Going Once, Going Twice ...
One Maryland county gets a charge out of reverse auctions.
Steve Nash doesn't like to think back to the spring of 2004.
Nash, chief of the engineering and management services section of the Division of Operations in Montgomery County, Md., worked long hours with a consultant to develop software to assess bids from competing electricity suppliers. But Nash and his operations team quickly realized they had a glitch.
"One Excel spreadsheet did not feed into another the way it was supposed to, so the figure we came up with was too good to be true," he said. "The bidder balked, and it was a good thing, because we would have been in big trouble if we [had] signed a contract with those figures."
Bidding was halted, the consultants fixed the software problem and the county successfully awarded contracts for some of its accounts. But the "meltdown," as Nash calls it, underscored the need for a more sophisticated approach to the energy procurement process when contracts came up for bid in 2006.
Montgomery County turned to the World Energy Exchange, an online reverse auction run by Worcester, Mass.-based World Energy Solutions Inc. Unlike a traditional auction where customers bid incrementally higher amounts, a reverse auction creates an environment in which suppliers bid their prices down to win a contract to supply a commodity. The Exchange provides customers documentation of the purchasing process, from pre-auction planning to real-time auction bid tracking, and contract and usage management after an auction is completed.
Over a two-day span in March 2006, Montgomery County -- located in the suburbs of Washington, D.C. -- held 68 auctions and received 292 bids. More than $125 million in contracts were awarded, with terms ranging from 12 to 36 months. The county estimated the cost avoidance for all the contract terms to be more than $24 million, and this time, there were no software glitches, Nash said. "We have been unbelievably pleased."
For local government agencies around the country, the deregulation of electricity has vastly complicated a procurement process they barely had to think about when prices were regulated. In states such as Maryland, deregulation has resulted in price hikes of more than 70 percent, making procurement officers' efforts to aggregate demand and squeeze savings out of a bidding process even more crucial.
"This has become another big task they have to do," said Jonathan Harvey, vice president of business development at World Energy. "The markets are much more complex, but the work force responsible for it hasn't changed, and the time they have to devote to it hasn't changed."
Montgomery County wasn't the first government entity in the Old Line State to try reverse auctions for energy purchases. In 2004, Maryland became the first government in the country to procure electricity through a reverse auction. Because they were pioneers, there was some trepidation, admitted Carl LaVerghetta, director of procurement for the Maryland Department of General Services in Baltimore. "But we found that with a pure commodity like electricity, a reverse auction works great," he said. "It's a perfect fit."
After interviewing several vendors, the state contracted with World Energy and its channel partner, San Diego-based SAIC. Between March 2004 and May 2005, they completed three procurements worth $114 million. The auctions involved seven suppliers, and LaVerghetta estimates the state avoided more than $13 million in costs over that time. "It's an interesting partnership," he added. "We now consider World Energy part of our procurement process."
Maryland has three more procurements scheduled for early 2007, combining state agencies and most of the University of Maryland system.
LaVerghetta said the biggest challenge his department faced was the organizational and educational effort to get state agencies ready for an auction. "We had 8,000 accounts in state agencies but we didn't even have a database of them. We had to go back and get our ducks in a row first," he recalled. "Then we had to go through a huge educational process with procurement executives and agency heads who were used to getting just one bill a month from a single electric utility."
In the case of Montgomery County, its officials saw deregulation coming several years ago and were determined to act, Nash said. "In 2000 they convened a meeting of county agencies such as schools, the community college, the sewer agency and others, and said, 'Let's create an 800-pound gorilla to leverage our size and negotiate better electricity deals.'"
Led by six county agencies, the jurisdiction created a 16-member aggregation group to procure electricity. Joining the group were several local cities and towns, such as Gaithersburg, Rockville and Takoma Park.
