Appendix D

Energy-Related Group-Purchasing Opportunities

Connecticut state agencies can use procurement contracts negotiated by the Department of Administrative Services to obtain energy-related commodities including:

• natural gas;
• fuel oil -- No. 1, No. 2, No. 4, and No. 6;
• propane;
• gasoline;
• diesel and bio-diesel fuel; and
• aviation gasoline and jet fuel.

The state purchases all of the commodities listed above, except natural gas, using the same type of procedures to select vendors and set prices that it uses for other traditional commodities. The process for purchasing natural gas is described in detail below. Also presented is a description of the state's efforts to set up an electric purchasing pool.

Natural Gas Procurement Assistance

Currently, 19 state agencies purchase natural gas supplies under a state procurement services contract. The Office of Policy and Management administers the program in conjunction with the Department of Administrative Services, the agency statutorily authorized to contract for goods and services on behalf of the state.

The current contract covers state fiscal years 2002 and 2003. Like other DAS contracts for commodities, the natural gas contract is a competitively bid, multi-year agreement available for use by multiple state agencies. The contract allows participating state agencies to obtain natural gas supplies under a group, firm¹ contract price negotiated by OPM and DAS. In addition, the billing process is simplified.

OPM estimates the quantity of natural gas consumed by the agencies currently participating in the program represents nearly 85 percent of the total amount of natural gas used by state agencies on firm (rather than interruptible) service agreements.²

OPM estimates the state saved $3.2 million since the start of the program in 1997. Until FY 02, annual percentage savings ranged from 12 to 22 percent of the dollars the state would have spent for participating accounts, if there was no contract. In FY 02, the state paid 16 percent more.

Pilot program. The idea for the natural gas procurement program dates to 1996 when OPM got involved with a DPUC informational docket related to the deregulation of natural gas. DPUC wanted to allow the use of competitive suppliers for commercial and industrial accounts. OPM became involved from the perspective of the state as a consumer of energy rather than as a policy maker.

At that time, most state agencies dealt directly with local utilities and made their own arrangements to obtain natural gas. (The Department of Public Works handles energy procurement for some agencies, while others in rented space receive their energy supplies as part of their lease arrangements.) Agencies with facilities in more than one portion of the state might deal with as many as three natural gas utility companies.

For the pilot phase of the program, OPM sought to contract with a third-party supplier to serve a few state agencies on firm contracts. Although this competitively bid contract began in mid-1996, agencies did not actually begin receiving gas supplies until January 1997. The three agencies participating in the pilot program were the military and judicial departments and the community-technical college system.

To keep the process simple during the initial phase of the program, the pilot contract used the "burner tip" method to calculate the cost of the natural gas being purchased. Under this type of pricing, the costs of the two components of natural gas -- the price of the commodity itself and the utility's fee for transportation -- are combined into a single rate.

Under the pilot contract, the third-party contractor -- Duke Energy -- sent each participating state agency a monthly bill for the total cost of the natural gas used. After the agency paid the bill, the contractor was responsible for paying the utility company its portion of the bill. (Increases in either component of the price had to be absorbed by the third-party contractor, while savings from decreases were retained by the contractor.)

Following the pilot effort, OPM teamed with DAS for the next contract cycle. OPM was responsible for the technical aspects of the proposal, while DAS provided legal backup and its purchasing authority.

The pilot contract with Duke Energy was extended to continue serving the agencies already covered under it, but the pricing was re-established. A new contract, also using the burner tip method of pricing, was awarded to Energy Vision for service to seven more agencies. The prices charged under the two contracts differed to reflect the usage of the agencies covered under each contract.

Change in pricing method. In the private sector when a customer seeks bids for natural gas, commonly only the cost of the commodity -- the deregulated portion of the equation -- is put out to bid. The transportation cost charged by the local utility, based on DPUC approved rates, is billed separately. (This latter charge varies by utility company.)

In 1999, when the State issued the request for proposal for the next natural gas contract, a variation of this more common pricing method was used. The commodity price was separated into its two sub-parts -- the NYMEX cost and the fixed MARKUP. The sum of the two components is called the total commodity price. When that price is added to the pass-through cost from the utility for its transportation services, it represents the total price the state pays the contractor per unit of measure.

The NYMEX component is the price per CCF (i.e., hundred cubic feet) posted by the New York Mercantile Exchange for future purchases of natural gas. Prices move up and down throughout the trading day in response to anticipated supply and demand for immediate and long-range time periods. Changes in the prices reflect expectations about future events such as regional temperatures, forecasted snow or tropical storms, and economic conditions. Figure D-1 summarizes the process.

