Energy procurement strategy

Report: 15
Date: 19 July 2001
By: Commissioner

Summary

The existing contracts for both electricity and gas are due for renewal on the 1st October 2001. The value of the contracts requires that both be tendered via European Community procedures. The present contracts were awarded during a period where tender prices, especially for electricity, were highly volatile and rising rapidly. The contracts were of one year duration due to price uncertainty.

Procurement should reflect the aims and aspirations of the current MPS Environmental Strategy, considering renewable energy sources for electricity whilst balancing cost against environmental considerations.

The lessons from previous tendering rounds have been considered and they are reflected within the recommendations. Consultation has been undertaken with the MPA policy unit, external utility supply specialists, London Electricity and Ecotricity.

A. Recommendations

1. To note that expressions of interest to tender have been sought through a notice published in the Official Journal of the European Community (OJEC) seeking separate electricity and gas supplies for the MPA Estate.
2. To agree the main electricity supply contract for all non-domestic supplies to the MPA Estate provide for the provision of electricity from either traditional or renewable sources and that the award be made on the basis of the best financial offer.
3. To consider whether the Committee wishes to tender for electricity supply to Cobalt Square and Orpington Police Station separately from the main tender on the basis of a renewable energy source in support of the Environmental Management System (EMS) pilot scheme. The likely additional costs (up to £34,000 per annum) to be financed from efficiency savings
4. To agree that if the successful tender for the main electricity contract is awarded on the basis of a traditional supply source, Cobalt Square and Orpington Police Station be omitted from the main contract, and be supplied separately under a renewable electricity contract.
5. To tender the gas supply contract on the basis of the best financial offer.
6. To agree tenders for both electricity and gas to be for a 2 year contract with a "match or release" clause for a third year.
7. To delegate authority to award the contracts to an MPA nominated officer, the Treasurer or Clerk following a recommendation by the Director of Procurement and Commercial Services based on the lowest tenders received. This would enable a contract to be signed within the few days available to evaluate and accept suppliers' offers.
8. To agree that any savings resulting from lower utility costs be used to reduce budgets.

B. Supporting information

1. The separation of electricity and gas tenders is proposed. This removes an option available to previous suppliers to supply both electricity and gas to the MPS in a combined offer. For domestic premises, it is usual for suppliers to offer both fuels in a combined package with one utility able to subsidise the other due to higher profit margins on domestic supplies. Profit margins are lower for commercial and industrial supply, due to increased competition and a reduced ability to subsidise. The number and diversity of sites in the MPA estate as well as the complexity of some resulted in only specialists in one or other utility having the resources necessary to make a competitive bid. The tendering process and market volatility makes it impractical for a specialist supplier to seek prices for the non-specialist utility needed to complete their package in a realistic timeframe. The complexity of the previous option substantially increased the tender preparation time and excessively complicated the evaluation process.

2. There is a commitment within the Environmental Strategy & Report - January 2001 (endorsed by the FP&BV Committee 20 March 2001) to consider renewable energy against both environmental and financial issues.

3. The value of the contract for electricity requires the contract to be tendered under EU procedures seeking an appropriate balance between cost and quality. In this context, the "quality" relates to the environmental impact. However, there is no legal obligation to take renewable energy contracts.

4. The industry estimates that electricity from renewable sources carries a premium of between 4 per cent and 20 per cent, even allowing for renewable energy exemptions from the climate change levy. The additional cost in respect of renewable energy across the MPA estate would be about £550,000 per annum based on a yearly value of £5.5m and a 10 per cent premium.

5. Not all suppliers are able to supply renewable energy. Those that can, may not have the capacity to supply the entire MPS contract at this time. It is difficult to justify the level of premium associated with obtaining all of our electricity from renewable sources based on reduced environmental impact.

6. The pilot Environmental Management System (EMS) at Cobalt Square and Orpington Police Station therefore provides an opportunity for the MPA to demonstrate commitment to the environment without incurring a significant financial penalty. The two sites represent 3 per cent of our electricity costs with a combined annual cost of about £170,000. The additional annual expenditure would be between £7,000 - £34,000 per annum. In support of the pilot EMS the recommendations are designed to ensure that the pilot EMS sites are supplied with renewable energy.

7. There are no "renewable" source implications in respect of the gas supply and no commitments within the Environmental Strategy that impact on the recommendations of this paper.

