Protecting Retail Margins by Commodity Point

A CommodityPoint Whitepaper

Protecting Retail Margins Bridging the Gap between Wholesale Energy Procurement and Retail Sales

Sponsored by:

CommodityPoint, a division of UtiliPoint International, Inc. 19901 Southwest Freeway, Suite 121 Sugar Land, Texas 77479 www.commodity-point.com August 2012

Introduction Wholesale energy market deregulation, starting with the natural gas marketing under FERC Order 636 in 1992 and then the power market under 888 in 1996, brought about a revolution in energy commodity trading in the US and opened the door to further deregulation in the downstream markets, including retail sales of gas and/or power within many states. Companies that have entered these retail markets have found a very difficult environment – lack of customer loyalty leading to high switching rates, unpredictable weather-driven loads, volatile prices for wholesale supply, and highly competitive markets in which margins have become razor-thin, forcing many retail providers to shutter their businesses. In this environment, properly measuring profitability in order to optimize a retail portfolio is an absolute necessity, but has proven to be extremely challenging for most retail providers primarily due to technology limitations. Portfolios of wholesale energy (gas and power) contain deals of varying length and commercial terms – matching that portfolio to a retail portfolio that includes tens or hundreds of thousands of customers, creative price structures of variable length and highly variable loads based upon weather conditions can be extremely difficult and poses a serious problem for retail. The ability to aggregate this data on a daily basis can be extremely difficult as the quantity and variable nature of the data points can be overwhelming, particularly without the right systems and tools in place. However, without access to this aggregated information, it is virtually impossible for any organization to properly manage and reliably maintain value in their portfolio of retail load and wholesale supply. When combined with any assets that may also be held in that portfolio (such as transmission, pipeline capacity, or gas storage) the ability to see margin, much less optimize profitability becomes a virtual impossibility without the proper systems and technical infrastructure.

Technology Challenges for Retail Providers Given the nature of retail energy markets (limited geographic areas served by numerous but generally small marketers), no technology providers have been willing to enter the market with a soup-to-nuts retail software solution that addresses all of that market's unique business processes and functional requirements; and unfortunately, few retail energy providers can afford the investment in building a bespoke system capable of managing the entirety of their business, from wholesale supply acquisition, asset management (such as gas storage), load forecasting; through customer management and ®

generation of tens or hundreds of thousands of invoices, including billing of complex retail pricing schemes that may include significant optionality. Given this environment, retail energy providers must rely on multiple systems to manage their commercial activities; piecemeal architectures that may include homebuilt components, vendor-supplied energy trading and risk management (ETRM) systems, spreadsheets and CRM/billing systems. Larger retailer providers have generally sought out a vendor-supported ETRM system to manage supply aggregation; homebuilt systems (including spreadsheets) to manage weather and retail load forecasts; and commercial CRM/billing systems to manage customer acquisitions and retail billing, with complex integration infrastructures supporting data exchange amongst those systems.

For smaller retail

providers, the options are more limited; few of these smaller companies can afford a large scale, traditional ETRM system as such, generally rely on spreadsheets for supply aggregation and load forecasting, and a homebuilt CRM/billing system or they may utilize an out-sourced solution for billing. Unfortunately, for either of these two groups, these technology architectures are generally inadequate for effectively managing their business. Notable concerns expressed by the users of these architectures include lack of established integration points between the multiple systems deployed (data is difficult to extract and integration requires complex technical "wiring" and multiple manual process or workarounds) and consolidated daily analysis and reporting across the supply/retail divide is extremely difficult if not impossible While many retail gas or power providers have attempted to force-fit many of their requirements into vendor-supplied ETRM systems, most of these systems lack key areas of functionality and ultimately necessitate the use of additional systems or custom developed functionality. These functional shortcomings include: •

Inability to process and distribute thousands of retail invoices, including cycle billing

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Lack of customer management functionality and reporting required for managing a large portfolio of retail customers; nor do they provide "out of the box" API's to integrate with industry standard CRM solutions for those capabilities

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Inability to incorporate load forecasting including forecasts of growth (customer acquisitions and losses)

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Inability to incorporate of weather data and weather forecasts, including historical data

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Inability to capture and manage retail power supply curves on an hourly basis ®

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Inability to capture and appropriately value retail price/cost components (including ancillary costs such as broker fees and transportation)

Experience has shown that while ETRM systems may be viewed as a valuable component of a retail energy provider solution, most do not reflect the business processes of that market. Without directly addressing the functional requirements previously noted, or providing structured methods for integrating with other systems for the requisite capabilities, ETRM-centric architectures cannot offer retail energy providers an accurate and timely answer to the most pressing concern they face - Are their retail portfolios profitable, and by how much or how little?

