  In that second step, an advisor can look at its wholesale market sources and at quotes it receives for other clients to evaluate whether the price quoted by that supplier or third party is justified by wholesale market price levels at that moment or not.

In 21 years of offering this service, E&C has reviewed millions of those OTC price quotes from hundreds of suppliers in dozens of countries. We push back about 50% of them which often results in a better quote. Just an example of one of our clients. On 256 hedges executed in the past 12 months we have managed to save 216.320 EUR for them by pushing back on OTC quotes that we deemed to be too high. And by the way: suppliers will never call what they add to the quotes “a fee to make some extra money”. They will call it a risk premium. And in all of those, I’ve had only one case where a supplier admitted that they did this to earn extra money. They’ll always argue that that’s the price they see in the market at that moment or that they must add this extra risk premium given the volatility in the markets. By consequently proofing the OTC quotes our clients receive, we save many millions every year. By pushing back when the extra premium added is excessive. By putting pressure on suppliers who are structurally adding excessive premiums in their OTC quotes. And above all, by the fact that suppliers know how serious we are about this. (Anecdote: over the years we’ve had several suppliers that told us they give us extra sharp OTC quotes because they know we are always checking them carefully.)

Recently we’ve seen some advisors that are offering to provide the OTC quotes themselves. They execute the hedges in the wholesale market themselves and then settle them with you either as a third-party hedge with their brokerage or trading branch or by sleeving them to the physical supplier. (Sleeving is a funny word that is used for the practice of passing on hedges between different wholesale market participants.) This is offered by companies that also have energy trading, brokerage and/or supply activities. Again, this might look like an attractive, valuable proposal: you get access to the powerful trading floor of a big energy company. We often here that this practice is promoted by saying that a service provider with a big trading floor can get better quotes for you. But how can you check this? It’s very simple: the advisor telling you whether it’s a good quote or not, is also the one that is giving you the quote, that makes money by adding a risk premium. Isn’t that the mother of all conflicts of interest? Of course, you can believe that the service provider will not abuse your lack of proofing capability. But when I first heard about this practice, my reaction was: “well, talk about signing a blank cheque …”.

Next on the horizon: optimization services

With growing presence of renewable energy on the grids and in clients’ supply portfolios, the large number of contracts now cashed out over the spot market and changes in grid fees as a reaction to more intermittent supply and demand, we observe how they are increasingly subject to a new type of variation in energy cost: the cost of when you consume your electricity. The solution for this is to optimize your profile. Find and unlock your sources of flexible demand and/or add battery storage to it and you can switch volume from expensive to cheap hours. This is a highly complex topic, but to highlight its importance: the difference between optimizing your load profile or not could run up to paying 40% less, respectively more in certain markets. If you want to keep control over your energy costs, it will be indispensable that you add optimization to your energy management practices. And as anyone who visited E-World can say, this is the next big thing in energy markets, with hundreds of companies, from the largest suppliers to many small start-ups offering optimization services.

In most cases, these companies are not offering these optimization against a service fee, but rather in constructions where the service provider is integrating your demand flexibility into their portfolio, making their money by using your flexibility to optimize their portfolio. Think about an energy supplier but also about the many aggregators or optimizers who are becoming traders, which means they integrate your flexibility (your flexible demand and/or battery) in a portfolio that they trade in the wholesale markets. In such set-ups it’s very clear that the incentive for those optimization service providers is not to minimize what you pay on your electricity invoices. It is to maximize the money they make on their portfolio. In some contractual set-ups, they might give you a percentage of those benefits. In many other cases you will receive a fixed amount. Which might seem like an attractive deal, if for example, it creates fixed revenue on your investment in batteries. But will you ever check how much more money you could have made by using the batteries (or your demand flexibility) to lower your own cost? Will you check that making you consume at full throttle to make money in a spot or flexibility market isn’t increasing your costs because it increases the capacity peak on which your payment of grid fees (utility rates) is based?

At E&C, we believe that large users should use their demand flexibility to their own benefit, to lower their own cost. This can be done by:

• Contracting service providers, such as BESS (Battery Energy Storage Systems) suppliers and optimization software providers and paying them fixed service fees,
• Developing, implementing, continuously evaluating and recalibrating an optimization algorithm that minimizes the total electricity on your invoices across all optimization vectors (there are four: spot market optimization, optimization of capacity charges in grid fees, maximization of on-site renewables usage and participation in ancillary service schemes and markets),
• Having unbiased advice on this,
• Setting up an unbiased data service that can calculate how much you would have paid without optimization so that you can objectively calculate your savings.

This is how we organize our optimization services at E&C. But it looks like we’re quite unique in this. All over the optimization market space at this moment, there are services provided aimed at making money for the service provider, not the customer.

