by Patricia Moore-Gode and Ginger Juhl
Some laws sit on the books forever without notice. Others reach out and touch us from the moment they come into law. Such is the case with the Public Company Accounting Reform and Investor Protection Act of 2002-known more commonly as Sarbanes-Oxley or SOX. Whether you welcome, fear or disparage SOX, it is a fact of modern business life.
With an underlying objective of increasing investor confidence following the massive fallout from the Enron debacle, the Sarbanes-Oxley Act of 2002 places significant new control, disclosure and reporting requirements on public companies-and on the executives of those companies.
As energy prices have escalated in recent years, the impact of energy costs on the financial bottom line has increased proportionately. Often representing one of the most significant expenditures faced by a company, energy buying poses several challenges relative to SOX compliance, many of which revolve around the transparency of supplier relationships and the process and reporting controls needed in a commodity market where price fluctuations are often volatile and difficult to predict. Making the situation more challenging, particularly for companies with operations in multiple states or provinces, are the difficulties inherent in understanding and adhering to market rules that vary significantly from region to region. In fact, complying with SOX is one the most daunting tasks public companies have faced in many years.
To cope with the new realities of enhanced security and control, the need for a documented audit trail, enhanced data and transaction archiving, and rapid access to financial information, more and more companies are turning to automation to support their key business processes and maintain SOX compliance. Today, the speed, transparency and regulatory compliance of online platforms are fueling the popularity of e-auctions in deregulated energy markets worldwide. Energy procurement is being freed of the confines of paper, phone and fax as streamlined, transparent, regulatory-compliant technology replaces paper RFPs and days spent analyzing bid results.
Johnson Controls, a large multi-national company, has benefited not only from the cost-cutting benefits of the online auction, but also its ability to enable SOX compliance. Austin Energy, while not a publicly traded company, has leveraged reverse auction technology to meet regulatory compliance mandates for fair and open competition that are nevertheless just as rigid and very similar in scope and intent.
The reverse auction
“Our energy procurement activities fall under Sarbanes-Oxley,” said John Ragland, global energy director for Johnson Controls. Johnson Controls (NYSE: JCI) has 136,000 employees in more than 1,000 locations serving customers in 125 countries, to whom it provides innovative automobile interiors, as well as building efficiency and power solutions. The company has leveraged the World Energy Exchange reverse online auction from Worcester, Mass.-based World Energy Solutions Inc. (TSX: XWE) since 2003 to procure energy for its facilities in deregulated U.S. markets, with a goal of both minimizing energy costs and automating the complex steps required to purchase gas and electricity.
“We use online energy auctions for three reasons,” said Ragland. “One is to generate the lowest price for energy. Two is to create a fair process so that suppliers have an equal opportunity to win our business. Three is so that we are able to award energy contracts the same day as the auction.” All three factors are crucial to documenting the fiscal responsibility mandated by SOX legislation.
The reverse auction brings together buyers and sellers of energy in both physical and financial derivative forms. With the reverse approach, where the buyer as opposed to the seller is driving the transaction, bids decrease as suppliers compete, with the lowest bidder winning the award. Typically, a buyer contracts with a market intermediary or participates in an energy exchange to help identify suppliers, organize and manage the auction and provide auction data to buyers to facilitate decision-making.
At the designated day and time, qualified suppliers log on to the auction site and submit bids during the 30-90 minute auction period that reflect the prices they are willing to accept for the energy needed by the buyer. The last few minutes of bidding typically result in highly charged competition where bidders scramble to submit their best and final bids. This rapid downward price pressure is difficult, if not impossible, to achieve using traditional static three-quote paper-based bidding processes.
The online procurement environment also helps ensure fair competition among a larger pool of participants. The final bid is “blind,” so that none of the competing suppliers can see who is bidding what. These auction characteristics enable buyers to demonstrate that contracts have been awarded in an open and transparent manner because the “blind” nature of the bidding process ensures more competitive bids and the fairness and equitable nature of the entire procurement process.