Serving as the group's lead procurement agency, Montgomery County structured a process that allowed electricity contracts to be bid and awarded within days. From October 2000 through June 2004, members of the aggregation group saw savings of $5.6 million below Maryland's Standard Offer Service (SOS) rate, which sets a regulated price for consumers who choose not to select an electricity supplier.
But both the governmental entities and the utilities had a lot to learn about the process. "We were new in the aggregation business and so were the utilities," said Nash. County officials found they had to keep going back to their chief administrative officer for exemptions from procurement rules. "They kept bumping into regulations that ran counter to quickly resolving the bidding process, such as a requirement to post requests for bids for 10 days," he added.
The utilities had to go through their own learning curve about things like terms and conditions. There were issues around indemnification and penalties for nondelivery. Also, some utilities balked at contract language stating that the contracts were dependent on continuing resolutions of municipalities, and subject to appropriations every year.
In the Hot Seat
Nash was handed responsibility for the aggregation board in summer 2003, just as the current set of contracts were set to expire in summer 2004. "I was the guy thrown into the hot seat to get a new contract in place," he recalled. By then, the aggregation group had grown to 18 members, including neighboring Prince George's County, and a contract for renewable "green energy" was included.
For what Nash called this "second iteration" of bidding, new regulations were created to eliminate the impediments they'd run into the first time. "We capped damages in disputes and made sure the suppliers agreed up front about terms and conditions before they were qualified to bid -- something that had led to problems earlier," he said. In prequalifying bidders, they also rated them on experience, financial stability and other measures.
One effect of Maryland's statewide deregulation, which took effect in July 2004, was to force the bidding processes to speed up. Wholesale prices were changing much faster, so negotiation and awarding of contracts had to move from several days to a process that could be completed in a single day.
"We realized that to receive bids on 2,630 accounts and assess whether they beat the default Standard Offer Service, we had to get a computer involved," Nash said.
That led to the 2004 software glitch. And although that second iteration of bidding was successful in saving the group $2 million on 526 awarded accounts, it also led Nash to realize the process might require a level of expertise the county didn't have. "You can't just take all these accounts and stick them together, and think you've got leverage," he explained. "It's more complicated than that. Suppliers wanted to bid on the larger accounts, but not on the smaller ones." When the group made it a requirement to bid on both large and small accounts, the suppliers offered bids for the smaller accounts that were more expensive than the SOS. "Utilities didn't want to fool with them," he said.
For the third iteration of electricity procurement in 2006, Nash began talking to World Energy and SAIC about using their reverse auction technology. "The more I talked to them, the more I realized they were speaking our language. Everything that got screwed up in the second iteration, they had been there, done that. We started to see this online reverse auction as a silver bullet."
World Energy executives said approximately 60 percent of the company's revenue is from government accounts. "There are a lot of online auction sites that deal with pencils and rubber bands, but our single focus is energy," Harvey said, adding that that specialty is important to government customers. "We bring them a tool so the procurement doesn't create an undue burden on them, and they don't have to deal with figuring out all the market forces at work."
World Energy's business model creates no risk and no up-front cost to the customers, according to Harvey. "If we don't get them rates they like, we don't get paid. If they do sign a contract, we get paid a fee by the winning supplier."
On March 21 and 22, World Energy ran 68 auctions for Montgomery County's aggregation group, with each auction lasting five minutes. With a graph projected on his conference room wall, Nash monitored each auction as the prices dropped. Much of the activity occurred in the last 15 seconds before the auctions ended. "It was so cool," he said. Out of 2,565 accounts, 2,407 were awarded, representing 97 percent of the aggregation group's total electricity load.
Montgomery County is now working on moving up to an even higher level of sophistication. Its school system is developing a pilot project to buy blocks of energy on the wholesale market, the same way utility companies do.
Both Nash and LaVerghetta said that although the cost avoidances they've achieved were substantial, government entities moving into aggregated procurement and reverse auctions shouldn't underestimate the complexity and the amount of organizational effort involved.
"You've got to be informed," Nash said, "and have a team with the horsepower to complete the deals on your side."