The word "auction" usually brings to mind the opportunity for low prices and great deals typically born out of some misfortune that has befallen the seller.  At face value, one would think an energy auction delivers the same value proposition as would a house auction, car auction, business auction, etc; in this case, an energy marketer is hungry to sell their product and is willing to drop their price until there is a taker, or even better under bid the next guy to take the business.  However, the reality behind the concept could not be further from the truth.  In this editorial, I will present several facts about the construct and process behind the reverse auction that you may want to consider in your evaluation of a best energy management practice for your organization.

Fact #1 Premium Openning Bid...the reverse auction typically begins with the auction administrator, more commonly referred to as a broker posting a starting or openning bid to establish a "not to exceed" threshold for the participating sellers.  Sounds simple enough, but what is the basis of the openning bid...is it prevailing market price for the requirements being auctioned, or is it prevailing market plus?  Unlike most products put up for auction, energy is priced and sold at prevailing market [plus profit].  This is because the energy being auctioned has not yet been purchased by the seller.  At the house auction, car auction, business auction, etc., the seller inevitably is liquidating assets already purchased and owned.  The seller has an incentive to liquidate, lest they continue to pay the carrying cost of the asset.  This is not the case with energy commodity, which is hedged or bought at the time of sale...not prior to the sale.  And for this reason, the seller does not incur future carrying costs if they do not make the sale.  Hence, the energy marketer either sells at a profit or they will not sell at all...and accordingly the openning bid is established well above market; primarily to produce the appearance that the auction is doing its job when bids start coming in below the starting bid and work their way down closer to actual market. How much above market is the openning bid set?  Well, that brings us to our next fact...how the broker makes their money in the auction process.

Fact #2 Hidden Transaction Fee...while most consumers are told that there is no direct cost to them for using the reverse auction, everybody should know that nothing in life is for free...and so too with energy auctions.   Reality is the broker is collecting a pay-to-play fee or transaction fee from the participating marketer...regardless of any direct-billed fees to the consumer.  This is done simply because the consumer either has no means of verifying the existence and value of the fee, as the auction's fee is (a) "confidential" between the marketer and the auction and (b) the marketer is not going to disclose the fee of what is effectively their sales outlet.  That would be what is referred to as "biting the hand that feeds you."   In addition the marketer only pays the fee if they are awarded the deal, so they effectively are receiving a sales channel at no up front cost.  So getting back to the openning bid, the higher the openning bid...the more room for the participating marketer has to accomodate transaction fees.  This brings up perhaps the most important fact about the reverse auction...the inherent conflict of interest between the auction administrator serving the customer's best interest [low cost] and serving the energy marketer [high profit] as well as themself [transaction fee].

Fact #3 Conflict of Interest...the broker is compensated on a transaction fee basis; meaning they need (a) an executed energy supply agreement, and (b) a marketer willing to incorporate the transaction fee into the price of energy, collect it, and pay it out in order to realize revenue.  Simply put...no contract, no money.  As a professional retail energy portfolio manager, I can tell you that there are times when a consumer may be better economically served through the utility's default supply service rather than a third-party marketer due to cost of credit, market risk premiums, and service fee premiums.  I can also tell you that there are times when a marketer makes gross billing errors in their favor [errors that may not be obvious to the consumer such as capacity costs, reliability costs, etc.].  Under either condition, it is not in the broker's economic interest to advise the customer truthfully as it may cost them revenue and/or a relationship with a marketer [all of which are reknown for not appreciating corrective actions that are shared with the customer].  Again, the auction administrator needs both a happy buyer and seller to make their money.  Hence, the broker is compromised at some point and given that there are many more consumers than energy marketers...you can arrive at the conclusion as to which relationship takes priority in the end.

Fact #4 Lack of Transparency...the consumer is pitched the value of transparency through utilizing the auction process; based upon the visibility of various marketer bids on a website.  While the consumer has access to live retail bidding, what they do not see is the relative value of those retail bids to the wholesale market clearing price which is the foundation of all retail prices [i.e. wholesale swaps or ISO clearing of hourly energy and non-energy costs...the marketer's cost].  For instance, the lowest bidder in the auction could very easily have an expensive price relative to the wholesale market because we have already established that the starting bid is pegged above the actual market clearing price to afford the appearance of price reduction during the auction.  Furthermore, the lowest bid in a very high market is far worse than the highest bid in a very low market.  So having the lowest offer does not necessarily equate to a market value or smart purchase.  In addition, the lowest bid is relative to the marketers participating in the auction.  There are energy marketers which do not participate in auctions.  Hence, an intelligent consumer should benchmark any retail bid against the actual wholesale cost as cleared by the market and understand where they are in the market cycle.  This sort of analysis requires live access to the wholesale markets and years of experience.  I'm yet to find an auction that publishes live wholesale market data and shares with the consumer the estimated premiums charged by the marketer.  Again, such disclosure would not be in the interest of the marketer, who controls the auction's revenue flow.

Fact #5 Bad Advice...ultimately the energy consumer avoids cost [vs. the utility supply alternative] based upon the time of purchase and time of use pattern.  Given that the auction (a) makes money by selling contracts and (b) makes money by selling volume [$/kWh, $/therms, or $/gallons on commission], it logically follows that the auction [as well as the marketer] has an inducement to prescribe longer-term contracts than shorter-term contracts, and certainly has no inducement to advise a consumer to transition back to utility service to avoid market premiums, or wait out market run-ups on occassion.  In this regard, the auction's interest are perfectly alligned with the interests of the energy marketer...certainly a red flag for any saavy consumer.

I don't mean to sound so negative about the reverse auction.  After all, there is a positive element to the value proposition...it sounds really cool to people who know nothing about the energy business!  The bottom line with buying retail energy contracts is that a monkey could connect a buyer and seller if you give him enough bananas.  However, managing retail supply positions that consistently outperform the alternatives requires a professional who is objective, transparent, and most important intelligent about all options available to the consumer...not the options which pay the most commission. 

I've done well over a thousand retail supply transactions of electricity, natural gas, and oil in the 12+ years I've been advising retail clients.  I've also helped create one of the first online auctions with Enermetrix.com back in the late 90's, where I became quite familiar with the weaknesses I've described in this editorial.  I still believe that with the proper advice on time of purchase and desired product structure, the old fashioned Request for Quote is still the best mechanism to secure energy supply contracts.  This is why we've modernized the classic RFQ process to a web-based, fully-transparent real-time application rather than incorporate an out-dated '90s fashion.  In any negotiation, the party to make the first offer typically loses.  Telling the marketer you want to begin negotiations at an above market rate just tells them you're ready to be taken advantage of.  Disclosing your options is suicide.  Let the marketer make a proposal, and counter as warranted by your market intelligence.  The less the seller knows about your options, the more the seller knows about your level of intelligence, the more control you will have on the negotiation process...and that adds up to the most economic contract you can make.