Five Keys to Negotiating Energy Supply Agreements

We are now on the final piece in our series on negotiating energy supply agreements – material change language. This wraps up the five-part discussion, which also offered our insights in the other four keys:

1. Payment terms
2. Termination fees
3. Adding and deleting accounts
4. Usage bandwidth

Material change language is something of a “catch-all” with regards to whether the customer is charged the contracted rate, or a different rate based on “material changes” in energy usage, perhaps due to operational or business changes.

Clarify Collateral Requirements

Many times material change language is broad enough that it touches upon several aspects of the supply agreement. If there is a change in the operations of the company, such as increases in production lines or shutting down of a facility, this can be interpreted as a material change by the energy supplier. Other times this is defined by a change in credit standing. The supply agreement often includes the requirement of “performance assurance” or collateral in the event of material change, and these situations of change in standing can cause the supplier to seek adjustments in the contracted supply rate.

Unfortunately for the buyer, the language is often left to the interpretation of the supplier. This can lead to unforeseen – and unbudgeted – costs. If the contract language asks for collateral, this typically takes the form of two to three months’ worth of bills posted as performance assurance. This often creates a battle over whether these measures are warranted in situations where a “negative” change in the customer’s standing is not clearly defined.

Understand Change in Usage and Bandwidth Language

The more common use of material change language has to do with changes in the customer’s operations that result in changes in usage. Let’s say you are a manufacturer, and your production has dramatically increased such that your energy usage is now doubled on a regular basis. This would be considered a “material change” in usage as defined by the supplier.

Remember that there is a distinction between “usage bandwidth” (which we discussed at length in the fourth installment of this series) and “material change.” Usage bandwidth applies to adjustments in your actual energy usage, given you are still operating as you normally would; material change deals with adjustments in your organization’s operations that are considered a more permanent change resulting in drastically higher or lower energy usage.

A material change comes about when your operations have changed on a regular and/or permanent basis, and this results in an ongoing increase or decrease to your usage. For most energy (electricity or natural gas) contracts, the supplier purchases the energy based on the estimates of your future use. If you suddenly – or consistently – use more or less than expected, the supplier must then either buy extra energy in the market or sell unused energy back. This can result in a potential loss for the supplier.

So even though your contract may have language saying that you have 100 percent usage bandwidth, a material change can trump that language and result in fees, penalties, or even a change in price that will have an effect on your overall budget.

Define the “Material Change”

As we mentioned during our discussion about changes in a company’s standing or energy usage, the key consideration is how that situation is measured. Material change language in a supply agreement can be very gray, leaving the definition – and resulting actions – up to the supplier’s assessment. In these cases, there is usually a significant back and forth between lawyers that leads to more time and cost.

Therefore, it is always a good idea for you, as the energy procurer, to push for a tighter definition of material change in the agreement before signing. Begin by requesting specific contract language to state that the energy usage must exceed a certain percentage of the estimated usage to qualify as a material change. You can further clarify your contract by adding verbiage stating that this change must take place for several months in a row, which would then be more indicative of some type of company change leading to more or less usage.

The result of a material change can range from the supplier updating the contract to reflect a different price to the supplier assessing a fee very similar to an “early termination fee.” Either way, you should pay attention to how this is defined so that you don’t end up paying something that is not reflective of the actual damages to the supplier.

Reach a Good Compromise

All of the five key factors we have discussed throughout this series are crucial to address before you sign any supply agreement with an energy supplier. By leaving these considerations unaddressed, you are really at the mercy of an agreement that most assuredly is written by the suppliers’ lawyers and puts much of the risk onto you as the buyer.

Price moves with risk. If you put all the risk on the supplier, you will pay a higher price. Avoid the temptation to get the very lowest price by agreeing to less favorable terms that put all the risk on you. If you, as the buyer, bear the risk with each of these five key factors, you have a very good possibility of paying more than you anticipated through the associated fees that come along with it. This then undoes your goal of getting the lowest price.

The goal is to arrive at a mutually agreeable compromise where each party is shouldering an appropriate amount of risk. A good compromise is where both parties are sharing risk and the price is then reflective of this. Now that you know what to consider, you can avoid the possible loopholes that pushes the risk onto your shoulders.

Bob Wooten, C.P.M., CEP, is Director of National Accounts for Tradition Energy, and has over 20 years of experience managing commercial, industrial and governmental procurement programs for a wide variety of clients. Bob holds professional certifications from the Association of Energy Engineers and the Institute for Supply Management, as well as a B.A. from Texas A&M University, and a Master’s in Public Administration from the University of Houston.