When it comes to SOX and the energy buying process, three of the 11 SOX titles that focus on how companies must report and document their finances are particularly relevant. Section 302 holds the CEO and CFO responsible for certifying the “appropriateness” of the company’s financial statements and disclosures. Section 404 mandates that the annual report include an “internal control report” assessing the effectiveness of internal controls and procedures for financial reporting. Section 409 requires company officials to disclose information about material changes to their financial conditions or operations on a rapid and current basis.
The requirements mandated by these sections raise a number of issues for energy buyers, relative to both internal controls and the way buyers interact with their energy suppliers. The key challenges revolve around documenting that everything possible has been done to secure the best possible price, at the lowest possible risk through use of a process that is fully documented with a detailed time and date-stamped audit trail.
Procuring power at Austin Energy
Energy brokerage platforms, with their energy-specific auction technology, processes, methodologies and inherent market intelligence, are not only helping with SOX compliance, but also creating new opportunities to improve overall operational performance.
“Deregulation has produced a series of rules and regulations on how the energy market is to be conducted, replacing the cost-based regulations of the Public Utilities Commission of Texas,” explained Roberto X. Delgado, energy marketer for Austin Energy, a community-owned electric utility that is a department of the city of Austin, Texas.
When Austin Energy needed to procure power in 2006 to meet its supply needs, it decided to replace its traditional paper-based RFP process with an online reverse auction. In September, the utility conducted a series of eight auctions on the Exchange for up to 150 MW of 5×16 replacement supply for May through September weekdays in 2008-2010. In November, when faced with the need for 664.8 million kilowatt hours of on-call electricity supply to replace power lost with the retirement of a 358 MW power plant, the utility once again went online to four bidding scenarios to determine which scenario would result in the lowest price.
Austin Energy’s previous RFP process often required several months to complete, which made it difficult to achieve competitive prices due to the risk premiums suppliers build in to accommodate potential changes in market conditions. These changes often occur between the time a price offer is made for an energy commodity and subsequently contracted. One of the utility’s objectives in leveraging the Exchange was to streamline the bid-to-award process.
Delgado said, “We historically used a paper RFP process to purchase electricity supply. From beginning to end we would spend four months. By the time we got through the paper process, the market had changed. The market moves very quickly, and our process wasn’t keeping pace. In fact, we have been faced with losing bids because vendors were unwilling to hold the original bid price after the months it took for us to go through the process and get city council approval.”
Because the time between an auction’s close and contract award is measured in minutes as opposed to days, the need for supplier risk premiums is removed, thus ensuring the lowest possible prices.
In addition, manual processes lack the analytical capabilities to quickly test and process numerous procurement alternatives, thus making it difficult to assess more than a handful of options. The analytical capabilities of the auction enable buyers to test and compare a virtually unlimited number of purchasing parameters in a rapid-fire manner so that different combinations of load, contract terms, conventional and renewable energy and other parameters can be analyzed and best possible combination selected within a matter of minutes.
“Deregulation has made the entire energy acquisition process more complicated,” said Wayne Morter, manager, energy supply and risk management, Austin Energy. “We decided to use online auctions for a portion of our energy buys because we felt that we were going to achieve benefits in the areas of competition, transparency, timeliness and pricing. What we thought was going to happen did prove to be true.”
With deregulation also has come increased risk, including congestion risk, because the power system has a finite ability to deliver electricity, as well as credit risk, because there are so many more players in the energy markets, according to Delgado. “The auctions help us to conduct business in a fair and visible manner,” said Delgado. “These truly are more intelligent platforms, allowing the buyer to see a wider range of options from more sellers.”
Ginger Juhl is president of Juhl Communications, a multi-faceted, technology-focused marketing and communications firm based in Centennial, Colorado. Ginger has studied and written about energy, government and technology markets for more than 17 years. Patricia Moore-Gode is a writer and communications consultant for Juhl Communications, with more than 15 years experience creating strategic print and electronic communications for global e-business, technology products, financial and telecommunications companies.