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Commonwealth of Pennsylvania

Energy Strategy

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Agenda

1. The need for change

2. Annual energy spend

3. Liquid Fuels

4. Tank wagon

5. Truck transport

6. Biofuels

7. Coal

8. Natural Gas

9. Electricity

10. Summary

Negotiation

Opportunity

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Need for Change! Objectives!

• Business model for energy procurement had not changed in the previous 50 years!

• $$$$ on the table by not adapting to the “Leading Edge” technologies and procurement strategies. $10M opportunity costs!

• As the Energy Market completes it’s shift from demand driven to supply driven we must assure the continued viability of our supply base for Pennsylvania.

High

Low

Tech

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Demand SupplyMarketFull Reg

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Dereg.

Limited

Greater

Energy in the News!

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Leadership

• Electricity, natural gas and petroleum products have all increased in cost becoming a significant part of our Commonwealth Operating Budget.

• Needed to take leadership role in energy management as model for balance of State and Local Gov’ts!

• Needed to offer our leadership to local Gov’ts to help them manage their energy spend!

It was the right thing to do!!We elected to move forward proactively

with a number of leading edge programs!!

Annual Energy Spend

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Commodity spend for fiscal year 2008

$214 Million in Spend!

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Proactively-This is what we are doing Today!

• Liquid Fuels• Natural Gas• Electricity• Renewable Energy• Coal

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Liquid Fuels

• Previous Contract Structure– Bid differential price (margin, transport) by county– Commodity price floats on daily index– Two methods of delivery by county: truck transport for over 5000 gal., tank

wagon for under 5000 gal.• Disadvantages

– Manages only small portion of our total unit cost (approx. 5%)– Full exposure to the daily volatility of the market– Provides little control over drastic increases in spend– Daily price changes cause frequent invoice payment problems

FY 05-06 FY 06-07 FY 07-08 FY 08-09$0

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

$40,000,000

$45,000,000

$50,000,000

Liquid Fuel Spend

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Tank Wagon Issues & Strategy

Issues

• Many small tanks (<500 gal.) located in remote areas.– Suppliers overbooking causes

OTD problems– Limits supplier base, discourages

new entrants• Invoice Payment problems

– GR entry problems– Supplier confusion– Vast majority of invoices < $5k

• Those who received deliveries closer to 5000 gal. and/or pay bills on time subsidize those who don’t

Strategy

• ITQ Contract for deliveries < 5000 gal.– Qualify suppliers by county

Agencies follow procurement procedures based on $ value

Agencies obtain quotes from qualified suppliers form the ITQ in county, select best price, cut PO

– Invoicing Quoted prices firm, easier to match

GR with IR, less potential for errors.

Mandated utility P- card use for orders under $5000 should remove bulk of payment issues.

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Truck Transport Issues & Strategy

Issues• Current contract structure provides no

control over commodity costs.• No coordination within or between

agencies in terms of delivery scheduling

• Significant purchasing power not utilized.

• Blanket PO’s used almost exclusively, little visibility of inventory or frequency of deliveries

Strategy• Manage fuel purchases for large users

through NYMEX.– Approx. 40% of large fuel customers

use this strategy– Bid differential price/make commodity

buys when price is advantageous Can make buys for front month or

several future months Buys made in 42,000 gal.

increments, can be dispersed to users throughout a supplier’s scope of awards.

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Truck Transport Strategy (Cont.)

• Advantages of NYMEX fuel purchasing strategy– Cost management, not speculation– Gain control of total commodity cost

Reduce market exposure Smooth out spikes in pricing

– Can use this strategy to buy incremental components of usage, reduces risk

“Diversified Portfolio” of fuel purchase quantities and prices

– Flexibility to purchase one or multiple months of usage when market prices reach low point

– BOP processing PO’s centrally, will provide higher quality usage data, visibility of delivery frequency

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Biofuels

• Biodiesel and Bioheat– B5 has been available on contract since 2006.– PennDOT began using B5 state-wide in November 2009 with great success

• Encountered minimal cold-weather issues• PennDOT intends to increase biodiesel percentages in warmer months to B10 or B20.

– State Legislation introduced in 2008 mandates use of biodiesel based on in-state production levels.

• Effective 5/1/2010, every gallon of diesel sold in PA must be at least B2• Mandated percentages increase in steps when increasing production thresholds are

met, will likely increase to B5 within a short time.– A similar mandate for bioheat is in the works.

• Ethanol– E10 is required in the Philadelphia and Pittsburgh areas

• As a result, it has become standard in many other areas of the state

– E85 is available on contract but coverage is spotty• Scarce supply and supply infrastructure• Requires flex-fuel vehicles.