8. The contract used during recent tenders provided the option to make offers of 1, 2 and 3 years' duration. As the duration extends, the ability to predict market movements becomes less certain. Very few traditional contracts can demonstrate best value beyond two years. (Last year market conditions were very volatile. External energy analysts could not demonstrate that any offer provided best value beyond one year.

9. A factor recognised, but not fully costed, is the resource necessary to undertake annual tenders. This, together with the difficulties of reconciling accounts for all properties between the outgoing and incoming suppliers on a contract of this size and complexity, makes a yearly contract unsuitable without a significant increase in team resource.

10. A "match and release clause" for the third year of the proposed contract provides the opportunity for the MPA to ensure the contract is providing best value. It enables the contract to be terminated, by the MPA alone, in the event that the incumbent supplier does not match current market rates.

11. Utility contracts are of a unique nature. They require rapid evaluation and acceptance of complex offers if best value is to be obtained. Last year the contract was awarded at a time of such market volatility that offers were continually being reviewed by the suppliers. The withdrawal of an offer and its replacement with a revised offer requires evaluation and approval to be carried out within a few days. The recommendation was for a one-year contract, the value of which fell within delegated officer powers and could be rapidly approved after evaluation. It will not be the case this year because of the proposed (up to) three-year contract duration.

12. The committee process to approve a tender requires a time span that would result in the likely loss of the offer and the application of default charges by the outgoing supplier. It is therefore suggested that a recognised procedure for utilities contract approval be established. It would delegate authority to the Clerk of the Authority to award a contract that complies with the agreed procurement strategy.

13. The most recent (and previous) tendering rounds identified areas within the specific terms and conditions that were time consuming and complex to administer but added no significant value to the process. Any potential advantages or savings being outweighed by the additional effort and resources necessary to carry them out. For this round these specific terms and conditions have been reviewed and amended.

14. Previously electricity supplies of domestic volume (representing 0.75 per cent of consumption, but 13 per cent of our sites) were included within the contract. The rates differed only slightly from published tariff rates from Regional Electricity Companies (REC's). The complexity of the tender process and the resources necessary to maintain these supplies on contract is out of proportion to their value. These have now been removed from the tender details and will be retained by their host REC.

15. The terms and conditions also allowed multi-rate, energy only, prices to be submitted which required significant analysis to be made before the offer could be evaluated. It required a disproportionate resource to process and record the information received in time. The tender will now be on the basis of an all-inclusive two-rate maximum demand tariff.

16. It was also the case that invoices were paid on actual or estimated consumption and reconciled annually and at contract end. This process required that all invoices were checked against previous consumption profiles, which is both time consuming and costly. As most invoices are of estimated consumption, the monthly reconciliation was unnecessary.

C. Financial implications

Payment will be of one fixed amount per month based on the estimated yearly consumption, reconciling each account meter reading at the end of the year and contract. A monthly spreadsheet will be provided which will update our database (TEAM) and enable benchmarking to be continued and consumption profiles checked. Prompt payment discounts achieved for this change and significant simplification of the invoice processing procedures should result in efficiency savings of £30,000 in a full year (£15,000 in 2000/01.) It will be necessary to reduce budgets by this amount.

The estimated value of the 3-year electricity contract totals £16.6m and for the 3-year gas contract is £6.65m. These values will vary with estate and consumption changes throughout the contract period. Existing budgetary provision is £5.5 m. for electricity and £2.2 m. for gas consumption in 2001/02. It will be necessary to reduce budgets by the anticipated budgetary savings.

The estimate of the increased costs associated with the purchase of renewable energy for Cobalt Square and Orpington Police Station will only be known after the tendering has been completed.

Industry opinion estimates the premium for renewable energy being between 4 per cent and 20 per cent. The estimates are subject to wide fluctuations because they represent the results of specific tendering exercises. They also assume that the renewable source of electricity receives exemption from the climate change levy. This report allows for a figure of 10 per cent in its estimate for additional costs. The range of additional financial expenditure associated with the proposal to purchase renewable energy for Cobalt Square and Orpington Police Station is therefore £6,800 to £34,000 per annum. If the Committee agrees to renewable energy contracts these additional costs will be offset by planned energy management initiatives within the highest energy consuming buildings.

D. Background papers

• The Environmental Strategy & Report January 2001

E. Contact details

The author of this report is Trevor Lawrence, Director Property Services.

For information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

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