Re: Concentration Risk. When Your Supplier Chooses Someone Else

Earlier in March, I discussed customer concentration and my goals were to shed more light on how to identify concentration risk, and how to price it (mitigate, rationalize, negotiate). Today, I will be discussing supplier concentration, with the same goals. Winter Storm Uri froze Texas for a week leading natural gas demand to spike, and at the same time causing supply shortage. Prices hit $600 per million BTU, roughly 120 times the normal rate. Natural Gas Utilities prioritized residential and hospitals customers, as expected by law. Large industrial customers with firm contracts came second. Small manufacturers with interruptible contracts came last. This caused thousands of small facilities to shut down for weeks. Meanwhile, a large food production facility in Texas with ten 24/7 production lines stayed operational. Because they had contracted Atlas Oil to deploy a mobile natural gas supply via truck, bypassing the curtailed utilities/pipeline entirely. H-E-B and Buc-ee's kept their lights on as well, they had invested in microgrids managed by companies like Enchanted Rock. Manufacturers in El Paso and Beaumont barely noticed the storm, as they were not on the ERCOT grid. El Paso connects to the Western Interconnection. What struck me was that supplier concentration risk can trigger a total shutdown regardless of how strong your contracts, relationships, or balance sheets are. Actual Meaning of Supplier Concentration I was in Midland last week talking to operators. They still bring up Uri, and how the events of that period changed their definition of reliability. Supplier concentration in energy is not simply about who you buy from, that’s surface level due diligence. When you dig deep, you see that it is about the legal rank of your contract and the physical reality of your infrastructure. You can have three different gas brokers. If all three pull from the same Local Distribution Company or single pipeline lateral. In such a case, you have 100% physical concentration. Having 3 different gas brokers gives you the illusion of diversification. But the infrastructure will not lie to you. You can have a long-term contract with your supplier. If it is an interruptible contract, you have essentially agreed to be the first customer cut when allocation decisions happen. You traded lower monthly costs for zero reliability under stress. Fragile Supply Chain I once ran a company that helped a university in Nigeria switch from diesel generators to compressed natural gas. They signed an independent power producer (IPP) agreement. We signed a gas supply and purchase agreement with the power producer. We pulled this off without owning a compression plant or skid trucks. We were buying gas from other producers who also handled delivery. So many layers of supplier risk. The supplier stack we built was fragile and we were at the mercy of someone else’s decisions. The point is not that supplier concentration is always fatal. It is that when you are small, dependent, and positioned several tiers deep in a supply chain, you are betting that every link holds under stress, or that the supply-side risk remains 'cheaper' than the CAPEX for backup infrastructure. During Uri, that bet failed for thousands of businesses. While a storm of that scale is rare, smaller, weather-driven 'hiccups' are becoming frequent. If a simple four-hour outage causes $5M in lost inventory, as it can in food processing or chemicals, the backup system pays for itself in a single minor event. What Buyers Should Look for in Diligence When you are evaluating a business with supplier concentration, here is what matters: Distinguish physical concentration from contractual concentration. A business might show you three supplier agreements. If all three suppliers pull from the same pipeline, grid, rail terminal or access road, you have one supplier, not three. Map the physical infrastructure. Audit the firmness of the supply. If the business you are buying is a high-priority user food processing, medical supplies, critical infrastructure, it has less supply risk on energy, fuel, raw materials etc. Small manufacturers who don’t fall into the high-priority band often choose interruptible service to lower costs. Treat an interruptible contract as a zero-supply scenario in your stress tests. Firm transportation agreements provide legal priority over residential users in some jurisdictions; however, they cost more. Why This Matters for Your Deal Supplier concentration shows up in the CIM as a footnote about cost of goods sold. Maybe a bullet point: "85% of natural gas purchased from CenterPoint Energy." The seller will tell you the relationship is solid, pricing is competitive, and terms are favorable. Twenty years never had a problem. All of that can be true, and the business can still shut down. When you are diligencing a business with single-supplier dependency in energy, ask three questions: What happens if supply stops tomorrow? What does this business do in the first 17 hours? And what does it cost them for every day after that? Price the answer in, structure around it, or walk away.