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Coal

• Coal price increase from 2007 - 2008– Anthracite: +15% to $159 per ton– Bituminous: +98% to $188 per ton

• Coal price reduction for 2008 – 2009 vs. 2009 – 2010– Anthracite: -19.05% per ton– Bituminous: -45.51% per ton

• Bulk of 2009-2010 contracts were two year agreements, those that weren’t have been renewed for an additional term due to the favorable pricing

• Coal still 1/2 the cost of natural gas or less based on heating value.• Meet frequently with State staff and suppliers as a working group to map

strategies for expanded use of coal.• Due to emissions requirements and DEP licensing more locations are

choosing alternative energy sources when upgrading their facilities.

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Natural Gas

• Current Strategy– Contract on index rate (margin, transport, & fees)– Commodity price set by NYMEX– Can lock in all, or portion of future commodity at current NYMEX prices at any time

• This strategy has been successful.– May 2009 gas bid achieved $5.7 M in avoided

costs.– More than $11 M in cost savings achieved

prior to May 2009.

• Index contracts provide ability to lock in commodity

price for any portion of total usage for any and all months of contract term. • Provides flexibility to respond to market conditions and utilize hedging

strategy

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Electricity

• Rate caps for PPL Electric Utilities expired at the end of 2009.– Through multiple bids to a pool of electric

generation suppliers, we achieved over $10 M in avoided costs, $1 M of that for local gov’t accounts

– Bids included approx. 1100 Commonwealth accounts and 300 belonging to local gov’t

– Overall, able to reduce the expected increase in generation rates from 30%-35% to 5%-10% on average.

Electricity (Cont.)

• Rate Caps - expire for the remaining PA utilities at the end of 2010• Allegheny Power * MetEd * PECO *Penelec

• Preparing to conduct similar bidding methodology as that used for PPL accounts

– Will also increase outreach to local gov’t to entities in the geographic footprint of these utilities.

• Demand Response - DGS awarded a contract in early 2009 to begin participation in programs offered by PJM Interconnection LLC.

– PJM ensures reliability of the power grid and manages the wholesale power market in all or part of 13 states, including the majority of PA

– Demand response programs offer financial incentives for reducing demand at times of stress on the power grid.

– Awarded contractor, Comverge, Inc. began with pilot program of 4 facilities, generating over $200K of revenues.

– Program expanded and made available to all Commonwealth and local gov’t accounts for 2010. Anticipated revenues are $5 M.

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PJM Membership

• DGS has applied for PJM membership– Would give DGS the ability to procure power in the wholesale market– Would develop a wholesale procurement program, managing power

purchases in real time.• DGS would likely contract with a third party PJM member to provide this service.

– Our membership application is scheduled to be voted on by the PJM Members committee in June.

• Wholesale Purchasing Advantages– Buying wholesale cuts “middle man” in competitive bidding out of the

equation.– Facilitates development and execution of long-term procurement

strategy, managing cost and mitigating market risk.– Allows PA to purchase power directly from generators and maximize

the value of any power we produce ourselves.

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Electricity Cost Savings Estimates

Pro

cure

men

t M

etho

ds

Wholesale ourselves

Wholesale thru agent

Index Price

Block Index

Firm Fixed Price

0% 5% 10% 15% 20% 25%

Cost Savings vs. Uncapped Rates

% Savings Potential

Advanced Energy Procurement

• Next-generation retail energy bidding and reporting platform.– Development undertaken by the Penn State Facilities

Engineering Institute, our long-term energy consultant.– Functionality

“Margin-plus” pricing for electricity and natural gas.Make strategic decisions based on historical data, real-time pricing.Ability to manage cost of most billing elements, not just commodity.

– Electricity• Supplier bids margin plus select fees only, trigger layers of on-peak

and off peak blocks of power, financial transmission rights (congestion) at real time rates

– Natural Gas• Supplier bids margin plus select fees only, trigger gas commodity,

basis based on real-time pricing.19

Summary

Liquid fuel - Purchases split into two categories based on delivery size– Gain control of total unit price for large deliveries and hedge against price

hikes. Mitigate administrative costs on small deliveries

Biodiesel – PennDOT has used B5 successfully, state-wide retail mandate now in place

Coal - Current procurement process has allowed for assured quality at lower per-ton prices and lower costs compared to other fuel sources.

Natural Gas - Strategy has generated tremendous savings vs. regulated utility costs and provides a mechanism to hedge against price increases.– Moving towards more sophisticated methods to achieve greater savings.

Electric - Working diligently to mitigate costs associated with continuing expiration of rate caps.– Will reduce impact of rate increases.– Moving towards wholesale procurement, the “Sam’s Club” of electricity.

The Commonwealth has responded to changes in energy markets

and rapidly rising costs by adopting leading edge strategies.

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Questions

• Questions for us?• Questions for you

– Management of market pricing in fuel contracts?

– Winter operability concerns with diesel fuel/biodiesel fuel? What are specifications?

– Buying renewable electricity? If so, how?– Emissions credits?

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