February 2007
By Peter Frandina, senior manager and Kevin Prevost, manager, Accenture Resources
High performing companies continually search for ways to mitigate the effects of volatile and rising energy costs. However, taking action is often a challenge for even top performers.
Rising energy prices continue to capture headlines across our industry. Since November 2001, coal, natural gas, and fuel oil prices have risen 6%, 20%, and 22% annually. With energy constituting up to 20% of a mill's explicit cost structure, harvesting low hanging fruit should be a top industry priority. Mill personnel are desperate for more and new information and flustered with selecting the right improvements.
Root causes for urgency and uncertainty
Lack of Information: In our experience working in the pulp and paper industry, we have seen operators and managers who do not know their energy costs on a "real-time" basis (as frequently as commodity energy pricing is updated, e.g. five minutes for power or daily for natural gas). In periods of extreme volatility, lack of information has a real cost. When natural gas spiked at the end of 2005, we saw stale pricing cost a mill half-a-million dollars in excess fuel costs in one month (when, with the right data, they should have switched to fuel oil). Similarly, facilities lack standard energy metrics and an understanding of the effect of operating rates on marginal energy consumption.
Lack of communication and price sensitivity: Within the mill, energy costs are not communicated down to the operator level. Why? Production areas are measured on output and often do not see energy consumption data. Thus they have historically thought of steam, air, and water as "free" and have used it accordingly. Think about gasoline in a car. If a driver isn't paying the bill and doesn't have a fuel gauge, how price sensitive is he to $3/gallon gasoline?
Misaligned policy: In many cases mills are not only updating energy prices too infrequently, they are using a bad operating philosophy. Instead of optimizing fuel costs with unhedged prices, they are incorporating the hedge into their fuel decisions, thus sub-optimizing. Energy policies and operating philosophies have failed to evolve with changing market conditions.
Real-time energy cost information is a must. Successful operations have thoughtful and thorough communication within the mill, between mills, and to/from the corporate parent. They also share best practices between comparable groups – breakthrough ideas are put to good use and leveraged across many sites. While hedging on the corporate level, good managers act unhedged on the local level to optimize fuel costs. Finally, they provide accurate consumption data to downstream users and charge them for the utilities they consume.
Marginal economics optimize production
The traditional production mindset has been harder, faster, longer. Today, the real goal is profit maximization. The new rules are to be quicker, more agile, and more opportunistic – driven by marginal economics and temporal decision making. We tell plant managers to ask themselves: "How do I run the plant when I realize that my costs are not average nor is the price my customer pays? If all of my capacity is not profitable, when do I produce?"
Electricity embodies these principles and can be an example of how practitioners are using these new rules.
The power markets are moving towards real-time locational marginal pricing (LMP). In short, LMP is a function of location on the grid, incremental cost of serving the load, and transmission constraints. What this means to the industry is that we now have greater transparency and control over our electricity costs. This contrasts with the past in which the power bill would show up and the cost would be averaged over the entire monthly production.
Today, hourly pricing should be factored into operating rates and manufacturing strategy. Electricity costs should not be viewed on the average, but rather the margin. The point is subtle, yet important. Sites need to understand that the world is dynamic and, to compete with the global players, they must develop the flexibility to maximize production during low-priced periods, design load shed strategies for high-priced periods, and understand the economics at each inflection point.
With energy use quickly becoming a cost differentiator in our industry, organizations need to become better educated on the tactical and strategic levers that they can pull to control input costs and consumption. While "low hanging" opportunities still exist, such as monitoring steam tracing, condensate return, and water/temperature recovery, the real opportunity is to link timely decision-making with a dynamic operating philosophy.
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