Total Cost of Ownership of advisory services

I hope this article helps the reader to consider more carefully how much energy market service providers are really costing them. The hidden ways of making money described in this article are a typical iceberg issue. Clients believe that they pay a low service fee, but ultimately, they end up paying a lot more:

• The brokerage fees paid by the supplier to the broker are added to your bill, explicitly or not. Let there be no doubt about this, no free lunch, the brokerage fee is ultimately paid by you,
• Every cent added to an OTC quote by your energy price management service provider is extra cost,
• And in optimization, optimizing the service provider instead of your electricity bills can be an important opportunity cost in the future, a competitor that is optimizing its own cost might have structurally lower energy costs than you have. Or worse: the switching on and off by your service provider to optimize their portfolio can lead to a situation where you pay more rather than less due to the optimization.

If I sound impassioned in some of my words, it is because we’re not talking about small amounts of money here. In many cases, it is an Iceberg, the money made below the waterline is a large multiple of the consultancy fees. The anecdote that sparked the writing of this blog article is the following. A few years ago, a large user of energy asked us for a quote to help them negotiate a pan-European PPA (or set of PPAs). They didn’t choose us, because we quoted just short of 50.000 euro in consultancy fees for this work, they chose a broker instead, so that they didn’t have to ask their organization for consultancy budget for this. Last week we found out that the brokerage fees received by the company that did the work on those PPAs amount to a total of just short of two million euro. Which makes me wonder: what is so broken in procurement practices that they make their companies pay 40 times more for the same service? Well, not the same service, ours would have been more unbiased, that client came to us to see if we could help them renegotiate the bad PPA contracts they have signed.

Of course, I understand the mechanisms that lead to this. In most companies “energy cost” and “consultancy fees” are two separate lines in the budget. And lowering consultancy budget is a classic when companies start looking for savings. Moreover: it’s easy to show those savings. Therefore, telling your bosses: “I’ve saved X euro on consultancy cost” is a sure route to a positive evaluation and in many companies, a bonus payment. Moreover: the cost of energy is subject to so many variables, consumption, wholesale market variations, changes in regulated fees, and so on. Therefore, the brokerage fees, quote premiums or higher costs due to bad optimization remain hidden in the total energy cost, even if they are a magnitude of 40 higher than the consultancy fees that you’ve saved. But when I hear such reasoning, my reaction is: “and what about Total Cost of Ownership (TCO)? Isn’t that what a professional procurement team is supposed to deliver to their company?” Therefore, this is my advice to procurement leaders: for service agreements, put in place TCO check-up mechanisms in your procurement procedures.

This also brings me to one of my favorite topics: negotiation tactics. I believe that one of the most important things you can do to negotiate good, thoughtful deals is to continuously check incentives, yours and those of the company you’re negotiating a deal with. Instead of that, I observe how often procurement professionals base their decisions to work with a certain service provider on so-called objective criteria, with size being a favorite one. But as everyone knows, the tendency to work in their own interest rather than the interest of the clients goes up as a company grows, rather than it diminishes. I’ve heard stories about how some consultants have approached the PPA topic in the past years that are very alarming: targets were set for the number of PPAs to be signed by their customers (or rather: volume, or commission revenue) and bonuses of consultants/brokers depended on it. Are you sure you will get good advice from someone for whom the possibility of going on a ski trip with the family depends on your decision? (In case you find this far-fetched, it’s literally what someone working for another company, focused on PPA brokerage, told us during a job interview: “I was in a situation where if I told my client not to sign what I thought was a bad deal, I wouldn’t get a bonus and I wouldn’t be able to afford a ski trip with my family.”)

At E&C, we have consequently chosen, for 21 years, to deliver energy procurement services with only one goal: helping the clients to get the best out of the complex energy markets. We’ve stood dozens of times at the crossroads where we could have made a choice to make more money with brokerage or other hidden fees. Every time we took the decision to say no to that temptation. We always chose to stick with our line of only accepting contractual set-ups and payment schemes that allow us to give our advice with only one interest: to make sure we give the best possible advice for our clients to take the best possible decision for themselves, not for us. This pure consultancy approach has become increasingly rare in the energy market. I hope this article gives the reader some starting points for reflection on their interests in this crucial market.

With energy transition resulting in more complex, diversified portfolios and the increasing demand for real-time data by energy cost & carbon stakeholders, data on the energy portfolio becomes increasingly important. For this reason, E&C is transforming from a consultancy firm supported by data into a data company supported by consultancy. To manage energy based on the right insights, it’s of crucial importance that you select the right service provider that helps you collect, process and report this energy portfolio data. And this is not just about the capabilities of a platform. How can you trust the data if it is processed by a service provider that needs it to make money for themselves?

In recent weeks, we have chosen to continue our path as E&C, that is independent from any larger company’s interests: E&C by and for E&Cers. One of the reasons for doing that, is because we fear that involvement through investment by a larger company would push us away from this “consultancy only” choice. And we’ve also taken steps such as employee participation to ensure this independent path in the long term. We want to continue to work exclusively in the interest of the buyer side of the energy market, under the adagio: “Power to the consumer”. Please share your thoughts on this in the comments or contact us if you want to learn more about what this could mean for you.