Under the state's contract, OPM analyzes the marketplace to target natural gas prices for specific time periods, which can range from one month to the length of the contract. ³ When the NYMEX futures price reaches the level OPM has decided on, that price is locked-in.⁴ If OPM has not locked-in a NYMEX price at least four days before the month that is about to begin, then a "default" price is set. The default price is the average of the final three daily settlement prices for the NYMEX futures contract for the delivery month.

The MARKUP rate is a set amount identified during the bidding process. It covers the supplier's handling costs, including applicable taxes and administrative expenses. The specific price is agreed upon when the contract is awarded, and it applies for the duration of the contract.

At the request of participating agencies, OPM retained the single billing requirement of the pilot contract. Although the state must pay the DPUC approved rate for the local utility's transportation component of the fuel, the third-party supplier was required to handle billing and payment of the pass-through charges. Under this system, the utility sends the actual bill to the contractor, but a copy is also sent to the state agency consuming the fuel. The contractor then provides each participating state agency with a single monthly bill showing the total cost of the fuel used as well as the portion attributable to each element.

The current contract, awarded in February 2001, uses the same pricing method, but requires revisions in the billing process and format. Specifically, the contractor must provide participating agencies with more information regarding previous balances, payments, and adjustments as well as current charges, including time period, quantity consumed, and pricing by component. The information is to be presented by service location, but upon request, the contractor must be able to provide each agency with a single invoice summarizing all of its accounts and meters.

Table D-1 summarizes the key elements of the natural gas contracts issued to date. The current contract expires at the end of FY 03.

Participation. The number of participants in the natural gas procurement program has increased from three state agencies to 19 (covering 32 locations). Table D-2 later in this section lists the participating agencies.

When the natural gas contract is put out to bid, OPM includes energy usage data for the agencies expected to participate. This provides the contractor with an estimate of the natural gas the participating agencies will need during the upcoming year. Updates are sent periodically to reflect accounts being added as well as reductions for facilities already closed or about to close.

Under the contract, new locations can be added at any time. Agencies already included under the contract on the starting date can add additional accounts and meters to the contract for the same price that the parent agency pays. New agencies joining the contract after it is underway receive a price based on market conditions at the time they join.

Municipal agencies can also purchase natural gas under the state contract, although none have. If any do sign up, they would be treated like a "new" state agency for pricing purposes.⁵

Billing issues. A simplified billing system for participating state agencies is a secondary goal of the natural gas procurement program. Achieving that goal has required OPM staff to expend considerable time since the start of the program resolving billing issues.

An early complication arose over the mechanism for paying the third-party contractor. State accounting procedures allow utility bills to be paid using a reservation account rather than a purchase order. However, the comptroller's (and some agency) computer systems did not recognize the third-party contractor as an entity eligible for payment under the reservation system because it was not a utility company. This issue was finally resolved in 2001. Under the newest natural gas procurement contract, agencies have been allowed to use the reservation system to pay for purchases under the natural gas contract.

When agencies initially begin participating in the program, there is sometimes confusion about the documents they receive from their local utility. Under the state contract, the utility sends the bill for each agency to the contractor, but the utility also sends a copy of the bill to the agency. This led some agencies to pay the utility directly based on the copy and then not pay the contractor when the actual bill arrived, or the agency paid the bill twice.

OPM also receives copies of the bills from the utilities. In some cases, OPM identified overcharges, resulting in credits for the agencies involved. For the past few contracts, agencies with multiple locations have been able to use one check to pay for all of their accounts.

Another billing-related problem concerned the time frames covered by the bills sent by the contractor. An invoice might cover fees for different months for different components of the bill. For example, the supplier might be billing for the most recent month of fuel consumption, while the utility charge might be for an earlier month because of a delay in the contractor receiving that bill.

Mixed time periods in the bills can affect the way agencies post the information to their billing system. It can also affect analysis of expenditures and consumption data. For example, the state consumption monitoring system tracks the usage of various fuels on a monthly basis. It needs to receive data according to when the fuel was used, not when it was billed or paid for.

New billing requirements in the current contract require the contractor to specify in greater detail the information participating agencies receive and the timeliness of payments to utilities. Although these requirements may have increased the cost of the MARKUP component of the contract, OPM anticipates the changes will reduce future billing problems. Combined with additional training of the fiscal staff of the participating agencies (in order to improve their understanding of the program), OPM expects to be able to reduce the staff resources it has assigned to this program.

Other issues. Several other issues have arisen as a result of the state moving away from a system of obtaining natural gas directly from a utility to one involving a deregulated supplier.