Retail-Enabled ETRM David Meyers, president of Enuit, a Houston-based software company, has worked with many clients who have struggled with the lack of insight into, and the ability to manage, the margins on their retail energy portfolios. According to Mr. Meyers, "Managing profit margin is the ‘golden goose’ of the retail energy business. Explaining the reasons why profit margins change from one day to the next is essential to managing margin. And, the reasons are many, including: changes to weather forecasts, enrollments of new customers, drops in existing customers, revisions to sales forecasts, changes to factors used in statistical forecasting models, and so forth. And, margin management is not possible unless a bunch of other data processes first reduce potentially millions of data records into more manageable datasets." He believes accurately measuring retail portfolio margins requires either a programmatic solution to bridge the ETRM system to the retail portfolio management solution; or ideally, an ETRM system with purpose-built, explicit capability to link directly to, and aggregate information from, the various tools that comprise a retail providers technical architecture. He describes the process components of day-to-day margin analysis/maintenance as follows: 1. Review/ensure all supply and hedge positions are accurately reflected in either the bridge application or directed linked ETRM solution 2. Aggregate forecasted demand positions 3. Report the combined demand/supply position 4. Calculate storage positions and costs 5. Value positions against market curves

6. Monitor financial and volumetric positions against risk policies 7. Attribute day-to-day margin changes to the causes of the changes Mr. Meyers notes that the last point, attributing margin changes is the most challenging, but is the key to understanding and managing retail portfolio performance. "REPs, especially the smaller ones, are getting by using spreadsheets for most of the other functions. But, tracking changes to margin and attributing the changes to their causes is a capability beyond most spreadsheet master-builders. And, I haven't mentioned all of the normal reasons why a company should be discouraged from using spreadsheets to track retail data. Spreadsheets are great for many reasons and many things. But, large retail customer datasets is not one of them. Fortunately, utilizing a systematic approach, retail energy providers can decrease their reliance on those spreadsheets and eliminate the risks that are inherent in their use." Mr. Meyers believes Enuit's retail solution, comprised of the Enstep ETRM product and the Enstep Retail module, is one of the few vendor supported systems that can provide the explicit capabilities to directly bridge the wholesale supply and retail portfolio divide for both natural gas and electricity retail applications. He notes that Enstep is a full-featured ETRM solution for managing wholesale supply trading operations including: •

Robust capability for capturing and managing wholesale supply deals and financial transactions/hedges including industry standard risk metrics

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Full physical scheduling capabilities including the ability to capture any and all transportation and transmission costs.

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Full back office and accounting capabilities.

Additionally, when deployed in a retail provider environment, he notes the Enstep retail solution provides, in a seamless fashion, many of the key capabilities required by energy retailers, including: •

Established integration to industry leading CRM products including Loadstar and Siebold

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Ability to calculate mass-market volumetric positions using standard retail risk factors including customer count forecast, stick rates, retail customer equivalent factors (RCE), attrition rates, and uplift factors.

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Aggregated volumetric, supply-side-equivalent positions based on customer profile dimensions including market, customer type, service price type, financial risk profile, location and others.

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Aggregated wholesale and retail physical/financial positions

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Robust billing engine capable of producing tens or hundreds of thousands of invoices per month

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Ability to decompose profit margin into profit components

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Attribution of daily profit/loss changes

These capabilities can provide retail energy providers a systematic approach to reducing the number and complexity of systems required to manage their business and reduce their dependence on spreadsheets for a number of critical processes. Additionally, and perhaps more importantly, this type of retail-enabled ETRM product can provide visibility into the current and forecast profitability of their retail efforts on a daily basis, allowing them to quickly adjust their supply portfolio or redirect their marketing efforts toward more profitable products. Mr. Meyers notes that while the Enstep Retail product is designed to work in conjunction with their Enstep ETRM product, the module can also be deployed with any other vendor's ETRM system.

Summary There is no singular software solution for managing the entirety of the retail energy provider's value chain and it is unlikely that, given the size of the market for retail specific capabilities, any vendor will attempt to produce such a solution. Wholesale supply acquisition and aggregation, weather load forecasting, customer acquisition/loss forecasting and CRM capabilities will undoubtedly continue to be found discreet applications. Nonetheless, with a retail-enabled ETRM system, such as Enstep from Enuit, a more systematic approach is possible, one that reduces architectural complexity and cost, can integrate key forecasting tools, and provide the operational insights and financial metrics that allows retail providers to better manage their business.

About Enuit Enuit is a Houston-based software development company specializing in software for use by energy commodity trading businesses. Its flagship product, Enstep, has many unique features not found in other competitive products, among which are natural gas processing contract management and Energy Retail Management. Enuit has developed technology to help businesses mine data from many data sources simultaneously and provides consulting and custom software development services outside of energy commodity-related applications. Enuit Corporation 1001 Texas Avenue Suite 405 Phone: 281-456-3690 For more information, please visit www.Enuit.com

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About CommodityPoint CommodityPoint is the industry leader in providing Commodity Trading & Risk Management (CTRM) research, analysis and advisory services. Our services bring insight into business issues, trends, processes and technology, to utilities, energy companies, banks, brokers, funds, investors and vendors that enhance their competitive position and support critical business decisions around the wholesale commodity trading markets. Our team provides expert analysis of market trends and, in particular, the technologies and applications supporting those that participate in regional or global commodity markets. With offices in Europe and the US, and backed by an experienced research team, our organization provides an unparalleled view of the marketplace. CommodityPoint is a division of leading energy and utilities analyst and consulting firm, UtiliPoint International, Inc.

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