DPUC requires customers using a third-party supplier to have a telecommunications line attached to each gas meter so the local utility can continue to monitor usage. Installation and maintenance of such lines to some sites (e.g., manholes in the street or a greenhouse) can be costly. This policy is currently under review by DPUC, which has already modified it to exempt meters for accounts that consume less than a certain quantity of fuel. Business managers in participating agencies also need to be informed of this requirement to insure they do not take steps to disconnect the telephones as unused.

The state needs to decide whether all state agencies that use natural gas should be encouraged or required to participate in the contract. Because of the variability in the quantity of fuel consumed by agencies and the rates charged by area utilities, it is not always cheaper for agencies to procure natural gas through the procurement contract.

In a related area, a decision has to be made about how to deal with agencies on interruptible contracts for natural gas service. Since rates for these customers are traditionally low, it is difficult for the state to enter into a procurement contract that will offer a pricing structure that can produce additional savings.

Savings. OPM calculates the benefits of the natural gas procurement contract monthly. Savings are determined by comparing the price paid for natural gas under the contract with what the same quantity of fuel would have cost if it had been purchased directly from the local utility company during the same time period.

The goal of the program is to attain overall dollar savings for the state, factoring in the results from all of the participating agencies. While some agencies achieve substantial savings, others may not save any money, and a few may even pay more.

The potential for savings varies by geographic region. Three natural gas utilities operate in Connecticut, and the rates they charge vary. Agencies with accounts in Yankee Gas territory will have the easiest time saving money under the procurement contract. Customers of Connecticut Natural Gas will have the hardest time, because the existing rates of that company are more competitive. (Southern Connecticut Gas -- the third company -- falls in the middle.)

OPM does not calculate non-fuel savings, but agencies do attain other benefits from participating in this program. In addition to the more efficient bill paying system discussed above, some agencies have consolidated the meters in their facilities, thereby reducing the monthly fees they pay for such equipment. Involvement in the program has also enabled agency personnel to better understand fuel pricing and given them experience working with suppliers of a less traditional commodity.

In FY 01, participating agencies spent $10.4 million for natural gas under the contract. OPM estimates the same quantities of fuel purchased outside the contract would have cost those agencies $11.9 million, for a savings of 13 percent. In FY 02, contract expenditures totaled $9.7 million versus $8.4 million if purchased outside the contract, for an additional cost of 16 percent. Table D-2 presents estimated annual savings by agency since FY 98.

Electric Procurement Program

Under C.G.S. Sec. 16a-14e, the Office of Policy and Management is required to operate a purchasing pool for the purchase of electricity for state operations. In 1998, OPM issued an RFP and hired a consultant -- Strategic Power Management -- to conduct an aggregation study to identify, quantify, and profile state government's aggregated electric load (including historical usage and peak demand).

The study, which took about six months, found approximately 3,500 accounts. Not all of the accounts were subject to deregulation because some were customers of municipal electric utilities. In addition, three state entities -- the University of Connecticut, Eastern Connecticut State University, and Western Connecticut State University -- had entered into special contracts with their local electric utility, Connecticut Light & Power Co., that precluded them from participating in the state program immediately.⁶

Once existing state electric accounts were identified, actual usage data had to be compiled. In addition, an assessment was made of the effect of the state of Connecticut becoming a single, unified electric customer. Based on the analysis by the consultant, it was determined that overall the state would fare better as one combined customer rather than a number of smaller customers. This analysis did not factor in the cross-subsidization issue wherein some agencies in a group purchasing pool save, while others do not.

In December 1999, DAS issued an RFP for an electric procurement contract.⁷ Bids were due in February 2000.

Although there was a lot of interest in the purchasing pool concept and a number of people attended the mandatory bidders conference, only two bids were actually received. One arrived late and was disqualified for that reason. The other arrived on time, but it was rejected for failing to fulfill the bid requirements. Specifically, the proposed price was valid for only a portion of the time frame the bid was to cover, and some agencies specified in the RFP were excluded from eligibility to make purchases at the bid price.

After rejecting both bids, OPM terminated the RFP process and undertook a discussion with industry representatives about the program concept. It wanted to find out which elements of the bid specifications had created problems. In addition, OPM wanted to understand the status of electric deregulation issues in general and how changes in the overall marketplace would affect the state's efforts to successfully establish a combined purchasing pool.

Based on those discussions, OPM identified several problems that may affect efforts to re-bid the contract. The first issue is the Connecticut standard offer.⁸ Potential bidders said the "default" price charged by CL&P or United Illuminating under the mandated standard offer through 2003 is so low it is difficult for them to offer a lower price through the competitive bid process.

Some people suggested the state's RFP should include a "green" component as a requirement. Under the current law, this would allow companies to place a higher price on that portion of electricity supplied, providing an opportunity to build in some profit.

The timing of the initial RFP with respect to supplies was also an issue. The bid request preceded an infusion of new capacity expected to come on-line after 2001. If the marketplace works as envisioned by the electric deregulation law, the availability of these new generation supplies should increase competition and decrease prices. Until then, the closeness of the levels of anticipated demand and existing supply keeps prices within a narrow range.

Another element of the contract requirements that created a challenge for potential bidders was the statutory mandate that any household with an individual who receives state or federal means-tested assistance has to be given an opportunity to participate in the state purchasing pool. Under the statute, households participating in the state pool must receive the same benefits and rate discounts as those available to state facilities. Among the concerns raised were:

• how to define "same benefits;"
• which of the multiple rate classes used by the state for its various accounts would be chosen for these residential customers;
• which of the multiple eligibility requirements used for various state and federal government assistance programs would be chosen to determine eligibility for participation in the State pool;
• how to estimate the number of households that would choose to participate;
• responsibility for unpaid bills; and
• how to handle the possibility that participation in the program might end up costing a household more than if it had purchased electricity outside the pool.

An additional issue OPM is examining is the billing process that will be used for the electricity contract. Based on state agencies' experiences with the natural gas contract, some invoice and payment problems can be anticipated initially when agencies switch to a commodities contract for electricity. Because there is more variability in the pricing of electricity and more money is spent on it, greater efforts may be needed to educate individual agency personnel on interpreting and monitoring data received from the supplier.

In September 2002, OPM issued an RFP to cooperatively purchase electric generation services for the state's approximately 300 unmetered street lighting accounts in the service territory of Connecticut Light & Power Co. (Annual consumption is estimated at 3.5 million kWh.) Bids are due in October 2002, with a targeted start date of no later than January 1, 2003.

The next attempt to set up a more comprehensive electric purchasing pool is expected to be announced in the second half of 2003. That RFP will seek to address problems identified with the scope of the first contracting effort. For example, the proposal may allow for the phase-in of the required residential component for individuals receiving means-tested assistance.

¹ There are two pricing structures for natural gas -- firm and interruptible. Under a "firm" contract, the customer receives a continuous flow of fuel from its local utility company. "Interruptible" rates are available to customers who have an alternative source of fuel available to use in place of natural gas. These customers pay a lower rate, but they are required to switch over to their alternative fuel under specific circumstances. Under manual interruptible contracts, once a customer is told to switch over, they have a contractually established amount of time, generally several hours, to make the change. Under automatic interruptible contracts, the system is set up to change over upon a pre-set trigger, such as an external temperature.

² Based on OPM consumption monitoring data, participating agencies consumed approximately one-third of all of the natural gas purchased by the state in FY 00.

³ OPM uses an ad hoc working committee with representatives from OPM, DAS, the Connecticut Business and Industry Association, and the contractor to analyze technical information about the natural gas marketplace for the heating and cooling seasons covered by the contract.

⁴ If the NYMEX price should increase prior to the time a locked-in rate will apply, the state cannot be charged more than the locked-in price. If the NYMEX price should decrease by the time the fuel is to be consumed, the state will still be required to pay the locked-in rate.

⁵ In preparation for the second contract in 1999, OPM specifically invited the Boards of Education in the 10 towns that spend the most on natural gas to join the bid process. Three towns -- Hartford, New Britain, and West Hartford -- expressed interest, but in the end all declined to participate in the contract. Since then, several regional planning agencies -- the Capital Region Council of Governments and the Greater New Haven Regional Planning Agency -- have set up purchasing groups similar to the one operated by the state, and local municipalities are joining those.

⁶ As a precursor to electric deregulation, DPUC allowed electric utility companies to enter into agreements with some customers to provide reduced rates in exchange for undertaking conservation efforts and equipment upgrades.

⁷ Although the statute establishing the program specifies OPM will operate it, OPM does not otherwise have specific purchasing authority. Therefore, it chose to work with DAS on this contract in the same way it does on the natural gas procurement program.

⁸ Under C.G.S. Sec. 16-244c, an electric distribution company must make electric generation and distribution services available to all customers in its distribution area through a "standard offer," set by DPUC for each company. The standard offer provides that the total rate charged (including electric transmission and distribution services, the conservation and load management program, the renewable energy investment charge, electric generation services, the competitive transition assessment, and the systems benefits charge) must be at least 10 percent less than the base rates (defined as the total amount charged each class of customer for the fully bundled costs of electricity) in effect on December 31, 1996. This pricing formula expires January 1, 2004, unless it is extended by the legislature.